1. These two appeals, one filed by the assessee against the order of the Commissioner (Appeals), New Delhi, passed in Appeal No. 18/03-04, dated 27-10-2003 and the other filed by the revenue against the order of the Commissioner (Appeals), New Delhi, passed in Appeal No.12/02-03, dated 31-10-2002 were heard together and are being disposed off by this single order for the sake of convenience because the issue involved in both the appeals i.e. whether the assessee is entitled to claim expenditure aggregating to Rs. 5,20,22,092 in assessment year 2000-01 and Rs. 5,31,22,080 in assessment year 1999-2000 is allowable as business expenditure under Section 37(1) of the Income Tax Act, 1961, is identical.
2. Briefly stated, the facts are that the assessee filed a return of income for assessment year 2000-01 declaring loss of Rs. 5,20,22,092 and a loss of Rs. 5,31,22,080 in assessment year 1999-2000. The assessee company is engaged in the business of the primary purpose grass roots exploration programme as laid down in the memorandum of understanding signed on 26-10-1994 between the assessee, BHPM & HZL. As per the MOU, purpose of the work was studying and identifying the potential deposits of commercially viable minerals like lead, zinc, copper, gold and associated minerals within the prospective geological terrains of Rajasthan. After considering the various clauses of the MOU and after studying the activities taken by the assessee-company, the assessing officer reached the conclusion that the work done was in the nature of pre-feasibility studies and so after considering the various clauses of MOU executed between the assessee and HZL, the assessing officer held that from the scope of the project and profile of the transactions, the expenses were not allowable as business expenditure because the same could be only considered as pre-commencement expenses.
Thereafter, he disallowed the loss claimed by the assessee in both the assessment years 1999-2000 and 2000-01 under consideration before us.
3.& 4. Aggrieved with the orders of the assessing officer, the assessee filed two separate appeals before the Commissioner (Appeals).
Commissioner (Appeals), in assessment year 2000-01, after considering the submissions of the assessee and examining the terms of MOU between the assessee and HZL, firstly came to the conclusion that the allowable expenditure on prospect of certain mineral was governed by Section 35E of the Act and second on considering the various case laws relied upon by the assessee and the assessing officer, came to the conclusion that the expenditure incurred by the assessee in exploration of the minerals could only be allowed as per provisions of Section 35E/37 of the Act i.e. when the new company for commercial exploitation of the minerals, comes into existence. Thereafter, the Commissioner (Appeals) concluding that as the new company has not come into existence for the above purpose so these expenses incurred by the assessee were not allowable as deduction and so the assessing officer was justified in disallowing the loss claimed by the assessee.
5. However, in assessment year 1999-2000, the Commissioner (Appeals) allowed the expen-diture claimed by the assessee by making following relevant observations in his order: I have considered the issues brought in appeal. I am in agreement with the appellant that the order does not clearly bring out the reasons as to why the expenses were disallowed, even if they were considered to be 'pre-commencement' expenses. The case law cited by the appellant, especially the cases Franco Tosi Ingegneria (241 ITR 268) (Madras) and Seshasayee Brothers Private Limited (127 ITR 218), have been gone through. When the issues therein are juxta positioned with the facts of the instant case, it appears that in this case also the business had been set up, in fact had commenced. It appears that the assessing officer has been guided by the terms 'pre-feasibility studies'. In the business of exploration, it is indeed necessary to carry out pre-feasibility studies. The entire gamut of activities cannot start at one go. Unless the pre-feasibility studies reveal the viability of the project and the possibility of minerals being found, actual exploration cannot start. Thus the concept of prefeasibility is somewhat unique to exploration business and may be somewhat akin to 'market research' undertaken prior to start of actual business. But once the results are positive, the entire operation begins and the accounts of the pre-commencement period will merge with the subsequent periods. I also have no doubt that the business in this case had been 'set up' at least when the Reserve bank of India had granted permission to allow setting up of a Project Office in 1997, if not in 1994 when the agreement was entered into with Hindustan Zinc Ltd. The question thus is of allowing the expenditure incurred in the period between these two landmarks. In view of the cases cited and the peculiar nature of the appellant's business, I am of the view that the expenses are allowable, even if it is 'pre-commencement expenditure'. It is also being kept in mind that this is the third year of the business being set up, and in the earlier assessment years, the department has accepted the returns, thereby allowing the claim of expenditure and losses returned in the assessment years 1997-98 and 1998-99. There does not appear to be any justification for disallowing the same in this year, and the addition on account of the same is therefore deleted and the loss returned is directed to be carried forward.
6. Before us, learned AR for the assessee, referring to Pages 32 to 38 of the Paper Book, submitted that this MOU was executed between the assessee and HZL on 26-10-1994. He further submitted that, as per Clause 11 of this MOU at Page 35 of the Paper Book, this entire expenditure regarding the project was to be borne by the assessee until the completion of a prefeasibility study. Thereafter, each party was to contribute towards the project expenditure in proportion to its participating interest. Then again referring to Clause 9 at Page 34 of the Paper Book, the AR for the assessee submitted that HZL was to simply provide the assessee assistance for exploration. Participating interest of the assessee, BHPM, and HZL would be in the ratio of 60 per cent and 40 per cent respectively. He further contended that in the instant case, the assessee's business was set up in February 1997 which is clear from the letter issued by the Reserve Bank of India placed at Page 28 of the Paper Book which indicates that the permission was granted to the assessee to open a Project Office in India to execute contract with HZL. He further contended that during assessment years 1999-2000 and 2000-01, the impugned expenditure incurred by theassessee, after setting up of the business of the assessee, was allowable to the assessee under Section 37(1) of the Act as revenue expenditure/business expenditure. In order to support his contentions that the assessee's project was set up in February 1997, he placed reliance on Page 44 of the Paper Book indicating that this feasibility project was to be completed in four phases i.e. I, II, III and IV and the same were completed before the assessment years 1999-2000 and 2000-01 under consideration before the Tribunal. Hence, the expenditure is allowable to the assessee under Section 37(1) of the Act. In support of his contention, he relied upon the judgment of Madras High Court in the case of CIT v. Franco Tosi Ingegneria . He further contended that for assessmentyear 1999-2000, the Commissioner (Appeals) has rightly allowed the expenditure claimed by the assessee whereas in assessment year 2000-01, the Commissioner (Appeals) has wrongly disallowed the claim of the assessee merely placing reliance on the provisions of Section 35(E) of the Act which are not applicable to the case of the assessee, firstly, because the assessee was a foreign company whereas this section was only applicable to the Indian Companies. Secondly, expenditure which was to be amortized by Indian Company was also to be specified.
7. On the other hand, learned DR for the revenue submitted that in the instant case, the facts of this case require to be examined very carefully because there is a Memorandum of Understanding between the two parties which also does not create any legal obligations upon the assessee towards HZL. Presently, there was no joint venture company of the assessee as the entire project has been abandoned by the assessee because the project undertaken by the assessee was not viable. In the instant case, even if Section 35(E) of the Act is not strictly applicable to the assessee- company because it is a foreign company, still the allowability of the expenditure under Section 37 of the Act could be considered only when the project was set up and ready to commence production. He further contended that these expenditures incurred by the assessee were merely pre-commencement expenditure, so, the same were capital in nature and cannot be allowed to the assessee as business expenditure. In support thereof, he relied upon the decision of Delhi High Court in the case of Triveni Engg. Works Ltd. v.CIT (1998) 232 ITR 6391. He further submitted that since the project has been terminated, this expenditure could not have been allowed to the assessee and in support thereof he has relied upon the case of Apex Court in the case of CIT v. Gemini Cashew Sales Corpn.
, in the case of Ram Chandra Munna Lal v. CIT (1949) 17 ITR 394 (Punj.) and 109 ITR 309 (Mad.) (sic).
8. The learned AR for the assessee, countering the arguments of the assessee placed reliance upon the case of Apex Court in the case of CIT v. Malayalam Plantations Ltd. and Calcutta High Court in the case of Indian Steel and Wire Products Ltd v. CIT and submitted that this expenditure incurred by the 9. We have considered the rival contentions of both the parties, perused the records and carefully gone through the orders of the tax authorities below as well as the case law relied upon by both the parties which was applicable to the facts of this case and relevant for deciding the issue under consideration before us.
10. As per the provisions of Section 37(1) of Income Tax Act, 1961, any expenditure laid out or expended wholly and exclusively for the purposes of business or profession shall be allowed in computing the income chargeable under the head 'Profits and gains of business or profession". On examining the decisions of the various High Courts it becomes clear that for considering whether the expenditure claimed by the assessee is revenue or capital in nature, we are required to look into the various factors like what constituted the business of the assessee. When the business of the assessee commenced or was set up.
What is the distinction between setting up of the business and commencement of a business. When the business is said to have been established and ready to commence. Thus, when a business is established and ready to commence operation, then it can be said of that business that it is set up; but before it is ready to commence business it is not set up. There may, however, be an interval between the setting up of business and the commencement of the business and all expenses incurred during that interval would be a permissible deduction. When a business is established and is ready to start business it can be said to be set up. The business must be put into such a shape that it can start functioning as a business. In order to see what constituted the business of the assessee we have to look into each and every activity of the assessee which is essential for the purpose of carrying on the business of the assessee and we have to also look as to which activity of the assessee is integral part of the business of the assessee so that we can arrive at a conclusion that in view of that activity the assessee could be said to have commenced its business. A business cannot be said to have be set up unless it is ready to discharge the function for which it is being set up. It is only when the business has been put to such a shape that it can start functioning as a business that it can be said that the business has been set up. Hence it can be summarized that there is a clear distinction between commencing of a business and setting up of business and for the purposes of Section 37(1) of Income Tax Act, 1961 the setting up of business and not the commencement of business is to be considered. It is only after the business is set up that the previous year of the business commences and any expenses incurred prior to the setting up of business would not be a permissible deduction. When a business is established and is ready to commence business than it can be said of that business that it is set up; but before it is ready to commence business it is not set up.
Hence, in the instant case we are required to determine what was the business of the assessee and, in particular, the activities which constituted such business.
11. Now reverting to facts of the instant case of the assessee, we find that the assessee is engaged in the business of prospecting, exploration, developing, extracting and processing of minerals and mineral ores. It means these entire business activities; of the assessee can be divided into two categories. First, prospecting and exploration; second, developing, extracting and processing of minerals and mineral ores. In the instant case, admittedly, the assessee has carried out first part of the activity, i.e. prospecting and exploration, in four stages and thereafter the assessee company had closed its Indian project office on 24-12-2003 and the assessee abandoned the second part of the business activity. From these facts it is further clear that except opening its project office in India to execute contract with HZL in February, 1997 on the basis of letter issued by the Reserve Bank: of India no further step was taken by the assessee in the direction of carrying out the second part of the activity, which, in fact, was the actual activity of the business of the assessee as the assessee had to do extraction and processing of minerals and mineral ores. It further means that the first part of the business activity of the assessee was only in the form of preparing project report for the purpose of studying and identifying the potential deposits of commercially viable minerals.
12. The question arises whether the expenditure incurred by the assessee on preparing such project report was allowable to the assessee as business expenditure under Section 37(1) of Income Tax Act, 1961.
The reliance placed by the assessee is mainly on the decision of Madras High Court in the case of Fanco Tosi Ingegneria (supra), wherein the assessee was held to be entitled to expenditure incurred holding that the assessee has commenced its business in India from 13-4-1981, when it secured and accepted the letter of intent from Neyveli Lignite Corporation and not from October, 1981 when it opened its site office, is of no assistance to the assessee because in that case the issue before the Hon'ble High Court was whether the assessee had commenced its business in India from 13-4-1981, when it secured and accepted the letter, or from the date 1-10-1981, when the assessee opened its site office, because the commencement of business or setting up of business was not an issue to be considered by the Hon'ble High Court. Whereas in the decision of jurisdictional High Court of Delhi in the case of Triveni Engineering Works Ltd. (supra) their Lordships while considering the nature of expenditure incurred on the preparation of project reports being capital or revenue clearly laid down that the test to discriminate between a capital and a revenue expenditure is not straight. An item of expenditure though incurred wholly and exclusively for the purpose of the business may nevertheless be inadmissible as an allowance, if it is of a capital nature. The border line between a capital expenditure and a revenue expenditure is a blurred one.
Different minds may come to different conclusions and may yet have valid reasons justifying each of the two view-points. The amount spent on the project reports was not for the purpose of facilitating the assessee's existing trading operations or enabling management and conduct of the assessee's business to be carried on more efficiently or more profitably, while leaving the fixed capital untouched. If only the project reports had been successfully accepted and put into implementation, the assessee would have gone into manufacturing of a new product which would have certainly required investment of fresh capital and coming into existence of additional fixed assets. The expenditure was, therefore, attributable to capital having been incurred with a view to bringing an asset or advantage into existence and having enduring benefit. Merely because the project did not materialize, the nature of the expenditure would not change to revenue.
13. We have already mentioned that in the instant case, in fact, the real business of the assessee is of extracting, developing and processing of minerals and mineral ores. For doing this business some infrastructure was required to be set up for commencing the business, whereas, in the instant case it has neither been pleaded by the assessee nor any evidence has been brought on record to show that some expenditure has been incurred by the assessee for bringing into existence such infrastructure. The only step taken by the assessee in the instant case is setting up of its project office in order to explore the possibility of minerals in the licensed area given to the assessee, on which the impugned expenditure has been incurred and deduction for the same has been claimed as a revenue expenditure under Section 37(1) of Income Tax Act, 1961. On carefully examining the facts we are clear in our mind that neither the real business of the assessee can be said to have set up or commenced or ready to commence because there is no such infrastructure by which the assessee can immediately start the business of extraction, developing and processing of minerals and mineral ores for commercial purpose. Hence applying the ratio of the decision of the jurisdictional High Court of Delhi in the case of Triveni Engg. Works Ltd. (supra), it is held that the expenditure claimed by the assessee in the preparation of the project report with a view to explore the possibility of minerals and mineral ores in the licensed area is not a revenue expenditure and the same has been rightly disallowed by the assessing officer and sustained by the Commissioner (Appeals) for assessment year 2000-01 and wrongly deleted by the Commissioner (Appeals) in assessment year 1999-2000.
Accordingly, the order of Commissioner (Appeals) for assessment year 2000-01 is upheld and the order of Commissioner (Appeals) for assessment year 1999-2000 is set aside for the reasons mentioned hereinabove.
14. Before parting we may mention that Section 35E has been wrongly applied by the Commissioner (Appeals) in assessment year 2000-01 in the instant case of the assessee because this section only applies to Indian companies, whereas, admittedly, the assessee-company in appeal is a foreign company to which the section has no application. Even during the course of the arguments the learned DR for the revenue conceded on this point. Hence, though the Section 35Eis not applicable in the case of the assessee for considering the claim of the impugned expenditure by the assessee but for the detailed reasoning given in our order hereinabove, we reiterate that for assessment years 2000-01 and 1999-2000 the assessee is not entitled to claim the deduction for the impugned expenditure incurred for the completion of the project report.
Consequently, the ground of appeal taken by the assessee in regard to Section 35E allowed and the other remaining grounds of appeal are rejected. The grounds of appeal taken by the revenue are allowed.
15. In the result the appeal filed by the assessee is partly allowed and the appeal filed by the revenue is allowed.