Swaraj Corporation Vs DCIT (ITAT Ahmedabad)
Expenses Incurred After Business Is Set Up but Before Commercial Operations Are Deductible: Ahmedabad ITAT
Summary: The appeal was filed by M/s. Swaraj Corporation against the order of the Commissioner of Income Tax (Appeals)-12, Ahmedabad, relating to Assessment Year 2015-16. The assessee, a partnership firm engaged in real estate development, was constituted on 14.12.2011. Its business involved development of agricultural land contributed by the partners as capital into residential plots.
During assessment proceedings, the Assessing Officer noticed that the assessee had debited Rs.2,07,39,569/- to the Profit and Loss Account under the head “Pre-operative Expenditure”. The amount represented administrative, selling, financial and miscellaneous expenses incurred during FY 2011-12, 2012-13 and 2013-14, relevant to AYs 2012-13, 2013-14 and 2014-15. The assessee explained that various statutory permissions were required before the developed plots could legally be transferred to customers. The final permission for conversion of land for Non-Agricultural residential use was granted by the Collector, Anand, on 04.01.2014. According to the assessee, commercial operations in the form of entering into agreements for sale commenced thereafter, and the accumulated expenditure was therefore claimed in AY 2015-16.
The Assessing Officer, applying the mercantile system of accounting and referring to sections 4, 5 and 28 of the Income-tax Act, 1961, treated the expenditure as prior-period expenditure because the relevant liabilities had accrued and crystallized in earlier years. The entire amount of Rs.2,07,39,569/- was consequently disallowed.
The CIT(A) upheld the disallowance. It relied, among other things, upon the principle that a liability is deductible in the year in which it crystallizes and held that the expenses could not simply be deferred and claimed in a later year. The CIT(A) also invoked the matching principle and noted that the assessee had not furnished sufficient details showing the revenue recognised from the project during the year. Further, in respect of borrowing costs including “Interest on Unsecured Loan” and “Interest on Vehicle Loan”, the CIT(A) found that the assessee had failed to establish the requisite nexus between borrowed funds and their utilisation for the business.
Before the Tribunal, the assessee contended that the expenditure was not prior-period expenditure because it had been recorded in the respective years and carried forward as pre-operative expenditure since commercial operations commenced only after receipt of the NA permission on 04.01.2014. It was submitted that the expenses were revenue in nature, incurred wholly and exclusively for business purposes and allowable under section 37(1) of the Act. The assessee also relied upon Ind AS 16 for its accounting treatment.
The Tribunal distinguished between a business being “set-up” and the actual “commencement” of business. It observed that expenses incurred during the inter-regnum between setting up of business and commencement of business would be permissible deductions and that whether a business has been set up is essentially a question of fact. In the case of the assessee, the Tribunal held that the business could be regarded as having been set up in 2011 once the firm was formed and land was acquired, while commencement took place when NA permission was granted in January 2014 and the assessee entered into agreements for sale.
The Tribunal therefore held that the expenses claimed by the assessee were deductible in principle. It held that the expenditure was incurred wholly and exclusively for the purposes of business and had been carried forward as pre-operative expenditure because commercial operations commenced only after receipt of the NA permission on 04.01.2014. The Tribunal found the provisions of section 37(1) applicable.
However, the Tribunal did not finally allow the quantified expenditure without further examination. It held that relevant details and supporting documents concerning the nature of expenditure, commencement of business, revenue recognised during the year and utilisation of borrowed funds, particularly interest expenditure governed by section 36(1)(iii), required proper examination.
Accordingly, the Tribunal restored the matter to the file of the CIT(A) for de-novo adjudication. The CIT(A) was directed to examine the issue afresh after considering complete details and supporting evidence and after providing adequate opportunity of hearing to the assessee. The Tribunal directed that the principle laid down in its order should be adhered to, while the assessee was required to comply with notices and furnish all relevant documents and explanations. The appeal was therefore allowed for statistical purposes.
Cases Discussed
- Bharat Earth Movers Ltd. v. CIT (Supreme Court)
- SMCC Construction India Ltd. v. Asst. CIT (Delhi High Court)
- Majestic Auto Ltd. (Punjab & Haryana High Court)
- Core Healthcare Ltd. (ITAT Ahmedabad)
FULL TEXT OF THE JUDGMENT/ORDER OF INCOME TAX APPELLATE TRIBUNAL
The captioned appeal has been filed by the assessee against the order passed by the Ld. Commissioner of Income Tax (Appeals)-12, Ahmedabad (in short “Ld. CIT(A)”) vide order dated 16.10.2025 relevant to Assessment Year 2015-16.
2. The assessee has raised the following grounds of appeal:
1. Ld. CIT (A) erred in law and on facts confirming disallowance made by AO of preoperative expenses of Rs. 2, 04, 85, 862/- claimed by the appellant.
2. Ld. CIT (A) gravely erred on facts observing that most of the notices issued u/s 250 of the Act remained unattended without fresh compliance and reply furnished earlier was taken into consideration for adjudicating the appeal.
3. Ld. CIT (A) erred in law and on facts confirming that expenditure incurred was in the nature of ‘prior period expenses’ as the liability for the same had crystalized and was paid/ payable during earlier assessment years.
4. Ld. CIT (A) erred in law and on facts confirming disallowance when expenses were duly accounted for in the books of account in respective years in which they were incurred and ITR for those years were also filed in time.
5. Ld. CIT (A) erred in law and on facts not appreciating the fact that expenses are of revenue in nature incurred wholly and exclusively for the purpose of business that are allowable u/s 37(1) of the Act.
6. Ld. CIT (A) erred in law and on facts to hold that claim based on accounting standard AS 16 for capital assets to justify the timing of revenue expenses is illogical and legally untenable.
7. Levy of interest u/s 234A/234B/234C of the Act is unjustified.
8. Initiation of penalty proceedings u/s 271(1)(c) of the Act is unjustified.
3. The brief facts of the case are that the appellant is a partnership firm constituted by a partnership deed dated 14.12.2011 and is engaged in the business of real estate development. During the course of assessment proceedings, the Assessing Officer noticed that the appellant had debited an amount of Rs.2,07,39,569/- to its Profit and Loss Account under the head “Pre-operative Expenditure”. On being called upon to explain the same, the appellant submitted that the said amount represented an accumulation of various administrative, selling, financial and other miscellaneous expenses incurred by the appellant-firm during the financial years 2011-12, 2012-13 and 2013-14, relevant to Assessment Years 2012-13, 2013-14 and 2014-15, respectively. The assessee explained that its business activity involved development of agricultural land, contributed by the partners as capital, into residential plots. It was further submitted that, before the developed plots could be legally transferred to customers, the firm was required to obtain various statutory permissions from the concerned authorities. The final permission for conversion of the land for Non-Agricultural (NA) residential use was granted by the Collector, Anand, on 04.01.2014. The assessee contended that its commercial operations, in the form of entering into agreements for sale with customers, commenced during the year under consideration and, therefore, the accumulated expenditure was claimed as a deduction in the year under consideration.
4. The Assessing Officer observed that the assessee follows the mercantile system of accounting, under which expenditure is required to be accounted for in the year to which it pertains, i.e., the year in which the liability in respect thereof accrues or crystallizes. The Assessing Officer referred to sections 4, 5 and 28 of the Income-tax Act, 1961, and observed that the computation of income is made with reference to a particular previous year. Accordingly, any expenditure claimed as a deduction must pertain to the relevant previous year. After considering the submissions of the assessee and relying upon various judicial precedents referred to in the assessment order, the Assessing Officer held that the expenditure of Rs.2,07,39,569/- was in the nature of prior-period expenditure, as the liability in respect thereof had accrued and crystallized during the earlier previous years. He, therefore, held that the said expenditure was not allowable as a deduction in the year under consideration. Accordingly, the Assessing Officer disallowed the entire amount of Rs.2,07,39,569/- and added the same to the income of the assessee.
5. Aggrieved by the Assessment Order, assessee preferred an appeal before the Ld. CIT(A), who dismissed the appeal of the assessee by observing as follows:
“…It is observed that decision of Hon’ble Delhi High Court referred to supra by treating administrative and selling expenses as allowable revenue expenditure in the year they are incurred, implicitly supports the Revenue’s position that these are period costs that cannot be deferred The AO’s reliance on the judgments in Bharat Earth Movers (SC) and SMCC Construction (Delhi) is found to be correct and directly applicable. The principle that a liability is deductible in the year it crystallizes is the bedrock of the mercantile system of accounting for tax purposes. The liability for the disputed expenses clearly crystallized in the prior years, and the AO was right in disallowing the claim in the current year.
6.8 The cases of Majestic Auto Ltd (P&H) and Core Healthcare Ltd. (ITAT, Ahd.) are not applicable to the facts of the present case. These decisions dealt with the concept of “deferred revenue expenditure primarily in the context of the capital versus revenue debate (the “enduring benefit” test). They do not lay down a general principle that an assessee is free to defer the claim of ordinary, day-to-day revenue expenses and claim them in a subsequent year of its choice, thereby overriding the fundamental principles of the mercantile system of accounting
6.9 It is also observed that the “matching principle” is a fundamental accounting concept that is implicitly recognized in the computation of business income under the Act. It posits that to ascertain the true profits of a period, the revenues of that period must be matched with the expenses incurred to earn those revenues. More importantly, the appellant has failed to discharge its onus of demonstrating that the income corresponding to this project has been offered to tax in current year. The submission merely states that the firm “has started entering into sale agreement with the customers. There is no data on record to show what revenue, if any, was recognized in the books of account in current year. Claiming a massive quantum of expenditure without offering the corresponding income to tax is a flagrant violation of the matching principle and goes against the concept of taxing “real income”. It is already held that various administrative, selling expenditure and other expenditure incurred in earlier year but claimed in current year are not allowable expenditure, the Appellant at the best should have claimed only proportionate expenditure out of 2015-16 aggregate preoperative expenditure against revenue, if any, recognised in profit & loss account in current year. The Appellant has not provided any such details in appellate proceedings nor made any such alternate claim hence even on this ground no expenditure incurred in earlier years and claimed in current year can be allowed
6.10 It is observed that preoperative expenditure claimed in current year also pertains to borrowing costs, such as “Interest on Unsecured Loan” and “Interest on Vehicle Loan”. The deductibility of interest on borrowed capital is governed by Section 36(1)(iii) of the Act. A prerequisite for allowing this deduction is that the assessee must establish a direct and clear nexus between the borrowed funds and their utilization for the purposes of its business. In the present case, it is recorded as a finding of fact that the appellant has failed to furnish any evidence to establish this nexus. No documentary evidence such loan agreements, bank statements, or fund flow statements were submitted during the assessment proceedings to demonstrate that the funds against which interest was paid were, in fact, used for the real estate project and were not diverted for any non-business purpose by the partners or otherwise. In the absence of any evidence to establish this crucial nexus, the claim for deduction of borrowing costs fails on this ground alone, independent of the primary issue of it being a prior period expense.
6.11 In view of above facts, and relying upon judicial pronouncements referred supra, disallowances of preoperative expenditure for Rs 2,04,85,862/- and other non-allowable expenses of Rs.2,53,707/- while computing taxable income are upheld. This ground of appeal is dismissed.
7. In the result, the appeal is dismissed…”
6. The Ld. AR argued that the expenditure was not in the nature of prior-period expenditure, as the same was recorded in the respective years and carried forward as “Pre-operative Expenses” since commercial operations had commenced only after receipt of NA permission on 04.01.2014. It was contended that the accumulated expenditure was revenue in nature, incurred wholly and exclusively for business purposes, and was therefore allowable under section 37(1) of the Act. The Ld. AR also relied upon Ind AS 16 in support of the accounting treatment adopted by the appellant.
7. Heard the argument of both the parties and perused the material available on record.
8. The Ld. AR argued that since commercial operations i.e. entering into sale agreements only began after the Collector granted NA conversion on 04.01.2014, all administrative/selling/financial expenses accumulated across FY 2011-12 to 2013-14 should be deductible in the year business “commenced” — treating them as a form of deferred revenue expenditure, supported by Ind AS 16 accounting treatment. On the other hand the Ld. DR’s sturdiest argument was that, under the mercantile system, liability accrues and also crystallizes when incurred, not when the assessee chooses to claim it. Relying on Bharat Earth Movers and SMCC Construction, the CIT(A) treated this as ordinary prior-period expenditure with no basis for deferral. We find that the Ld. CIT(A) has confirmed the disallowance of the pre-operative expenditure primarily on the ground that the expenditure pertained to earlier years and that the appellant had not furnished sufficient details regarding the revenue recognised during the year under consideration. The Ld. CIT(A) has also recorded findings regarding the allowability of interest expenditure under section 36(1)(iii) of the Act for want of evidence establishing the nexus between the borrowed funds and the business of the appellant. In the case of Majestic Auto and Core Healthcare dealt with deferred revenue expenditure treatment where there’s an “enduring benefit”, not simply because a business hasn’t yet generated revenue. There is well-established distinction, between a business being set up, established and ready to commence and a business being commenced, actual trading/operations begin. It was time and again held that all expenses incurred during the inter-regnum between setting up of business and commencement of business would be permissible deductions under the Income Tax Act, and that whether a business has been set up is essentially a question of fact. In the business of the assessee i.e. real estate development, it can be said that the assessee had ‘set-up business’ (2011) once it had land i.e formation of the firm and acquisition of land and ‘commencement’ once the NA permission (Jan 2014) was granted, that is the date rom which the assessee entered into agreement for sale. The prior period expenditure is not default by choice but by provisions of accounting taking it away from the matching principle as canvassed by the revenue. Having examined the component business activity and the business activity as a whole, we hold that the expenses claimed by the assessee are deductible in principle.
9. We hold that the expenditure was incurred wholly and exclusively for the purposes of its business and is carried forward as pre-operative expenditure since the commercial operations commenced only after receipt of the NA permission on 04.01.2014. The provisions of section 37(1) of the Act are applicable. Nevertheless, the relevant details and supporting documents in respect of the nature of the expenditure, the commencement of business, revenue recognised during the year and the utilisation of borrowed funds, particularly in respect of interest expenditure, require proper examination. In the interest of justice, we deem it appropriate to restore the matter to the file of the Ld. CIT(A) for de-novo adjudication. The Ld. CIT(A) shall examine the issue afresh after considering the complete details and supporting evidences furnished by the assessee and after affording adequate opportunity of being heard to the assessee. The principle laid down in this order shall be adhered by the Ld. CIT(A). The assessee shall comply with the notices and furnish all relevant documents and explanations in support of its claim.
10. In the result, the appeal of the assessee is allowed for statistical purposes.
The order is pronounced in the open Court on 25.08.2026.
