1. At the instance of the Additional Commissioner of Income-tax, Gujarat, the following question has been referred to us by the Income-tax Appellate Tribunal, Ahmedabad, for our opinion :

"Whether on the finding of the Tribunal that the assessee had been equipped with all the plant and machinery including wet press found necessary to produce the requisite quality of paper and substantial quantity of raw materials necessary for the manufacture of products by the end of June, 1966, the assessee must be held to have set up its business at that point of time, although only trial production followed thereafter and regular commercial production commenced some time later ?"

2. The facts and circumstances of this case in which this question arises are as under :

3. The relevant assessment year with which we are concerned is 1967-68, the corresponding previous year being the 12 months ending on September 30, 1966. It appears that the assessee filed its original return on June 21, 1967, declaring a loss of Rs. 1,27,520. By a subsequent revised return of July 25, 1971, it declared a loss of Rs. 1,21,884. The revised return was required to be filed for the purpose of claiming depreciation of machinery and plant which was not claimed in the original return. In the course of the assessment, it was claimed on behalf of the assessee-company that the business had been set up somewhere in June, 1966, and the expenses incurred thereafter were in the nature of revenue expenses which should be allowed for purposes of computing the profits and income of the business. The ITO examined the assessee' s claim in detail and rejected the contention on the ground that up to the end of the accounting year, that is, September 30, 1966, the tests and trials were going on and the success was achieved at the end of the accounting year and, therefore, it could not be said that the company had set up the business. He, therefore, rejected the claim of the assessee-company for treating the expenses subsequent to June, 1966, as revenue expenses. The assessee-company, therefore, went in appeal before the AAC, who disallowed the appeal since, in his opinion the order of the collector of Central Excise, Baroda, holding that the assessee-company had gone into production on September 26, 1966, was a conclusive piece of evidence and therefore, it could not be said that the assessee-company set up its business before that date. He, therefore, confirmed the order of the ITO.

4. The assessee-company, therefore, went in further appeal before the Income-tax Appellate Tribunal, which, on re-appraisal of the evidence, reached the conclusion that the assessee-company had set up the business by the end of June, 1966, since it was at that point of time ready to commence its business of producing paper for which the company was set up. The Tribunal, therefore, by its order of May 17, 1974, allowed the appeal of the assessee-company and directed deduction of the expenses subsequent to that date as revenue expenses. At the instance of the Commissioner, therefore, the question set out above has been referred to us for our opinion.

5. The learned advocate appearing on behalf of the revenue raised the following two contentions :

(1) The conclusion of the Tribunal that the company was fully equipped with all the plant and machinery and raw materials necessary to produce the requisite quality of paper by the end of June, 1966, was a wrong inference having regard to the two important established facts that, (a) the admission of the directors in the report of the year ending 1965, that the installation of the wet press was necessary for purposes of producing the quality paper, and (b) that such plant was being installed by about June 7, 1966, and went into trial production in the early part of September, 1966 and, therefore, the Tribunal has committed an error of law in reaching that conclusion.

(2) In any case, the Tribunal has applied the wrong test by holding that the assessee-company was on the point of going into production though admittedly it was holding the trial test for satisfying itself whether it would go into commercial production.

What is the meaning of setting up of business came up for consideration before the Supreme Court in CWT v. Ramaraju Surgical Cotton Mills Ltd. [1967] 63 ITR 478, in the context of exemption under s. 5(1) of the W. T. Act, 1957. The facts in that case were that the company was a public limited company incorporated under the Indian companies Act, 1913, in the year 1939, and was carrying on the business of manufacture of absorbent cotton wool. In March, 1955, the board of directors resolved to establish a new spinning unit under the name of Sudarsanan Spinning Mills for which a licence was obtained from the Govt. of India under the Industries (Development and Regulation) Act, 1951, in August, 1955. The orders for purchase of necessary spinning machinery and plant were placed in the months of January and February, 1956. The construction of factory buildings was taken in hand in March, 1956, and was completed by December, 1957. The erection of the spinning machinery and the plant in the building was completed in several stages commencing from June, 1957. A licence from the inspector of factories for working the factory was obtained in June, 1958. The company was assessed to wealth-tax for the assessment year 1957-58 and it claimed that in computing the wealth on the valuation date, which was 30th September, 1956, an amount of Rs. 1,43,727 should be deducted as being the amount laid out in setting up this new unit. The claim was not accepted up to the stage of the Appellate Tribunal and, Therefore, the question was required to be referred to to the High Court of Madras, whether, the company was entitled to claim the amount. The High court answered the question in favour of the respondent, and the commissioner, therefore, went up in appeal before the Supreme Court. Bhargava J., speaking of the court, referred to the decision of the Bombay High Court in western India Vegetable Products Ltd. v. CIT [1954] 26 ITR 151 and held that 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, and it is only when the unit has been put into such 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. The above decision in Ramaraju Surgical Cotton Mill's case [1967] 63 ITR 478 (SC) was followed by the Supreme Court in its subsequent decision in Travancore-cochin Chemicals (P). Ltd. v. CWT [1967] 65 ITR 651. The facts in that case were that on July 22, 1949, a partnership was formed between two public limited companies, viz., Fertilizers & Chemicals Travancore Ltd. Alwaye, and the Mettur Chemicals & Industrial Corporation Ltd., Mettur for establishing a caustic soda factory with an estimated capital of Rs. 1 crore. The Govt. of Travancore was approached for necessary finance to complete the purchase of plant and machinery which had been started in August, 1949, and the Government entered the company and subscribed a large share of capital and a new private limited company was formed and registered under the Indian companies Act, on November 8, 1951. The new company took over the plant and machinery buildings construction stores, materials, etc. at different stages of erection and also all book debts and liabilities. the erection and construction of the factory was completed in December, 1953, and production commenced from January 1, 1954. The trading accounts were closed for the first time of March 31, 1954. For the assessment year 1957-58, the assessee-company claimed before the WTO that it was not liable to pay wealth-tax during the year of account as it was exempted from the wealth-tax under s. 45(d) of the Act. the WTO rejected the claim on the ground that the assessee was established within the meaning of s. 45(d) and the proviso thereto in November, 1951, and consequently, the period of five years exemption was over with the assessment year 1956-57. This order was confirmed by the AAC. The assessee however, succeeded before the Income-tax Appellate Tribunal. the question was referred to the High Court of Kerala (See [1964] 54 ITR 50) at the instance of the Commissioner. The Supreme Court referred to its earlier decision in Ramaraju Surgical Cotton Mills case [1967] 63 ITR 478 him order to find out what is the meaning of the word "established". The Supreme Court referred to the decision of Thomas J. Davidson v. W. I. Lanier [1867] 4 Wall 447 and quoted with approval the following passage (p. 655 of 65 ITR) :

"` What is meant by putting in operation or establishing a banking company ? We think that this language has a much wider import than mere commencement of business. To establish a company for any business means complete and permanent provision for carrying on that business and putting a company in operation may well include its continued as well as it first original operation.'"

We are of the opinion, having regard to this settled position that the contention of the revenue must prevail obviously for the following reasons : The Tribunal has found on a reappraisal that the following facts have been established :

(1) the installation of the plant and machinery had been completed by 30th June, 1966.

(2) Raw material worth Rs. 5,42,000 were purchased at the beginning of the accounting year relevant for assessment year 1967-68. The additional machinery of the value of Rs. 3,70,806 was installed in the additional machinery of the value of Rs. 3,70,806 was installed in the course of the accounting year ending on 30th September, 1966. The plant was expected to go into commercial production soon. The directors found, as recorded in their report for the year ending 30th September, 1965, that the experimental production disclosed that the existing machinery would not be able to deliver the correct quality of paper.

(3) after containing expert opinion, it was considered necessary to install a wet press.

(4) The erection of the wet press was in progress by about 7th June, 1966, as recorded in the report of the directors of the 7th June, 1966.

(5) The hope of the directors expressed in the said report was that with the additional equipment the company would be able to produce marketable quality of paper.

(6) the reaction of wet press had been completed and it went into production in the early part of September, 1966, as recorded in the report of the directors for the relevant previous year ending on 30th September, 1966.

(7) the trial production disclosed that the average monthly production was about 35 tons which was economically not satisfactory and, therefore, the company required installation of additional plant and machinery to achieve the production of 100 tons per month.

6. The learned advocate for the revenue was perfectly justified in making the grievance as he did that the Tribunal committed an error of law in reaching the conclusion that the company was ready to go into the production by about the end of June, 1966, in spite of three important facts which are found to have been established that the trial production indicated unless the wet press was erected, quality paper could not be produced. The wet press was under erection by about 7th June, 1966, and went into trial production in the early part of September, 1966, and the trial production have been indicated that the monthly production of 35 tons was not economically satisfactory and therefore, additional plant and machinery to achieve production of 100 tons was required to be installed. In view of these three facts, the conclusion of the Tribunal that the company was ready to go into production by about end of June, 1966, is clearly erroneous. In any case, the Tribunal ought to have appreciated that the assessee-company was holding trial production and having test of their plant and machinery and was trying to ascertain whether the quantity and quality of the production was satisfactory.

7. A Division Bench of this court had in Income-tax reference No. 26 of 1973 a decided on August 25, 1975 [CIT v. saurashtra Cement & Chemical Industries Ltd. [1981] 127 ITR 47 (Guj)] (per divan C.J.), following the decision of the Supreme Court in Challapalli Sugars Ltd. v. CIT [1975] 98 ITR 167, held that it is commonsense and matter of common knowledge that the test and trial of the plant has to be taken before the plant goes into actual production so that any defects in the plant and machinery can be detected at an early stage and can be rectified and without test and trial no plant can ever go into actual regular production. In the fact of the case before the Division Bench, therefore, the amount of Rs. 11,900 claimed by the assessee-company to have been incurred for test and trial was held to be capital expenditure qualifying for depreciation and development rebate. The Tribunal was, therefore, as rightly claimed by the learned advocate for the revenue, in error on the matter of principle in holding that the point of time at which a perticular manufacturing company is holding test by way of going into trial production, could be said to be sufficient point where it can be held to be in a position to go into commercial production. The real test indicated by the Supreme Court is whether, a company has put its plant and machinery and other business activities in such a shape that it was ready to go into the business of production. In that view of the matter, therefore, the Tribunal had committed clearly an error of law in holding that the company had set up its business by about the end of June, 1966. In the facts of the case, it cannot be held that it was so ready at the point of time.

8. The result is that this reference should be allowed. However, the question which had been referred to us is not happily worded and therefore, in order to bring out the real dispute between the parties in focus, we reframe the question as under :

"Whether, n the facts and in the circumstances of the case, the Tribunal was right in law in holding that the assessee had set up its business by about the end of June, 1956, since it was equipped with all the plant and machinery and the raw materials necessary for manufacturing the product ?

We answer this question as reframed by us in the negative in favour of the revenue and against the assessee. The assessee shall pay costs of this reference to the Commissioner.

9. In view of our answer to the question reframed by us in this reference, there would be no order in Income-tax Application No. 40 of 1975. Rule issued on the said application is discharged with no order as to costs.