SWARAJ CORPORATION,ANAND vs. THE DY.CIT, CENTRAL CIRCLE-2, VADODARA

Ld. CIT (A) erred in law and on facts confirming disallowance made by AO of preoperative expenses of Rs. 2, 04, 85, 862/- claimed by the appellant.

Ld. CIT (A) gravely erred on facts observing that most of the notices issued u/s 250 of the Act remained unattended without fresh compliance and reply furnished earlier was taken into consideration for adjudicating the appeal. Asst. Year : 2015-16 - 2–

Ld. CIT (A) erred in law and on facts confirming that expenditure incurred was in the nature of 'prior period expenses' as the liability for the same had crystalized and was paid/ payable during earlier assessment years.

Ld. CIT (A) erred in law and on facts confirming disallowance when expenses were duly accounted for in the books of account in respective years in which they were incurred and ITR for those years were also filed in time.

Ld. CIT (A) erred in law and on facts not appreciating the fact that expenses are of revenue in nature incurred wholly and exclusively for the purpose of business that are allowable u/s 37(1) of the Act.

Ld. CIT (A) erred in law and on facts to hold that claim based on accounting standard AS 16 for capital assets to justify the timing of revenue expenses is illogical and legally untenable.

Levy of interest u/s 234A/234B/234C of the Act is unjustified.

Initiation of penalty proceedings u/s 271(1)(c) of the Act is unjustified.

The brief facts of the case are that the appellant is a partnership firm constituted by a partnership deed dated 14.12.2011 and is engaged in the business of real estate development. During the course of assessment proceedings, the Assessing Officer noticed that the appellant had debited an amount of Rs.2,07,39,569/- to its Profit and Loss Account under the head “Pre-operative Expenditure”. On being called upon to explain the same, the appellant submitted that the said amount represented an accumulation of various administrative, selling, financial and other miscellaneous expenses incurred by the appellant-firm during the financial years 2011-12, 2012-13 and 2013-14, relevant to Assessment Years 2012-13, 2013-14 and 2014-15, respectively. The assessee explained that its business activity involved development of agricultural land, contributed by the partners as capital, into residential plots. It was further submitted that, before the developed plots could be Asst. Year : 2015-16 - 3– legally transferred to customers, the firm was required to obtain various statutory permissions from the concerned authorities. The final permission for conversion of the land for Non-Agricultural (NA) residential use was granted by the Collector, Anand, on 04.01.2014. The assessee contended that its commercial operations, in the form of entering into agreements for sale with customers, commenced during the year under consideration and, therefore, the accumulated expenditure was claimed as a deduction in the year under consideration.

The Assessing Officer observed that the assessee follows the mercantile system of accounting, under which expenditure is required to be accounted for in the year to which it pertains, i.e., the year in which the liability in respect thereof accrues or crystallizes. The Assessing Officer referred to sections 4, 5 and 28 of the Income-tax Act, 1961, and observed that the computation of income is made with reference to a particular previous year. Accordingly, any expenditure claimed as a deduction must pertain to the relevant previous year. After considering the submissions of the assessee and relying upon various judicial precedents referred to in the assessment order, the Assessing Officer held that the expenditure of Rs.2,07,39,569/- was in the nature of prior- period expenditure, as the liability in respect thereof had accrued and crystallized during the earlier previous years. He, therefore, held that the said expenditure was not allowable as a deduction in the year under consideration. Accordingly, the Assessing Officer disallowed the entire amount of Rs.2,07,39,569/- and added the same to the income of the assessee. Asst. Year : 2015-16 - 4–

Aggrieved by the Assessment Order, assessee preferred an appeal before the Ld. CIT(A), who dismissed the appeal of the assessee by observing as follows:

The Ld. AR argued that the expenditure was not in the nature of prior-period expenditure, as the same was recorded in the respective years and carried forward as “Pre-operative Expenses” since commercial operations had commenced only after receipt of NA permission on Asst. Year : 2015-16 - 7– 04.01.2014. It was contended that the accumulated expenditure was revenue in nature, incurred wholly and exclusively for business purposes, and was therefore allowable under section 37(1) of the Act. The Ld. AR also relied upon Ind AS 16 in support of the accounting treatment adopted by the appellant.

Heard the argument of both the parties and perused the material available on record.

The Ld. AR argued that since commercial operations i.e. entering into sale agreements only began after the Collector granted NA conversion on 04.01.2014, all administrative/selling/financial expenses accumulated across FY 2011-12 to 2013-14 should be deductible in the year business "commenced" — treating them as a form of deferred revenue expenditure, supported by Ind AS 16 accounting treatment. On the other hand the Ld. DR’s sturdiest argument was that, under the mercantile system, liability accrues and also crystallizes when incurred, not when the assessee chooses to claim it. Relying on Bharat Earth Movers and SMCC Construction, the CIT(A) treated this as ordinary prior-period expenditure with no basis for deferral. We find that the Ld. CIT(A) has confirmed the disallowance of the pre-operative expenditure primarily on the ground that the expenditure pertained to earlier years and that the appellant had not furnished sufficient details regarding the revenue recognised during the year under consideration. The Ld. CIT(A) has also recorded findings regarding the allowability of interest expenditure under section 36(1)(iii) of the Act for want of evidence establishing the nexus between the borrowed funds and the business of Asst. Year : 2015-16 - 8– the appellant. In the case of Majestic Auto and Core Healthcare dealt with deferred revenue expenditure treatment where there's an "enduring benefit”, not simply because a business hasn't yet generated revenue. There is well-established distinction, between a business being set up, established and ready to commence and a business being commenced, actual trading/operations begin. It was time and again held that all expenses incurred during the inter-regnum between setting up of business and commencement of business would be permissible deductions under the Income Tax Act, and that whether a business has been set up is essentially a question of fact. In the business of the assessee i.e. real estate development, it can be said that the assessee had ‘set-up business’ (2011) once it had land i.e formation of the firm and acquisition of land and ‘commencement’ once the NA permission (Jan 2014) was granted, that is the date rom which the assessee entered into agreement for sale. The prior period expenditure is not default by choice but by provisions of accounting taking it away from the matching principle as canvassed by the revenue. Having examined the component business activity and the business activity as a whole, we hold that the expenses claimed by the assessee are deductible in principle.

We hold that the expenditure was incurred wholly and exclusively for the purposes of its business and is carried forward as pre-operative expenditure since the commercial operations commenced only after receipt of the NA permission on 04.01.2014. The provisions of section 37(1) of the Act are applicable. Nevertheless, the relevant details and supporting documents in respect of the nature of the expenditure, the commencement of business, revenue recognised during the year and the Asst. Year : 2015-16 - 9– utilisation of borrowed funds, particularly in respect of interest expenditure, require proper examination. In the interest of justice, we deem it appropriate to restore the matter to the file of the Ld. CIT(A) for de-novo adjudication. The Ld. CIT(A) shall examine the issue afresh after considering the complete details and supporting evidences furnished by the assessee and after affording adequate opportunity of being heard to the assessee. The principle laid down in this order shall be adhered by the Ld. CIT(A). The assessee shall comply with the notices and furnish all relevant documents and explanations in support of its claim.

In the result, the appeal of the assessee is allowed for statistical purposes.