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Facts
The assessee filed a return declaring nil income, which was selected for scrutiny. The Assessing Officer (AO) made additions including disallowance of pre-operative expenses and interest on borrowed funds. The Commissioner (Appeals) partly allowed the assessee's appeal, upholding a portion of the disallowance for pre-operative expenses and deleting the disallowance of interest.
Held
The Tribunal held that pre-operative expenses incurred on expansion of existing business, even if treated as capital expenditure in books, are allowable as revenue expenditure under Section 37(1) if the business has commenced. The disallowance of interest expenditure was also deleted, following consistent decisions in favor of the assessee.
Key Issues
Whether pre-operative expenses incurred for expansion of existing business are allowable as revenue expenditure? Whether disallowance of interest expenditure on loans given to associate entities is justified when the assessee has sufficient own funds?
Sections Cited
37(1), 36(1)(iii), 35D(1)(ii), 143(3), 250
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Before: SHRI AMIT SHUKLA & SMT. RENU JAUHRI
आदेश / O R D E R PER RENU JAUHRI [A.M.] :- These cross appeals are filed by the assessee and the Revenue against the order of the Learned Commissioner of Income-tax (Appeals), Mumbai/National Faceless Appeal Centre, Delhi [hereinafter referred to as “CIT(A)”] dated 30.09.2024 passed u/s. 250 of the Income-tax Act, 1961 [hereinafter referred to as “Act”] for Assessment Year [A.Y.] 2017-18.
2. The assessee has raised following grounds of appeal:
1. The Commissioner of Income Tax(Appeals), National Faceless Appeal Centre, Delhi ['CIT(A)'] erred in confirming the disallowance of pre-operative expenses to the extent of Rs.44,10,304/- [out of total disallowance of Rs.2,09,67,669/- made by the AO] on the ground that the expenses are capital expenditure not deductible u's 37(1) of the Act. The Appellant submits that the pre-operative expenses were incurred after setting up of its business and in the course of and for the purpose of carrying on its business activity and hence, the expenses incurred on expansion of its existing business are allowable as revenue expenditure u/s 37(1) of the Act. The Appellant further submits that the expenses have not brought into existence any capital asset or enduring benefit and satisfy all the essential conditions of Section 37(1) of the Act; hence on the facts and circumstances of the case, disallowance of pre-operative expenses u/s 37(1) of the Act made by the AO shall be deleted.
1. 2. The CIT(A) erred in confirming the action of AO in not granting the credit of TDS of Rs.11,02,610/- to the Appellant in respect of demerged restaurant business of Sussegado Bar & Kitchen (P) Ltd. The Appellant submit that all income and expenses of restaurant business of demerged entity Sussegado Bar & Kitchen are accounted in the books of the Appellant and the AO shall be directed to allow the credit of TDS of demerged undertaking to the Appellant.”
3. The revenue has raised following grounds of appeal:
1. On the facts and circumstances of the case and in law, the CIT(A) erred in restricting the addition to the tune of Rs. 44,10,304/- as against Rs. 2,09,67,669/- made by the AO in respect of pre-operative expenses without appreciating the fact that in the books of account of the assessee pre-operative expenses amounting & 6255/Mum/2024 A.Y. 2017-18 Olive Bar and Kitchen Pvt. Ltd.
Rs.2,09,67,669/- were shown under the head of Lease Hold Property/Capital WIP and reflected under Fixed Assets Schedule.
2. On the facts and circumstances of the case and in law, the CIT(A) did not appreciate the fact that the pre-operative expense is allowable only u/s 35D(1)(ii) of the Income Tax Act, 1961 to the extent mentioned therein and section 37(1) of the Income Tax Act also does not allow any capital expenditure.
3. On the facts and circumstances of the case and in law, the CIT(A) erred in deleting the disallowance made u/s. 36(1)(lit) towards interest of Rs. 1,37,07,281/- paid on loans without appreciating the fact that the onus vests with the assessee to establish that the advancing interest free loans to sister concerns falls within the purview of business activities within the meaning of section 36(1)(iii) of the Income Tax Act, 1961.
4. On the facts and circumstances of the case and in law, the CIT(A) erred in deleting the disallowance made u/s. 36(1)(iii) towards interest of Rs. 1,37,07,281/- paid on loans without appreciating the ratio laid down by the Punjab and Haryana High Court in case of Abhishek Industries Ltd. 286 ITR 1 that instead of applying the theory of direct nexus of the funds between borrowings of the funds and diversion thereof for non-business purposes, there should be nexus of use of borrowed funds for the purpose of business to claim deduction under section 36(1)(lit) of the Income Tax Act, 1961.
The appellant prays that the order of the CIT(A) on the grounds be set aside and that of the Assessing Officer be restored.”
Brief facts of the case are that the assessee filed return declaring nil income for AY 2017-18 on 28.10.2017. The case was selected for scrutiny and assessment was completed at an income of Rs. 3,49,89,391/- vide order u/s 143(3) dated 17.12.2019. Following additions were made by Ld. AO to the returned income: i. Disallowance of pre-operative expenses -Rs. 2,09,67,669/- ii. Disallowance u/s 36(1)(iii) on account of interest on borrowed funds -Rs. 13,72,07,281/-. iii. Disallowance u/s 36(1)(va) -Rs. 3,14,441/-
5. Aggrieved with the order of Ld. AO, the assessee preferred an appeal before Ld. CIT(A). Vide order dated 30.09.2024, the assessee’s appeal was partly allowed. Out of pre-operative expenses, disallowance to the extent of Rs. & 6255/Mum/2024 A.Y. 2017-18 Olive Bar and Kitchen Pvt. Ltd. 44,10,304/-was upheld by Ld. CIT(A). The disallowance out of interest was entirely deleted, while disallowance of Rs. 3,14,441/- was confirmed by Ld. CIT(A). Aggrieved with the order of Ld. CIT(A), both the assessee and the revenue are in appeal before us.
(Assessee’s appeal) Ground No. 1 : Disallowance of pre-operative expenses.
The assessee had shown pre-operative expenses in respect of eight units which were claimed as deduction in the computation of income. Ld. AO noted that these expenses have been shown by the assessee himself as pre-operative expenses. Even though the assessee had started his business earlier, these expenses were incurred on the units/outlets which had commenced business subsequently. Accordingly, he held that the pre-operative expenses of Rs. 2,09,67,669/- were not allowable u/s 37(1) of the Act and these have to be capitalized and depreciation at the rate of 15% only was allowable.
Ld. CIT(A) examined the details of these expenses and noted that a sum of Rs. 9,20,34,539/- had been debited under the head “lease holding property/ capital working progress” in the books of account. Out of these, the assessee claimed a sum of Rs. 2,09,67,669 as revenue expenditure spent on 10 restaurants out of which 4 were made operational during the financial year and balance were made operational in the succeeding financial year. The assessee & 6255/Mum/2024 A.Y. 2017-18 Olive Bar and Kitchen Pvt. Ltd. claimed that since it was already in the business of running restaurants, opening of new restaurants constituted expansion and extension of existing business, and therefore, such expenses could not be treated as pre-operative expenses.
In the previous A.Y. 2013-14 also the same issue was decided in assessee’s favour by the co-ordinate bench in and ITA No. 5165/Mum/2017. Hence, following the decision of the co-ordinate bench, Ld. CIT(A) allowed a major portion of these expenses except the following which were treated as capital expenses: “1. Brokerage and commission for acquisition of new property to start the business of new restaurant -Rs. 25,89,825/-.
Registration charges and stamp duty paid - Rs. 8,74,990/-.
License and permission -Rs. 9,45,489/-. Total -Rs. 44,10304/- Accordingly, part relief to the extent of Rs. 1,65,57,365/- was allowed by the Ld. CIT(A). Out of total amount of Rs. 2,09,67,669/-.
Before us, Ld. AR has submitted that the assessee has been in the business of running restaurants since the year 2000, when its first restaurant was opened. Thereafter, it has been expanding its business and opening new restaurants from time to time. The same issue came up for adjudication in earlier years also and for AY 2013-14, the co-ordinate bench has already decided it in favour of the assessee. He, therefore, argued that the issue is squarely covered in favour of the assessee and it should be allowed in favour of the assessee for this year also.
& 6255/Mum/2024 A.Y. 2017-18 Olive Bar and Kitchen Pvt. Ltd. Ld. DR, on the other hand, relied heavily on the order of Ld. AO and vehemently argued that these expenses were treated as pre-operative expenses by the assessee himself in his financial statements and, therefore, these cannot be allowed u/s. 37(1) of the Act.
We have heard the rival submissions and perused the material placed before us. It is seen that the issue is squarely covered by the decision of the co- ordinate bench in assessee’s own case in the immediately preceding year in ITA No. 5097/Mum/2017. Relevant portion of the order is reproduced as under: “9. We have heard both the parties, perused the material available on record and gone through the orders of authorities below. The fact with regard to the commencement of business by the assessee is not disputed by the lower authorities. The assessee is into the business of running restaurants and had commenced its business activities. During the year under consideration the assessee has expanded its existing business by opening three more restaurants at different places. The assessee has treated expenditure incurred in connection with the establishment of restaurants under the head 'capital work in progress' in its books of account. But, when it comes to computation of total income, the expenses in the nature of revenue are treated as revenue expenditure and claimed as such. The AO disallowed pre- operative expenses on the ground that a particular expense cannot have two treatments, i.e. one in the books of account and the other in computation of total income. According to the AO, pre-operative expenses can be deducted as per the provisions of section 35D(1)(ii) to the extent as indicated therein. It is the contention of the assessee that it is in the business of running restaurants and it has commenced its business during the year under consideration. Though, the commercial operations has not been taken place in respect of three new restaurants, the commencement of its business activities is not in doubt. The assessee further contended that all expenditure incurred in connection with setting up of new units which are in the nature of capital expenditure has been debited to capital work in progress. Even revenue expenditure incurred in connection with a particular unit has been treated as capital work in progress in its books of account. But, when it comes to computation of total income revenue 0065penditure has been claimed as deduction u/s 37(1) of the Act, because the assessee has commenced business activities.
10. Having heard both the sides, we find that there is no dispute with regard to the nature of expenditure claimed by the assessee as revenue expenses in its statement of total income. The assessee has incurred various revenue expenditures like salaries and wages, PF and ESI contribution, travelling expenses, repairs and maintenance, staff room expenses and like other general administrative expenses. It is also not in & 6255/Mum/2024 A.Y. 2017-18 Olive Bar and Kitchen Pvt. Ltd. dispute that the assessee had not commenced commercial operations of the particular new units established during the year under consideration. Therefore, once particular expenditure is revenue in nature, for the purpose of determination of income, what is relevant is whether a particular expenditure has been incurred wholly and exclusively in connection with business and such expenditure has been incurred for the business in the relevant period or not. It is not relevant as to how the assessee shows a particular income or expenditure in the books of account. Separate computation of income and expenditure would be justified only when several distinct business are carried on and not when the separate business activities were carried out by same person and one set of account is maintained for all set of activities. In this case, it is not in dispute that the assessee has maintained one set of books of account for its business activity even though it has separate units in different places. Further, it is also not in doubt that pre-operative expenses claimed in statement of total income are in the nature of revenue expenses. Therefore, we are of the considered view that when the assessee has commenced its business activity in the relevant previous year and also incurs certain expenses which are revenue in nature, there is no reason for the AO to treat said expenditure as capital expenditure merely for the reason that the assessee has given different treatment for such expenditure in its books of account and statement of total income.
Coming to the case laws relied upon by the assessee. The assessee has relied upon plethora of judgements, including the decision of Hon'ble Bombay High Court in the case of CIT vs Reliance Supply Chain Solutions Ltd (supra). The Hon'ble jurisdictional High Court, under similar circumstances held that when assessee has incurred expenditure for expansion of its existing business, expenditure incurred in the nature of revenue expenditure could not be disallowed. The relevant observations of the Hon'ble Court are as under:- "6] We have considered the submissions canvassed by the learned counsel for the respective parties. 7] It is not relevant as to how the Assessee shows a particular income or expenditure in the books of account. In the present case, the Commissioner (Appeals) and the Tribunal has specifically on appreciation of factual matrix arrived at a conclusion that the expenditure are directly identifiable with the operations and maintenance of the existing stocks i.e. with regard to the payment of salary, travelling and conveyance allowance, telephone expenses, professional fees paid, audit fee and other miscellaneous expenses. 8] In view of the specific finding of fact arrived at by the Commissioner (Appeals) and the Tribunal, the Tribunal have held he expenditure to be revenue expenditure. In case of Kothari Auto Parts Manufacturers Pvt. Ltd. (supra), this Court had specifically observed that separate computation of income and expenditure would be justified only when several distinct business are carried on, and not when the separate business activities were carried out by some person and when one set of account is maintained for all set of activities. 9] In the present case also, one set of account is maintained for the business activity by the Assessee. The Assessee had incurred expenditure on account of & 6255/Mum/2024 A.Y. 2017-18 Olive Bar and Kitchen Pvt. Ltd. expansion of business and the Assessee had commenced the business as per the findings of the Commissioner (Appeals) and the Tribunal. The said findings are findings of the fact."
12. The assessee has also relied upon the decision of Hon'ble Bombay High Court in the case of CIT vs Evergrowth Telecom Ltd (2013) 29 taxmann.com 273 (Bom). The Hon'ble jurisdictional High Court, while considering the issue of expenditure incurred after setting up of business and before commencement of business held that the said expenditure is allowable as a deduction u/s 37(1) of the Income-tax Act, 1961. The relevant observations of the Court are as under:- "Any expenditure incurred after setting up of a business and before the commencement of business is allowable as a deduction under section 37(1). The issue whether the expenditure has been incurred for purposes of business is an issue of fact and two authorities under the Act have rendered a finding of fact that expenses incurred on account of PSTN charges and dealer's commission are incurred for purposes of business and allowable under section 37(1). In view of the above, no substantial question of law arises with regard to issue in question. [Para 5]"
13. The assessee has also relied upon the decision of Hon'ble Madras High Court in the case of CIT vs Shakti Sugars Ltd 339 ITR 400 (Mad). The Hon'ble High Court, while considering the issue of deductibility of pre-operative expenses held that expenditure on setting up of new unit by way of expansion of existing business is revenue expenditure. The relevant observations of the Court are as under:- Held, dismissing the appeal, that the Commissioner (Appeals) as well as the Tribunal were fully justified in accepting the case of the assessee in respect of the expenses claimed by the assessee as revenue expenditure. The expenses in respect of the B unit were incurred towards salaries, wages, bonus, contribution to provident fund, workmen welfare expenses, power, fuel and water, manufacturing expenses, rent for office buildings, insurance premium, repairs and maintenance for machinery and building, motor vehicle, office equipment, etc., interest on bills cleared, freight and transport, cane development expenses, travelling expenses, other administrative expenses and financial and bank charges. In respect of the D unit, the expenses incurred by way of pre-operative expenses for the year 1991-92 were towards cane development expenses, travelling expenses, administrative and other expenses, legal and professional charges, electricity charges, rates and taxes, insurance premium, repairs and maintenance charges for building and machinery and motor vehicle and other office equipment maintenance, financial and bank charges, freight and transport, salaries, wages, bonus, etc., workmen welfare expenses, interest charges and depreciation. The various kinds of expenditure were incurred in the relevant years for the purpose of manufacture of sugar in the respective & 6255/Mum/2024 A.Y. 2017-18 Olive Bar and Kitchen Pvt. Ltd. factories with a view to earn profits and, therefore, they were nothing but revenue expenditure."
14. In this view of the matter and respectfully following the case laws discussed hereinabove, we are of the considered view that the AO was erred in disallowing deduction claimed towards pre-operative expenses in statement of total income u/s 37(1) of the Income-tax Act, 1961 even though the said expenditure has been treated as capital expenditure in books of account. The Ld. CIT(A), after considering relevant facts has rightly deleted addition made by the AO. Therefore, we are of the considered view that there is no error in the findings of the Ld.CIT(A) and hence, we are inclined to uphold the findings of the C / T * (A) and dismiss appeal filed by the revenue.”
11. Since facts in the present year are identical, respectfully following the decision of the co-ordinate bench, we, hereby, allow the entire claim of the assessee in respect of pre-operative expenses of Rs. 2,07,67,669/- u/s 37(1) of the Act. Ground No. 2 Grant of TDS of Rs. 11,08,610/-.
Brief facts in this regard are that in addition to the TDS deducted in its own name, the assessee had also claimed TDS of Rs. 11,08,610/- in respect of its demerged restaurant business of Sussegado Bar & Kitchen (P) Ltd. in the return of income. However, the same was not allowed by the Ld. AO on the ground that it did not appear in the 26AS statement of the assessee. In this regard, the assessee has furnished a reconciliation of 26AS statement along with reconciliation of income shown as per ITR and 26AS statement. It has further been explained that the income of Rs. 3,41,21,095/- from Sussegado Bar & Kitchen (P) Ltd. has been duly offered for tax in assessee’s return. A copy of the scheme of amalgamation and arrangement between the assessee and Sussegado & 6255/Mum/2024 A.Y. 2017-18 Olive Bar and Kitchen Pvt. Ltd. Bar & Kitchen (P) Ltd. has also been furnished wherein there is an express provision regarding treatment of tax as under: “10 TREATMENT OF TAX AND ACCOUNTING TREATMENT 10.1 Treatment of Tax: 10.1.1 It is clarified that all taxes and duties payable by SUSSEGADO, accruing and relating to the operations of the Demerged Undertaking from the Appointed Date onwards, including all advance tax payments, tax deducted at source, any refund and claims shall, for all purposes, be treated as advance tax payments, tax deducted at source or refunds and claims of OLIVE BAR. Accordingly, upon this Scheme becoming effective SUSSEGADO is expressly permitted to revise, and OLIVE BAR is expressly permitted to file their respective income tax returns, including tax deducted at source certificates, sales tax/ value added tax returns, excise returns, service tax returns and other tax returns for the period commencing on and from the Appointed Date, and to claim refunds/ credits, pursuant to the provisions of this Scheme. . . . . . . . 10.1.4 Upon the Scheme becoming effective, the Transferee Company is also expressly permitted to revise their Income Tax returns, and other returns filed under the Tax Laws and to claim refunds, advance tax and withholding tax credits, etc. as applicable pursuant to the provisions of this Scheme.”
In the light of above facts, Ld. AR has requested that the matter may be restored to AO for verification of its claim regarding TDS credit.
In all fairness, Ld. DR has also not objected to the said proposition.
We have heard both the parties and perused the material placed before us. We, accordingly, deem it proper to set aside the issue to the Ld. AO with directions to allow the credit of TDS to the assessee after verifying whether or & 6255/Mum/2024 A.Y. 2017-18 Olive Bar and Kitchen Pvt. Ltd. not Sussegado Bar & Kitchen (P.) Ltd. has claimed the credit in respect of amount in question in its return of income. 6255/MUM/2024 (Revenue’s Appeal) Ground No. 1 & 2 of revenue’s appeal related to claim of pre-operative expenses have already been discussed as decided under paras 6-12 hereinabove. Ground No. 3 & 4 : Disallowance of interest amounting to Rs. 1,37,07,281/- u/s 36(1)(iii).
Brief facts in this regard are that the assessee had given interest free loan of Rs. 3,01,67,041/- to one of its associate entities which is also in the business of running restaurants. The assessee’s contention was that the loan was given in an earlier financial year out of its own sources. It was, further, claimed that the interest expenses of the assessee during the year under consideration were on specific borrowing which had no nexus with the interest free loan given to its associate entities. Ld. AO, however, did not accept the contention of the assessee and disallowed the interest expenditure to the extent of Rs. 1,37,07,281/- u/s 36(1)(iii) of the Act.
In appeal, it was observed by the Ld. CIT(A) that exactly similar issue was decided by the co-ordinate bench in assessee’s own case for AY 2014-15 after relying on the decision of the Hon’ble Supreme Court in the case of Essay Builders v/s CIT 288 ITR 1. Accordingly, Ld. CIT(A), after noting that no advance was made to any associated entity during the year and the amounts & 6255/Mum/2024 A.Y. 2017-18 Olive Bar and Kitchen Pvt. Ltd. advance earlier had already been held to be out of internal resources in the preceding years, deleted the disallowance of Rs. 1,37,07,281/-. Ld. AR strongly relied on the order of Ld. CIT(A). Ld. DR, on the other hand, placed reliance on the order of Ld. AO.
We have heard the rival submissions and perused the material placed before us. It is seen that this issue is a recurring one and has been consistently decided in favour of the assessee by the co-ordinate benches in earlier years. As there is no change in facts and circumstances in this year, we are inclined to follow decision of the co-ordinate bench for AY 2014-15 wherein it has been held as under: “6. So far as the disallowance u/s 36(1) (iii) is concerned, upon perusal of financial statements, it transpires that the assessee's opening own funds in the shape of share capital and free reserves aggregating to Rs.36.87 Crores far exceeds the interest free loans of Rs.3.05 Crores advanced by the assessee. It has been argued that in case of mixed usage of funds, a presumption was to be drawn in assessee's favor that interest free loans were granted out of free funds available with the assessee in terms of decision of Hon'ble Bombay High Court rendered in CIT Vs. Reliance Utilities & Power Ltd. [313 ITR 340]. However, both the lower authorities distinguished the same on the ground that the decision was rendered in the context of investments made by the assessee and not in the context of grant of interest free advances. However, the said reasoning, in our opinion, would hold no water since the ratio of the cited decision would apply in all cases where the funds were diverted for non-business purposes i.e. either to make investments or to advance interest free loans. Therefore, the lower authorities were not justified in disallowing the same particularly in view of the fact that fresh loans granted by the assessee to the said entity during impugned AY was only to the tune of Rs.88.78 Lacs. Another factor is to be noted that the loan has been granted by the assessee to its subsidiary company and Ld. AO has rejected the stand of the assessee on the ground that the business of the subsidiary could not be considered in law as the business of the assessee without controverting the fact that the aforesaid subsidiary was also engaged in the business of running the restaurants and without appreciating the fact that the assessee would derive business benefits out of the same. In such a scenario, the ratio of decision of Hon'ble Apex Court rendered in S.A. Builders Vs. CIT [288 ITR 1] would also become applicable to the facts of the case. Therefore, viewed from any angle, the impugned disallowance, in our opinion, could not be sustained. Hence, by deleting the same, we allow the assessee's appeal.”
& 6255/Mum/2024 A.Y. 2017-18 Olive Bar and Kitchen Pvt. Ltd.
In view of above, we find no reason to interfere with the decision of the Ld. CIT(A) which is in consonance with the decisions of the co-ordinate benches for earlier years. Accordingly, disallowance of Rs. 1,37,07,281/- u/s 36(1)(iii) of the Act is hereby deleted and order of Ld. CIT(A) is upheld.
In the result, the appeal of the revenue is dismissed and the appeal of the assessee is allowed for statistical purposes. Order pronounced in the open court on 22.01.2025.