THE issues before the Special Bench are - Whether business can be said to have been set up from the date when one of the categories of business activities among various activities is started and it is not necessary 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; Whether flow of revenue is a condition precedent for coming to a conclusion that business of the Assessee has been set up and Whether it is open to the Revenue to challenge the constitution of Special Bench. And the verdict goes against the Revenue.
(2002-TIOL-99-SC-IT);
Facts of the case
The Assessee is a Company, established as a wholly-owned Government Company to carry out the execution of Sardar
The Assessee is a Company, established as a wholly-owned Government Company to carry out the execution of Sardar
Sarovar Project - an inter-state multi-purpose project of four States viz. Madhya Pradesh, Maharashtra, Gujarat and Rajasthan with a terminal major dam on the river Narmada in Gujarat. The Government of Gujarat executed a part of the project and on being advised, it decided to form a Nigam and it passed a resolution vide the Government of Gujarat, Narmada Development Department's Resolution No.NMD/1073(86)/ 33(2)/H dated 21-3-1988. The assessee Corporation was granted Certificate of Commencement of Business by the ROC, Gujarat on 9th May, 1988.
No profit and loss account was prepared by the assessee in any of the years (AY 1989-90 to 2000-01) and in Note No. 7 forming part of the accounts in the Annual Report 1988-89 it was mentioned that (a) No Profit and Loss Account for the period from 24th March, 1988 to 31st March, 1989 has been prepared as the Projects of the Company were under construction and the Company's operation of supply of water and power had not commenced by 31st March, 1989; and (b) Most of the items classified under incidental expenditure during construction, according to the Company, were relating to the Project and it was therefore the intention of the Company to capitalize the same as and when the commercial operations commenced."
The position of the project executed and establishment of infrastructure continued upto the previous year relevant to the A.Y. 2000-2001. Pending project completion /construction, the money available with the assessee, out of capital contribution by the Govt. of Gujarat and also the borrowings, which could not be utilized for construction immediately, became surplus and was invested in short-term deposits with the banks and the assessee earned interest thereon in all these years.
Pursuant to the notice Under Section 148, the assessee filed return of income for the years under consideration, claiming all expenditure incurred by it as business expense, even though in the books of account, the expenditure was capitalized and carried and debited to work-in-progress. The assessee corporation/Nigam contended that it was incorporated with the sole purpose of construction of dam, canals and power houses and there is no provision to continue to operate, once construction is complete and, therefore, the Nigam was carrying on the construction business, and therefore, the moment it had put first bricks for construction and started its first activity with regard to construction, it has commenced its business activity. As a consequence it claimed that the all revenue expenditure incurred by it for the purpose of carrying on its business have to be allowed as deduction. If it is so allowed as claimed by the Assessee, then the result of computation under the head “Income from Business” would be a loss. Even if interest income is taxed under the head “Income from other sources”, the loss under the head “Income from Business” will be set off against “Income from other sources” and if so set off, admittedly there would be no total income which will be chargeable to tax. As already stated, the Assessee deposited funds raised by it by issue of bonds etc., which were lying idle in banks and earned interest on such deposits. The Assessee also claimed that the interest it paid to the bond holders should be allowed as a deduction against interest that it earned on deposits u/s.57(iii) of the Act.
The Assessee took a stand before the AO that the main object for the formation of the company was to construct dams and canals etc., and the business has commenced from the very first year of incorporation of the Assessee. The AO held that the Assessee was not a contractor and therefore the contention that on formation and beginning of construction activities, it cannot be said that the business of the Assessee has commenced.
The Assessee claimed before the AO that receipts by way of rent, tender fees, miscellaneous recovery, interest etc., are incidental and inextricably linked with the project and hence have to be set off against the sums that have to be capitalised and cannot be brought to tax as “Income from other sources”. The Assessee took a plea before the AO that the facts as it prevailed in AY 01-02 are different from the earlier years.
Apart from the above, the Assessee also submitted that the Assessee generated income from supply of water. Later it turned out that the water charges received were not for water released by Narmada Canal but were for the water supplied from Shedhi Branch canal which belonged to the Government of Gujarat and which was transferred to the Assessee on 19.3.1987 for rotational water supply. These water charges were subsequently transferred back to Government of Gujarat. The facts with regard to supply of water on an emergency basis by using the facilities already created by the Assessee viz., partially completed Narmada Main Canal, as stated in the earlier paragraph of this order are not disputed.
The AO concluded that the Assessee has not commenced its business. The AO thereafter held that interest income earned by the Assessee has to be brought to tax under the head “income from other sources”. The CIT(A) dismissed the appeals of the assessee.
On further appeal, originally a Division Bench heard the appeal. On the issue raised by the Assessee in Gr.No.9 viz., administrative expenses, vehicles expenses, interest expenses etc., which were debited in the books of accounts as “Incidental Expenditure Pending capitalisation” ought to be allowed as deduction u/s.57 of the Act while computing income under the head “income from other sources”, the Division Bench found that in Assessee’s own case for AY 89-90 to 2000-01 the Tribunal had by its order dated 31.8.2004 disallowed similar claim of the Assessee. The order of the Tribunal is since reported as JCIT Vs. Sardar Sarovar Narmada Nigam Ltd. (2005-TIOL-55-ITAT-AHM). The Division Bench found that in subsequent decisions viz., ACIT Vs. Torrent Gujarat Biotec Ltd. In ITA No.3139 & 3140/Ahd/1996 for AY 93-94, the Tribunal by its order dated 5.6.2009 had taken a contrary view on the question whether interest expenditure on funds borrowed pending utilisation for the purpose for which it was borrowed, if it yields interest income on its deployment in deposits, whether would be allowed as deduction as expenditure incurred for earning interest income. The Division Bench also found that the decision in the case of Torrent Gujarat Biotec was followed in another case by the Tribunal in Jhagadia Copper Ltd. ITA No.3741/Ahd/2007 order dated 13.11.2009. The Division Bench therefore made a reference to the President of the Tribunal for constitution of a Special Bench to decide the following question: (1) “Whether, interest expenditure incurred by the assessee on amount though borrowed for the purpose of business but pending such utilization, is actually utilized for earning interest income, can such interest expenditure be held as expended for the purpose of earning interest income in view of the provisions of section 57 (iii) of the Act or not?” and (2) “Whether on the facts and circumstances of the case, interest expenditure incurred on borrowed funds which were actually utilized for earning of interest income is to be allowed as deduction from the gross interest receipts or not for computing the income assessable under section 56 of the Act?”
The DR raised a preliminary objection for reference to the Special Bench and submitted that the order of the President referring the entire appeal for consideration by the Special Bench as against the questions referred to by the Division Bench was passed without notice to the Department. According to him the appeal of the Assessee, in so far as it relates to grounds other than the one referred for consideration by a Special Bench by the Division Bench, has already been decided by the Tribunal in Assessee’s own case in the earlier assessment years and therefore there is no reason for referring the issues raised in those grounds for consideration by a Special Bench. According to the DR, consideration by the Special Bench of those issues other than the question referred to Special Bench by the Division Bench would be virtually reviewing the earlier order of the Tribunal. It was his submission that in the circumstances, reference of the entire appeal for consideration by the Special Bench would require reconsideration and for this purpose, the Revenue should be afforded opportunity to make appropriate application to the President of the Tribunal.
The Assessee on the other hand submitted that the question whether Business of an Assessee had been set up during the previous year relevant to a particular assessment year is a question of fact to be decided on the facts and circumstances prevailing in a particular assessment year and therefore the earlier order of the Tribunal cannot hold good for all assessment years. It was his submission that reference of the entire appeal to a special bench would therefore not amount to review of the earlier order of the Tribunal. The above submission was made by him without prejudice to his submission that the President in exercise of his administrative powers is entitled to refer any case for consideration by a Special Bench. It was also submitted that no party to a proceeding can be allowed to challenge the order of President of the Tribunal referring a case for consideration by a Special Bench.
Having heard the matter, the Special Bench held that,
++ the preliminary objection raised by the DR cannot be accepted. The power of President of the ITAT to constitute a Special Bench suo motu by an administrative order is no longer res judicata and has been settled by the Supreme Court in the case of ITAT v. DCIT
No profit and loss account was prepared by the assessee in any of the years (AY 1989-90 to 2000-01) and in Note No. 7 forming part of the accounts in the Annual Report 1988-89 it was mentioned that (a) No Profit and Loss Account for the period from 24th March, 1988 to 31st March, 1989 has been prepared as the Projects of the Company were under construction and the Company's operation of supply of water and power had not commenced by 31st March, 1989; and (b) Most of the items classified under incidental expenditure during construction, according to the Company, were relating to the Project and it was therefore the intention of the Company to capitalize the same as and when the commercial operations commenced."
The position of the project executed and establishment of infrastructure continued upto the previous year relevant to the A.Y. 2000-2001. Pending project completion /construction, the money available with the assessee, out of capital contribution by the Govt. of Gujarat and also the borrowings, which could not be utilized for construction immediately, became surplus and was invested in short-term deposits with the banks and the assessee earned interest thereon in all these years.
Pursuant to the notice Under Section 148, the assessee filed return of income for the years under consideration, claiming all expenditure incurred by it as business expense, even though in the books of account, the expenditure was capitalized and carried and debited to work-in-progress. The assessee corporation/Nigam contended that it was incorporated with the sole purpose of construction of dam, canals and power houses and there is no provision to continue to operate, once construction is complete and, therefore, the Nigam was carrying on the construction business, and therefore, the moment it had put first bricks for construction and started its first activity with regard to construction, it has commenced its business activity. As a consequence it claimed that the all revenue expenditure incurred by it for the purpose of carrying on its business have to be allowed as deduction. If it is so allowed as claimed by the Assessee, then the result of computation under the head “Income from Business” would be a loss. Even if interest income is taxed under the head “Income from other sources”, the loss under the head “Income from Business” will be set off against “Income from other sources” and if so set off, admittedly there would be no total income which will be chargeable to tax. As already stated, the Assessee deposited funds raised by it by issue of bonds etc., which were lying idle in banks and earned interest on such deposits. The Assessee also claimed that the interest it paid to the bond holders should be allowed as a deduction against interest that it earned on deposits u/s.57(iii) of the Act.
The Assessee took a stand before the AO that the main object for the formation of the company was to construct dams and canals etc., and the business has commenced from the very first year of incorporation of the Assessee. The AO held that the Assessee was not a contractor and therefore the contention that on formation and beginning of construction activities, it cannot be said that the business of the Assessee has commenced.
The Assessee claimed before the AO that receipts by way of rent, tender fees, miscellaneous recovery, interest etc., are incidental and inextricably linked with the project and hence have to be set off against the sums that have to be capitalised and cannot be brought to tax as “Income from other sources”. The Assessee took a plea before the AO that the facts as it prevailed in AY 01-02 are different from the earlier years.
Apart from the above, the Assessee also submitted that the Assessee generated income from supply of water. Later it turned out that the water charges received were not for water released by Narmada Canal but were for the water supplied from Shedhi Branch canal which belonged to the Government of Gujarat and which was transferred to the Assessee on 19.3.1987 for rotational water supply. These water charges were subsequently transferred back to Government of Gujarat. The facts with regard to supply of water on an emergency basis by using the facilities already created by the Assessee viz., partially completed Narmada Main Canal, as stated in the earlier paragraph of this order are not disputed.
The AO concluded that the Assessee has not commenced its business. The AO thereafter held that interest income earned by the Assessee has to be brought to tax under the head “income from other sources”. The CIT(A) dismissed the appeals of the assessee.
On further appeal, originally a Division Bench heard the appeal. On the issue raised by the Assessee in Gr.No.9 viz., administrative expenses, vehicles expenses, interest expenses etc., which were debited in the books of accounts as “Incidental Expenditure Pending capitalisation” ought to be allowed as deduction u/s.57 of the Act while computing income under the head “income from other sources”, the Division Bench found that in Assessee’s own case for AY 89-90 to 2000-01 the Tribunal had by its order dated 31.8.2004 disallowed similar claim of the Assessee. The order of the Tribunal is since reported as JCIT Vs. Sardar Sarovar Narmada Nigam Ltd. (2005-TIOL-55-ITAT-AHM). The Division Bench found that in subsequent decisions viz., ACIT Vs. Torrent Gujarat Biotec Ltd. In ITA No.3139 & 3140/Ahd/1996 for AY 93-94, the Tribunal by its order dated 5.6.2009 had taken a contrary view on the question whether interest expenditure on funds borrowed pending utilisation for the purpose for which it was borrowed, if it yields interest income on its deployment in deposits, whether would be allowed as deduction as expenditure incurred for earning interest income. The Division Bench also found that the decision in the case of Torrent Gujarat Biotec was followed in another case by the Tribunal in Jhagadia Copper Ltd. ITA No.3741/Ahd/2007 order dated 13.11.2009. The Division Bench therefore made a reference to the President of the Tribunal for constitution of a Special Bench to decide the following question: (1) “Whether, interest expenditure incurred by the assessee on amount though borrowed for the purpose of business but pending such utilization, is actually utilized for earning interest income, can such interest expenditure be held as expended for the purpose of earning interest income in view of the provisions of section 57 (iii) of the Act or not?” and (2) “Whether on the facts and circumstances of the case, interest expenditure incurred on borrowed funds which were actually utilized for earning of interest income is to be allowed as deduction from the gross interest receipts or not for computing the income assessable under section 56 of the Act?”
The DR raised a preliminary objection for reference to the Special Bench and submitted that the order of the President referring the entire appeal for consideration by the Special Bench as against the questions referred to by the Division Bench was passed without notice to the Department. According to him the appeal of the Assessee, in so far as it relates to grounds other than the one referred for consideration by a Special Bench by the Division Bench, has already been decided by the Tribunal in Assessee’s own case in the earlier assessment years and therefore there is no reason for referring the issues raised in those grounds for consideration by a Special Bench. According to the DR, consideration by the Special Bench of those issues other than the question referred to Special Bench by the Division Bench would be virtually reviewing the earlier order of the Tribunal. It was his submission that in the circumstances, reference of the entire appeal for consideration by the Special Bench would require reconsideration and for this purpose, the Revenue should be afforded opportunity to make appropriate application to the President of the Tribunal.
The Assessee on the other hand submitted that the question whether Business of an Assessee had been set up during the previous year relevant to a particular assessment year is a question of fact to be decided on the facts and circumstances prevailing in a particular assessment year and therefore the earlier order of the Tribunal cannot hold good for all assessment years. It was his submission that reference of the entire appeal to a special bench would therefore not amount to review of the earlier order of the Tribunal. The above submission was made by him without prejudice to his submission that the President in exercise of his administrative powers is entitled to refer any case for consideration by a Special Bench. It was also submitted that no party to a proceeding can be allowed to challenge the order of President of the Tribunal referring a case for consideration by a Special Bench.
Having heard the matter, the Special Bench held that,
++ the preliminary objection raised by the DR cannot be accepted. The power of President of the ITAT to constitute a Special Bench suo motu by an administrative order is no longer res judicata and has been settled by the Supreme Court in the case of ITAT v. DCIT
++ further, it is not open to the revenue to challenge the constitution of Special Bench before us. Nevertheless, the primary argument of the assessee on the question whether business of the assessee has been set up during the previous year relevant to AY 2000- 01, is based mainly on facts as it prevails in the previous year relevant to assessment year 2001-02. The question whether the business of the assessee can be said to have been set up during the previous year is a mixed question of both, law and facts, and therefore dependent on the facts that prevailed during the previous year relevant to assessment year 2001-02. It is open to the Tribunal to come to the conclusion as to whether the business of the assessee was set up during the previous year. Therefore, there would be neither a review of the decision rendered by the Tribunal in assessee’s case for the A.Y. 1989-90 to 2000-01. We are also conscious of the fact that the aforesaid decision of the Tribunal for the earlier years are pending for consideration by the High Court of Gujarat. We would, therefore, confine ourselves to the issues raised by the assessee in the grounds of appeal, keeping in mind the facts and circumstances as it prevailed in the assessee’s case during the previous year relevant to A.Y. 2001-02;
++ as already mentioned, we will consider the issue as to whether the Assessee had set up/commenced its business during the previous year relevant to AY 01-02, in the light of the facts that prevailed during the previous year relevant to AY 01-02. The above issue arises because of the requirement of the law that profits and gains of new business can be computed only when the business is set up. Sec. 3 of the Act defines “Previous Year”;
++ the previous year for a business newly set up will be the period beginning with the date of setting up of the business. Till such time the business is set up, all expenses even if in the nature of revenue expenses will have to be capitalized. There will be no computation of income under the head “Income from Business” in respect of such business for the period before the business is set up. It is because of the above provision, the revenue is taking a stand that the business of the Assessee has not been set up and therefore there can be no computation of income under the head “Income from Business”. There are no receipts of business during the previous year. If the business is held to be set up during the previous year, then there has to be computation of income under the head “Income from Business”. If such computation is done then all revenue expenses have to be allowed as deduction. Since there are no receipts of business the expenses so allowed will result in loss under the head “Income from Business”. Such loss will be available for set off against income under any other head of income u/s.71 of the Act;
++ another aspect which is required to be kept in mind is that there is a clear distinction between a person commencing a business and a person setting up a business and for the purposes of the Indian Income-tax Act. In Western India Vegetable Products Vs. CIT 26 ITR 151 (Bom), the Bombay High Court held that the setting up of the business and not the commencement of the business that is to be considered;
++ the Revenue authorities have proceeded on the basis of facts as contained in the Directors report to the shareholders of the Assessee in 13th Annual Report for the year 2000-01. The said report has been accepted as disclosing the real state of affairs both by the Assessee and the Revenue. We shall therefore proceed to decide the issue on the basis of the said report;
++ the Assessee was formed for the purpose of construction of canal for supply of water for all purposes and also construction of dam for generation of power and distribution of water through the canal. It is the claim of the Assessee that during the year under consideration it had started the activity of supplying water to the people through its canal from the Narmada Dam. The Assessee in this regard relied on its Director’s report in the annual report for 2000-01;
++ the above facts as claimed by the Assessee are not disputed by the Revenue. The AO did not however consider the above claim of the Assessee but proceeded to discuss the supply of water from Shedhi Branch canal for which income was received but later refunded to the Government. From the order of the AO the only reason which one can cull out for rejecting the claim of the Assessee was that the supply of water through canals done by the Assessee was not for commercial exploitation as no revenue was earned by the Assessee on such supply of water;
++ It is thus clear that there was supply of water through the Narmada canal as claimed in the Directors report. The question that would arise for our determination would be as to whether partially completed canals which were put to use by the Assessee for supply of water would be sufficient to hold that the business of the Assessee has been set up during the previous year, to be exact as on 21.2.2001 when the supply of water started as mentioned in the Directors report.
++ With the particular stage of completion of the main canal and branch canals, the Assessee could manage to supply water from Narmada river. The reference to the main canal having been partially completed should be taken as incomplete upto the desired destination. The Assessee could achieve supply of water through its completed canals completed upto a particular length;
++ Gujarat High Court in the case of Saurashtra Cement & Chemical Industries has laid down that business is nothing more than a continuous course of activities and all the activities which go to make up the business need not be started simultaneously in order that the business may commence. The business would commence when the activity which is first in point of time and which must necessarily precede the other activities is started;
++ the fact that through the completed canals the Assessee was able to supply water would be sufficient to hold that the Assessee was ready to serve the purpose for which it was formed. Business can be said to have been set up from the date when one of the categories of business activities among various activities is started and it is not necessary 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. 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;
++ the Tribunal in the earlier assessment years after analyzing the objects clause of the Memorandum of Association, the audit notes, statements in the prospectus and other circumstances came to the conclusion that the assessee Corporation is to engage itself in all other work incidental or ancillary to the project. The Tribunal concluded that the ultimate aim of the project is to develop irrigation system and a network of hydro-electric power generation for consequential exploitation and such exploitation was incidental (i.e. liable to happen as a consequence) to the above project which would ultimately lead to generation of revenue. The Project includes the provision of infrastructure and operation and exploitation thereof for supply and distribution of water and electricity i.e. not only to construct the dams but to exploit the same;
++ the above conclusions of the Tribunal are in challenge by the Assessee in the appeal before the High Court against the order of the Tribunal. Even assuming the above findings to be true, it can be seen that the business of the assessee consists of different categories. Construction of dams and canals would be the activity which would precede the other activities and an essential part of the business activity of the Assessee. The company can be said to have set up its business from the date when one of the categories of its business is started and it is not necessary 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. 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;
++ one of the main object of the Assessee as per Clause 3(A)(10) of the Memorandum of Association is to “To promote Schemes for irrigation and water supply in the State for utilization of water from the Sardar Sarovar". In the light of the facts prevailing in Assessee’s case, it can be said that the Assessee by supplying water through its main canal had in fact achieved the purpose for which it was established. One of the purpose for which the Assessee was set up was to supply water through canals. The canal was complete in respect of part of the stretch and that enabled supply of water through such canal to certain destinations. The fact that the entire stretch of canal up to the desired destination was not completed would not be sufficient to hold that the Assessee’s business was not set up;
++ the flow of revenue from supply of water is not relevant. The AO as well as CIT(A) have misdirected themselves in this regard by laying emphasis on flow of revenue as a condition precedent for coming to a conclusion that business of the Assessee has been set up. In fact in the past the revenue has been taking a stand that flow of water through the canal would be the point of time when the business of the Assessee can be said to be set up. When that happened, the revenue is taking a stand that there should be flow of revenue on supply of water and only then it can be said that the business of the Assessee has been set up. This apparent contradiction in the stand taken by the Revenue is not acceptable. In any event the question whether business of an Assessee is set up or not is a question which would depend on facts of a given case and the stand taken by the revenue regarding absence of flow of revenue would be irrelevant;
++ for the reasons given above, the business of the Assessee was set up on 21.2.2001 when water was supplied through the main canals and all revenue expenditure after that date have to be allowed as deduction. If business of the Assessee is held to be set up on 21.2.2001 then the proportionate expenses for the period from 21.2.2001 to 31.3.2001 would be much more than the interest income brought to tax. Therefore the other issues raised by the Assessee in its appeal, do not require any adjudication in view of above conclusion on the commencement/ setting up of business.
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