ITAT MUMBAI BENCH ‘D’
Deccan Goldmines Ltd.
Assistant Commissioner of Income-tax, Range-6(2)
IT APPEAL NO. 7656 (M) OF 2010
[ASSESSMENT YEAR 2005-06]
JANUARY 31, 2013
D. Karunakara Rao, Accountant Member
This appeal filed by the assessee on 8.11.2010 is against the order of the CIT (A)-XXVIII, Mumbai dated 10.10.2008 for the assessment year 2005-2006.
2. In this appeal, assessee raised the following grounds which read as under:
“1. On the facts and circumstances of the case, the Ld CIT (A) erred in confirming the action of the AO in disallowing the administrative and other expenses amounting to Rs. 67,57,190/-.
1.1 While doing so, on the facts and circumstances of the case, the Ld CIT (A) further legally erred in giving a finding that the appellant had not set up its business.
1.2 Without prejudice and in alternative to the above, the CIT (A) legally erred in not allowing the setting off of the interest income of Rs. 7,84,860/- with such expenditure. (Reference 315 ITR 255)
2. On the facts and circumstances of the case, the Ld CIT (A) erred in confirming the action of the AO for taxing the interest income under the head “income from other sources”
3. CIT (A) erred in confirming the charging of interest u/s 234B/ 234C.”
3. Briefly stated relevant facts as emanates from the orders of the AO and the CIT(A) are that the assessee is engaged in the business of ‘exploration’ and filed the return of income declaring loss of Rs. 65,08,033/-. In the assessment proceedings u/s 143(3) of the Act, AO completed the assessment determining the income at Rs. 7,06,370/-. AO rejected the claim of administrative and other expenses amounting to Rs. 67,81,270/-. Further AO treated the interest income of Rs. 7,84,860/-. Otherwise, the assessee the said expenditure as allowable one and not covered by the provisions of section 35E of the Act. Per contra, AO is the opinion the said expenditure is capital in nature as the business has not commenced in the year under consideration. Further, the AO held that by claiming this expenditure before the commencement of commercial production, the assessee has tried to advance the claim. AO rejected the assessee’s submissions that its business of “exploration of minerals” at various sites has commenced in the year under consideration and therefore, the expenditure incurred up to the period of commencement of commercial production should be capitalized. In connection with the taxing of the interest income of Rs. 7,84,860/- earned on the term deposits from the banks as ‘income from other sources’, AO relied on the jurisdictional High Court judgment in the case of CIT v. Ravi Ratna Export (P.) Ltd.  246 ITR 443 for the proposition that the interest income has to taxed under the head ‘income from other sources’. With regard to the relatable expenditure for earning of the interest income, AO applied the ratio of 10% of such income as allowable expenditure u/s 57(iii) of the Act. Aggrieved with above decisions of AO i.e. business is not set up in this year, denial of deduction of expenditure, taxing of interest income under the head income from other sources etc, the assessee filed appeal before the CIT(A).
4. During the proceedings before him, assessee made various submissions and relied on various decisions. The submissions as summarized by the CIT (A) in para 6 of the impugned order are as under:
“6. The submission of the appellant are as under:
a. That the exploration expenses incurred were capitalized as preoperative expenses.
b. Expenses which are connected with the administrative and business of the company were claimed as business expenditure together with the depreciation on the fixed assets.
c. That the licenses to prospect were received during 2003.
d. That the company having set up the business, claimed administrative other expenses. It is immaterial that the actual gold was excavated or ….
e. That the expenditure claimed by the assessee did not fall under the category of expenses listed u/s 35E and hence the AO is not correct in disallowing the expenses u/s 35E.
f. That the appellant commenced the business by putting plant machinery to use.”
5. CIT (A) has examined the above submissions of the assessee, in principle, and upheld the conclusion of the AO relating to the commencement of business and therefore capitalization of expenditure of preoperative expenses as well as the taxation of interest income under the head ‘income from other sources’. However, she did not agree with the AO’s conclusion that expenditure of Rs. 67,81,270/- is covered by the provisions of section 35E of the Act. CIT(A) arrived at the conclusion that the business is considered set up only when assessee is successful in identifying the commercially viable block. As mentioned in para 8, the conclusion of the CIT (A) reads that “till the assessee identifies the commercially viable block and start production, the business cannot be considered as set up”. Only when the business is established and ready to commence the commercial production, then only, it can be said that the business is set up and the expenditure prior to that set up have to be capitalized as per-operate expenditure. Before coming to this conclusion, the CIT (A) discussed various contents of the Annual Report of the Company before coming to the said conclusion. Briefly the contents of the said report include the assessee entered into various agreements with reference to technical services and obtaining from the Government the Reconnaissance Permit (RP), commissioning of reverse circulation (RC) drilling rigs into services, acquiring of the said rig for cost of Rs. 72 lacs, discovery identification of a 1.2 kilometer open ended zone of gold mineralization at Hirenagnur in the North Hutti exploration blocks, identification of a probable gold resource of 1.9 lac ounces in the Ganajur main prospect in the Dharwar Shimoga exploration block and many other exploration activities. CIT (A) also discussed about the fact that making of RP application and obtaining successful permit with regard to an area of 834 sq km located at Pallakad District of the Attapadi valley in Kerala and many other exploration activities discussed in para 7 of the impugned order. On the issue of treating of interest income under the head income from other sources, the CIT (A) confirmed the AO’s decision relying on the Hon’ble Supreme Court judgment in the case of CIT v. Bokaro Steels Ltd.  236 ITR 315. Aggrieved with the above decision of the CIT (A), assessee filed the present appeal before us. The issues raised in the grounds include (i) whether the business is set up or not; (ii) whether the administrative and other expenses amounting to Rs. 67,57,190/- constitutes preoperative expenditure or not and finally (iii) if the interest income is taxation u/s 56 of the Act or not with or without set off against the interest expenditure.
6. During the proceedings before us, Shri Vijay Mehta, Ld Counsel for the assessee mentioned that the core issue to be decided by the Tribunal relates to if the business of the assessee is actually set up during the year or not. When the business of the assessee is held set up and commenced during the year, the expenditure of Rs. 67,57,190/- is no longer constitutes ‘pre-operative’ expenditure which is capital in nature and therefore, the same becomes an allowable expenditure. Ld counsel also mentioned that now there is no issue before the Tribunal that the said expenditure of Rs 67,57,190/- is covered by the provisions of section 35E of the Act in view of the relief given by the CIT(A) on this issue. Regarding his claim relating to set up and commencement of the business in this year, Ld Counsel explained various activities under taken by the assessee in this year connected with the activities of exploration of minerals/gold and mentioned that this process mainly involves three stages ie (i) Reconnaissance Permit (ii) Prospecting licenses and (iii) mining lease. As per the Ld Counsel, considering the nature of the business of the assessee i.e. exploration of minerals and gold, the fact that the assessee started exploration of mineral in this year, the assessee has already set up business in the year under consideration. Referring to the decision of the CIT (A) that the business becomes set up, only when the assessee identifies commercially viable block and start production of the minerals/gold, Ld Counsel mentioned that she is under wrong perception and she has not understood the business of the assessee i.e. exploration of minerals. Attempting to distinguish various businesses relating to minerals, Ld counsel mentioned that the ‘business of mineral exploration’ is distinct from the ‘business of commercial production/extraction of the explored minerals’. The business of commercial production of minerals is different from the business of mineral exploration and the exploration involves survey of the mineral rich locations with the use of geographers and geologists, identification of the blocks using the rigs specially designed for the purpose. Mentioning that assessee successfully identified various mineral blocks in this regard, Ld Counsel mentioned that the assessee succeeded in such identification and already made application to the Government called Reconnaissance Permit (RP) Application for an area of 8026 sq kms in the states of Kerala, Karnataka and Andhra Pradesh. It is an undisputed fact that assessee obtained necessary permission i.e. RP from the Government of Kerala for gold exploration over an area of 834 sq kms in Attapadi Valley.
7. The other areas of exploration are as follows:
“It is a pleasure to report that the Government of Kerala has granted Deccan its first RP for gold exploration over an area of 834 sq km in Attappadi Valley. Other, Deccan applications for RPs in Kerala are pending.
By agreement with two private AIR group companies, Geomysore Services (India) Private Limited (GMSI) and Indophil Resources Exploration Services (India) Private Limited, Deccan (assessee) has secured an additional 2,021 sq km of RP land prospective for gold in Karnataka.
Deccan has applied for Prospecting Licenses over an area of 85 sq km in Karnataka and Kerala. These are first in time application and are under active consideration for grant by the respective State Governments.
By agreement with the two private AIR group companies mentioned above, another 267 sq km for exploration under PLs will be made available to Deccan when the licenses are granted to the other companies.
Deccan is also in the process of obtaining a Mining Lease (ML) over an area of 2 sq km in Rajasthan, targeting silver. By agreement with GMSI, Deccan has two other ML application pending over areas of 6 sq km and 0.24 sq km respectively in Andhra Pradesh and Karnataka.”
8. Giving the details of investment in the activities of exploration, Ld Counsel mentioned that the assessee purchased drilling rigs for a sum of Rs. 72 lacs and the same was utilized the same for exploration activities and identifying certain blocks successfully. Emphasizing on need for completion of exploration activities before making RP application to Governments, Mr Mehta referred to the above extract and stated the assessee successfully obtained the requisite RP in some cases and waiting in others. He also referred to fact of making application “prospecting license” and “Mining License” in other cases of such identified blocks. The annual report provides requisite minute details in this regard. In this regard, Mr Mehta mentioned that the commercial production/exploitation of the minerals, by way of mineral extraction, is not the business activity of the assessee and reiterated that the same is different from the ‘business of mineral exploration’. Assessee may or may not go for such activities or the blocks so identified may be leased out to some lessees who shall do the job of commercial extraction of minerals which is a separate business by itself. Therefore, the Ld Counsel summed up by stating the fact that the company is incorporated for the purpose of ‘mineral extraction’, assessee invested in purchase of rigs, requisite manpower i.e. managers, geologists etc were appointed, Reconnaissance Permits in respect of certain mineral blocks were also obtained, application were also made in respect of Prospecting/Mining Licenses, which are required for further business activities of the assessee and all these activities are possible only when the business is set up and commenced.
9. In this regard, Ld Counsel relied on various judicial pronouncements. To start with, Ld Counsel relied on the decision of Tribunal (Delhi Bench) in the case of Hughes Escorts Communications Ltd. v. Jt. CIT  157 Taxman 46 (Mag.) which is subsequently upheld by the Hon’ble High Court of Delhi in CIT v. Hughes Escorts Communications Ltd,  311 ITR 253 and mentioned that the said decision confirms the stand of the assessee. Further, he relied on the decision of ITAT, Delhi Bench in the case of Evergrowth Telecom Ltd. v. ITO, IT Appeal No. 1258/Del/02 and the judgment of the Hon’ble Gujarat High Court in the case of CIT v. Saurashtra Cement & Chemical Industries Ltd.  91 ITR 170 and analyzed that there are various stages combined to constitute business of the assessee and commercial exploitation is last stage of the business and the exploration stage set up by the assessee should constitute commencement of the business of the assessee. Ld Counsel also referred to the Special Bench decision in the case of Sardar Sarovar Narmada Nigam Ltd. v. Asstt. CIT  138 ITD 203 for the proposition that the business of the assessee should be considered to be set up from the date when water was supplied through main canals during current year and all revenue expenditure after that date had to be allowed as deduction.
10. Per contra, Ld DR not only relied on the orders of the AO/CIT (A) but also relied on the Hon’ble jurisdictional High Court judgment in the case of Western India Vegetable Products Ltd. v. CIT  26 ITR 151 (Bom) and brought our attention to the contents of para 9 for the proposition that distinction between the set up and commence is that when the business is established and is ready to commence business, then it can be said that business is set up but before it is only ready to commence business does not set up.
11. We have heard both the parties, perused the orders of the Revenue and the paper book filed before us. The case of the assessee is that when it is in the business of exploration, to qualify set up and commencement of its business, the assessee is not required to wait till it commercially produces minerals or gold or silver as the case may be. Completing the activities of investment in requisite plant and machinery, employing requisite personal like managers, geologists, surveyors etc for doing the business of the company, obtaining legal or governmental procedures etc, successful procurement of RPs from the government etc should constitute ‘set up or commencement’ of business. This line of argument has the strength of various binding judgments and assessee does not need to commence commercial exploitation of the minerals or gold in this case as held by the CIT(A). The commercial exploitation of the mineral blocks is not a pre-requisite for calling the assessee commenced his business activities. The assessee also relied heavily on the fact that he obtained RP from Government of Kerala for exploring gold over an area of 834 sq kms at Attappadi Vally and it shows the commencement of the business of exploration by the assessee for the year under consideration.
12. On the other hand, the case of the Revenue is that the assessee’s business cannot be concluded as business commenced until the identification of commercially viable blocks is finalized and the commercial production began. As per the Revenue, all the stages for obtaining permissions, licenses are initial stages and trying to identifying blocks and business cannot be called commenced.
13. We have considered the divergent views of the parties in litigation and find that so far as the bare facts of the case are concerned, there is no dispute. The crux of the litigation relates to if the business of the assessee is set up and has commenced in this year and if the assessee is legally correct in debiting the impugned expenditure of Rs 67,57,190/- to P and L account in this year and when admittedly the assessee is yet to commence to commercially produce the minerals/gold/ silver etc; but only when the assessee successfully invested in the requisite plant and machinery, employed the skilled personal like managers, geologists etc, obtained RPs successfully from Kerala Government and other RP applications are pending with other Governments etc. In this regard, we have examined the settled legal position on the issue of ‘set up and commencement’ qua the business of exploration in the instant case. In our opinion, the Gujarath High Court has laid a good foundation to understand the concepts of ‘set up and commencement’ of business while dealing with the case of Saurashtra Cement & Chemical Industries Ltd. (supra). The held portion of the said judgment is relevant and therefore, the same is reproduced as under:
“Held, that the activities which constituted the business of the assessee were divisible into three categories, the first category consisted of the activity of extraction of limestone by quarrying the leased area of land. This activity was necessary for the purpose of acquiring the raw material to be utilized in the manufacture of cement. The second activity comprised the activity of manufacture of cement by use of the plant and machinery set up for that purpose; and the third category consisted of selling manufactured cement. These three activities combined together constituted the business of the assessee. The activity of quarrying the leased area of land and extracting limestone from it was as much an activity in the course of carrying on the business as the other two activities of manufacture of cement and sale of manufactured cement. This activity came first in point of time and laid the foundation for the second activity and the second activity when completed laid the foundation for the second activity and the second activity when completed laid the foundation for the third activity. Hence, the assessee commenced its business when it started the activity of extraction of limestone. Since extraction of limestone commenced in 1958, the assessee was carrying on business during the relevant years of account. The expenditure incurred by the assessee in carrying on the activity of extraction of limestone as also depreciation allowance and development rebate in respect of machinery employed in extracting limestone were deductible in computing the trading profits of the assessee for the assessment years 1960-61 and 1961-62.”
14. From the above, it is evident that for deciding if the business of manufacturing the cement in that case is set up or not, the timing of assessee’s start up of activity of extraction of limestone, which is the first stage of the business process, constitutes the time of ‘commencement’ of business and the assessee is not required to produce cement commercially to qualify for ‘set up and commencement’. The reasoning is obvious that the business is summation business activities and one business steps lays foundation for the next one as held in the said case of Saurashtra Cement & Chemical Industries Ltd. (supra). In the case of cement manufacture, where the lime stone being a raw material, ‘the activity of quarrying the leased area of land and extracting limestone from it was as much an activity in the course of carrying on the business as the other two activities of manufacture of cement and sale of manufactured cement. This activity came first in point of time and laid the foundation for the second activity and the second activity when completed laid the foundation for the third activity. Similarly, in the instant case, which is with the business object of exploration of minerals/gold/silver etc, there are various business stages and they are: acquiring requisite plant and machinery and building, employing skilled & unskilled persons ie surveyors, geologists and other experts in the field of exploration, identifying mineral blocks, obtaining reconnaissance permits, prospecting /mining licenses etc. As seen from the Annual Report, Government of Kerala has already granted the assessee its first RP for gold exploration over an area of 834 sq km in Attappadi Valley. In our opinion, such stages must constitute foundation for the subsequent business activities for the assessee, who is engaged in the field of ‘exploration’ of minerals. It is not required that the assessee must raise purchase order for constituting ‘set up or commencement’ of business as held by the Tribunal (Delhi Bench) in the case of Hughes Escorts Communications Ltd. (supra) which is subsequently upheld by the Hon’ble High Court of Delhi reported in and its conclusion reads that “assessee’s business of satellite communication system could be said to be set up at the point of time when purchase order was placed for acquiring very small aperture terminal (VSAT) as the use of this equipment was necessary for such business and not when the first purchase order was placed by the assessee”. Therefore, the activity of commercial production is not needed to describe the business is set up when he is in the business of exploration. In this line of business of exploration, the business commences with ‘exploring’ for minerals/ gold/ silver in the crests of the Earth and ends with successful identification of such mineral rich blocks of earth. For this, the requirements include permissions/licenses from the Governments, appointing of personal or geologists equipped with the ability to study the relevant data and interpret for the purpose of identifying the gold/ silver/ other minerals, plant and machinery to delve the hidden mineral riches in the Earth etc. In the instant case, the business should be construed set up as the assessee obtained necessary approvals, recruited requisite personal, procured requisite machinery etc. In fact, the assessee has successfully identified certain mineral rich blocks too. As analyzed by the jurisdictional High Court in the case of Western India Vegetable Products Ltd. (supra), the expression ‘setting up’ means ‘to place on foot’ or to establish or ‘to ready to commence’. Therefore, we find no difficulty in coming to the conclusion that the assessee’s business is set up in this year and in fact commenced too. Thus the expenditure incurred after the set up constitutes allowable expenditure.
15. Therefore, we are of the opinion that the arguments of the assessee are valid and the claim of the assessee in respect of the debiting the sum of Rs 67,57,190/- to Profit and Loss account in this year is proper. Consequently, the describing the said expenditure as pre-operative ones is incorrect. Accordingly, grounds 1 and 1.1 of the appeal are allowed.
16. Grounds 1.2 and the 2 relates to the nature of interest receipts and the tax treatment to be given to the interest receipts of Rs 7,84,860/-. Assessee claims that the said receipts constitutes business receipts and entitled for set off against he business expenditure Rs 67,57,190/- AO rejected the claim of the assessee relying on the jurisdictional High Court’s judgment in the case of Ravi Ratna Export (P.) Ltd. (supra) and taxed the same under the head ‘income from other sources’. During the first appellate proceedings, there was discussion about the applicability of the apex court’s judgment in the case of Bokaro Steels Ltd. (supra) and also the conditional concession of the assessee for taxing the same under the head ‘income from other sources’. CIT(A) however, did not allow the claim of set off of interest income with the expenditure of Rs 67,57,190/- mentioning that the assessee failed to evidence that the source deposits are not linked to the process of set up of the business. Aggrieved with the above decision of the CIT (A), assessee raised this ground no.2 before us.
17. During the proceedings before us, Ld Counsel mentioned that the interest earned by the assessee from the banks in relation to the deposits kept with the banks which are primarily brought for infusion in the business. Such income cannot be qualified as income from other sources and relied on the Hon’ble Delhi High Court judgment in the case of Indian Oil Panipat Power Consortium Ltd. v. ITO  315 ITR 255. There is reference in the ground that the assessee relied in the judgment in the case of Bokaro Steel Ltd. (supra).
18. On the other hand, Ld DR relied on the Hon’ble Supreme Court judgment in the case of Tuticorin Alkali Chemicals & Fertilizers Ltd. v. CIT  227 ITR 172
19. We have heard both the parties, perused the orders of the Revenue as well as the judgments cited before us. It is noticed that all these judgments are pronounced taking into account the receipt of interest during the period prior to commencement/set up of the business. The discussion given in the orders of the AO as well as CIT (A) also reflects the manner of treatment towards the interest receipts earned during the period prior to the set up of the business. The IT Authorities have examined the issue in the background that the business yet to set up or commence. But the fact is that the said interest receipts are earning after set up of the business of assessee as held by us in the paragraphs above. Therefore, this issue requires fresh adjudication considering our finding on the main issue discussed and adjudicated above i.e. whether the business of assessee is set up in the year under consideration or not. We have held that the business is set up in the year under consideration and the expenses of Rs. 67,57,190/- as an allowable expenditure in the year under consideration. As such, the orders of the Revenue do not contain requisite details on the source of the funds kept with the banks which yielded interest income of Rs. 7,84,860/- and the details related to the source of these funds kept with the Banks i.e interest bearing funds/non-interest bearing funds/excess funds or otherwise own funds of the assessee etc. In the set aside proceedings, AO is directed to examine these issues afresh and adjudicate the same after considering all the decisions cited above and also other relevant judgments which are in force. Accordingly, ground no.2 is set aside.
20. Ground no.3 is dismissed being consequential to the above raised grounds.
21. In the result, appeal of the assessee is partly allowed.