Income Tax Appellate Tribunal - Delhi
Hughes Escorts Communications Ltd. vs Joint Commissioner Of Income Tax on 31 May, 2006
Equivalent citations: (2007)106TTJ(DELHI)1065
ORDER
N.V. Vasudevan, J.M.
1. ITA No. 184/Del/2003 is an appeal by the assessee while ITA No. 191/Del/2000 is an appeal by the Revenue. Both these appeals are directed against the order dt. 16th Oct., 2002 of the learned CIT(A)-XV, New Delhi, relating to the asst. yr. 1995-96.
2. First we shall take up for consideration the appeal of the assessee. Ground Nos. 1 and 1.1 of the grounds of appeal of the assessee, read as follow:
1. That the CIT(A) erred on facts and in law in holding that the appellant's business was set up on 6th Oct., 1994, when the first supply order from Bank of America was received, without appreciating that the business is regarded to be set up when the first of the series of commercial activity takes place;
1.1 That the CIT(A) erred on facts and in law in not holding that the business of the appellant was set up in the month of July, 1994, when a letter of intent was secured from a prospective customer, Bank of America, purchase orders for the equipment were placed and substantial commercial activity had commenced.
2.1 The above grounds can be conveniently disposed of with ground Nos. 1 and 2 raised by the Revenue, which read as under:
On the facts and circumstances of the case, the learned CIT(A) erred in:
1. holding that the date of setting up of business was 6th Oct., 1994 i.e. the date on which first supply order was secured and not 15th March, 1995 which is the date when the first hub was set up;
2. allowing revenue expenditure from 6th Oct., 1994 and not from 15th March, 1995.
3. The facts necessary for adjudication of the aforesaid grounds of appeal are as follows:
The assessee is a company. As per the object clause of the memorandum of association of the assessee, the main object of the assessee was to provide products and services to the digital satellite market place in India, in particular, to initially import and gradually produce in India, the "personal earth station", a very small aperture terminal product (hereinafter referred to as VSAT) and packet switch product line, including frame relay and ATM and to produce, in course of time other satellite communication products as requirements of the market grow. The assessee was incorporated as a company under the Companies Act, 1956 on 17th March, 1992. It obtained the certificate of commencement of business from the Registrar of Companies (hereinafter referred to as RoC) on 2nd Feb., 1993. The product of the assessee was basically to have an effective business communication system in India. The assessee had to use VSAT, which is an apparatus necessary for effective communication. VSAT can be used only after establishing, maintaining and using the communication facilities of the Department of Telecommunications (hereinafter referred to as DoT), Government of India. The assessee had made an application for grant of such licence to the DoT. The DoT had vide its letter dt. 7th July, 1994 gave a draft licence agreement to be signed on or before 20th July, 1994. On 3rd Aug., 1994 licence agreement was signed between the assessee and DoT by which the assessee was granted a licence to use the DoT facilities. The assessee had to purchase the equipments, namely, VSATs and had placed purchase order dt. 28th July, 1994 with M/s Hughes Network Systems, USA. M/s Bank of America, vide their letter dt. 3rd June, 1994 expressed their interest in purchasing and installing four VSAT PES modules to be located at Bombay, Madras, Delhi and Calcutta. The letter also mentions that it is not a letter of commitment. The above significance of dates can be summarized as follows:
Chart of dates
1. Certificate of incorporation of the company issued by RoC 17-3-1992
2. Certificate of commencement of business issued by RoC 2-2-1993
3. Draft licence agreement forwared by DoT 3-5-1994
4. Letter of intent from Bank of America for installation of VSATs 3-6-1994
5. Purchase order to HNS, USA for purchase of VSATs, etc. 28-7-1994
6. Final licence agreement signed with DoT 3-8-1994
3.1 The assessee had claimed ah expenditure of Rs. 28,96,269 as revenue expenses. These expenses were earlier capitalized for the reason that the assessee considered its business as having commenced in the month of March, 1995 and since these expenses were incurred prior to the commencement of business, in the revised return, these expenses were claimed as revenue expenses and claimed as a deduction. The plea of the assessee was that these expenses were incurred after placing of purchase order to purchase the VSAT equipments by the assessee from M/s Hughes Network Systems, USA on 28th July, .1994. According to the assessee on placing an order for purchasing the equipment, it could be said that the business of the assessee has been set up and, therefore, the expenses on and from the date on which the business has been set up are to be allowed as a revenue expenditure and does not require to be capitalized. The case of the Revenue has, however, been that the assessee company was receiving the satellite systems only in the month of February, 1995 and that the installation was completed by the assessee only on 15th March, 1995 and, therefore, it is only on 15th March, 1995 that it can be said that the business of the assessee has been set up. The AO accordingly held that the claim for deduction of the aforesaid sum as revenue expense cannot be allowed as it related to the period prior to setting up of the business of the assessee and had to be capitalized.
3.2 Before the CIT(A), the assessee again reiterated its submission that as on 28th July, 1994 when the equipments were purchased the business can be said to have been set up. The CIT(A) was of the view that it is only on 6th Oct., 1994 that Bank of America, which originally gave a letter of intent of installation of VSAT on 3rd June, 1994 formally placed an order for supply of VSATs and it is this date that can be considered as a date on which the business of the assessee had been set up.
4. The Revenue is aggrieved by the order of the CIT(A) in not upholding the order of the AO in concluding that the business commenced or was set up only on 15th March, 1995. The assessee is aggrieved by the action of the CIT(A) in not holding that the business was set up and was commenced as early as 28th July, 1994, hence the aforesaid grounds of appeal by the Revenue and the assessee before the Tribunal.
5. We have heard the rival submissions. The parties reiterated their stand as was taken before the Revenue authorities. We have considered their submissions. Before we proceed to set out the facts of the present case, we deem it proper to set out the principles emerging from the various decided cases on the question as to when it can be said that an assessee can be said to have commenced his business. The first thing which one will have to bear in mind is that there is a distinction between setting up of a business and the commencement of business. In Western India Vegetable Products Ltd. v. CIT (1954) 26 ITR 151 (Bom), it has been held that under the IT Act, what is relevant is the setting up of business and not the commencement of the business that is to be considered. The definition of the previous year as contained in Section 3 of the IT Act, 1961 reads as follows:
3. "Previous year" defined-For the purposes of this Act, "previous year" means the financial year immediately preceding the assessment year: Provided that, in the case of a business or profession newly set up, or a source of income newly coming into existence, in the said financial year, the previous year shall be the period beginning with the date of setting up of the business or profession or, as the case may be, the date on which the source of. income newly comes into existence and ending with the said financial year.
It is on the basis of this definition that the Hon'ble Bombay High Court held that for the purpose of Indian IT Act, it is the setting up of the business and not the commencement of the business that is to be considered. The Hon'ble High Court further held that when the business is established and ready to commence the business, then it cannot be said that business itself is set up but before it is ready to commence, it is not set up. It further held that there may be time gap in setting up of the business and commencement of the business and all the expenses incurred during that intervening period would be permissible deduction. In CIT v. Saurashtra Cement & Chemical Industries Ltd. , it was held that the term business connotes a continuous course of activities. 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 all other activities, is started. It was further held that in order to determine the question whether the business of an assessee has commenced or not, it is necessary to consider, what constitutes the business of the assessee. It was also laid down that in determining this question arising under fiscal legislation, one must consider what are the activities which constituted such business without being misguided by the loose expressions of vague and indefinite import. In Prem Conductors (P) Ltd. v. CIT , it was again reiterated that where the business of the assessee consists of different activities, whether the activity which was started earlier than actual commencement of the production, can be said to have been essential part of the business activity of the assessee, has to be decided considering the time at which a businessman would regard a business as having commenced and the approach must be from the commonsense point of view. Considering the principles emerging from the various decisions referred to above, we shall now examine as to what constitutes the business of the assessee.
6. In the case of CIT v. Ralliwolf Ltd. , the Hon'ble Bombay High Court had an occasion to deal with a question as to when the business of an assessee was set up. One of the objects of the company was also trading. The act of purchase for the purpose of trading or for manufacture was held to be an act, which could be construed as a date on which the business of the assessee had been set up or had commenced. The Hon'ble Delhi High Court in the case of CIT v. L.G. Electronic (India) Ltd. (2005) 199 CTR (Del) 205 : (2005) 149 Taxman 166 (Del) has again reiterated the position that setting up of the business and commencement of the business are two different aspects and once the business is set up the expenses have to be allowed as revenue expenses. The Hon'ble Madras High Court in the case of CIT v. Franco Tosi Ingegneria has held that when a letter of intent for securing a product in India was obtained, it could be said that the business of the assessee had been set up. Keeping in mind the principles merging from the aforesaid decisions, if we analyse the facts of the present case, it becomes clear that VSAT equipment is necessary for the purpose of carrying out the business of the assessee, which was to set up satellite based business communication system. The fact that this system cannot become operational without getting a licence from the DoT cannot lead to a conclusion that it is only on obtaining the licence from the DoT that it can be said that the business of the assessee has been set up. As already noticed, even the first step, namely, purchase of VSAT is an activity, which is necessary before the assessee could render the service of providing satellite based business communication system to its customers. The Hon'ble Gujarat High Court in the case of CIT v. Saurashtra Cement & Chemical Industries Ltd. (supra) was dealing with the case of the business of manufacture and sale of cement for which the raw material was limestone. The activity of extracting limestone was held by the Hon'ble High Court to be the point of time when the business was set up by the assessee. In the present case we further notice, that as early as on 3rd May, 1994 the draft licence agreement was forwarded by the DoT to the assessee. Even ignoring this, the purchase order placed by the assessee for acquiring VSAT from M/s Hughes Network Systems, USA, could be said to be the point of time on which the business of the assessee had been set up or had commenced, for the use of this equipment was necessary for the assessee's business. In our view, the CIT(A) ought to have held that the date of set up of the business was 28th July, 1994. The first purchase order placed by the assessee on 6th Oct., 1994, in our view, is not the date on which it could be said that the business of the assessee was set up. We, therefore, direct that the revenue expenses incurred on or after 28th July, 1994 be allowed as a deduction. Ground Nos. 1 and 1.1 of the appeal of the assessee are allowed' while ground Nos. 1 and 2 of the Revenue, are dismissed.
7. Ground Nos. 2 and 2.1 of the grounds of appeal of the assessee, read as follow:
2. That the CIT(A) erred on facts and in law in confirming disallowance of expenditure on entertainment to the extent of Rs. 3,50,000;
2.1 That the CIT(A) erred on facts and in law in not allowing deduction in respect of l/3rd of the expenditure on entertainment as attributable towards employees' participation.
8. The assessee had claimed business promotion expenses of Rs. 8,62,152 out of which a sum of Rs. 3,00,984 was identified and reported by the tax auditors as entertainment expenses. In the original return filed, the assessee added back a sum of Rs. 1,45,492 in the computation of income as disallowable portion of entertainment expenditure. In the revised return, the assessee claimed that l/3rd of the entertainment expenses of Rs. 3,00,984 could be attributed by the participation of the employees and that only a sum of Rs. 2,00,656 could be considered as disallowable entertainment expenses under Section 37(2) of the Act. In the revised return the assessee, therefore, considered only a sum of Rs. 95,328 as disallowable portion of the entertainment expenses. The AO, however, disallowed the entire claim of the assessee holding that the entire expenses were of an entertainment nature. The CIT(A), however, refused to allow the claim of the assessee that l/3rd of the entertainment expenses should be treated as not of the nature of entertainment expense because the employees of the assessee participated while entertaining the clients. Aggrieved by the order of the CIT(A), the assessee has preferred the present grounds of appeal.
9. We have heard the rival submissions. The Hon'ble Delhi High Court in the case of CIT v. Expo Machinery Ltd. has held that where in the discharge of their official duties the employees of a company have their food along with the company's customers in a hotel they take food while at work because it is their duty and work to entertain the customers of the company. The Court further held that any expenditure on the food and beverages of the employees when they are discharging their duties to entertain the customers of the company is to be excluded from the purview of entertainment expenses. The Court further held that when the entertainment expenses are composite consisting of expenses on customers as well as the employees, resort has to be made to an estimate in ascertaining that part of the expenses incurred on food and beverages on the employees and the part so excluded cannot be disallowed as entertainment expenses. Considering the ratio laid down by the Hon'ble Delhi High Court in the case of CIT v. Expo Machinery Ltd. (supra), we are of the view that the claim of the assessee that 1/3rd of the entertainment expenses has to be attributed towards employees participation is just and fair and deserves to be allowed. We accordingly direct the AO to consider 1/3rd of the entertainment expenses as attributable towards employees' participation and not disallowable under Section 37(2) of the Act. This ground of appeal of the assessee is allowed.
10. In the result, the appeal by the assessee, is allowed.
11. The only other ground that remains for consideration is the third ground of appeal of the Revenue, which reads as follows:
On the facts and circumstances of the case, the learned CIT(A) erred in : 3. deleting the disallowance of Rs. 11.93 lakhs out of miscellaneous expenses in absence of supporting material in view of decision of Delhi High Court in the case of Goodyear India Ltd. v. CIT .
12. The assessee had claimed a deduction of Rs. 23,87,568 under the head miscellaneous expenses. The AO was of the view that the assessee failed to file the necessary details and documentary evidence and he, therefore, disallowed 50 per cent of the expenses, which resulted in an addition of Rs. 11,93,784. Before the CIT(A), the assessee submitted that the details of the miscellaneous expenses had been duly furnished before the AO and that they related to the general maintenance, insurance, payment to auditors, postage, security, etc. The assessee also pointed out that the auditors have not given any adverse remarks on these expenses. Reliance was placed on the decision of the Hon'ble Delhi High Court in the case of Addl. CIT v. Jay Engineering Works Ltd. , wherein the Hon'ble High Court has opined that the auditors report can be relied upon by the Revenue authorities. It was also submitted that without pointing out any specific item of disallowable nature the AO was not entitled to make any disallowance. The CIT(A) deleted the addition made by the AO for the reasons given in para 4.2 of his order, which reads as follows:
On going through the details of the expenses, which were furnished before the AO, I find that all the said expenses appear to be legitimate business expenses. As mentioned above, the expenses are mainly on account of general maintenance, insurance, security, payment to auditors, etc., and no presumption can be made that such expenses, which have been duly certified by the auditors, could include expenses not incurred for the purposes of the business. Considering the nature of expenses and the decision of the Delhi High Court, cited by the appellant, the addition made by the AO is deleted.
13. Aggrieved by the order of the CIT(A), the Revenue has preferred the aforesaid ground of appeal.
14. We have heard the rival submissions. The details of the expenses are available from page Nos. 102 to 159 of the assessee's paper book. A perusal of the nature of expenses clearly shows that they were part and parcel of the expenses in connection with the business of the assessee. As rightly pointed out by the assessee the AO has not pointed out any item of expense, which is of a disallowable nature. We, therefore, concur with the decision of the CIT(A) on this issue and dismiss the third ground of appeal of the Revenue also.
15. In the result, the appeal by the Revenue, is dismissed.
16. In the result, the appeal by the assessee is allowed and the appeal by the Revenue, is dismissed.