ITAT Chennai: Commercial Sales Not Essential Once Bio-Pharma Business Is Set Up

Pochiraju Industries Ltd. Vs ACIT (ITAT Chennai)

No Sales Yet? That Alone Cannot Turn a Set-Up Division’s Expenses into Capital Expenditure: Chennai ITAT Deletes ₹10.70 Crore Disallowance

A new business division may be ready for operations before it generates substantial commercial sales. Can all its expenses be capitalised merely because the Revenue says commercial production has not commenced? The Chennai Tribunal addressed this question in the case of Pochiraju Industries Ltd., where the Assessing Officer had disallowed ₹10,70,08,883 relating to the company’s Bio-Pharma Division.

The Tribunal deleted the blanket disallowance. It found that the company’s contemporaneous Annual Report recorded completion of the division’s first phase and commencement of production. It also emphasised the distinction between a business being set up and its commercial commencement. The ruling does, however, leave each category of expenditure subject to the statutory conditions applicable to that deduction.

Why was ₹10.70 crore disallowed?

The assessee-company carried on activities in agriculture, pharmaceuticals and bio-pharma. Following proceedings under section 263, the AO passed an assessment order disallowing expenses claimed for its Bio-Pharma Division in AY 2013–14.

The AO’s premise was that the division had not commenced commercial operations during the relevant year. He treated the expenditure as relating to a new project that was still being set up and therefore required the entire amount to be capitalised. The disallowance covered consumables and stores, staff costs, administrative and operating expenses, depreciation, bank term-loan interest and research expenditure.

The CIT(A) upheld the disallowance. In doing so, the appellate authority relied substantially on the AO’s observations and on statements concerning the company’s financial difficulties and later action against its assets under the SARFAESI Act.

What did the company’s Annual Report say?

The assessee pointed to its Annual Report for FY 2012–13. The Directors’ Report stated that the first phase of the Bio-Pharma unit, known as BIOPIL, had been fully implemented and that production had started. It described the second phase as still under implementation.

The company also referred to ₹876.57 lakh of revenue reported for the combined “Pharma & Bio-Pharma” segment. The Revenue objected that this figure had not been shown to arise exclusively from the Bio-Pharma Division. The Tribunal accepted that the precise split of segment revenue was not conclusively established. But that uncertainty could not, by itself, establish that the Bio-Pharma unit had never been set up.

The Directors’ Report was a document relating to the very financial year in dispute, rather than an explanation prepared years later for the appeal. The Revenue had produced no cogent material showing that its statement about the commencement of production was false, withdrawn or corrected.

“Setting up” and “commencement” are different stages

The Tribunal relied on the established distinction between setting up a business and commencing business. A business is set up when it has been established and is ready to perform the activity for which it was created. There may be an interval before regular commercial activity or meaningful sales begin; that interval does not automatically make every expense inadmissible.

In discussing this principle, the Tribunal referred to Western India Vegetable Products Ltd. v. CIT, CWT v. Ramaraju Surgical Cotton Mills Ltd., and other decisions. It also referred to the Chennai Tribunal’s ruling in Orient Green Power Co. Ltd. v. ACIT, where preparatory steps and business readiness were material to deciding whether the business had been set up.

Applied here, the question was not simply how much the Bio-Pharma Division sold. The AO first had to examine the division’s actual state during FY 2012–13. The company’s Annual Report directly addressed that question, yet its contents had not been effectively dealt with by the lower authorities.

Later bank action could not decide an earlier year’s facts

The CIT(A) had also relied on the company’s statements about financial distress and bank action affecting its operations. The assessee explained before the Tribunal that Punjab National Bank took over its properties only on 30 December 2015, while the Bio-Pharma Division was auctioned on 3 March 2017.

Both events occurred after FY 2012–13. The Tribunal held that later financial difficulties or a later takeover of assets could not, without further evidence, establish that the division had not been set up or was incapable of operating in the year under appeal.

The nature of each expense still matters

The Tribunal objected to treating every item of expenditure as capital solely because it related to a new division. Staff, administrative and operating costs must be considered according to their nature and purpose. Equally, depreciation has to satisfy section 32, interest has to be examined under section 36(1)(iii) and its proviso where relevant, and scientific research expenditure must meet the applicable conditions of section 35.

This qualification is material. The Tribunal directed deletion of the ₹10.70 crore disallowance made on the AO’s broad premise that the entire division’s expenditure was capital because commercial production had not commenced. It did not hold that every component qualifies automatically, regardless of its own statutory requirements. The assessee had also withdrawn Ground No. 4 concerning section 35(2AB); that withdrawal remained binding.

Author’s comments

The decision turns on the correct question and the evidence available for the correct year. The combined segment turnover did not establish precisely how much the Bio-Pharma unit sold. Yet that gap did not justify ignoring a contemporaneous Directors’ Report saying that the first phase was complete and production had begun. Likewise, a bank’s action years later could not determine the unit’s status in FY 2012–13.

For a newly established division, the useful records are those showing when it became ready to function: completion of facilities, availability and use of assets, required approvals, staffing and production records. Once that stage is established, a lack of substantial sales cannot support a blanket capitalisation of its expenses. The individual deductions must then be tested under the provisions that govern them.

Cases Discussed

• Western India Vegetable Products Ltd. v. CIT, 26 ITR 151 (Bombay High Court) — Relied upon for the distinction between setting up and commencement of business and the principle that expenditure incurred after a business is set up but before actual commencement may be deductible.
• CWT v. Ramaraju Surgical Cotton Mills Ltd., 63 ITR 478 (Supreme Court) — Referred to for the proposition that a unit is set up when it is established and ready to discharge the function for which it was established.
• CIT v. Hughes Escorts Communications Ltd., 311 ITR 253 (Delhi High Court) — Referred to among the High Court decisions applying the principles governing when a business can be regarded as having been set up.
• Carre four WC & C India (P.) Ltd. v. Dy. CIT, IT Appeal No. 42/2014, dated 22-09-2014 (Delhi High Court) — Referred to among the High Court decisions concerning setting up of business.
• Sarabhai Management Corpn. Ltd. v. CIT, [1976] 102 ITR 25 (Gujarat High Court) — Referred to among the High Court authorities on the stage at which business can be regarded as set up.
• CIT v. Coromandal Fertilizers Ltd., [2003] 128 Taxman 869 / 261 ITR 408 (Andhra Pradesh High Court) — Referred to among the High Court decisions applying the principles relating to setting up and commencement of business.
• Orient Green Power Co. Ltd. v. ACIT, [2022] 138 taxmann.com 383 (ITAT Chennai) — Relied upon for holding that acquisition of land, obtaining approvals, deployment of technical personnel, placement of purchase orders and execution of long-term power purchase agreements could establish that a business had been set up and was ready to commence.

FULL TEXT OF THE ORDER OF ITAT MUMBAI

This appeal by the assessee is directed against the order dated 21.02.2025 passed by the ld. Commissioner of Income Tax (Appeals), National Faceless Appeal Centre (NFAC) [“Ld. CIT(A)”], for Assessment Year (AY) 2013-14.

2. The assessee has raised several grounds challenging the validity of the impugned order as well as the sustenance of the disallowance relating to the Bio-Pharma Division. During the course of hearing, the ld.Authorised Representative (AR) submitted that Ground No. 4 is withdrawn. The withdrawal is accepted and Ground No. 4 is, accordingly, dismissed as withdrawn.

3. The surviving grounds, in substance, relate to the failure of the Ld. CIT(A) to consider the material and written submissions placed on record and the sustenance of the disallowance of expenditure of Rs.10,70,08,883/- relating to the Bio-Pharma Division.

4. Brief facts of the case are that the assessee-company is engaged in three principal business activities, namely, Agriculture, Pharmaceuticals and Bio-Pharma. The assessment proceedings in the present case arose pursuant to proceedings u/s. 263 of the Income Tax Act, 1961 (“the Act”). Consequent to the revisionary proceedings, the Assessing Officer (AO) passed an order u/s. 143(3) read with section 263 of the Act and disallowed expenditure claimed by the assessee in relation to its Bio-Pharma Division amounting to Rs.10,70,08,883/-, treating the expenditure as relating to a division which had not commenced commercial operations and, therefore, requiring capitalization. The Assessing Officer proceeded on the premise that the Bio-Pharma Division had not commenced commercial activity during the relevant period. According to the Assessing Officer, since the division had not commenced commercial production, expenditure incurred in relation thereto represented expenditure connected with setting up a new division/project and was consequently required to be capitalized rather than allowed as revenue expenditure. The Assessing Officer accordingly disallowed the expenditure of Rs.10,70,08,883/-.

The expenditure in question, as furnished by the assessee, comprises the following:

5. The assessee carried the matter before the Ld. CIT(A). During the appellate proceedings, the assessee contended, inter alia, that the Bio-Pharma unit had already been established and production had commenced during financial year 2012-13. Reliance was placed upon the Annual Report of the assessee-company. In particular, attention was drawn to the Directors’ Report, wherein it was stated that the first phase of the Bio-Pharma unit, established under the name and style of “BIOPIL”, had been fully implemented and that the company had started its production, while the second phase was under implementation. The assessee also relied upon the segment information contained in the Annual Report and submitted that revenue of Rs.876.57 lakhs had been reported under the Pharma & Bio-Pharma segment (Page 55 of Annual Report 2012-13).

6. The Ld. CIT(A), however, rejected the assessee’s contentions and upheld the disallowance principally by relying upon the observations of the Assessing Officer that no commercial production had commenced and that the assessee itself had stated during the revision proceedings that its properties had been subjected to action under the SARFAESI Act and that its operations were affected.

7. Before us, the ld. Authorised Representative (AR) submitted that the impugned order of the Ld. CIT(A) suffers from both factual and legal infirmities. It was submitted that the assessee had specifically brought to the notice of the Ld. CIT(A) the relevant Annual Report for financial year 2012-13, wherein the Directors’ Report expressly records that the first phase of the Bio-Pharma unit had been fully implemented and that the company had started its production. It was further submitted that the Annual Report is a statutory corporate document and that the financial statements and segment information were available in the public domain. The ld. AR further submitted that the Ld. CIT(A) failed to properly appreciate that the alleged SARFAESI proceedings relied upon by the Revenue occurred subsequently. According to the assessee, the properties were taken over by Punjab National Bank only on 30.12.2015 and the Bio-Pharma Division was auctioned on 03.03.2017. Therefore, those subsequent events could not establish that the Bio-Pharma unit had not been set up or was incapable of carrying on business during the previous year relevant to Assessment Year 2013-14.The ld. AR further submitted that the assessee had furnished written submissions before the Ld. CIT(A) on 01.03.2021 and 20.01.2024, notwithstanding which the appellate order records that the hearing notices dated 17.02.2021 and 17.01.2024 had not been complied with. It was accordingly argued that the impugned order had been passed without proper consideration of the submissions and documentary evidence placed on record and, therefore, violated the principles of natural justice.

7.1 On merits, the ld. AR submitted that the very foundation of the disallowance was erroneous because the Bio-Pharma unit had been established and production had commenced during the relevant previous year. The ld. AR also submitted that the fact that the Revenue disputes the exact attribution of the reported turnover between Pharma and Bio-Pharma cannot by itself establish that the Bio-Pharma Division was not operational. The Directors’ Report independently records commencement of production. It was further argued that the expenditure comprised routine revenue expenses, staff costs, administrative expenses, operating expenses, depreciation, interest and research expenditure. Once the unit had been set up and was capable of carrying on its business, such expenditure could not be treated as capital expenditure merely because the unit was a new division. The ld. AR relied upon the settled principle that there is a distinction between “setting up” and “commencement” of business and that expenditure incurred after the business is set up is allowable notwithstanding an interval before actual commencement of commercial operations.

8. The ld. Departmental Representative (DR) strongly relied upon the orders of the lower authorities. It was submitted that the assessee had itself stated before the Ld. PCIT that additional funding was required to comply with regulatory requirements and that the Punjab National Bank had declined the requested funding, resulting in financial difficulties. According to the ld. DR, the Bio-Pharma Division could not have commenced commercial operations without satisfying the applicable regulatory requirements. The ld. DR further submitted that the revenue of Rs.876.57 lakhs relied upon by the assessee was not demonstrated to be exclusively attributable to the Bio-Pharma Division. According to the Revenue, the Annual Report combined “Pharma and Bio-Pharma” for reporting sales and profit. It was also submitted that the annual report separately disclosed certain particulars relating to Pharma and Bio-Pharma but did not disclose opening and closing stock or raw-material consumption for the Bio-Pharma Division in the manner claimed by the assessee. Therefore, according to the Revenue, the assessee had not established that the reported turnover represented sales generated by the Bio-Pharma Division. The ld. DR further submitted that the detailed bifurcation of revenue relied upon by the assessee before the Tribunal was not supported by contemporaneous documentary evidence and was furnished for the first time before the Tribunal. Accordingly, the Revenue submitted that there was no commercial activity in the Bio-Pharma Division during the relevant year and that the expenditure of Rs.10,70,08,883/- was rightly treated as capital expenditure.

9. We have carefully considered the rival submissions and perused the material available on record. At the outset, we note that the assessee has withdrawn Ground No. 4 during the course of hearing. The same is, therefore, dismissed as withdrawn. The remaining controversy essentially centres around the allowability of expenditure of Rs.10,70,08,883/- relating to the Bio-Pharma Division. The principal basis adopted by the Assessing Officer and thereafter by the Ld. CIT(A) is that the Bio-Pharma Division had not commenced commercial production during the relevant year. 10. In our considered view, the approach adopted by the lower authorities does not properly appreciate the distinction between setting up of a business and commencement of business. The Hon’ble Bombay High Court in Western India Vegetable Products Ltd. v. CIT, 26 ITR 151 (Bom.), explained that “setting up” and “commencement” are distinct concepts. The principle is that once a business is established and is ready to commence business, it can be regarded as having been set up, the interval between setting up and actual commencement does not necessarily render expenditure incurred during such interval inadmissible. The aforesaid principle has also received approval in subsequent judicial decisions, including the decision of the Hon’ble Supreme Court in CWT v. Ramaraju Surgical Cotton Mills Ltd., 63 ITR 478 (SC), wherein the expression “set up” was understood as the stage at which the unit is established and ready to discharge the function for which it was established.

11. Similar has been taken by the different Hon’ble High Courts in the following cases:

i. CIT v. Hughes Escorts Communications Ltd. (Delhi High Court);

ii. The Hon’ble Delhi High Court in the case of Carre four WC & C India (P.) Ltd. v. Dy. CIT [IT Appeal No. 42/2014, dated 22-09-2014];

iii. The Hon’ble Gujarat High Court in the case of Sarabhai Management Corpn. Ltd. v. CIT [1976] 102 ITR 25;

iv. The Hon’ble Andhra Pradesh High Court in the case of CIT v. Coromandal Fertilizers Ltd.[2003] 128 Taxman 869/261 ITR 408.

12. The Co-ordinate Chennai Bench of the Tribunal in the case of Orient Green Power Co. Ltd. v. ACIT [2022] 138 taxmann.com 383held that Where assessee-company, engaged in business of investing, owning and operating renewable energy sources, had already acquired land to carry out business activities, obtained various approvals permissions in-hand, deployed technical personnel, placed purchase orders and also signed long-term power purchase agreement with clients, it could be said that business had been set up and was ready to commence, and hence, business expenditure claimed towards employees cost, depreciation etc. was to be allowed as deduction. Therefore, the mere fact that the Revenue disputes the volume or quantum of commercial sales cannot, by itself, determine whether the business/division had been set up.

13. In the present case, there is important contemporaneous evidence which has not been properly appreciated by the lower authorities. The Annual Report for financial year 2012-13, as placed before us, contains a categorical statement in the Directors’ Report that:

“The Implementation of the first phase of company’s Bio pharma unit being setup under the name and style of BIOPIL was completed fully and the company has started its production…”

The aforesaid statement is significant. It is not a subsequent self-serving explanation prepared for purposes of the present appeal. It forms part of the statutory corporate reporting for the relevant financial year itself. The Annual Report also records the proposed expansion of the second phase of the project involving additional capital expenditure. This contemporaneous disclosure supports the assessee’s contention that the first phase of the Bio-Pharma project had reached the stage of production, whereas further expansion was being undertaken. The Revenue has not brought before us any cogent material demonstrating that the aforesaid statement contained in the Annual Report was false or had subsequently been withdrawn or corrected.

14. We also find merit in the assessee’s contention concerning the timing of the SARFAESI proceedings. The Ld. CIT(A) relied upon the statement attributed to the assessee that the bank had seized the properties and that the company’s operations were affected. However, the assessee has specifically submitted before us that the properties were taken over by Punjab National Bank only on 30.12.2015 and that the Bio-Pharma Division was auctioned on 03.03.2017.These events, even if accepted, are subsequent to the relevant previous year ending on 31.03.2013.Consequently, subsequent financial distress or subsequent taking over of the assets by the bank cannot, without more, be used to negate the contemporaneous evidence regarding the status of the Bio-Pharma Division during financial year 2012-13.The Ld. CIT(A), in our considered view, therefore erred in treating the subsequent SARFAESI proceedings as determinative of the question whether the Bio-Pharma Division had been set up during the relevant previous year.

15. We have also considered the Revenue’s objection that the turnover of Rs.876.57 lakhs disclosed under “Pharma & Bio-Pharma” could not be conclusively attributed to the Bio-Pharma Division alone. We find that this objection does not, by itself, answer the primary question before us. Even assuming that the segment reporting combines the Pharma and Bio-Pharma activities and that the exact bifurcation of the reported turnover is not independently established, the same cannot automatically lead to the conclusion that the Bio-Pharma unit was not set up or that no production activity whatsoever was undertaken therein. The contemporaneous Directors’ Report constitutes an independent piece of evidence and specifically records that production had started in the Bio-Pharma unit. Thus, the Revenue’s objection regarding the precise attribution of the Rs.876.57 lakhs may create a question regarding the quantum or allocation of turnover, but it does not justify rejection of the entire claim merely on the assumption that the Bio-Pharma Division had not been set up. The assessee has furnished a detailed break-up of the expenditure of Rs.10,70,08,883/-.A substantial portion consists of staff costs, administrative expenses, operating expenses, financial charges and other recurring expenditure. These items cannot be treated as capital expenditure merely because they relate to a newly established division. The law requires examination of the nature and purpose of each expenditure rather than applying a blanket rule that all expenditure relating to a new division must necessarily be capitalized. Further, depreciation is governed by section 32 of the Act and interest on capital borrowed for business purposes is specifically governed by section 36(1)(iii). In the case of interest relating to acquisition of an asset, the statutory proviso restricts deduction only for the period beginning with borrowing and ending with the date on which the asset is first put to use. Therefore, once the relevant assets have been put to use for business purposes, the statutory provisions cannot be displaced merely by characterising the entire expenditure of the division as “pre-operative”. Likewise, expenditure on scientific research is specifically dealt with u/s. 35, subject to fulfilment of the conditions applicable to the particular claim. Section 35 itself recognises expenditure on scientific research related to the business as a distinct statutory category.

16. We make it clear that the present adjudication is confined to the disallowance made by the Assessing Officer on the broad premise that the entire expenditure relating to the Bio-Pharma Division was capital in nature merely because, according to the Revenue, commercial production had not commenced.

17. We also find another important aspect. The assessee has specifically stated that written submissions were filed before the Ld. CIT(A) on 01.03.2021 and 20.01.2024. The assessee also claims to have produced before the Ld.CIT(A) the material relating to the proceedings u/s. 263 and the Annual Report evidencing commencement of production. However, the impugned order proceeds substantially on the basis of the assessment order and does not demonstrate adequate consideration of the specific documentary evidence relied upon by the assessee, particularly the contemporaneous statement in the Annual Report that the Bio-Pharma unit had started production. An appellate authority is required to examine the evidence and submissions placed before it and render a reasoned finding on the controversy. In the present case, the Ld. CIT(A)’s conclusion that the Bio-Pharma Division had not commenced commercial activity is principally founded upon the observations of the Assessing Officer regarding the position stated during the subsequent revision proceedings. The contemporaneous Annual Report, which directly bears upon the status of the unit during financial year 2012-13, has not been effectively dealt with. The appellate finding, therefore, cannot be sustained merely by reproducing or adopting the reasoning of the Assessing Officer without examining the contrary contemporaneous evidence.

18. On a cumulative consideration of the material available on record, we are of the considered view that the Revenue has not established that the Bio-Pharma Division was merely a project under construction throughout the relevant previous year so as to justify capitalization of the entire expenditure. On the contrary, the Annual Report for financial year 2012-13 records that the first phase of the Bio-Pharma unit had been completed and that production had commenced. This contemporaneous evidence has not been rebutted by any cogent material. Further, the subsequent SARFAESI proceedings cannot retrospectively establish that the unit was not operational during the relevant previous year. Most importantly, the test for allowability of business expenditure cannot be reduced to the question whether the assessee generated a particular quantum of commercial sales during the year. The distinction between “setting up” and “commencement” of business is well settled. Accordingly, the blanket disallowance of Rs.10,70,08,883/- merely on the ground that the Bio-Pharma Division had not commenced commercial production is not sustainable.

At the same time, we clarify that each component of the expenditure remains subject to the specific statutory conditions governing the relevant deduction. The withdrawal of Ground No.4 concerning the claim u/s. 35(2AB) is also binding upon the assessee and has been separately dealt with above.

19. In view of the foregoing discussion, Ground No. 1 is general in nature and is disposed of in terms of the findings recorded above. Ground Nos. 2 and 3 are allowed to the extent that the impugned order is found to have failed to properly deal with the material and submissions relied upon by the assessee. Ground No. 4 is dismissed as withdrawn. Ground No. 5 is allowed and the disallowance of Rs.10,70,08,883/- made in respect of the Bio-Pharma Division is directed to be deleted. Ground No. 6 is consequential/general and requires no separate adjudication.

20. In the result, the appeal of the assessee is allowed in the terms indicated above.

Order pronounced in the open Court on the 23rd day of September 2026, in Chennai.