When company not started its core activity, it cannot be construed that it had commenced its business

Hyderabad Metro Rail Ltd. Vs. ITO (ITAT Hyderabad)

Hyderabad Metro Rail Ltd.: when company not started its core activity, it cannot be construed that it had commenced its business and the income shown in the P&L A/c is not generated from the business activity of the assessee, rules ITAT, Hyderabad.

In Hyderabad Metro Rail Ltd. vs. ITO [ITA No. 1232/Hyd/2017, decided on 29 December, 2017], among st other grounds, it was raised that the learned CIT(A) erred in confirming the order of AO in disallowing the entire expenditure incurred on facilitation for setting up at Metro Rail project and debited to Profit and Loss account on the ground that the assessee company has not yet commenced its business and the learned CIT(A) erred in confirming the order of AO in treating the credits in income from interest and other miscellaneous income as “income from other sources”.

The brief facts of the above case were that the assessee was a Special Purpose Vehicle company formed on behalf of the Govt. of Andhra Pradesh for interacting with the BOT Developer for setting up and operation of prestigious project of “Metro Rail Development”. It filed its return of income for the A.Ys 2010-11 & 2011-12 admitting ‘Nil’ income. Subsequently, the revised returns of income were filed and during the scrutiny proceedings under section 143(3) of the Income Tax Act,1961, the AO noticed that the assessee had admitted income from:

(i) Govt. grant

(ii) Interest on deposits and

(iii) other incomes.

He also observed that the assessee claimed administrative expenditure, M.D’s remuneration and preliminary expenses written off as business expenditure. The AO observed that the assessee company is an intermediary between the Govt. of A.P. and L&T Construction for the prestigious project of Metro Rail Development in Hyderabad and that the assessee company is still in the process of constructing the infrastructure. Therefore, he was of the opinion that the assessee company has not yet started its business and the expenditure claimed is pre- operative expenditure which cannot be allowed. He also observed that the assessee has earned interest income on bank deposits and also earned other income out of activities which are not part and parcel of the business activities of the assessee and also that the expenditure debited to the P&L a/c has no connection with the earning of the above incomes. Therefore, a show cause notice was issued to the assessee. The assessee submitted its detailed reply vide letter dated 21.01.2013, according to which, the assessee was incorporated mainly to plan, build and commercially operate/facilitate building and commercial operation of various mass transit systems and that the first limb of the activities does not generate any revenue as it is only to develop or facilitate to develop the transport systems. It was submitted that for the years under consideration, the assessee company had undertaken only the first mentioned limb of the activity i.e. developing or facilitating the development of the transport system and therefore, the assessee has in fact commenced its business. However, the AO was not convinced with the assessee’s contentions and held that the core objective of the assessee is to commercially operate the mass transit system and since it has not yet started its core activity, it cannot be construed that the assessee has commenced its business. Further, he also observed that the income shown in the P&L A/c is not generated from the business activity of the assessee. Therefore, he treated the business income returned by the assessee as “income from other sources“. As regards the expenditure incurred by the assessee, the AO held that the same has to be disallowed as it has no connection with the earning of the income returned by the assessee.

Against above, the assessee preferred an appeal before the CIT (A) who confirmed the order of the AO and the assessee filed second appeal before ITAT, Hyderabad.

The Hyderabad, ITAT considering the facts and circumstances of the case, rival contentions, observed that similar issue had come up before the Hon’ble Kerala High Court in the case of CIT vs. Kerala Infrastructure Investment Fund Board ((2010) 191 TAXMAN 0259) wherein the question was as to whether the assessee therein who was to finance infrastructural projects and has raised funds but had not advanced any funds, has commenced its business or not?. It was held that the answer to such questions will depend upon the facts of each case. The Honorable High Court has also considered the judgment of the Honorable Supreme Court in the case of Tuticorin Alkali Chemicals & Fertilizers Ltd vs. CIT (227 ITR 172) and at Para 3 of its order has held as under:

“3. The only question to be considered is whether the assessee can be said to have commenced business before actual advancing of any fund for any infrastructure project. Standing counsel relying on the decision of the Supreme Court in Tuticorin Alkali Chemicals & Fertilizers Ltd.’s case (supra), contended that the case herein is similar to the facts of the case decided by the Supreme Court because as in that case, income earned by the assessee is interest income on deposits made prior to the commencement of business, that is advancing of amounts for infrastructure projects. We are unable to accept the contention of standing counsel that facts in Tuticorin Alkali Chemicals & Fertilizers Ltd.’s case (supra) apply to this case, because that was a case where the company was engaged in manufacture of heavy chemicals and before starting business, it applied surplus fund in short-term deposits and earned interest, which is obviously not out of any business carried on by it. Admittedly that company was not engaged in financing and on the other hand it was an industrial company engaged in manufacture. Therefore, interest earned by it can never be income from business, more so when such interest is earned from deposits made even prior to commencement of production by the company. However, facts of this case are entirely different because the activity of the respondent is financing for infrastructure projects. In fact, it raised fund towards working capital through public borrowings by issue of bonds. Admittedly, interest earned by the respondent is on deposits of borrowed funds retained in Treasury accounts and in other Bank accounts. The question as to whether the assessee has commenced business or was carrying on business will depend upon the facts of each case. Infrastructure projects themselves are very few and respondent can fund the project only when it conforms to assessee’s norms for eligibility. The fund required for infrastructure projects is substantial and, therefore, fund has to be first raised before identifying the project to be funded. Therefore, in our view, raising of fund for project financing itself is commencement of business because fund raised is nothing but working capital to be applied for business purposes. Respondent cannot be expected to immediately advance fund because only after projects are identified and their eligibility is proved, in accordance with the norms of the respondent, they can fund a project. However, respondent cannot be expected to keep the interest bearing borrowings idle without any returns, which will lead to heavy loss. Therefore, necessarily respondent had to deploy available fund in short-term deposits to earn interest which is to be utilized for paying interest to the bond holders and to meet the administrative cost. May be months, or years, may take for funding projects. Therefore it, cannot be said that business can be said to commence only after first project is financed. In our view, the business commenced when the respondent raised fund from public through bonds issued and when they were ready with the fund to deploy for infrastructure projects which is the business of the respondent. Therefore, in our view, deposit of funds in Banks and Treasury is nothing but an activity done in the course of business and, consequently, interest earned is income from business. Since the assessee is a financing company, the interest earned by it on the funds raised through public borrowings cannot be compared to the interest earned on business like manufacturing industries and, therefore, the decision of the Supreme Court relied on by the department is not applicable to the facts of this case. Therefore, the first appellate authority as well as the Tribunal have rightly held that the assessee is entitled to all the deductions available in the computation of business income.

We, therefore, uphold the orders of the Tribunal confirming the order of the first appellate authority. Consequently, departmental appeals are dismissed”.

The learned Members of the Hyderabad, ITAT observed that in the case before us also, the assessee had acquired the land and paid compensation to the displaced land owners and has floated tenders and awarded the contract for building the infrastructure. Thus, the assessee has started its activity of planning and building the Mass Transit System. As observed by the Hon’ble High Court in the above case, infrastructure projects take time to be completed and the assessee can operate the Metro Rail System only after the infrastructure is built. Thus, in our opinion, the assessee has started its business of planning the Mass Transit System, i.e. first limb of its activity. Further, the Honorable Gujarat High Court in the case of CIT vs. Gujarat Ports Infrastructure & Development Co. Ltd reported in (2012) 20 Taxmann.com 10 (Guj.) has considered similar issue at length and at Paras 10 to 17 has held as under:

“10. Having thus heard learned counsel for the parties and having perused the documents on record, we find that the main objects outlined in the Memorandum of Association for which the respondent company was incorporated included besides others to undertake and carry on the business of promoting, organizing, managing and developing in the State of Gujarat and elsewhere minor and major ports, ship-yards, jetties, harbours and docks as well as to set up warehouses, godowns, open plots etc. appertaining to any dock. It also included the object of setting up infrastructural facilities, utilities, conveniences and amenities including roads, buildings, warehouses etc. relating to cargo-handling, ship-building, ship-repairing and ship-breaking. Besides these another main object for which the company was incorporated was to undertake, promote, develop, aid and assist all types, kinds and forms of port related activities and also to undertake, render and provide all types of services in all matters relating to ports, jetties, harbors, docks and ship- yards. It also included the object of promoting, developing, upgrading and assisting all types, kinds and forms of works, undertakings, projects or enterprises and carrying on port related activities in the State of Gujarat and elsewhere by investment in such bodies in the form of equity participation, preference participation, subscription of other securities or through any other form of financial assistance or participation and to invest the capital of the company; the money raised or borrowed by the company.

11. To achieve such main objects, the Articles of Association also listed objects incidental and ancillary to the attainment of the main objects, one of them being to work and act as agents of the Government, Municipal local Boards, Railway Contractors and suppliers.

12. Bearing in mind these main and ancillary objects of the company, we would need to peruse the materials on record. We have perused the company’s profile presented by the company before the Assessing Officer during the course of the assessment. It emerges that the company entered into collaboration with Adani Port Limited (“APL” for short) and set up a joint venture company called Gujarat Adani Port Limited in which the respondent company had 26% equity share. General public, foreign investors etc. held 49% equity share, remaining 25% equity share was held by APL. During the year relevant to assessment year 2001-02, the company had investment of Rs. 15 crores in APL. Besides thus carrying out joint venture activities with APL, the assessee had also undertaken various other activities, as can be seen from its communication dated 26.5.2004 to the Commissioner (Appeals) and had actively participated in the management of the said company.

13. From the documents on record, we further notice that the respondent company had, in consultation with the Government, participated in development of Mundra Port.

14. On the basis of such materials, if we revert back to the decision of the Tribunal under challenge we notice that the Tribunal had come to the conclusion that the assessee had set up its business. We are of the opinion that the Tribunal committed no error. As already noted, the main objects of the company included wide variety of subjects principally concerned with the development of minor ports in and outside State of Gujarat. This could be done by acting as promoters, organizers, managers and developers of the ports or also through entering into joint venture undertaking. The subsidiary objective, incidental to the main objects also envisaged the company to work and act as agent of the Government, Municipal Local Boards, Railway Contractors etc.

15. In furtherance of such objects, principal as well as ancillary, the assessee company having entered into a joint venture with another company, which was developing ports at Mundra, it cannot be stated that the business of the company was not set up.

16. It is not in dispute that any expense incurred prior to the setting up of a business would not be a permissible deduction. In the case of Prem Conductors Pvt. Ltd. v. CIT [1977] 108 ITR 65, the Division Bench of this Court relying on and referring to the decision of the Bombay High Court in the case of Western India Vegetable Products Ltd. v. CIT [1954] 26 ITR 151 observed that for deciding when a company could be said to have set up its business, what the Court has to consider is whether the business of the assessee consists of different categories and whether the activity, which was started earlier is said to have been the essential part of the business activity of the assessee. The Court held and observed as under:- “Thus, it is clear in the light of the decisions of this High Court in Saurashtra Cement and Chemical Industries’ case [1973] 91 ITR 170 (Guj) and Sarabhai Management corporation Ltd.’s case [1976] 102 ITR 25 (Guj) that what the court has to consider is, whether the business of the assessee consists of different categories and whether the activity which was started earlier than the actual commencement of the production in the instant case could be said to have been 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 activity 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. Again, as Bhagwati C.J. Has emphasized in Saurashtra Cement and Chemical Industries’ case [1973] 91 ITR 170 (Guj), 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.”

17. In view of the above judicial pronouncement, the findings of the Tribunal and our observations made herein above, we see no reason to interfere. We may also notice that in the earlier years, the case of the assessee that it had set up the business was not questioned by the Assessing Officer”.

The learned Members of the Hyderabad, ITAT held that in view of the above judgments and also in view of the fact that the Revenue has not disallowed the business expenditure claimed by the assessee in the earlier two years, we are of the opinion that the assessee has commenced its business and the expenditure has to be allowed as business expenditure.

Coming to the nature of the income earned by the assessee, the learned Members of the ITAT, Hyderabad found that it consists of (i) Govt. grant (ii) Interest on deposits and (ii) other income. The govt. has released the grant for carrying out the objects of the assessee and therefore, the govt.grant has to be considered as the business receipts of the assessee. The interest on deposits is the interest earned by the assessee on deposits made by the assessee of the unutilized funds as short term deposits. It is thus clear that the funds are for business purposes of the assessee and when they are not immediately needed, instead of keeping them idle, the assessee is parking them in short term deposits. The funds received by the assessee are for the purpose of the business of the assessee but it is for commercial exploitation of the unused funds, that they are parked as short term deposits. Therefore, we hold that interest income is business income. The decision of the Honorable Supreme Court in the case of Tutocorin Alkali Chemicals & Fertilizers Ltd (Supra) is not applicable to the facts of the case before us. The Honorable Supreme Court in the case of SA Builders reported in 288 ITR (1) S.C. has held that where the interest bearing funds are advanced without interest for commercial expediency, then the interest paid on such borrowings is to be allowed. Applying the said principle of commercial expediency in a counter situation, where the assessee earns interest on its business receipts which are temporarily not required for business, and are parked in banks for earning of interest in order to reduce the cost, then the same attains the nature of business income. As regards, the other miscellaneous income details were not given, therefore, the learned Members of the ITAT, Hyderabad inclined to treat the miscellaneous income as “income from other sources”.