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Commissioner Of Income-Tax v. Sarabhai Sons Pvt. Ltd.,
Structured Summary of the Opinion
Factual and Procedural Background
The reference arises from an income-tax assessment for the assessment year 1966-67 (previous year ending 31 March 1966). The assessee was a private limited company which had acted as managing agent for Swastik Oil Mills Ltd. and decided toward the end of 1965 to start a new business manufacturing scientific instruments and communication equipment. In November 1965 the assessee appointed Dr. Ramanathan as General Manager for the new business. Orders for machinery and equipment were placed in January 1966, some machinery was received in February 1966, and orders for raw materials and stores were placed from January 1966. The assessee occupied rented premises in Naroda Industrial Estate in February 1966. Machinery was installed in July 1966 and manufacturing commenced thereafter.
For the assessment year 1966-67 the assessee claimed a revenue deduction of Rs. 16,237 (later confined to Rs. 13,770 on appeal) for expenditure incurred in connection with the new business during the period ending 31 March 1966. The Income-tax Officer rejected the claim, holding the new business was not set up prior to 31 March 1966 and thus the expenditure could not be allowed as a revenue deduction. The Appellate Assistant Commissioner allowed the claim (relying on the Bombay High Court decision in Western India Vegetable Products Ltd.), holding that purchase of raw materials in January 1966 meant the business was set up in January 1966. The Income-tax Officer appealed to the Tribunal, which affirmed the Appellate Assistant Commissioner's view that the business was set up in January 1966. The revenue challenged the Tribunal's finding by making the present reference.
Legal Issues Presented
- Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that in the previous year the business of the assessee had been set up?
- Whether the finding of the Tribunal that the business of the assessee had been set up in the previous year was unreasonable, contrary to evidence, or based on no evidence at all? (This is the reframed question adopted by the Court.)
Arguments of the Parties
Revenue's Arguments
- The revenue did not contend that the Tribunal misapplied the legal meaning of "setting up" a business; rather, it argued that, on the facts recorded, it was impossible for the Tribunal reasonably to have found that the business was set up in January 1966 or at any time prior to 31 March 1966.
Assessee's Position
- The assessee claimed that sums expended up to 31 March 1966 in relation to the new business were revenue expenditures deductible in computing trading profits for the assessment year 1966-67, on the basis that the new business had been set up prior to 31 March 1966 (with facts such as orders placed for machinery and raw materials, occupation of rented premises, and appointment of a General Manager).
Appellate Authorities' Findings (as described in the opinion)
- The Appellate Assistant Commissioner, relying on the Bombay High Court decision in Western India Vegetable Products Ltd., concluded that because raw materials and stores were purchased in January 1966 the new business must be held to have been set up in January 1966 and allowed the revenue deduction for expenditure from 1 January 1966 to 31 March 1966.
- The Tribunal agreed with the Appellate Assistant Commissioner and held that the new business was set up in January 1966, thus affirming the allowance.
Table of Precedents Cited
| Precedent | Rule or Principle Cited For | Application by the Court |
|---|---|---|
| Western India Vegetable Products Ltd. v. Commissioner of Income-tax (Bombay High Court) | Distinction between "commencing a business" and "setting up a business"; adoption of the test that "set up" means "ready to commence business" (i.e., established and ready to discharge its function). | The Appellate Assistant Commissioner relied on this decision to hold that purchase of raw materials in January 1966 meant the business was set up in January 1966. The Court described and referenced this decision when discussing the applicable test for "set up." |
| Commissioner of Wealth-tax v. Ramaraju Surgical Cotton Mills Ltd. (Supreme Court) | The Supreme Court approved the Western India test and held that a unit is "set up" only when it is ready to discharge the function for which it is being set up (i.e., ready to commence business); being in stages of construction or ordering machinery is not sufficient. | The Court applied the Supreme Court's formulation of the test to the present facts and concluded that the business was not set up until machinery was installed (in July 1966), and therefore not prior to 31 March 1966. |
Court's Reasoning and Analysis
The Court first reframed the issue from whether the Tribunal had been "right" to a focused question of whether the Tribunal's finding that the business was set up in the previous year was unreasonable, contrary to evidence, or based on no evidence. The Court observed that the question of when a business is set up is ordinarily one of fact unless a factual finding rests on a legal misdirection; here the revenue did not allege misdirection but asserted that the factual finding was impossible on the recorded facts.
The Court identified the legal importance of the timing under section 3(1)(d) of the Income-tax Act, 1961: a business newly set up in a financial year has a previous year beginning on the date of setting up, and only expenditure incurred during that previous year can be claimed as a revenue deduction. Thus the precise date of "setting up" determined whether alleged expenses before 31 March 1966 fell within the relevant previous year for assessment 1966-67.
The Court relied on settled authority: the Bombay High Court's distinction (in Western India) between commencing and setting up a business and the Supreme Court's approval of that distinction in Commissioner of Wealth-tax v. Ramaraju Surgical Cotton Mills Ltd. The Supreme Court's statement — that a unit cannot be said to be set up unless it is ready to discharge the function for which it is being set up — was treated as the controlling test.
Applying that test to the facts found by the Tribunal (appointment of a general manager in Nov 1965; orders for machinery and raw materials in Jan-Feb 1966; occupation of rented premises in Feb 1966; machinery installation in July 1966; manufacturing commencing thereafter), the Court concluded that mere steps taken towards setting up (leasing premises, appointing a manager, placing orders) constituted preparatory operations but did not render the business "set up" for the statutory purpose. The Court reasoned that readiness to discharge the intended function (manufacture of scientific instruments and communication equipment) required installation of necessary machinery; therefore the business was not put into a shape enabling it to start functioning until the machinery was installed in July 1966.
Because the Tribunal itself found facts showing machinery installation and commencement of manufacture only in July 1966, the Court held it was impossible on those facts for the Tribunal to have reasonably concluded that the business was set up prior to 31 March 1966.
Holding and Implications
HOLDING: The Court answered the reframed question in the affirmative: the finding of the Tribunal that the business of the assessee was set up in the previous year (i.e., prior to 31 March 1966) was contrary to evidence or based on no evidence at all. The Tribunal's conclusion that the business had been set up prior to 31 March 1966 was set aside.
Implications:
- Direct effect on the parties: the Tribunal's finding in favour of the assessee on the timing of "setting up" is reversed by the Court. The Court ordered that the assessee will pay the costs of the reference to the Commissioner.
- No broader legal innovation: the Court applied existing Supreme Court authority (Commissioner of Wealth-tax v. Ramaraju Surgical Cotton Mills Ltd.) and the test approved therein; the opinion does not claim to establish new precedent beyond applying that settled test to these facts.
1. The reference arises out of assessment to income-tax made on the assessee for the assessment year 1966-67, the relevant previous year being the financial year ending 31st March, 1966. The assessee is a private limited company which has been acting as managing agent of Swastik Oil Mills Ltd. since several years past. Some time towards the end of 1965, the assessee decided to start a new business for manufacture of scientific instruments and communication equipment. The assessee appointed one Dr. Ramanathan as General Manager of the new business in November, 1965, and Dr. Ramanathan immediately thereafter started exploring possibilities for purchase of machinery and equipment necessary for the purpose of carrying on the business. In January, 1966, the assessee placed orders for machinery and equipment and some of the machinery and equipment was received by the assessee in February, 1966. The assessee also started placing orders for raw materials and stores from January, 1966, and diverse amounts were expended by the assessee at the time of placing such orders. The assessee for some time occupied rented premises in Naroda Industrial Estate from the Gujarat Industrial Development Corporation in February, 1966. The preparations for setting up the new business thus went on for a few months and in July, 1966, the machinery was installed and the assessee thereafter started manufacturing scientific instruments and communication equipment. The assessee in the course of the assessment to income-tax for the assessment year 1966-67 claimed that an aggregate sum of Rs. 16,237 spent by it in connection with the new business during the period ending 31st March, 1966, should be allowed as a revenue deduction in computing the trading profits of the assessee. The Income-tax Officer, however, rejected the claim of the assessee on the ground that the new business in respect of which the expenses were stated to have been incurred was not set up prior to 31st March, 1966, and the expenses incurred by the assessee could not, therefore, be allowed as a revenue deduction. The assessee preferred an appeal to the Appellate Assistant Commissioner and before the Appellate Assistant Commissioner, the claim for deduction was confined to a sum of Rs. 13,770. The Appellate Assistant Commissioner disagreed with the view taken by the Income-tax Officer and held, relying on the decision of the Bombay High Court in Western India Vegetable Products Ltd. v. Commissioner of Income-tax, that since assessee purchased raw materials and stores in January, 1966, the new business of the assessee must be held to have been set up in January, 1966, and the assessee was, therefore, entitled to deduction of revenue expenditure made by it during the period from 1st January, 1966, up to 31st March, 1966. The Income-tax Officer being aggrieved by this decision given by the Appellate Assistant Commissioner in favour of the assessee, preferred an appeal to the Tribunal but the Tribunal also took the same view as the Appellant Assistant Commissioner and held that the new business of the assessee was set up in January, 1966, during the previous year and the claim of the assessee for deduction was, therefore, rightly allowed by the Appellant Assistant Commissioner. This view taken by the Tribunal is challenged in the present reference made at the instance of the revenue.
2. Before we proceed to examine the question which has been referred to us for our opinion, we may point out at the outset that the question needs to be reframed. The question which has been referred to us for our opinion is in these terms :
"Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that in the previous year the business of the assessee had been set up ?"
3. Now the question as to when a business is set up would ordinarily be a question of fact, unless of course it can be said that in arriving at its decision on this question, the Tribunal has misdirected itself in law by not properly appreciating the legal connotation of what is setting up of a business. Here, the case of the revenue is not that the Tribunal has misconceived the true legal meaning of what is setting up of a business and applied a wrong test for the purpose of determining the question as to when the new business of the assessee was set up. The contention of the revenue is that, on the facts on record, it was impossible for the Tribunal to have come to the decision that the business of the assessee was et up in January, 1966, or at any time prior to 31st March, 1966. We would, therefore, reframe the question so as to read :
"Whether the finding of the Tribunal that the business of the assessee had been set up in the previous year was unreasonable or contrary to evidence or based on no evidence at all ?"
4. This question as reframed, we now proceed to consider.
5. Now the question as to when a business is set up assumes importance because, according to section 3(1)(d) of the Income-tax Act, 1961, the previous year for a business newly set up in a financial year means the period beginning with the date of the setting up of the business and ending with the financial year and it is only if expenditure is incurred by an assessee during the previous year that he can claim it as a revenue deduction in computing the trading profits of the business. Here, in the present case the assessee claimed to deduct an aggregate sum of Rs. 13,770 as revenue expenditure in the assessment for the assessment year 1966-67 and this revenue expenditure could be claimed by the assessee only if it was incurred during the previous year and the new business of the assessee could have the previous year for the assessment year 1966-67 only if it was set up prior to 31st March, 1966. It was for this reason that the question arose before the Tribunal as to when the new business of the assessee was set up; was it set up prior to 31st March, 1966, or was it set up subsequent to that date ? If it was set up prior to 31st March, 1966, the previous year of the new business for the assessment year 1966-67 would be the period from the date of the setting up of the business and ending on 31st March, 1966, and the revenue expenditure incurred during this period would be a permissible deduction, provided the other conditions of section 37 were satisfied. But if it was set up subsequent to 31st March, 1966, the revenue expenditure incurred prior to that date would not be a permissible deduction in the assessment of the assessee for the assessment year 1966-67.
6. Now, the question as to when a business can be said to be set up is no longer a matter of doubt or debate. It is concluded by a decision of the Supreme Court in Commissioner of Wealth-tax v. Ramaraju Surgical Cotton Mills Ltd. We shall presently refer to that decision but before we do so, it is necessary to refer to one other decision and that is the decision and that is the decision of the Bombay High Court in Western India Vegetable Products case. The Bombay High Court pointed out in this case that there is a clear distinction between a person commencing a business and a person setting up a business and for the purpose of section 2(11) which was the section of the Indian Income-tax Act, 1922, corresponding to section 3(1)(d) of the Income-tax Act, 1961, what is required to be considered is the setting up of a business and not the commencement of business. It is only when a business is established and is ready to commence business that it can be said of that business that it is set up. Before it is ready to commence business, it is not set up. This view taken by the Bombay High Court was approved by the Supreme Court in Commissioner of Wealth-tax v. Ramaraju Surgical Cotton Mills Ltd. There the question was whether a new spinning unit started by the assessee was set up after the commencement of the Wealth-tax Act, 1957, so as to qualify the assessee for exemption under section 5(1)(xxi) of that Act. The licence for establishing the new spinning unit was obtained by the assessee from the Government of India in August, 1955; the assessee had placed orders for purchase of necessary spinning machinery and plant in January and February, 1956, and the construction of factory buildings had started in March, 1956, and was in progress on 1st April, 1957, when the Wealth-tax Act, 1957, came into force. The construction of factory buildings was completed by December, 1957, and the erection of spinning machinery and plant in factory buildings was completed in several stages commencing from June, 1957, and a licence from the Inspector of Factories for working the factory was obtained in June, 1958. The question arose before the Supreme Court on these facts as to when the new spinning unit could be said to have been set up by the assessee; whether it was before 1st April, 1957, or after. The Supreme Court, speaking through Bhargava J., pointed out :
"Thereafter, the High Court referred to a decision of the Bombay High Court in Western India Vegetable Products Ltd. v. Commissioner of Income-tax, and, on its basis, concluded that the proper meaning to be assigned to the expression 'set up' in section 5(1)(xxi) would be 'ready to commence business'. We are unable to agree with the learned counsel for the Commissioner that, in arriving at this view, the High Court committed any error. A unit cannot be said to have been set up unless it is ready to discharge the function for which it is being set up. It is only when the unit has been put into such a shape that it can start functioning as a business or a manufacturing organisation that it can be said that the unit has been set up."
7. The Supreme Court accordingly held that the new spinning plant was set up after 1st April, 1957, since it was long after that date that it could be said to be ready to discharge the function for which it was set up. These observations of the Supreme Court lay down the test which must be applied for the purpose of determining when a business can be said to be set up. If this test is applied to the facts found by the Tribunal - which facts we have already enumerated while stating the facts giving rise to the reference - it is clear that the new business started by the assessee was not set up until July, 1966. The new business which was sought to be established by the assessee was a 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, namely, manufacture of scientific instruments and communication equipment, until the machinery necessary for the purpose of manufacture was installed. It is only when the machinery was installed that the business could be said to be put into such a shape that it could start functioning as a manufacturing organisation. It was not sufficient that the assessee obtained the land on lease from the Gujarat Industrial Development Corporation or appointed Dr. Ramanathan as a General Manager or placed orders for purchase of raw materials and stores or ordered out the necessary machinery and equipment. These were merely operations for the setting up of the business. 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. The new business in the present case could not, therefore, be said to be set up by the assessee until July, 1966, when the machinery was installed and the factory was ready to commence business.
8. We, therefore, answer the question as reframed by saying that the finding of the Tribunal that the business of the assessee was set up in the previous year, that is, prior to 31st March, 1966, was contrary to evidence or based on no evidence at all. It was impossible for the Tribunal to have come to that decision on the facts found by it. The question must, therefore, be answered in the affirmative. The assessee will pay the costs of the reference to the Commissioner.
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