There is a distinction between setting up and commencement of a business. When a business is established and is ready to commence business, it can be said that the business is set up. However, before it is ready to commence its initial activity, the business is not set up. There may be an interregnum, there may be an interval between a business, which is set up and a business, which is commenced. All expenses incurred during the interregnum after the setting up of the business but before its commencement would be permissible deductions.
Just as income is taxable from the date on which the business is set up, likewise, all expenditure incurred for the purpose of the business and all allowances and deductions under the Income Tax Law would be available from the date of the setting up of the business though the actual commencement of the business may be at a later point of time.
Therefore, it is necessary to determine when the assessee has set up its business. There are a few decisions on this point, which unfortunately do not lay down a specific and clear-cut test to determine the date of setting up of a business. Western India Vegetable Products Ltd v CIT (26 ITR 151); CIT v Sarabhai Sons Pvt Ltd (90 ITR 318); CIT v Parekh and Co (India) Ltd (29 ITR 661 (SC)) and Travancore-Cochin Chemicals (P) Ltd. v. C.W.T. (65 I.T.R. 651 (S.C.)). In the case of Western India Vegetable Products Limited, the Bombay High Court held that a business was said to be set up when raw materials were purchased.
In the case of Sarabhai Sons Private Limited, the assessee placed orders for the machinery, equipment, raw materials and stores in January 1966. 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 ended on March 31, 1966, should be allowed as a revenue deduction in computing the trading profits of the assessee.
According to the High Court, the new business could not be said to be ready to discharge the function for which it was established, namely, the manufacture of scientific instruments and communication equipment, until the machinery necessary for the purpose of manufacture was installed. Obtaining land on lease, placing orders for machinery and raw materials were merely operations for the setting up of the business.
In the present case, the business could not be said to be set up until July 1966, when the machinery had been installed and the factory was ready to commence business. Hence, the court held that revenue expenditure incurred before that date would not be a permissible deduction for the assessment year 1966-67.
This point came up recently before the Delhi High Court in CIT v Hughes Escort Communications Ltd (311 ITR 253). The facts in the case were that the assessee carried on the business of satellite business communications for which a very small aperture terminal VSAT equipment was used. The VSAT could be used only after establishing, maintaining and using the communication facilities on a licence from the department of telecommunications.
The assessee made an application to the department of telecommunications for grant of such licence. On August 3, 1994, a licence agreement was entered into between the assessee and the department of telecommunications. The assessee placed a purchase order dated July 28, 1994, with H of USA for the purchase of the VSAT equipment.
In its return for the assessment year 1995-96, the assessee claimed an expenditure of Rs 28,96,269. The assessing officer rejected the claim on the ground that the assessee had begun receiving the satellite signals only in the month of February 1995, and further ,since the installation was complete only on March 5, 1995, it could be said that the business of the assessee had been set up only on March 5, 1995. The Tribunal, however, allowed the assessees claim.
Relying on the judgment in Western India Vegetable Products Ltd v CIT (26 ITR 151) and other judgments, including the judgment in CIT v LG Electronic (India) Ltd (282 ITR 545), the Tribunal held that the setting up of business and commencement of the business can be on two different dates. It was held that the business was set up on July 28, 1994, on which date the assessee had placed a purchase order on M/s Hughes Network Systems, USA. Accordingly, the revenues appeal was dismissed and the assessees appeal allowed.
On further appeal, the High Court observed that the important question to be considered was from which date are the expenses of a business to be considered permissible deductions Section 2 (34) defines previous year and for the purpose of a business the previous year begins from the date of setting up of the business.
Turning to the facts before it, the Delhi High Court held that the business of the assessee involved different activities in which the first step was the purchase of the VSAT equipment. There was no question of the assessee having to place a purchase order with M/s Hughes Network Systems, USA, for a purpose other than that of its business. The purchase order was placed on July 28, 1994. The application to the department of telecommunications for licence and the receipt of the satellite signals were the consequential stages.
The signals were to be received after the VSAT equipment was installed in the premises of the customer. In the circumstances, the court was of the view that the business of the assessee should be held to have been set up on July 28, 1994. This is the relevant date for determining the nature of the expenses incurred thereafter.
The aforesaid decision throws considerable light on the principle applicable to the setting up of a business.
The author is advocate, Supreme Court