Non-prospecting related expenditure incurred prior to commencement of mining is deductible u/s. 37 of the Income-tax Act

INCOME TAX APPELLATE TRIBUNAL, MUMBAI
ITA No. 40/Mum/2006 and
ITA Nos.6193 & 86/Mum/2007
(Assessment Years: 2001-02 to 2003-04)

De Beers India Prospecting Pvt.Ltd Vs. Income Tax Officer

ITA Nos. 6560 & 6561/Mum/2007 (Assessment Years 200 1-02 & 2003-04)

De Beers India Surveys Pvt.Ltd. Vs. Income Tax Officer

ITA No 6562/Mum/2007 – (Assessment Year 2003-04)

De Beers India Minerals Pvt.Ltd. Vs. Income Tax Officer

Date of Pronouncement: 16/12/11

ORDER

Per B. Ramakotaiah, A.M.

All these appeals are filed by assessees in respective Assessment Years from 2001-02 to 2003-04. These companies are

the subsidiary companies of De Beers Mauritius Ltd which commenced its operations after getting approval from the Foreign Investment Promotion Board (FIPB) with reference to prospecting and mining of diamonds and other minerals (except coal and iron ore). Now all these companies have merged and known as De Beers India Private Limited. The lead order was passed in Assessment Year 2002-03 in ITA No.40/M/2006, the findings of which are the basis for reopening the other assessments in various assessee’s cases. The main issue is with reference to allowance of expenditure claimed by the assessee, disallowed by the Assessing Officer on the reason that the assessee has not commenced the business in the year under consideration. Since the lead order was in Assessment Year 2002-03, the facts and grounds are discussed elaborately in that appeal.

ITA 40/M/2006, AY 2002-03

2.             The assessee De Beers India Prospecting Pvt. Ltd has raised
the following two grounds:

“1. The learned CIT (A) erred in confirming the action of the Assessing Officer in disallowing expenses on non-prospecting activities amounting to 27,88,O3O/- and depreciation of 7, 13,781/- claimed in the return of income on the ground that the company has not commenced its business of mining during the relevant year.

2. The learned CIT (A)erred in confirming the action of the Assessing Officer in taxing the interest received on short term deposits under the head “income from other sources” instead of “business income” as claimed in the return of income”.

Ground Nos. 3 & 4 are general in nature. The appeal was originally dismissed for want of prosecution by assessee and was recalled by order in MA No. 713/M/08dt.14-01-09.

3.        Briefly stated, the assessee filed return of loss of
1,00,04,244/-. Subsequently it filed a revised return of income declaring a net loss of 33,56,816/-. Filing the revised return was

due to the fact that an expenditure of 57.44 lakhs stated to have been incurred on prospecting activities were not claimed as per the provisions of section 35E of the Act and was capitalized by the assessee. Stating that the above expenditure pertains to prospecting activities, the assessee claimed balance of expenditure to an extent of 27,88,030/- and depreciation of 7,13,781/- under section 37(1) being a non-prospecting expenditure. The Assessing Officer held that the assessee has not commenced its business and allowed the capitalization of the entire expenditure claimed including the depreciation claim. The assessee has contested the same before the CIT (A) who while admitting that under section 35E expenditure of 1/10^th only can be allowed to the appellant, considered that the assessee has not commenced the mining activity and since the mining activity of the company has not commenced in the year under consideration, there is no question of allowing non prospecting of expenditure of .27.88 lakhs to the assessee in the current year. Similarly, claim of depreciation was also disallowed. Therefore, the assessee is in appeal before us.

4. Referring to the orders of the Assessing Officer and the CIT(A), the learned Counsel submitted that the assessee obtained FIPB permission as early as October, 1996 which was amended by the

letters dated 15/07/1997, 26/05/1998, 06/11/1998 and 04/10/2000 and the main objects of the company for which the FIPB permission was granted, was with reference to undertaking prospecting and mining activities for diamond and prospecting for other minerals identified for private participation (except coal and iron ore). Consequent to the above permission, the assessee further obtained permissions from various state governments. In the present year assessee De Beers India Prospecting (P) Ltd had obtained permit from Govt. of Andhra Pradesh for prospecting of diamond in various areas of the districts of Andhra Pradesh. The learned Counsel referred to Page No.117 in the paper book for the

permission granted by the Ministry of Industry for prospecting for diamond and further page Nos. 126 onwards for the permissions granted by the Govt. of Andhra Pradesh in various areas. It was his submission that the assessee having been incorporated and obtained permission from the FIPB can be stated to have commenced business operations and since the main activity is exploration and prospecting for diamonds, the assessee has commenced its business. It was submitted that even though the assessee has not started the mining activity, the assessee’s business of prospecting has been commenced. The learned Counsel placed on record all the details of expenditure claimed in the P&L account, bifurcation between the prospecting activities capitalized under section 35E and non prospecting activities in respective Assessment Years. It was submitted that the expenditure which was capitalized under section 35E was not in dispute and as the assessee has not claimed any deduction to the extent of capitalization but claim of other expenditure not covered by Section 35E and is eligible under section 37(1) is the issue in appeal. He further submitted that this issue was covered by the decision of the Mumbai Tribunal in its own case De Beers India (P) Ltd vs. DCIT in ITA No.6420/Mum/2008 for the Assessment Year 2005-06. It was submitted that the Hon’ble Tribunal has considered the issue and directed the Assessing Officer to allow the expenditure under section 37(1) for non-prospecting. It was further submitted that the Assessing Officer did not allow the expenditure as revenue expenditure but permitted to be capitalized on the reason that the assessee has not commenced the business of mining activities. Referring to the various permissions and the legal propositions on the issue it was submitted that the assessee has commenced its activities of prospecting in Assessment Year 2001-02 itself and so the business of the assessee has been set up and expenditure

allowable was under section 37(1) of the Income Tax Act. The learned Counsel placed reliance on the various decisions:

i)         Saurashtra Cements and Chemical Industry Ltd 91 ITR 170( Guj).

ii)        Sarabhai Management Corporation Ltd 192 ITR 151 (SC)

iii)       CIT vs. Franco Tosi Ingegneria (2000) 241 ITR 268 (Mad.)

iv)          DCIT vs. ACC RIO Tinto Exploration Ltd., (125 TTJ)(Del) (92).

v)       DDIT v. Stork Engineers &Contractors BV India Project
Office (127 ITD 211)(Mum).

He also distinguished the decisions relied by Assessing Officer in CIT vs. Sponge Iron India Ltd.[201 ITR 770] A.P and CIT vs. L & T Macneil Ltd. (1993) 202 ITR 662 (Bom).He raised various prepositions on the basis of the above case law to submit that the assessee has commenced its business activities of prospecting and so there is no need for disallowance of the expenditure claimed.

5.                The learned Departmental Representative however, submitted that the assessee has not started the activity of mining and as seen from the permissions granted by the FIPB, the assessee was permitted to do prospecting and mining as per the approvals granted and since the assessee has not commenced its mining activity, it cannot be stated that the assessee has commenced its business activities. It was submitted that the Assessing Officer was correct in disallowing the expenditure claimed as revenue expenditure in the absence of any business activities during the year. It was also further submitted that the assessee has not earned any incomes and has only claimed expenditure and relied on the decisions which the Assessing Officer relied and distinguished cases relied by the assessee.

6.                We have considered the issue and examined the facts available on record. There is no dispute with reference to the fact that the assessee has undertaken prospecting activities in the year

under consideration and has suo moto disallowed the expenditure pertaining to the prospecting activities under section 35E of the Income Tax Act. The Assessing Officer permitted as such as claimed by the assessee. There is also no dispute with reference to the bifurcation of expenditure between the prospecting activities and non prospecting activities as was done by the assessee while filing the revised return withdrawing claim to the extent of capitalized expenditure under section 35E. It is also a fact that the assessee has not yet claimed any deduction under section 35E as no mining activity has commenced yet. The issue is with reference to the claim of non prospecting expenditure stated to be salaries of persons in Head Quarters and other expenditure of the company not related to prospecting activities. As seen from the provisions of Section 35E and particularly the restricted meaning given to sub section 5(a) for ‘operation relating to prospecting’, one cannot fault the assessee in bifurcating the expenditure directly relating to prospecting activities and other expenditure as non-prospecting activities. The Assessing Officer has not disputed the bifurcation of the expenditure. The reason for disallowance of the expenditure and permitting it to be capitalized by AO is on the opinion that the assessee has not commenced its business activities. Commencement of the business activities has various facets. As permitted by the Department of Industrial policy and promotion, the assessee is permitted to undertake prospecting and mining activities for diamonds originally and subsequently prospecting for other minerals also (except coal and iron ore) for private participation. This indicate that the assessee was permitted to indulge in mining activities only with reference to diamonds whereas it was not permitted to involve in mining activities for other minerals. Prospecting is an activity prior to activity of mining. Without prospecting and without examining whether particular precious stones/minerals were available in a particular area, it is not possible to undertake mining activities. It is

also observed that the FIPB permits various foreign companies having expertise in various fields to undertake various activities in India and in the case of the assessee initially it was permitted to undertake prospecting and mining activities for diamond and subsequently modified to include prospecting for other minerals except coal and iron ore. This indicates that the activities of prospecting are itself a separate business activities. The Hon’ble Delhi High Court in the case of CIT vs. ACC RIO Tinto Exploration Ltd 321 ITR 426 has considered that the assessee was not permitted to undertake commercial production of any mineral or ore and therefore, section 35E has no application to the facts of the case. The facts on the above case was that the assessee was engaged in the business of prospecting and exploring ores and minerals, the Assessing Officer did not permit the claim of expenditure on the reason that the apparent changes in the accounting policy was to circumvent the provisions of 35E, as there is no mining activity and the expenditure cannot be allowed as revenue expenditure when the business of activity has not commenced. The CIT (A) while deleting the addition made by the Assessing Officer came to the conclusion that the activity of exploration constituted to a separate activity itself and was different and distinct from commercial production and relying on the permissions received from the FIPB with respect to only exploration activity in various States in India, the CIT(A) allowed the claim of the assessee. The ITAT confirmed the same and held that the provisions of Section 35E are not applicable as assessee was not in engaged in any commercial production. The Hon’ble Delhi High Court upheld the conclusions that the assessee company objectives did not include mining of ore or mineral or commercial production and therefore, the provisions of section 35E would not be applicable to the facts of the case as there was no possibility of any commercial production. In the present case the assessee was

permitted to undertake reconnaissance for prospecting activities with reference to diamonds in the State of Andhra Pradesh and accordingly claimed expenditure under section 35E which was directly related to prospecting expenditure. It cannot be stated that the assessee has not commenced the business activities. The assessee’s business activities has already started from the time it obtained the permission from the Govt. of A.P. (if not from the time it obtained FIPB permission) and started the activities of exploration/prospecting as per the permissions granted by various government agencies. In view of this, we are of the opinion that undertaking prospecting activities being an activity preceding the activity of mining which is a separate activity, the same can be said to be an activity by which the assessee has commenced its business.

7. The issue of commencement of the business was discussed elaborately by the Hon’ble High Court of Gujarat in the case of Saurashtra Cements and Chemical Industry Ltd,9 1 ITR 170 wherein the assessee started extracting lime stone from the leased area from 1958, completed installation of plant & machinery in the year 1960 and started manufacturing of cement in October, 1960. It was held that the assessee had commenced its business in 1958 when it started its activity of extracting limestone by quarrying leased area of land. While allowing, the Hon’ble High Court has held as under:

“To determine what was the business of the assessee, one must consider what were the activities which constituted such business without being misguided by loose expressions of vague and indefinite import. 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 leased area of land. This activity was necessary for the purpose of acquiring raw material to be utilized in manufacture of cement. The second category comprised the activity of manufacture of cement

by user of the plant and machinery set up for the purpose; and the third category consisted of the activity of selling manufactured cement. These three activities combined together constituted the business of the assessee. Each one of these activities was as much essential for the purpose of carrying on the business of the assessee as the others. If the assessee ceased to carry on any one of these activities, the business would come to an end. Each one of these activities constituted an integral part of 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. The business could not in fact be carried on without this activity. This activity came fist 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. The business consisted of a continuous process of these three activities and when the first activity was started with a view to embarking upon the second and the third activities, it clearly amounted to commencement of the business. It might be that the whole business was not set up when the activity of quarrying the leased area of land and extracting limestone was started. That would be set up only when the plant and machinery was installed, the manufacture of cement started and an organization for sale of manufacture cement was established. But, the business is nothing more than a continuous course of activities and 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 the other activities is started.

As soon as an activity which is an essential activity in the course of carrying on the business, or which, in other words, is a business activity is started, the assessee must be held to have commenced the business. To take any other view would not only be illogical but also irrational. The conclusion reached by the Tribunal could not, therefore, be said to be unreasonable or perverse or based on no evidence at all”.

8.        The Hon^’ble Supreme Court in the case of CIT vs. Sarabhai
Management Corporation Ltd 192 ITR 151 also took similar view in

holding that it cannot be said that the assessee commenced its business only when licensee or lessee occupied the premises and started paying rent. Hon’ble Madras High Court in the case of CIT vs. Franco Tosi Ingegneria (2000) 241 ITR 268 considered that assessee has commenced its business from the time it opened its site office and allowed the expenditure under section 37(1). In view of the principles decided in above cases, we are of the opinion that the assessee’s activities of prospecting which is a permitted activity by the FIPB in which the assessee has considerable expertise and further, considering that various permissions granted by the Govt. of Andhra Pradesh was only for reconnaissance with reference to exploration of diamonds, it can be concluded that the assessee has commenced its business from the time it started the prospecting activity. It is also seen from the permissions granted by the FIPB that in some cases the assessee was permitted to undertake for prospecting only for other minerals (except coal and iron ore). Therefore, prospecting activity itself is to be considered as assessee’s business activity. There is no dispute with reference to the expenditure being spent on prospecting activities in the year under consideration. Accordingly, it is held that the assessee has commenced its business activities.

9. Another reason for AO not allowing non prospecting expenditure as deduction to the assessee as revenue expenditure is that there was no income on this activity. Just because there are no incomes, it cannot be stated that the assessee’s expenditure is not allowable. Even though the assessee was involved in prospecting activities, there were no receipts during the year other than incomes from interest on deposits. However, it is an established law that the receipt of income is not a condition precedent for allowing the expenditure. This issue was already considered the Coordinated Bench in assessee own case in ITA no 6420/Mum/08 dt.05-09- 2011 asunder:

“8. It is in this light that the assessee has amortized prospecting, survey and exploration expenses (aggregating to .9.51 crores and these expenses include tenements fees, equipment rental, aircraft charter,

exploration data, exploration drilling, consumables, vehicle operations and maintenance, custom duty and clearance charges, computer software costs, freight

charges                   and professional fees etc), professional
fee( 35. 94 lakhs), direct employee costs ( 4. 82 crores)

and administrative charges ( 2.29 cro res).These expenses are directly related to prospecting of diamonds, and have been, therefore, rightly capitalized under section 35D. However, the expenses incurred by the assessee on salaries of employees, who are not working on the prospecting projects ( 1.93 crores), professional

fees not connected with exploration project ( 36.80 lakhs), administration charges not connected with prospecting work ( 3. 10 crores – including rates and

taxes,         property       rentals,       property          expenses,
communication expenses, travelling and conveyance

unconnected with                    prospecting projects, auditors
remuneration etc), interest and financial charges ( 1 9.91

lakhs), amalgamation expenses ( 4.33 lakhs) and depreciation ( 29. 98 lakhs), have not been included in the scope of capitalization under section 35E. These are the expenses, subject to suo motu disallowance by the assessee – which is not subject matter of dispute anyway, have been claimed as a deduction under section 3 7(1) of the Act. The Assessing Officer has, however, proceeded on the basis that since assessee is,

inter alia, engaged in the business of prospecting minerals- all the expenses incurred by the assessee are to be treated as eligible for amortization under section 35E, unless he can demonstrate that the expenses are incurred for earning an income which is taxable in the hands of the assessee. That is clearly an incorrect approach on the part of the Assessing Officer. The assessee even when engaged in the business of prospecting minerals, is eligible for amortization of such expenses as are eligible under section 35E(2) r.w.s. 35E(5)(a). All other expenses are eligible for deduction as in the normal course of computation of business income”.

10. In view of this, respectfully following the same we direct the Assessing Officer to allow the expenses on non-prospecting activities amounting to .27,88,030/- and depreciation .7,13,781/- claimed in this year.

11.       Ground No.2 in assessee’s appeal is with reference to taxing the interest received on short term deposit under the head ‘income from other sources’ instead of ‘business income’ as claimed in the return of income. It was the contention of the assessee that the funds received in the course of its business activity were kept in short term deposit on which the interests were earned, but these are the working capital funds, therefore, the interest so earned is to be treated as business income. The Assessing Officer has considered that in view of the reason that assessee not commenced its business interest income is to be assessed as ^Iincome from other sources’ relying on the decision of the Hon’ble Supreme Court in the case of Tuticorin Alkali Chemicals and Fertilizers Ltd. v. Commissioner of Income-tax 227 ITR 172. The CIT (A) confirmed the action of Assessing Officer that the assessee has not commenced its business.

12.       Even though both the Counsels relied on various case law supporting their respective stands, we are of the opinion that this issue has become academic in nature as the incomes of interest whether assessed under the head ‘business’ or ^Iincome from other sources’, the same is eligible for set off to the other expenditure being claimed under the head ^Ibusiness’. Consequent to our finding that the assessee has commenced its business and is eligible for claim of deduction under section 37(1) on expenditure of non-prospecting activities and depreciation thereon, the assessee is eligible for set off of the interest income. Since the issue becomes academic in nature, we do not intend to go into the aspect whether income is to be assessed as business income or other sources. There is various case law on the issue, holding if the capital funds are kept in deposits then the income is to be assessed as income from other sources and if the working capital funds are kept then to be treated as business income but, most of the case law was given on respective facts. Most of the issues arose as deductions are being

claimed on non-operational incomes also. In that context various decisions were rendered depending on facts and applicable law. The discussion will become only academic in nature in this case without there being any consequential effect as interest income is eligible for set off to business loss whether assessed as income from business or income from other sources. The Assessing Officer is however directed to allow the set off of business loss as per the provisions of the Act.

13.       With these directions, the appeal is considered as partly allowed.

ITA No.6193/Mum/2007 for Assessment Year 2001-02:

14.         In this appeal the assessee is contesting in Ground No.2 claim of expenditure on non prospecting activities amounting to 8,75,744/- and in Ground No.3 taxing of interest of 2,58,505/- as income from other sources. For the reasons stated in ITA No.40/Mum/ 2006 on the similar issue, we direct the Assessing Officer to allow the expenditure on non prospecting activities under section 37(1) and direct to set off to the interest income as per the provisions of the Act. In view of the above directions, Ground No.1 contesting about reopening of the assessment under section 147 becomes academic in nature which the learned Counsel also admitted as such. Therefore, Ground No.2 is considered allowed and Ground Nos. 1 & 3 are rejected. In the result appeal in ITA No/6193/Mum/2007 for the Assessment Year 2001-02 is partly allowed.

ITA No.86/Mum/2007 for the Assessment Year 2003-04:

15. In this appeal the assessee is contesting in Ground No.1 claim of expenditure on non-prospecting activities amounting to 63,91,157/- and in ground no.2 taxing of interest of 73,244/- as income from other sources. For the reasons stated in ITA No.40/Mum/ 2006 on the similar issues, we direct the Assessing Officer to allow the expenditure of non prospecting under section 37(1) and also direct to set off the interest income as per the provisions of the Act. In the result appeal in ITA No/86/Mum/2007 for Assessment Year 2003-04 is partly allowed.

ITA Nos. 6560 and 6561/Mum/2007 for the Assessment Years 2001-02 and 2003-04:

16. The assessee in these cases is De Beers India Surveys Pvt. Ltd. The assessee filed return of income for Assessment Year 2001- 02 declaring loss of .42,06,764/- and filed revised return disallowing expenditure allowed for prospecting under section 35E and claimed only loss of 7,36,797/- in the revised return of income. This company is also a subsidiary of De Beers Maurities Pvt. Ltd and commenced its operation under approval from FIPB dated 20.11.1997 as amended by a letter dated 16.09.1998 with the following objectives:

a)     To undertake prospecting the mining activities for diamond in the State of Madhya Pradesh, Andhra Pradesh and Orissa including other States.

b)     To undertake prospecting for other minerals except coal and iron ore.

In both the Assessment Years, the Assessing Officer took similar action consequent to his findings in De Beers India Prospecting (P) Ltd for Assessment Year 2001-02. The assessee has raised similar grounds in both the Assessment Years. As the facts are similar and nature of expenditure and activity being similar for the reasons stated in ITA No.40/Mum/2006, we hold that the assessee has commenced its business operations in the activity of prospecting and accordingly is eligible for claim of deduction under section 37(1) of the expenditure of non prospecting nature. The Assessing Officer is directed to allow the amount and give set off to the interest income earned by the assessee during the year as per the provisions of the Act. In view of the above directions, in ITA No.6560/Mum/ 07, Ground No.1 contesting about reopening of the assessment under section 147 becomes academic in nature which the learned Counsel also admitted as such. Ground No.2 is considered allowed and Ground Nos. 3 is rejected. Similarly, ground No.1 on the issue of claim of expenditure and allowance of depreciation is allowed and the Ground No.2 on heads of income to be considered for interest income is dismissed as academic in nature in ITA No 6561/Mum/04. Hence appeals in ITA Nos. 6560 and 6561/Mum/2007 for the Assessment Years 2001-02 and 2003-04 are partly allowed.

ITA No.6562/Mum/2007 for Assessment Year 2003-04:

17. De Beers India Minerals (P) Ltd is the subsidiary of De Beers Mauritious (P) Ltd commenced its operations under approval from FIPB dated 2.11.1998 as amended by letter dated 12.9.2000, initially for conducting diamond prospecting and mining and subsequently for prospecting and mining of other minerals (except coal and iron ore). The company obtained permissions from the Govt. of Andhra Pradesh on 28.2.200 1 and started its operation of exploration in the State of Andhra Pradesh. During the year the assessee declared a loss of 42,85,363/- after capitalizing an amount of 57,245/- being the amount covered under section 35E. For the reasons discussed by the Assessing Officer in 2 002-03 in the case of De Beers India Prospecting, the Assessing Officer disallowed the revenue expenditure but allowed it to be capitalized the same along with depreciation. The grounds raised by the assessee are similar to other companies discussed above. The assessee’s activities of prospecting has commenced in earlier years and for the reasons stated in ITA No.40/Mum/2006, we direct the Assessing Officer to allow the expenditure under section 37(1) including the depreciation as claimed. AO is also directed to give set off of interest of 70,779/- earned by the assessee as per the provisions of the Act. Accordingly Ground No.1 is considered as allowed and Ground No.2 is dismissed as academic in nature. Appeal in ITA No. 6562/Mum/2007 for the Assessment Year 2003- 04 is partly allowed.