JUDGMENT
V.K. Singhal, J.
1. The Income-tax Appellate Tribunal has referred the following two questions of law arising out of its order dated October 30, 1980, for the assessment year 1974-75 :
“(1) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that the assessee commenced its business for new unit when it started booking orders for the products of the new unit ?
(2) If the answer to the first question is in the negative whether the Tribunal was justified in allowing the claim of deduction of expenditure of Rs. 1,85,460 as revenue expenditure ?”
2. The brief facts of the case are that the assessee has claimed expenses of Rs. 1,85,460 in respect of its Palghat unit which were disallowed by the Income-tax Officer on the ground that the expenses are not incurred in connection with the business being either in the nature of preliminary expenses or expenses to be capitalised and, therefore, the claim is not allowable. During the course of assessment proceedings, it was informed on July 12, 1976, that travelling expenses do not include any expenditure incurred for the Palghat project as they have been separately indicated in schedule 5 of the annual accounts.
3. The Inspecting Assistant Commissioner of Income-tax, after taking into consideration the objections and the evidence produced, came to the conclusion that the amount of Rs. 1,85,460 cannot be allowed as a revenue expenditure and, accordingly, the assessment order was finalised.
4. In the appeal preferred to the Commissioner of Income-tax (Appeals), Rajasthan, it was held that it is an admitted fact that the Palghat unit was still under the process of construction and the machinery was still under installation and the building was under construction. In these circumstances, the Palghat unit could not be said to have been set up during the relevant previous year. All expenses pertaining to a business before it is set up have to be treated as expenditure of capital nature. Accordingly, the disallowance was confirmed. It may also be noted that the assessee has contended that this amount pertains to the salary, wages and travelling expenses of the persons working at Kota for promotion of sales of the products at the Palghat unit and these persons have to attain promotion of sales in the unit in advance so that there may not be any difficulty in regard to the sales of the product of the unit after it has commenced production.
5. The matter was agitated before the Income-tax Appellate Tribunal and it was held that a prudent businessman would explore markets before the production commences. The booking of orders and exploring the market for the goods intended to be produced by the assessee in the near future was very essential. If this activity was started by the assessee after the goods had actually been produced, the huge quantities of production would lie piled up for want of a market. It was in view of the commercial expediency that the assessee had to book orders in advance and in these circumstances it was held that the assessee’s business has commenced when it started booking orders for the new unit. The expenditure was allowed as revenue.
6. Learned standing counsel for the Department has submitted that neither any raw material was purchased nor was the unit set up during the relevant previous year and the machinery was under installation and the building was under construction and, therefore, the Income-tax Appellate Tribunal has not taken the correct view in accordance with the provisions of law.
7. The submission of Mr. Ranka is that there is a difference between the setting up of business and commencement of business and for that purpose he has relied on the decision in CIT v. Sarabhai Management Corporation Ltd. [1991] 192 ITR 151, wherein the apex court has held that where an assessee had purchased a property and it was on the look out for persons to whom it could be let out and it had been able to get a customer and it had carried out repairs, rewiring, installation of lift and other steps in the process of getting the premises converted from a residential house into a business and storage accommodation conforming to the requirements of the customer, it was held that the activities of acquisition of a property for being let out can be said to be only a preparatory stage (analogous to the acquisition of buildings, plant and machinery in a manufacturing business), and the subsequent activities certainly constitute activities in the course of the carrying on of the assessee’s business.
8. Reliance was also placed on the decision of Prem Conductors Pvt. Ltd. v. CIT [1977] 108 ITR 654 (Guj), where it was held that the test to be applied is as to when a businessman would regard a business as being commenced and the approach must be from a common sense point of view and the activity of securing orders before commencement of actual production was held to be that the business had commenced though the actual production had not started. The expenses were allowed as business loss.
9. Reliance was also placed on the judgment, Hotel Alankar v. CIT [1982] 133 ITR 866 (Guj), in which it was held that the list of repairs which had been provided before the Tribunal clearly indicated that there were no major structural changes except installation of lifts, making the building more ventilated, etc., and hence the expenses were of a revenue nature. It was further observed that the business of boarding and lodging house would necessarily comprise variegated activities commencing from the stage of acquisition of a proper and suitable building, making it more suitable and convenient for the business ; appointing the staff of managers, bearers, cooks and ultimately reaching the stage of receiving the customers. It would be de hors the commercial sense to assert that it is only when one reaches a take-off stage for receiving customers that one can be said to have set up the business for a boarding and lodging house”.
10. Reliance was also placed on the decision of the Bombay High Court in CIT v. Ralliwolf Ltd. [1980] 121 ITR 262, wherein the activities of mere purchase were considered as the commencement of the business and a distinction was drawn between setting up and commencement and it was held that the distinction is that when a business is established and is ready to be commenced, then it can be said that business is set up but before it is ready to commence business, it is not set up. Any expenditure during the interval between the setting up of a business and its commencement would be a permissible deduction.
11. Reliance has also been placed on the decision of this court in CIT v. Shah Theatres (P.) Ltd. [1988] 169 ITR 499, where the expenditure incurred in connection with the extension of business and not for setting up of a new business, and travelling expenses were allowed as allowable expenditure and exclusively for the purpose of business. The expenses were in the nature of starting construction of another cinema building.
12. Reliance was also placed on the decision of the Karnataka High Court in CIT v. Hindustan Machine Tools Ltd. (No. 1) [1989] 175 ITR 212 where the expenditure incurred in connection with the new unit were allowed as revenue expenditure on the ground that there was complete unity and interlacing among all divisions of each unit and all units of the business.
13. We have considered the matter. In the annual report for 1973-74, i.e., assessment year 1974-75, it was reported by the directors :
“Palghat Plant : The work for establishment of a second unit of the company at Palghat (Kerala) for manufacture of control valves, safety relief valves and allied items with a capital investment of Rs. 40 million as per the revised capital cost estimate submitted to the Government for approval is progressing as per schedule. A technical collaboration agreement with Messrs. Yamatake Honeywell, Tokyo, Japan, a reputed firm in the line of manufacture of control valves, has been entered into. Action for procurement of plant and machinery from Japan as well as from indigenous sources, contracts for construction of main plant building, training of Indian engineers with Messrs. Yamatake Honeywell, in Japan, etc., have been initiated. The plant is expected to go into commercial production by the end of 1975.”
14. The balance-sheet of the year 1974-75 is as under:
Liabilities
Schedule
Figures as at 31st March, 1074
Figures as at 31st March, 1973
Rs.
Rs.
Share capital
1
4,32,55,000
3,97,53,000
Reserve surplus
1
2,21,13,004
2,31,58,416
Unsecured loans
2
1,97,64,043
2,24,80,277
Deterred credits
2
5,35,09,438
4,07,25,922
Current liabilities and provisions
3
4,37,83,366
4,36,40,237
Contingent liabilities and notes
8
18,24,22,870
18,97,57,802
Assets
Schedule
Figures as at 31st March, 1974
Figures as at 31st March, 1973
Rs.
Rs.
Fixed assets
4
5,11,19,530
5,31.29,101
Project period expenditure (for
Palghat unit to be capitalised)
5
37,23,144
2,35,401
Investments
6
2.91,300
2,71,300
Current assets, loans and
advances
7
12,72,88,896
11,61,22,000
18,24,22,870
16,97,57,802
15. The expenses incurred for the project (Palghat unit) to be capitalised were shown on the assets side of the balance-sheet for this year as well as for the preceding year. The expenditure of Rs. 2,35,401 for the assessment year 1973-74 incurred were shown as revenue expenditure and Rs. 91,456, were shown as capital expenditure. It was claimed that the expenditure was incurred by way of preliminary survey before the decision was taken to set up a new plant at Palghat and, therefore, the expenditure of head office has to be allowed as business expenses. The matter was taken up before the Income-tax Appellate Tribunal and the matter was sent back for deciding this issue again as per order passed in 1979. In the assessment year 1974-75, the total expenditure was Rs. 34,87,743 out of which a sum of Rs. 1,85,460 was claimed as revenue expenditure comprising Rs. 1,14,877 in respect of salaries and wages and Rs. 70,583 in respect of travelling expenses. The assessee has not made the claim before the Income-tax Officer for the reason that the said amount was revenue expenditure on account of being incurred for procuring orders for the Palghat unit and it was before the Commissioner of Income-tax (Appeals) and during the course of arguments only that the contention was raised that the amount pertains to sales promotion of the Palghat unit. The Commissioner of Income-tax (Appeals), without examining the details, rejected the contention on the ground that machinery was under installation and the building is under construction and the unit cannot be said to have been set up during the relevant previous year. The Tribunal has allowed the deduction considering it to be an expenditure of revenue nature as a prudent businessman would explore the market before the production commences and booking orders for the goods intended to be produced by the assessee in the near future was very essential. If this activity was started by the assessee after the goods had actually been produced, huge quantities of production would lie piled up for want of a market. It was in view of commercial expediency that the assessee has to book orders in advance. It may be noted here that the production of the unit started in December, 1975.
16. In Bombay Steam Navigation Co. (1953) Pvt. Ltd. v. CIT [1965] 56 ITR 52, it was held by the apex court that “in considering whether an expenditure is revenue in nature, the court has to consider the nature and the ordinary course of business and the objects for which the expenditure is incurred. A question whether a particular expenditure is revenue expenditure incurred for the purpose of the business must be viewed in the larger context of business necessity or expediency. If the outgoing or expenditure is so related to the carrying on or conduct of the business that it may be regarded as an integral part of the profit-earning process and not for acquisition of an asset or a right of a permanent character, the possession of which is a condition to the carrying on of the business, the expenditure may be regarded as revenue expenditure”.
17. In Empire Jute Co. Ltd. v. CIT [1980] 124 ITR 1, it was held by the apex court that (at page 10) “the test of enduring benefit is not a certain and conclusive test and it cannot be applied blindly and mechanically without regard to the particular facts and circumstances of a given case…. What is an outgoing of capital and what is an outgoing on account of revenue depends on what the expenditure is calculated to effect from a practical and business point of view rather than upon the juristic classification of the legal rights, if any, secured, employed or exhausted in the process. The question must be viewed in the larger context of business necessity or expediency”.
18. In Prem Conductors Pvt. Ltd. v. CIT [1977] 108 ITR 654 (Guj), the actual production of the conductor commenced on June 27, 1965. The expenditure incurred prior to this date was disallowed by the Income-tax Officer. The assessee-company was formed for the purpose of taking over the business of a going concern, Prem Industrial Corporation, Ahmedabad, and it actually took over some of the contracts which Prem Industrial Corporation had entered into with the Electricity Boards of different States in India. The assessee-company took over the raw materials in the shape of the aluminium wires worth Rs. 1 lakh or so and it also got the benefit of some contracts which Prem Industrial Corporation had entered into even before the assessee-company was incorporated. It was held that the selling of aluminium conductors manufactured by it is as much a part of the business activity of the assessee-company as the manufacture of the aluminium conductors. The orders acquired by the assessee-company from the different Electricity Boards ensured a ready market for the company when the company actually went into production and it purchased raw materials and stock in advance so that it could go into production on an appropriate scale and supply the goods against the orders which it had already received. In these circumstances, it was said that the assessee-company has commenced its business and the business was set up when it started securing orders against further production. One business activity may precede the other. What is required to be seen is, whether one of the essential activities for the carrying on of the business of the assessee-company as a whole was or was not commenced.
19. In the present case, it is no doubt true that we have to see the setting up of the business and not the commencement of the business. Any expenditure prior to the setting up of the business is not an allowable deduction. There may be an interval between setting up of a business and commencement of business. The term “business” has been defined in Section 2(13) of the Act to include any trade, commerce or manufacture or any adventure or concern in the matter of trade, commerce or manufacture. A continuous exercise of activity constitutes the business. A bundle of activities are required to be carried on for carrying on the business. Procuring of orders is one of them and in a trading concern procuring orders for the commodities in which the assessee intends to deal will be a vital point for deciding the issue that he. has in fact commenced the business. The criteria in a manufacturing concern may differ. The facts of Prem Conductors Pvt. ltd. v. CIT [1977] 108 ITR 654 (Guj) referred to above are different from those of the assessee inasmuch as in that case a going concern was taken over and raw material in the shape of aluminium wires was also purchased. If the orders are secured simultaneously with the installation of machinery and construction of building then the activity of procurement of such orders is one of the business activities. In the present case, the Tribunal has proceeded on the basis of the argument advanced before it and not on the basis of the facts which are found by the authorities below or by the Tribunal itself and has held that a prudent businessman would explore the market before production is commenced. It is worth noting that no such argument was taken before the Income-tax Officer or before the Inspecting Assistant Commissioner of Income-tax in the proceedings under Section 144B and it was for the first time raised before the Commissioner of Income-tax (Appeals) that the amount pertains to salary and wages and travelling expenses of the persons working at Kota for promotion of sales of the products of the Palghat unit. The appellate authority had not examined the contention on the ground that the expenditure pertains to the period before the business is set up and the machinery was still under installation and building under construction and, therefore, it was treated as expenditure of capital nature. When this point was argued before the Income-tax Appellate Tribunal, the Tribunal could have itself examined the details after giving opportunity to the opposite side or could have sent the matter back to the lower authorities for examining the point as to whether the expenditure of Rs. 1,85,460 could be attributed to salaries, wages and travelling expenses in respect of booking of orders for the Palghat unit. No discussion of any sort has been mentioned in the order of the Tribunal as to how the expenditure was considered related to the booking of orders. The accounting year involved is 1973-74, i.e., ending on March 31, 1974, and the production commenced in December, 1975. The balance-sheet and the notes thereunder were also important factors to be taken into consideration besides the contention of the assessee that such a plea was not taken before the Income-tax Officer or the Inspecting Assistant Commissioner and no document was produced in support thereof. Simply on the basis of the averment/ argument, a decision could not be given and more particularly when the burden was on the assessee to prove that the expenditure incurred was directly related to the orders booked for the Palghat unit as alleged before the Tribunal.
20. In these circumstances, we are of the view that since a finding of fact has not been recorded and the Tribunal has proceeded only on the basis of the argument raised before it, the answer to the question raised cannot be given. The reference is returned unanswered with the direction that the Tribunal shall record a finding on the point as to whether the expenditure incurred of Rs. 1,85,460 was directly co-related to the orders booked for the Palghat unit and pertain to the salaries, wages and travelling expenses for that purpose after giving opportunity to both the parties. The reference is accordingly unanswered. No orders as to costs.