ACIT, NEW DELHI vs. M/S. LODHI PROPERTY COMPANY LTD., NEW DELHI

For Assessment year 2007-08, assessee filed its return of income 31st October 2007 declaring total business loss of Rs. 9,08,84,894/-. However, on finding certain inadvertent omissions/ mistakes in the original return, assessee voluntarily revised its return of income on 26 March 2009 declaring a total loss of Rs.7,70,05,921/- well within the time limit. Net interest income from advances made to the group companies amounting to Rs.1,68,355/- 2 & 4970/Del/2011 was offered to tax. An amount of Rs.6,85,114/- was also offered to tax being short term capital gain on sale of liquid mutual funds.

As the assessee has temporarily suspended Lodhi hotel operations in view of extensive renovation of the hotel building (which was under renovation/reconstruction during the previous year relevant to the subject assessment year) no income was earned by the assessee from the business for the subject assessment year. The assessee had capitalized expenses in connection with the renovation/reconstruction activity under the head 'Capital Work-in- progress' (CWIP). However operating and other expenses relating to day to day administration of the business were charged to Profit and Loss account and the same, except preoperational period expense, were claimed by the assessee in the return of income under section 37(1) of the Act being revenue expenditure incurred for the purposes of business.

However, the Learned Assessing Officer (Ld. AO) in his assessment order dated 23 December 2010 assessed the income of the appellant as Rs.7,29,36,102/- as against the returned loss of Rs.77,005,921/-, by making the following additions/disallowances: Expenses disallowed Preoperative expenses 7,38,96,181 Disallowance under section 35 DDA of 1,56,21,450 Disallowance under section 36(l)(iii) of 6.04,24,392 Total disallowance 7,29,36,102

Aggrieved by such addition, assessee preferred appeal before the Ld. CIT(A). By way of impugned order, Ld. CIT(A) observed that the amount of expenditure relating to the period of the suspension of the business activities is capital in nature, and he directed the Ld.AO to 3 & 4970/Del/2011 allow the expenses in respect of Rs.7,38,96,181/- by way of deprecation at the rate allowable on buildings.

However, subsequently by order dated 10.03.2011, Ld.AO observed that inasmuch as the assessee claimed deduction of only Rs.3,55,63,725/- as revenue expenditure in the relevant year, only a sum of Rs.3,55,63,725/- was added back in the palace of Rs.7,38,96,181/-. Assessee challenged the categorization of expense as capital by the Ld. CIT(A) and the consequent disallowance thereof in whereas the Revenue challenged the direction of the Ld.CIT(A) to allow deprecation in respect of the same, holding to be capitalized on building account, though no business activity was carried out during the year in .

Ld. CIT(A) further observed that the assessee borrowed a sum of Rs.23 crores to purchases of shares in Golden Green Golf Resorts Ltd. (“GGGRL”), and incurred an interest expenditure of Rs.2,77,70,375/- on the said loan during this assessment year. Assessee further borrowed Rs.36 crores for giving loans to GGGRL and incurred an interest expenses of Rs.3,26,54,017/- during this assessment year. Ld.CIT(A) concluded that the loans borrowed by the assessee were used for the purpose of acquisition of shares of GGGRL as such it cannot be said that the borrowed capital was used for business purpose and consequently interest on the borrowed amount is not deductible u/s 36(1)(iii) of the Act.

Learned CIT(A) placed reliance on the decision of Hon’ble Gujarat High Court in the case of Sarabhai Sons P. Ltd. vs CIT (1993) 201 ITR 464 wherein it was held that when the shares which are acquired not for the purpose of earning of income but only for the & 4970/Del/2011 purpose of acquiring the controlling rights over another company, the interest on the borrowed funds cannot be treated as business purpose of the assessee and was not allowable. Ld.CIT(A) turned down the alternative plea of the assessee that the interest expense of Rs.6,04,24,392/- should be allowed as part of cost of shares in the year of sale of shares of GGGRL by the assessee on the ground that inasmuch as the shares of GGGRL were not sold by the assessee in the relevant assessment year, such a plea is a pre-matured one. Assessee challenged this in ITA No.4851/Del/2011.

In respect of the observations of the learned CIT(A) that the alleged expenses claimed by the assessee as revenue in nature be treated as capital expenditure and the learned AO to allow depreciation thereon at the rates allowable on buildings, it is the argument of the learned AR that the assessee purchased a running hotel and admittedly conducted operations till October 2002, as such it cannot be said that the business of the assessee was not set up. He placed reliance on the decisions reported in CIT vs Dhumketu Builders & Development Pvt. Ltd. [2014] 368 ITR 680 (Del.); CIT vs Samsung India Electronics Ltd. [2013] 356 ITR 354 (Del.); Carefour WC & C India P. Ltd. vs DCIT [2014] 368 ITR 692 (Del.); CIT vs ESPN Software India Pvt. Ltd. [2009] 184 taxmann 452 (Del.); CIT vs Arcane Developers (P.) Ltd. [2014] 42 taxmann.com 10 (Del.); and M/s Multi Act Realty Enterprises Pvt. Ltd. vs ITO [ITA No.7274/Mum/2011] (Mumbai Tribunal) in support of his contention that the business shall be deemed to have been commenced when its first activity is started.

He submitted that for the purpose of renovation and better business profits they demolished the old building and constructed a 5 & 4970/Del/2011 new building subsequent to October 2002 and the construction was complete by 2006-07. Some repairs and changes were complete by June 2007, application to the MCD for completion certificate was made in July 2007. Delhi Pollution Control Committee and Environmental Clearance Board gave the consent order on 21.2.2008. In the January 2009 the completion certificate was received by the assessee and the hotel resumed its commercial operation in April, 2009. Basing on all this he submits that as a business entity the assessee never ceased to exist but for a total renovation the hotel business was suspended between the period October 2002 and April 2009, during which period the assessee continued with their business operations in the management of Golden Green and Golf Resorts Ltd. (GGGRL). The hotel business resumed its commercial operation in April 2009. In the circumstances, as is the routine practice in hotel business, reopening operations were taken before commencement of hotel activity and in that process the expense of Rs.3,55,63,725/- was incurred towards salary of the company Secretary, membership and subscription to the Northern India Regional Circle for corporate membership fee of ICI, Board meeting fees, rates and taxes paid to municipality, lease rent to the Govt. of India. In respect of lease rent, the assessee claims the expense relating to AY 2007-08 and charged it off to the Profit and Loss account.

Basing on all these things, it the argument of the learned AR that the hotel building is only a devise in the business of the assessee and the temporary suspension of such business during the reconstruction of the building, at no point of time, brought the business of the assessee to an end. Even during this period also the assessee actively engaged in the business in managing the GGGRL. 6 & 4970/Del/2011 Learned AR, therefore, submitted that the operating expenses incurred in the course of resumptions of hotel operations should be allowed for tax purposes, inasmuch as the renovation of the building was essential for the assessee to continue their business and in fact, immediately after the renovation assessee resumed the hotel business.

In support of his contention that the suspension or discontinuance of business has to be decided based on the facts and circumstances prevailing at the time of suspension/discontinuance and the intention of the management irrespective of the period of suspension, learned AR placed reliance on the decision reported in CIT vs Vikram Cotton Mills Ltd. (1988) 36 Taxman 1 (SC). In that case the assessee suspended its business activities for the purpose of reconstruction of the building and leased out the machinery for 10 - 19 years to exploit them commercially after which they were returned to the assessee. Hon’ble Apex Court held that it was only temporary in nature and the business was not considered to have been stopped or discontinued.

In CIT vs Mass Products Ltd. 221 ITR 456, the assessee company suspended its manufacturing activity in 1965 and resumed it in 1971 after having taken over by the new management. Suspended period of 6 years was considered a temporary suspension of the business.

For a similar principle, on similar facts, learned AR relied upon the decision reported in M/s Kalyanji Mavji & Co.,(1980) 122 ITR 49 (SC) wherein it is held that the assessee is entitled to claim the & 4970/Del/2011 expenditure incurred during the period of temporary suspension of business.

Per contra, it is the submission of the Ld. DR that in this matter, no sort of business was conducted by the assessee in the entire year as such it cannot be said that there is temporary suspension of business. He submitted that Dhumketu Builders & Developers Pvt. Ltd.(supra) and Arcane Developers Pvt.ltd. (supra) relate to the real estate business and in such case it was held that when the loan was taken for the purpose of development of real estate, they are in a position to perform certain acts towards the acquisition of land that would clearly show that it is ready to commence business. However, it is not so in this case because the assessee is not ready to cater the customers inasmuch as the construction activity went on till 2009. He also submitted that in Samsung India (supra) also, the Hon’ble high Court held that in manufacturing activity when the first activity towards the production takes place, the business is said to be commenced. In Carefour WC & C India P. Ltd. case (supra) when the premises was rented out, bank account was opened, employees are appointed, the business is said to have commenced. In ESPN Software case (supra), it was held that as soon as the essential activity of business is started, it is said that business is commenced. In M/s Multi Act Realty case, the Mumbai Tribunal held that if the assessee has done requisite preparation and if the assessee can be said to be in a position to cater its customers, it can be said that the business is set up. He submitted that the golden thread that runs through these decisions is that whether or not the assessee was earning from the business, but what is essential to say that the business has set up is that the assessee must be in a position to cater 8 & 4970/Del/2011 the customers. In real estate business, the moment land is purchased and steps for development are taken, the businessman would be in a position to cater to its customers. So also in manufacturing activity when one of the several steps in that direction is taken irrespective of the first sale, the business is said to have been commenced.

Insofar as the fact pleaded by the assessee that as on the date of acquisition of the Lodhi Hotel by the assessee and the running of the hotel till October 2002 is concerned, absolutely there is no dispute by the revenue. The order of the ITAT in ITA 2515/Del/2007 in respect of the Asstt. Year 2003-04, referred to by the learned CIT(A) in his order also shows that the assessee conducted hotel business up to 31st October 2002 therein. The question - whether the assessee commenced business or not – is, therefore, not relevant for the adjudication of the claim now preferred by the assessee. What is to be seen is whether there was any closure of business necessitating the assessee to set up the business again? and whether the assessee is entitled to claim the expenses to the tune of Rs.3,55,63,725/- could be allowed as deduction under section 37 of the Act or not?

According to the assessee, there is temporary suspension of the business between November 2002 and it actually resumed commercial operations in April 2009. Admittedly, assessee resumed business in April 2009. It is not the case of the revenue that the assessee has now been doing a different business and they had abandoned the hotel business. The assessee is accounting the period of suspension by stating that the contract for the building work was given to the contractor on 1.7.2005, construction was completed during the FY 2006-07, small changes took place till June 2007, hotel 9 & 4970/Del/2011 property was operational in June 2007, application for completion certificate was made in July2007, completion certificate was issued in January 2009 and ultimately commercial operations of the hotel resumed in April 2009. Further, Learned CIT(A) also, vide para 5.2 of his order, clearly held that there is no dispute over the fact that the hotel activity was temporarily in suspension. It, therefore, makes the things amply clear that the intention of the assessee was to temporarily suspend the business and not to bring the business to a close.

In these circumstances, we find it difficult to agree with the findings of the learned AO that inasmuch as during the financial year 2006-07 the assessee was unable to cater the needs of the customers, the business was not yet commenced. We also do not agree with the theory of estoppel proposed by the learned CIT(A) that since the assessee did not claim the expenses relatable to Asstt. Year 2002-03 for the period subsequent to 31.10.2002, by their own conduct they are estopped from claiming the same for any period subsequent thereto. As a matter of fact, the assessee purchased the business that had already been commenced and conducted business operations till 31.10.2002, from which date the assessee suspended the business operations till April 2009 for renovation of the hotel building. The period between November 2002 and April 2009 is only the temporary suspension of the Lodhi Hotel business of the assessee, but as a matter of fact, as a business entity, the assessee did not cease to exist or permanently shut down the business.

Respectfully following the decision of the Hon’ble apex court in Vikram Cotton Mills case (supra), we find that merely because there was a temporary lull in the business for some period, it cannot be 10 & 4970/Del/2011 said that the assessee abandoned the business requiring them to re- setup it again. No set up is required in this case. While respectfully following the decision of the Hon’ble apex Court in M/s Kalyanji Mavji (supra) we further hold that the assessee’s claim of expenditure incurred during the period of temporary suspension of business has to be allowed. However, the quantum of expenditure needs to be verified at the end of the AO. For this purpose of verification of the quantum, we set aside the issue to the file of the AO with a direction that after verification and if the claim is found to be genuine, the AO will allow the same. Consequently we find that the order of the Ld. CIT(A) on this aspect cannot be sustained. Revenue grounds are dismissed and the assessee’s grounds are allowed.

Now coming to the interest expense, it is the case of the assessee that in order to expand their business in hospitality in NCR region, it was necessary for them to invest in GGGRL, which was owning and operating a premium 18 hole golf course, that in that pursuit on 2.5.2005 they have acquired 51% stake for a consideration of 24.25 crores and as a condition precedent for such acquisition they had to lend some amounts to enable them to repay the loans taken from the existing shareholders. Funds were borrowed from HDFC and IDFC. Total interest expenditure incurred during the year was Rs.6,04,24,392/- whereas interest earned was Rs.3,37,50,177/-. Though the interest earned Rs. 3,37,50,177/- was brought to tax, learned AO refused to treat the interest paid as business expenditure.

It is submitted by the learned AR that when the interest earned from GGGRL is business income, then the interest paid on the amounts borrowed for acquisition of shares of GGGRL for acquiring controlling interest and on the amounts lent for business exigencies 11 & 4970/Del/2011 of GGGRL will also be the business expenses. According to the assessee both the activities i.e. acquiring controlling interest in and lending the amounts to GGGRL are in furtherance of the business interest of the assessee. On this aspect absolutely there is no dispute by the authorities below.

Learned DR argued that since no business was conducted during the FY 2006-07, the question of business expenditure does not arise. Learned CIT(A) while not disputing the borrowing of amounts for the purpose of acquiring the controlling share in GGGRL and for the purpose of giving loan to GGGRL, observed that the borrowed amount was not spent for the purpose of business as such the interest is not deductible under section 36(1)(iii) of the Act. He placed reliance on the decision reported in Sarabhai Sons P. Ltd. vs CIT (1993) 201 ITR 464 (Guj) for the principle that when the shares which were acquired for the purpose of acquiring the controlling rights of another company, the interest on the borrowed funds cannot be treated as per the business purpose of the assessee and was not allowable.

In CIT vs. Tulip Star Hotels Ltd. (2011) 16 Taxman.com 335 (Del) it was noticed that the assessee was in the business of owning, running and managing hotels and for affective control of new hotel acquired by the assessee under its management it had invested in a wholly owned subsidiary. The Hon’ble jurisdictional High Court held that under such circumstances, interest borrowed on capital should be treated as expenditure incurred for business purpose and allowable under section376(1)(iii) of the Act. & 4970/Del/2011 26. In CIT vs Reliance Communications Infrastructure Ltd. (2012) 21 Taxman.com 118 (Bom), the authorities found that the investments were made in subsidiary company and monies were advanced to related companies for furthering business of the assessee. The Hon’ble Bombay High Court held that no disallowance of interest charges can be made.

In CIT vs RPG Transmissions Ltd. (2014) 48 Taxman.com 57 (Mad), it is held that when an investment is made by the assessee in shares of the group company for strategic business purposes, because companies were promoted as special purpose companies to strengthen and promote its existing business by combining different business segments, interest on borrowed capital cannot be disallowed.

In Hero Cycles P. Ltd. vs CIT (2015) 63 Taxman.com 308 (SC) the Hon’ble apex court held that when the assessee had used the borrowed funds for giving interest free loans to its subsidiary companies, and when it was imperative for the assessee to advance such loans in the business expediency, the interest expense on the borrowed capital cannot be disallowed.

Now coming back to the facts of the case, the reasons for disallowance of the expense by the learned AO is that during the relevant previous year the assessee did not carry on any business and that is the reason why such an expense cannot allowed. However, ld. sustained the disallowance on the ground that the borrowed funds were invested in GGGRL and not used for the purpose of the business of the assessee. & 4970/Del/2011 30. In the preceding paragraphs we held that the assessee acquired the business which had already been set up and conducted it for some time, but there was a temporary lull between the period of demolition of the hotel building and resuming the same in April 2009. Learned CIT(A) also vide para 5.2 of his order clearly held that there is no dispute over the fact that the hotel activity was temporarily in suspension. It is, therefore, clear that the business activities of the assessee were suspended for some time and following the decision of the Hon’ble apex court reported in Vikram Cotton Mills (supra), Mass Products Ltd. (supra), Sylvania & Laxaman P. Ltd. (supra) and M/s Kalyanji Mavji & Co. (supra), we held that the assessee’s claim of expenditure during the period of temporary suspension of business is allowable.

On the same footing, in view of the decisions in Tulip Star Hotels Ltd.(supra), RPG Transmissions Ltd.(supra), Reliance Communi- cations Infrastructure Ltd. (supra) and Hero Cycles (supra), laying down the law that where there is nexus between expenditure and purpose of business, interest on borrowed capital whether it is for investment of acquire controlling interest in a subsidiary or towards loan in view of the business expediency, interest on the borrowed capital cannot be disallowed, we hold that the investment in GGGRL and to lend amounts to them for the purpose of strengthening the hospitality business, mere non conduct of hotel business in the previous year due to the temporary suspension thereof by the assessee cannot be a ground to deny the deduction of the interest expense on the borrowed capital. Reasoning given by learned CIT(A) does not stand to judicial scrutiny. & 4970/Del/2011 32. For these reasons, we find it difficult to sustain the additions made by the learned AO either in respect of the expenses incurred during the relevant previous year i.e. prior to the resumption of the hotel business and also in respect of the interest on the borrowed capital, cannot be sustained.

In the result, appeal of the assessee is allowed and the appeal of the revenue is dismissed.