Also See Analysis of the Order

2009-TIOL-528-ITAT-MUM

(Also see analysis of the Order)

IN THE INCOME TAX APPELLATE TRIBUNAL
"E" BENCH, MUMBAI

ITA Nos. 4843 & 759/Mum/2006
Assessment Years : 2002-03 & 2003-04

SHAPOORJI PALLONJI POWER CO LTD
SHAPOORJI PALLONJI CENTRE, 41/44
MINOO DESAI MARG, COLABA, MUMBAI-5
PAN NO : AAACS9195F

Vs

THE ITO-3(3)(2)
AAYAKAR BHAVAN, M K ROAD, MUMBAI

S V Mehrotra, AM and George George K, JM

Dated : April 20, 2009

Appellant Rep by : Shri Beharilal
Respondent Rep by : Ms Usha S Nair

Income tax - Assessee is into setting up power project - enters into agreement with SEB for power purchase - incurs pre-operative expenses and capitalises the same - project is abandoned due to subsequent developments - assessee reclassifies expenses as business expenditure - AO disallows - held,

++ business activities may be classified into two broad categories, firstly the activities which are in furtherance of setting up of a business and secondly the activities which are in furtherance of commencement of business after it has been set up. Business is set up when it is ready for takeoff but the activities following the setting up of business prior to its commencement constitute the essential activities for commencement of business and the expenditure incurred in carrying on such activities is allowable deduction under the head "income from business".

++ However, the expenditure incurred prior to the setting up of business is only in capital field and cannot be treated as business expenditure. The assessee had only entered into agreement with MPEB but MPEB finally backed out from the said agreement. This was only an assurance to the assessee for purchasing power from it subject to fulfillment of series of activities. It cannot be said that the assessee's business had been set up when the agreement had been entered into with MPEB. Entering into agreement with MPEB can at best be said to be an activity in furtherance of setting up of business but per se, cannot lead to the conclusion that the business had been set up.

++ it is well settled commercial principle of accounting that the nature of expenditure is determined at the first instance when it is incurred and its nature cannot be altered on account of subsequent events. Once the expenditure has been classified as capital in nature, it cannot partake the character of revenue on account of supervening circumstances.

ORDER

Per : S V Mehrotra:

Both the appeals filed by the assessee are directed against separate orders of learned CIT(A)-XXXII for the assessment years 2002-03 & 2003-04, respectively.

2. Facts in brief are that the assessee company was incorporated in 1995 and its main business was promoting and implementing diesel based power project at Pithampur, Indore (MP). For the assessment year 2002-03, the assessee filed its return of income declaring a total loss of Rs.2,62,45,564/-. The Assessing Officer noted from the profit and loss account that the assessee company had debited Rs.2,43,96,772/- as opening balance of 'pre-operative project expenditure pending allocation written off'. He required the assessee to submit the details of the same and show cause as to why the same should not be disallowed. The assessee vide its reply dated 30.9.2004, reproduced in para 4 of the assessment order, pointed out that in view of the Madhya Pradesh Government and Madhya Pradesh Electricity Board failure to honour the Power Purchase Agreement entered into in 1997 particularly with respect to security package, the power project at Pithampur (Indore) got frustrated. It was further pointed out that the financial position of Madhya Pradesh Electricity Board had deteriorated to an extent that it had failed to give Escrow Security Package even to independent power producers (IPPS) to whom, it had agreed to provide, which was even confirmed by the Hon'ble Supreme Court. Thus, the implementation of project was not within the control of the company and, therefore, it had to abandon the project. Accordingly, the pre-operative expenses of Rs.2,43,96,772/- incurred on the project had been written off for the A.Y. 2002-03 as revenue expenditure. It was pointed out that the total expenditure of Rs.2,43,96,772/-comprised of expenses of administrative nature, such as traveling, professional & legal expenses, salaries and allowances, etc, as apparent from the details of such expenditure. Accordingly, the expenses had been re-classified as revenue expenditure. The assessee relied on the decision of the Hon'ble Madras High Court in the case of CIT vs. Seshasayee Paper and Boards Ltd. (2000) 243 ITR 421 (Mad). The Assessing Officer rejected the assessee's contention, inter alia, observing that the assessee company had not explained under which section, the assessee company was claiming these expenses, which had already been capitalized and routed through the balance sheet of the earlier assessment years, can now be categorized as revenue expenditure. He observed that the assessee company after having made entries in the books of account, consistent with the method of accounting followed, guided by the principles of accounting, could not be permitted to seek assessment of his income for income tax purposes on a different basis altogether at variance with its books of account. He observed that to this extent the entries made in the books of account are as much binding as the method of accounting itself. He pointed out that only when the entries are not conclusive or decisive of the matter, then only, they can be varied. He relied on the decision of the Hon'ble Supreme Court in the case of Kedarnath Jute Manufacturing Co. Ltd., 82 ITR 363 (SC) = (2002-TIOL-383-SC-IT) . He, accordingly, determined the net taxable income at Rs.39,55,741/- by adding therein interest income of Rs.58,04,533/-. He further observed that since the book profit as computed for the purpose of section 115JB was negative, the question relating to payment of MAT thereunder does not arise.

3. Learned CIT(A) dismissed the assessee's appeal on this issue observing that since the expenditure was incurred by the assessee for setting up of a plant, the same was capital in nature and, therefore, could not be allowed as deduction to the assessee as revenue expenditure. The main reasons given by Learned CIT(A) were as under:-

i) The expenditures were incurred by the assessee for setting up of a new business.

ii) When the business was not set up, there was no question of computing any business income.

iii) This was in view of the provisions of section 3 of the I.T. Act, as per which, in respect of a newly set up business coming into existence in any financial year, previous year shall be beginning from the date of setting up of business upto the end of the financial year. Since the business had not been set up, therefore, there was no previous year under the head business income. Accordingly, there was no question of computing business income/loss and, therefore, there was no question of allowing any expenses.

iv) Since the expenditures incurred in earlier years were capitalized, the loss if any, on frustration of project could only be treated as capital loss and could not be allowed as deduction.

4. At the time of hearing, Learned Counsel for the assessee narrated the facts as noted earlier and pointed out that a Power Purchase Agreement (PPA) had been executed on 18th November, 1997 with Madhya Pradesh Electricity Board (MPEB) in terms of the Government of India, Privatisation of Power Project Scheme, 1991 for implementing the Diesel based power project at Pithampur, Indore, Madhya Pradesh. He submitted that one of the modes of payment by MPEB for supply of power by the company was that the payments to be made through Escrow Bank Account. In the said Escrow Account, the amounts to be collected by MPEB from its customers for supply of power were to be credited. MPEB had signed power purchase agreement with a number of independent power producers (IPPS) for setting up of Speed Power Projects in the State of Madhya Pradesh having aggregate capacity of about 5000 MW. As per the appraisal made by the Financial Institutions, MPEB had a financial capacity to provide Escrow Agreements for only 2,561 MW. It was, therefore, necessary for MPEB to provide IPPS for providing Escrow Agreements upto 2500 MW. In order to priorities IPPS for Escrow Protection. MPEB asked all IPPS vide its letter No 07/11/PC/1006 dated 24th July, 1998 to submit their offers for better terms on different parameters. Each IPPS was also required to pay alongwith the offer a security deposit equal to an amount of 2% of the Project Cost . The project cost in the case of the company was Rs.466.54 crores. Two percent of such cost worked out to Rs.9.33 crores. Accordingly, the company submitted its offer alongwith a demand draft of Rs.9.33 crores on 11th August, 1998 towards security deposit.

5. Thereafter, MPEB invited revised Bids from Liquid Fuel Based IPPS on different parameters vide its letter dated 11th September, 1998. This was challenged by the assessee company and other IPPs by writ petition before the Madhya Pradesh High Court. The Division Bench of the Hon'ble High Court upheld the legality and validity of the impugned MPEB letter dated 11th September, 1998 by its order dated 25th June, 1999. Some of the IPPs including the assessee company had gone to the Hon'ble Supreme Court on Escrow protection by MPEB and Madhya Pradesh Government. The Hon'ble Supreme Court upheld the decision of the Madhya Pradesh Government and MPEB to give priority to the two coal based and one Hydro Power Projects. The Hon'ble Supreme Court did not decide on liquid fuel project, as a result, appeals filed by some IPPs including the assessee company were dismissed by the Hon'ble Supreme Court by its order dated 16th February, 2000.

6. In view of the Madhya Pradesh Government and Madhya Pradesh Electricity Board's failure to honour the Power Purchase Agreement entered into with them in 1997, the power project of the company at Pithampur (Indore) was frustrated without any fault on the part of the assessee company. The company's efforts to explore alternative also did not yield any result. The financial position of MPEB had deteriorated to an extent that it had failed to give Escrow Security Package even to Independent Power Producers (IPPs) to whom it had agreed to provide which was even confirmed by the Hon'ble Supreme Court. Hence, the implementation of the project was not within the control of the company. The assessee company, therefore, left with no other option but to abandon the project.

7. Learned Counsel for the assessee submitted that under such circumstances, the expenses which had been treated as preoperative had to be reclassified as revenue expenditure in the A.Y. 2002-03. Learned Counsel submitted that the first issue is whether the business of the assessee was set up or commenced during the period under consideration. He referred to the decision of the Hon'ble Gujarat High Court in the case of CIT vs. Saurashtra Cement & Chemical Industries Ltd., 91 ITR 170 (Guj), wherein, it has been held that the business is nothing more than a continuous course of activities and all the activities which go to make up the business need not be started simultaneously in order that the business may commence. He further relied on the decision of the Hon'ble A.P.High Court in the case of CIT vs. Sponge Iron India Ltd., 201 ITR 770 (AP), wherein, it was held that there is a distinction between setting up of business and commencement of business. A business is said to be set up when it is ready to commence. Where the business consists of continuous course of activities, for commencement of business all the activities which go to make up the business need not be started simultaneously. It was held that as soon as an activity which is the essential activity in the course of carrying on the business is started, the business must be said to have commenced. Similar view was expressed by the Hon'ble Gujarat High Court in the case of Hotel Alankar vs. CIT, 133 ITR 865 (Guj), wherein, it was laid down that it is no doubt true that a business can be said to have been set up when it is established and it is ready to commence business. It does not mean necessarily that the business must be fully equipped in the sense that it could commence all its activities at a time immediately. He further relied on the decision of the Hon'ble Rajasthan High Court in the case of CIT vs. Stones and Minerals Associated Ltd., 257 ITR 479 (Raj), wherein, it was held that procurement of materials for export in an export business would mean that the business has already been set up, the expenditure incurred for procuring materials for export should ordinarily be business expenditure. Learned Counsel for the assessee pointed out that the decision in the case of Saurashtra Cement and Chemical Industries Ltd (supra), the Hon'ble Gujarat High Court has laid down the guidelines that in the case of manufacturer, the manufacture commence as soon as the trader undertakes the activity required for manufacture. These guidelines laid down by the Hon'ble High Court have been approved by the Hon'ble Supreme Court in the case of CIT vs. Sarabhai Management Corporation Ltd., 192 ITR 151 (SC). Learned Counsel pointed out that the Hon'ble A. P. High Court in the case of Sponge Iron ltd.,(supra) observed as follows:

i) Commencement of business is a question of fact.

ii) There is a distinction between setting up of business and commencement of business. A business is said to be set up when it is ready to commence.

iii) Where the business consists of continuous course of activities for commencement of business, all the activities which go to make up, the business need not be started immediately. As soon as activity which is essential activity in the course of carrying on the business is started, the business must be said to have commenced.

8. Learned Counsel submitted that in the present case, the assessee company had already set up its business long before the assessment years under consideration and had carried on and completed all the activities and had done the business for the following reasons:-

i) The company got incorporated in 1995.

ii) The assessee raised capital and deposited Rs.9,33,29,600/- on 11.8.1998 with MPEB as a security deposit pursuant to Madhya Pradesh Electric Board's letter dated 24.3.1998.

iii) The assessee submitted its offer to Madhya Pradesh Electric Board.

iv) All the formalities for setting up business were completed. Tender was submitted. The profits were to be shown on completed project basis. Thus, the business activity for the commencement of the business had practically started since the very date of incorporation and further activities of depositing security amount of Rs.9,33,29,600/- with the Madhya Pradesh Electricity Board.

v) During the year project had to be abandoned and on date of abandonment, the profit and loss account was worked out which resulted into the claim of expenses of Rs.2,43,96,772/- as there was no receipt. This loss was written off in the assessment year 2002-03 and such loss was carried forward to the subsequent assessment years to be set off against the business income which would accrue to the assessee in subsequent years. The abandonment of the project was not because of any lapse on the part of the assessee but was due to reasons beyond control of the assessee.

vii) The activity of the company was within the parameters of Articles of Association and Memorandum.

viii) After the abandonment of the project with MPEB, the assessee did not stop its business which was already set up and the company continued its activities and it was in search of some other project. Hence, the expenses incurred of Rs.2,43,96,772/- were correctly claimed by the assessee as business loss.

Learned Counsel for the assessee referred to proviso to section 3, which defines the previous year, wherein, it is mentioned as under:

"Provided that, in the case of a business or profession newly set up, or a source of income newly coming into existence, in the said financial year, the previous year shall be the period beginning with the date of setting up of the business or profession, as the case may be, the date on which the source of income newly comes into existence and ending with the said financial year."

He relied on the following decisions for the proposition that the expenses incurred after the business is set up are to be allowed u/s. 30 to 37:

i) CIT vs. Sarabhai Management Corporation ltd., 192 ITR 151 (SC)

ii) CIT vs. Electron India, 241 ITR 166 (Mad)

iii) CIT vs. Piem Hotel Pvt.Ltd., 209 ITR 616 (Bom)

iv) CIT vs. Western India Seafood P.ltd. 199 ITR 777 (Guj)

v) CIT vs. ESPN Software India Ltd.218 CTR (Del) 427 = (2008-TIOL-170-HC-DEL-IT)

vi) ITAT Bench 'D' Mumbai in the case of Rajesh Khanna in ITA No..4864/M/2000

Finally, Learned Counsel submitted that the test to be applied is as to when a businessman would regard its business as having been commenced and the approach must be from a common sense point of view. What is material is the date when the company went into or started one or the other of its component activities. Learned Counsel submitted that the assessee's business was set up on the date of agreement on 18.11.1997 and the returns were filed from A.Y. 1998-99 onwards. Learned Counsel submitted that merely because the assessee had classified the expenditure as preoperative expenses could not be of consequence keeping in view the supervening circumstances of abandonment of project in the assessment year under consideration.