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Bhodilal Menghraj And Co. P. Ltd. v. Commissioner Of Income-Tax, Bombay City-I

Bombay High Court

Jan 31, 1979

Judgment

Subsequent
References

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Summary of Opinion — Income-tax Reference (Assessment Year 1962–63)

Factual and Procedural Background

This reference arises under s. 256(1) of the Income-tax Act, 1961, made by the Income-tax Appellate Tribunal at the instance of the assessee. The central factual matrix is as follows:

The assessment year in question is 1962–63 (accounting year ending 31 March 1962).
The assessee is a limited company that previously acted as managing agents of Shreeram Mills and thereafter established a factory for manufacturing tools under the trade name "Hansa Tools" which went into production in August 1961 at Udhna in Surat District (Gujarat).
On 14 July 1960 the Gujarat Electricity Supply Board offered power supply on condition that the company pay Rs. 92,400 as its share of the estimated cost of laying a new 22 KV single circuit line (total estimated cost ~ Rs. 1,80,000, shared between the assessee and another consumer).
The board's letter (quoted in the Tribunal's order) indicated that although the cost would be borne by the assessee and the other consumer, the service line would remain the property of the board and be maintained by it.
The assessee and the other consumer paid the agreed amount, the line was laid, and electric supply commenced to run the factory.
In the assessee's accounts the Rs. 92,400 contribution was treated as a revenue expenditure. The ITO disallowed the deduction as capital expenditure. The AAC upheld the ITO but on the ground that the expense was for initiation/installation of the factory (capital). The Tribunal also held the expenditure to be capital, observing that it was incurred to enable the company to start its factory and was not in the course of running the factory, and that it was capital even though the asset was not the assessee's property.
The correctness of the Tribunal's conclusion was referred to the court in this reference; the specific referred question was whether, on the facts and in the circumstances, the sum of Rs. 92,400 is deductible in computing the income of the company.

Legal Issues Presented

Whether, on the facts and in the circumstances of the case, the sum of Rs. 92,400 paid to the Gujarat Electricity Supply Board is deductible (i.e., a revenue expense) in computing the income of the company, or whether it is a capital expenditure?

Arguments of the Parties

Assessee's Arguments (as advanced by Mr. Kolah)

The assessee contended that the payment of Rs. 92,400 was a revenue expenditure and therefore deductible.
It was submitted that the court should apply the well-established distinction between the setting up of a business and its commencement, adopting a businessman's commonsense approach — i.e., to ask whether the business was "set up" when the expenditure was incurred.
The assessee relied on the test laid down in Western India Vegetable Products Ltd. v. CIT and subsequent authorities to argue that operations for establishment (which include amounts spent before a business is truly "set up") are distinct from capital expenditure incurred after a business is already "set up."
Specific authorities from the Gujarat High Court were relied upon to support a commonsense approach that, in some circumstances, an activity may be regarded as "set up" when some categories of the business commence or when a businessman would regard the business as commenced.

Revenue / Respondent's Position (as reflected in the orders below)

The Income-tax Officer held the Rs. 92,400 contribution was capital in nature and disallowed it as a revenue deduction.
The AAC agreed with the ITO, treating the expenditure as incurred for initiation/installation of the factory and hence capital.
The Tribunal also held the expenditure was capital, reasoning that it enabled the company to start its factory and was not incurred in the course of running the factory; the Tribunal further held it to be capital despite the fact that the asset (service line) was not the property of the assessee.

Table of Precedents Cited

Precedent	Rule or Principle Cited For	Application by the Court
Western India Vegetable Products Ltd. v. CIT, [1954] 26 ITR 151 (Bom)	Distinction between "setting up" of a business and commencement; expenses after setting up but before commencement (interregnum) may be deductible as revenue; operations for establishment are not the same as the setting up.	The court treated this decision as foundational and repeatedly applied its test: operations for establishment precede the setting up of a unit and are distinct from being "set up." The test was applied to determine whether the assessee's unit was "set up" when the expenditure was incurred.
CWT v. Ramaraju Surgical Cotton Mills Ltd., [1967] 63 ITR 478 (SC)	Approved the Western India test; held that "set up" is equivalent to "established" and that operations for establishment cannot be equated with the establishment itself.	The Supreme Court's approval of Western India reinforced the principle applied by the court: operations for establishment must precede actual setting up and therefore expenses incurred before setting up are not capital as such.
CIT v. Sarabhai Sons Pvt. Ltd., [1973] 90 ITR 318 (Guj)	Expenses for obtaining leasehold land, placing machinery orders and purchasing raw materials were operations for setting up and not the setting up itself; business was not ready to discharge its function at the stage of those expenses.	The court cited and applied this case to support the proposition that pre-production expenses of the kind incurred by the assessee were operations for establishment and did not constitute the setting up of the business.
Prem Conductors Pvt. Ltd. v. CIT, [1977] 108 ITR 654 (Guj)	Where a business has different categories, it can be said to be set up when one category is started; the test is when a businessman would regard the business as commenced — a commonsense approach.	The assessee relied on this decision to urge a commonsense businessman’s viewpoint; the court noted the decision but applied it in context, finding the present facts unfavourable to the assessee.
CIT v. Industrial Solvents and Chemicals Pvt. Ltd., [1979] 119 ITR 608 (Bom)	Installation of machinery alone does not equate to setting up; for a manufacturing unit, it cannot be said to be ready to commence unless an end product can be or is produced — machinery installation can remain part of setting up.	The court applied the test and compared the present facts to this case, noting that even where some production commenced (albeit sub-standard) the business was deemed set up only when it could produce a limited quantity of end product; the present facts were considered worse for the assessee than in that case.
CIT v. Forging & Stamping Pvt. Ltd., [1979] 119 ITR 616 (Bom)	Business was held to be set up when it received power connection (not merely on earlier installation of machinery or trials with generators).	The court relied on this recent decision of the Bench to underscore that receiving power connection can mark the point of being "set up"; on the present facts, however, the court found the assessee's position less favourable than in Forging & Stamping.
CIT v. Saurashtra Cement and Chemical Industries Ltd., [1973] 91 ITR 170 (Guj) & Sarabhai Management Corporation Ltd. v. CIT, [1976] 102 ITR 25 (Guj)	These decisions were cited before the Division Bench in earlier related litigation; the opinion does not set out detailed principles from these two cases within the text provided.	The cases were noted as having been cited before the Division Bench; the present opinion records they were among authorities considered but does not summarize their specific rules in the passages reproduced.

Court's Reasoning and Analysis

The court's analysis proceeded by identifying and applying the authoritative test distinguishing operations for the establishment of a business from the setting up of the business itself. The key analytical steps are:

The court accepted and relied on the long-established principle from Western India Vegetable Products Ltd. v. CIT that "setting up" means being established and ready to commence business, while operations for establishment precede that stage and are not synonymous with the setting up.
It noted the Supreme Court's approval of that principle in CWT v. Ramaraju Surgical Cotton Mills Ltd., which confirmed that operations for establishment cannot be equated with the setting up of the unit.
The court examined subsequent decisions of the Gujarat High Court and of the Bombay High Court (Industrial Solvents; Forging & Stamping; Sarabhai) applying the same test and distilled from them practical indicators of when a manufacturing unit can be regarded as "set up" (for example, the commencement of production or receipt of power connection, and whether an end product can be obtained).
Applying that body of authority to the present facts, the court asked whether the assessee's Hansa Tools unit was "set up" at the time the Rs. 92,400 was paid. The court concluded it was not: the expenditure was incurred to enable the company to start its factory — i.e., part of the operations for establishment — and therefore not deductible as a revenue expenditure at that stage.
The court expressly compared the present facts to Industrial Solvents and Forging & Stamping, observing that the present facts were "more hopeless for the assessee" than in those cases, and concluded it was impossible to hold the assessee had set up its business when the contribution was made.
On that basis the court upheld the Tribunal's conclusion that the amount was capital in nature (or at least not allowable as a revenue deduction at that time), thereby answering the referred question in the negative and in favour of the Commissioner.

The court's reasoning is expressly tied to precedent and the specific factual circumstances (timing of production, nature of expense, ownership/maintenance of the line by the board) as narrated in the opinion.

Holding and Implications

Holding: The referred question is answered in the negative and in favour of the Commissioner.

Direct Effect and Consequences:

The Tribunal's decision that the sum of Rs. 92,400 was not deductible as a revenue expenditure (and must be regarded as capital expenditure for the purpose of the assessment) is upheld.
The assessee is ordered to pay the costs of the reference to the Commissioner.

Broader Implications:

The opinion applies established authority distinguishing operations for establishment from the setting up of a business; it does not assert the creation of a new legal principle beyond applying those precedents. The court did not discuss any wider change to the law; its decision is an application of existing authorities to the facts of this case.

Show all summary ...

Desai, J.:— The following question of law has been referred to us in this reference by the Income-tax Appellate Tribunal at the instance of the assessee under s. 256(1) of the I.T Act, 19611

“Whether, on the facts and in the circumstances of the case, in computing the income of the company the sum of Rs, 92,400 is deductible?”

2. A few facts may be stated:

We are concerned in this reference with the assessment year 1962–63, for which the accounting year is the year ending on March 31, 1962. The assessee is a limited company, which was formerly acting as the managing agents of Shreeram Mills. The assessee-company thereafter established a factory for manufacturing tools under the trade name of Hansa Tools, which factory went into production in August, 1961. The factory was at Udhna in Surat District (State of Gujarat). The assessee-company had earlier approached the Gujarat Electricity Supply Board for getting power supply, and on 14th July, 1960, the board communicated to the company its willingness to provide necessary supply on condition that the company paid a sum of Rs. 92,400 towards the estimated cost of laying a new 22 KV single circuit line from Tapti sub-station to the Udhha Control Room over a length of about five miles. The additional facilities to be provided were to cost the board about Rs. 1,80,000, which, according to the board, was required to be shared between the assessee-company and another consumer named in the said letter, so that the cost to the assessee would come to Rs. 92,400. The relevant portion of the letter of the board in this connection has been fully extracted in the order of the Tribunal and it clearly indicates that notwithstanding that the cost is fully borne by the assessee and M/s. Adarsh Chemicals, the service line shall remain the property of the board by whom it is to be maintained.

3. The assessee-company and, presumably, Messrs. Adarsh Chemicals also agreed to the condition and paid the agreed amount and in due course the lines were laid and the company started getting electric supply to run the factory. In the accounts of the assessee-company the expenditure of Rs. 92,400, being the contribution made to the board, was debited as a revenue item. The ITO disallowed the same, holding that it was in the nature of a capital expenditure. The assessee-company carried the matter in appeal to the AAC, who agreed with the conclusion of the ITO but on a slightly different footing. According to him, these were expenses incurred for the initiation of business or installation of the factory. Accordingly, the amount of. Rs. 92,400 was required to be regarded as a capital expenditure.

4. The matter was thereafter carried in second appeal to the Tribunal. The Tribunal also concurred with the ITO and the AAC, observing that the expenditure in this case was incurred to enable the company to start its factory and it was not an expenditure incurred in the course of running the factory. Further, according to the Tribunal, this must be regarded as a capital expenditure despite the fact that the asset on which the expenditure is incurred was not the property of the assessee. It is the correctness of this conclusion of the Tribunal which is impugned in the reference.

5. Mr. Kolah appearing on behalf of the assessee-company submitted that the decision of the Tribunal and the approach of the revenue run counter to the well-settled distinction between the setting up of a business and the commencement thereof, which was pointed out by this High Court as far back as in 1954 in Western India Vegetable Products Ltd. v. CIT, [1954] 26 ITR 151. It was observed by Chagla C.J (at page 158):

“…when a business is established and is ready to commence business, 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. But there may be an interregnum, there may be an interval between a business which is set up and a business which is commenced and all expenses incurred after the setting up of the business and before the commencement of the business, all expenses during the interregnum, would be permissible deductions under s. 10(2).”

6. The aforesaid decision of the Bombay High Court, which appears to us to have stood the test of time, came to be considered and approved by the Supreme Court in CWT v. Ramaraju Surgical Cotton Mills Ltd., [1967] 63 ITR 478, where Bhargava J., delivering the judgment of the Supreme Court, observed (p. 482):

“The word ‘set up’ in the principal clause, in our opinion, is equivalent to the word ‘established’, but operations for establishment cannot be equated with the establishment of the unit itself or its setting up.”

(Underlining* supplied).

7. After referring to the decision of the Bombay High Court in Western India Vegetable Products’ case, [1954] 26 ITR 151, Bhargava J. continues (p. 482):

“These operations for establishment of the unit cannot be simultaneous with the setting up of the unit, as urged on behalf of the Commissioner, but must precede the actual setting up of the unit. In fact, it is the operations for establishment of a unit which ultimately culminates in the setting up of the unit.”

8. The question then is: Was the assessee-company's unit of Hansa Tools set up at the time. when the expenditure was incurred? According to Mr. Kolah, the question was required to be considered and answered from a businessman's point of view, adopting a commonsense approach, and not in the manner in which the revenue wants us to answer the same. In connection with this submission he referred us to several decisions of the Gujarat High Court, to which brief reference may now be made.

9. The first of these decisions is CIT v. Sarabhai Sons Pvt. Ltd., [1973] 90 ITR 318. The Gujarat High Court was considering expenses incurred for obtaining land on lease, for placing orders for machinery and purchasing raw materials. In its view these were merely operations for the setting up of the business; and, on the facts, at the stage at which these expenses were incurred, the new business could not be said to have been set up. The test which was indicated by Chagla C.J in Western India Vegetable Products’ case [1954] 26 ITR 151 (Bom) and approved by the Supreme Court in Rama-raju Surgical Cotton Mills’ case [1967] 63 ITR 478 was extracted at page 321 of the aforesaid decision and thereafter applied. The court observed that the new business which was sought to be established by the assessee before it was the business of manufacturing scientific instruments and communication equipment, and it could not be said to be ready to discharge the function for which it was being established, viz., manufacture of scientific instruments and communication equipment by merely obtaining land on lease from the Gujarat Industrial Development Corporation or appointing a qualified man as general manager or placing orders for purchase of raw materials and stores and ordering out the necessary machinery and equipment. In the view of the Gujarat High Court, these were merely operations for the setting up of the business, and the business could be set up only as a culmination of these operations when all that was necessary for the setting up of the business was done.

10. We were also referred to a later decision of the Gujarat High Court in Prem Conductors Pvt. Ltd. v. CIT, [1977] 108 ITR 654, where it was observed that if the business of the assessee consists of different categories, then it could be said to have set up its business from the date when one of the categories of its business is started. It was not necessary, according to the Gujarat High Court, that all the categories of its business activities must. start either simultaneously or that the last stage must start before it can be said that the business was set up. According to the Gujarat High Court, 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 commonsense point of view. It is this approach, which Mr. Kolah on behalf of the assessee has commended to us, and his submission was that if this approach is adopted and properly applied right from the initial stage of the activity, the assessee must be deemed to have set up its business which was ultimately to culminate in the production of tools.

11. A similar case came up for consideration before a Division Bench of this court in Income-tax Reference No. 72 of 1967, CIT v. Industrial Solvents and Chemicals Private Ltd., decided by Kantawala C.J and Desai J. on 20th June, 1978 (since reported in [1979] 119 ITR 608), The earlier decision of the Bombay High Court in Western India Vegetable Products’ case [1954] 26 ITR 151, the decision of the Supreme Court in Ramaraju Surgical Cotton Mills’ case [1967] 63 ITR 478 and four decisions of the Gujarat High Court, viz., Sarabhai & Sons Pvt Ltd.'s case, [1973] 90 ITR 318, CIT v. Saurashtra Cement and Chemical Industries Ltd., [1973] 91 ITR 170, Sarabhai Management Corporation Ltd. v. CIT, [1976] 102 ITR 25 and Prem Conductors Private Ltd.'s case, [1977] 108 ITR 654, were cited before the said Division Bench and have been noted in the judgment given. In Industrial Solvents and Chemicals Private Ltd.'s case, [1979] 119 ITR 608 (Bom) the case of the assessee was that it must be deemed to have set up its business of producing industrial solvents, viz., ether, at least when the machinery was installed. However, even this submission was negatived by the Division Bench applying the test earlier propounded in Western India Vegetable Products’ case [1954] 26 ITR 151 (Bom) and holding that for a manufacturing company or a unit thereof till some end. product is or can be obtained, it cannot be said that the company or unit is ready to commence production. On the facts as were found by the Tribunal it was ascertained by the High Court that although machinery had been installed in December, 1960, or January, 1961, there was no worthwhile production till August, 1961; and even though this production of August, 1961, was sub-standard, the court found in favour of the assessee (to a limited extent) that it must be deemed to have set up its business when it could produce a limited quantity of the end product (though of a substandard quality) on this date. Thus, even the installation of machinery simpliciter was, in the special circumstances of the case, regarded as part of the operations for the setting up and not equivalent to the setting up of the business. We have applied the test pro-pounded in this decision in a very recent decision given by this very Bench, viz., Income-tax Reference No. 85 of 1970, CIT v. Forging & Stamping Pvt. Ltd., decided on 29th January, 1979 (since reported in [1979] 119 ITR 616 (Bom)). In the said case, it was held that the assessee had set up its business when it received power connection and not earlier although the machinery had been installed earlier and trials had taken place with the help of a generator.

12. In the matter being considered presently by us, the facts are more hopeless for the assessee than were the facts in the aforesaid two cases, viz. Industrial Solvents and Chemicals Private Ltd.'s case, [1979] 119 ITR 608 (Bom) and Forging and Stamping's case, [1979] 119 ITR 616 (Bom).’ In our opinion, considering the test laid down in Western India Vegetable Products’ case [1954] 26 ITR 151 (Bom) as applied in the aforesaid two cases, viz., ITR No. 72 of 1967 (CIT v. Industrial Solvents and Chemicals P. Ltd., [1979] 119 ITR 608 (Bom)) and ITR No. 85 of 1970 (CIT v. Forging and Stamping Pvt. Ltd., [1979] 119 ITR 616 (Bom)), it is impossible to hold that the present assessee could be regarded as having set up its business which was of producing tools when it incurred the expenditure of Rs. 92,400. In this view of the matter, the decision of the Tribunal would be required to be upheld since the assessee cannot claim deduction of this amount as a revenue expenditure till it could be regarded as having set up the business. In this view of the matter, the question referred to us is answered in the negative and in favour of the Commissioner.

13. The assessee will pay to the Commissioner the costs of the reference.