High Court Of Delhi
Indo Rama Synthetics (I) Ltd. vs. CIT
Assessment Year : 2000-01
Section : 37(1)
A.K. Sikri And Valmiki J. Mehta, JJ.
IT Appeal No. 843 Of 2009
September  25, 2009
JUDGMENT
A.K. Sikri, J. – This appeal was heard on the following questions of law :—
“(1) Whether on the facts and in the circumstances of the case, the Tribunal erred in law in holding that the expenditure incurred by the appellant on expansion of its existing business by setting up a weaving and spinning unit for manufacture of fabric and textiles in the State of Karnataka was capital in nature?
(2) Whether on the facts and in the circumstances of the case, the Tribunal erred in law in holding that consultancy fee paid by the appellant to McKinsey &. Co. for carrying out detailed operational efficiency and profitability study was capital in nature solely on the ground that the said assignment was terminated before the conclusion of the study?”
2. Genesis of the Question No. 1 can be traced to the following factual backdrop.
3. The appellant is in the business of manufacture of yarn and polyester for number of years. According to the petitioner, for several years prior to the previous year relevant to the assessment year 2000-01 (the assessment year under consideration), the appellant had been generating substantial surplus cash from its existing business of manufacture of yarn and polyester. With a view to utilizing the said cash surplus available and with a view to expanding its hitherto existing operations, the appellant company commenced the setting up of a spinning and weaving unit for the manufacture of fabric and textile during the financial year 1995-96 in the State of Karnataka. The manufacture of the underlying product was authorized by the Memorandum of Association and the Articles of Association of the appellant company. The said unit was in line with the appellant’s strategy to expand its business operations in the same line of business through vertical integration, by utilizing as raw materials for the proposed new unit, the products such as yarn and polyester, manufactured by the existing units. For setting up the new unit, the appellant identified manpower from the existing pool of resources of the appellant company. Furthermore, the said unit was proposed to be established under the common control of the Board of Directors of the appellant company and out of the surplus funds generated by the existing business operations. In relation to the setting up of the said weaving and spinning unit, the appellant, from time to time, incurred revenue expenditure in the nature of salary, wages, repair, maintenance, design and engineering fee, travelling and other expenses of administrative nature. The said proposal of the appellant company, however, could not see the light of the day since the appellant company could not procure the allotment of requisite land from the Government of Karnataka. Since the setting up of the said proposed unit was abandoned during the previous year relevant to the assessment year 2000-01, related project expenses amounting to Rs. 64,47,855 were written off and claimed deduction in computation of income for the assessment year 2000-01 under section 37(1) of the Act.
4. Vide order dated 31-12-2002 passed by the Assessing Officer (AO) under section 143(3) of the Act, the Assessing Officer disallowed the aforesaid related project expenses incurred by the appellant company for setting up the said unit holding the same to be capital in nature. Aggrieved by the said order dated 31-12-2002 passed by the Assessing Officer under section 143(3) of the Act, the appellant preferred an appeal to the Commissioner of Income-tax (Appeal). The CIT (A), videorder dated 28-11-2003, upheld the disallowance made by the Assessing Officer on the ground that since the unit was proposed to be set up in Karnataka, which was geographically very far from the existing unit of the appellant, it did not prove the inextricable linkage of the proposed unit with the existing business of the appellant. It was further held by the CIT(A) that since the proposed unit could not, in fact, be set up, the question whether the same constituted mere expansion of the existing business could not be answered.
5. The appellant, still aggrieved, carried the matter in further appeal to the Income-tax Appellate Tribunal (hereinafter referred to the ‘Tribunal’), but without any success as the appeal of the appellant has been dismissed by the Tribunal videimpugned order dated 16-1-2009. In the opinion of the Tribunal the mere fact that the product proposed to be manufactured in the proposed unit was authorized by the Memorandum and Articles of Association did not prove the inextricable linkage of the proposed unit with the existing business of the appellant. On the contrary, the Tribunal observed that since the unit was proposed to be set up in the State of Karnataka, which was much far away from the existing unit of the appellant, the new unit could not be regarded as part of the existing business. The Tribunal, accordingly, upheld the order of the CIT(A) and sustained the disallowance.
6. Submission of Mr. Ajay Vohra, learned counsel appearing for the appellant, was that the expenditure incurred would be treated as revenue expenditure, inasmuch as : (a) the said expansion was authorized by the Memorandum of Association and the Articles of Association of the appellant company; (b) the setting up of the new unit was part of the process of vertical integration by utilizing the products manufactured by the existing units as raw materials for the new unit; (c) the resources proposed to be utilized for the said unit were identified from within the existing pool of resources of the appellant; (d) the unit was proposed to be established under the common control of the Board of Directors of the appellant company; (e) the unit was proposed to be financed partly out of the funds provided by the existing units of the appellant. He further submitted that the decisive test for determining if the two lines of businesses,constitute the same business is unity of control, interlacing of funds and common management. The mere fact that the unit was proposed to be set up in the State of Karnataka, which was geographically distant from the existing unit of the appellant, could not be a ground to hold that what was proposed to be set up was a different unit altogether. The learned counsel submitted that this test laid down by the Apex Court in the following judgments :—
(i) CIT v. Prithvi Insurance Co. Ltd. [1967] 63 ITR 632 ;
(ii) Produce Exchange Corpn. Ltd. v. CIT [1970] 77 ITR 739 ;
(iii) Standard Refinery & Distillery Ltd. v. CIT [1971] 79 ITR 589 ;
(iv) B.R. Ltd. v. CIT [1978] 113 ITR 647 .
He further argued that applying the principles laid down in the aforesaid judgments, it had been held by various High Courts that where existing business is to expand or set up a new unit in the same business fold, revenue expenditure incurred on setting up such new unit/expansion of the existing unit is admissible business deduction.
7. Learned counsel for the respondent, on the other hand, relied upon the reasoning given by the Tribunal holding the expenditure incurred by the appellant as capital expenditure.
8. In a recent judgment given by this Court in CIT v. Priya Village Roadshows Ltd. [IT Appeal No. 145 (Delhi) 2007] identical issue came up for consideration. In that case also the assessee was in the business of running cinemas. There was a proposal for taking over another cinema, namely, Savitri Cinema, from its owners for conversion into multiplex and operation and management thereof. In order to carry out technical and financial feasibility, the assessee availed the services of an architect and paid fee to him. From the report of the architect, it was found that the project was not financial and technical viable and, therefore, the assessee decided to drop the said project. The amount paid to the architect and other expenditure was claimed as revenue expenditure. Similarly, there was another proposal before the assessee to take over Priya Cinema for the purpose of conversion into a four screen cinema complex. Detailed technical feasibility was carried out and building plans were prepared by M/s. Consultancy Engineering Group and Morphagenisi Architecture Studio, who were paid certain remuneration. On subsequent market research, the assessee preferred to retain single screen cinema and the proposal of the conversion of the said cinema into a multiplex complex was shelved. The amount paid to the said consultants was claimed by the assessee as revenue expenditure. The Assessing Officer had disallowed the said expenditure treating the same as capital expenditure. The Tribunal, however, held that both the expenditures were in the nature of revenue expenditure. This opinion of the Tribunal was upheld and the said appeal, i.e., ITA No. 145/2007, was dismissed vide judgment dated 24-8-2009. In the process, this Court took into consideration few judgments of this Court and gave harmonious constructions thereto. Because of the close proximity of facts of both the cases, we deem it proper to reproduce the detailed discussion contained therein, which would provide reasons for deciding the question of law raised in the present appeal as well :—
“6. Insofar as Savitri Cinema project is concerned, the same was abandoned as not feasible. Insofar as Priya Cinema project is concerned, again it was decided to continue by retaining single screen cinema and the project of conversion of said cinema into a multiplex was shelved. In this backdrop, we have to answer the issue involved. This Court in the case of Triveni Engineering Works Ltd. v. CIT [1998] 232 ITR 639 (Delhi) after taking note of various judgments of the Supreme Court observed that test to determine an expenditure to be capital or revenue is not straight. However, the test of “enduring benefit is largely accepted and applied by the courts. Further, if the expenditure is incurred with a view to bringing an asset or advantage into existence, it is to be treated as capital expenditure and while doing so, it is not necessary that such expenditure should have that result. Relevant portion of the discussion contained in that judgment is reproduced below :—
‘The test to discriminate between a capital and a revenue expenditure is not straight. An item of expenditure though incurred wholly and exclusively for the purpose of the business may nevertheless be inadmissible as an allowance if it is of a capital nature. The border line between a capital expenditure and a revenue expenditure is a blurred one. Different minds may come to different conclusions and may yet have valid reasons justifying each of the two view points. In the leading case ofAtherton v. British Insulated & Helsby Cables Ltd. [1925] 10 TC 155 : [1926] AC 205 (HL), it was held that when an expenditure is made not only once and for all but also with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade, there is a very good reason (in the absence of special circumstances leading to an opposite conclusion) for treating such an expenditure as properly attributable not to revenue but to capital. A perusal of the available case law on the point reveals that the test of enduring benefit has been accepted and applied by and large. It has also been held that the expenditure is to be attributed to capital, if it be made with a view to bringing an asset or advantage into existence and it is not necessary that it should have that result. Collins v. Joseph Adamson & Co. [1939] 7 ITR 92, 99 [KB].
In Empire Jute Co. Ltd. v. CIT [1980] 124 ITR 1 (SC), their Lordships have held (headnote) :—
“There may be cases where expenditure, even if incurred for obtaining an advantage of enduring benefit, may, nonetheless, be on revenue account and the test of enduring benefit may break down. It is not every advantage of enduring nature acquired by an assessee that brings the case within the principle laid down in this test. What is material to consider is the nature of the advantage in a commercial sense and, it is only where the advantage is in the capital field that the expenditure would be disallowable on an application of this test. If the advantage consists merely in facilitating the assessee’s trading operations or enabling the management and conduct of the assessee’s business to be carried on more efficiently or more profitably while leaving the fixed capital untouched, the expenditure would be on revenue account, even though the advantage may endure for an indefinite future. The test of enduring benefit is, therefore, not a certain or conclusive test and it cannot be applied blindly and mechanically without regard to the particular facts and circumstances of a given case.”
In the case at hand the amount spent on the project reports was not for the purpose of facilitating the assessee’s existing trading operations or enabling management and conduct of the assessee’s business to be carried on more efficiently or more profitably while leaving the fixed capital untouched. If only the project reports had been successfully accepted and put into implementation, the assessee would have gone into manufacturing of a new product which would have certainly required investment of fresh capital and coming into existence of additional fixed assets.’
7. In that case the amounts were paid to the consultants for preparing project reports on manufacturing insecticide formulation – an item to be used for improving the quality of cane produced in the area by individual agriculturists and societies and also for another project, namely, for survey report on extra melkral alcohol as the assessee wanted these reports for better use of its by-products, namely, molasses. After explaining the principle to be applied for determining the nature of expenditure in the afore-quoted portion, the Court was of the view that the expenditure was attributable to capital having been incurred with a view to bringing an asset or advantage into existence and having enduring benefit. It was categorically observed that merely because the project did not materialise the nature of the expenditure would not change to revenue.
8. Obviously, heavy reliance is placed on this judgment by the learned counsel for the revenue on the basis of which it was argued by Mr. Subhash Bansal that merely because the projects were shelved ultimately, is of no consequence. Mr. Aggarwal, learned counsel appearing for the respondent, on the other hand submitted that the entire argument is misconceived inasmuch as the project reports were got prepared with the intention of starting new business. The assessee was already in the business and the study in question was conducted for the same and existing business. He sought to distinguish the judgment of this Court in Triveni Engineering Works Ltd. (supra) by drawing our attention to the fact that in that case the manufacturing of insecticide formulation was not carried out by the assessee and the assessee had incurred the expenditure for starting a new line of business, whereas in the instant case it was only an expansion of business. He submitted that this fine distinction is taken note of by the Tribunal in the instant case which materially affected the final outcome. He submitted that the Tribunal referred to various judgments on these aspects. In addition, he also placed reliance upon Jay Engineering Works Ltd. v. CIT 311 ITR 405.
9. One of the judgments on which the Tribunal based its decision is of this Court, i.e., CIT v. Modi Industries [1993] 200 ITR 341. In that case the assessee company which was manufacturing various commodities like sugar, vanaspati, soap, paints and varnish, torch and lantern, started manufacturing a new commodity, viz., special alloy wire and billets. Debentures were issued for raising funds for this new steel unit and the assessee incurred expenditure for issuing of debentures. The question was whether the expenditure incurred by the assessee in the year in which the unit had not started working was allowable as business expenditure. The Appellate Tribunal found that the management of the new unit and the earlier business were the same and there was unity of control and a common fund, and held that the manufacture of special alloy and billets was an expansion of the assessee’s business and not a new business and allowed deductions of expenditure. The decision of the Tribunal was affirmed by the High Court holding that all the assessee’s bid was to start manufacturing a new commodity. In the larger sense, the business of the assessee remained the same, viz., the business of manufacture. The assessee was already manufacturing diverse items and a new item was added to this business. The Tribunal had found that there was complete unity of control and that there was a common fund which was most material for testing whether the business was the same. In considering whether the two business run by an assessee are the same business, what is important is that unity of control and interfacing of the two businesses and not the nature of the business.
10. A harmonious reading of the aforesaid two judgments of this Court, namely, Triveni Engineering Works Ltd. (supra) on the one hand and Modi Industries (supra) on the other, would clearly demonstrate that one has to keep in mind the essential purpose for which such an expenditure is incurred. If the expenditure is incurred for starting new business which was not carried out by the assessee earlier, then such expenditure is held to be of capital nature. In that event it would be irrelevant as to whether project really materialised or not. However, if the expenditure incurred is in respect of the same business which is already carried on by the assessee, even if it is for the expansion of the business, namely, to start new unit which is same as earlier business and there is unity of control and a common fund, then such an expense is to be treated as business expenditure. In such a case whether new business/asset comes into existence or not would become a relevant factor. If there is no creation of new asset, then the expenditure incurred would be of revenue nature. However, if the new asset comes into existence which is of enduring benefit, then such expenditure would be of capital nature.
11. When we keep in mind the aforesaid fine distinction, the conclusion on the facts of this case becomes obvious. The expenditure was incurred in respect of same business which is already carried on by the assessee. Two projects which were undertaken were for the expansion of same business, namely, one for taking over Savitri Cinema for conversion into multiplex and operation and management thereof and other for conversion of Priya Cinema into four-screen multiplex. Payments were made to the consultants for preparing feasibility reports in respect of both the projects. However, ultimately projects were not found to be financially and technically viable and were shelved. Thus, we find that no new asset came into existence, which was the basis adopted by the Assessing Officer for treating the expenditure as capital expenditure but wrongly.
12. In the present case both the ingredients are satisfied, namely,
(i)the feasibility study conducted by the assessee was for the same and existing business with a common administration and common fund and,
(ii) the study was abandoned, without creating any new asset.
13. We note two judgments of other High Courts taking this view in identical circumstances. One case is decided by Gauhati High Court which is reported as Dy. CIT v. Assam Asbestos Ltd. [2003] 263 ITR 357 . In that case the assessee was in the business of manufacturing asbestos sheets. Contemplating to set up a mini cement plant, which was the same line of business activity of the assessee, a feasibility report was prepared. However, the project would not be undertaken as Government refused to grant required permission. The Court opined that no new capital asset came into existence and the expenses incurred on preparation of the feasibility report, same line of business, were in the nature of revenue expenditure. Rajasthan High Court had also occasion to deal with this issue in the case of Maharaja Shri Umaid Mills Ltd. v. CIT [1989] 175 ITR 72. There also the expenditure incurred in obtaining survey and feasibility report for setting up polyethylene plant for manufacturing packing material was treated as revenue expenditure as the new venture was inter-connected and formed part of existing business.”
9. In the present case also, as already pointed out above, the expenditure incurred was in the nature of salary, wages, repairs, maintenance, design and engineering fee, travelling and other expenses of administrative nature. Indubitably, in normal course, these expenses would be treated as revenue expenditure. The unit, which the appellant proposed to set up had inextricable linkage with the existing business of the appellant. The proposed business was not an individual business but vertical expansion of the present business. Thus, test of existing business with common administration and common fund is clearly met. Since the project was abandoned, no new asset also came to be created.
10. We may point out at this stage that this Court in CIT v. Monnet Industries Ltd. [2009] 176 Taxman 81 treated the interest borrowed on capital as business expenditure when the amount was borrowed for setting up a new plant. That was a case where the assessee was already in the business of Ferro alloys plant and it had set up sugar plant. Still, the interest paid on borrowed capital was treated as revenue expenditure by applying the test of common management and common funds, inasmuch as, there was a common Board of Directors controlling the two plants, which operated from the head office located at New Delhi and funds of the two plants were common. On this basis, it was opined that there was intermingling and interlacing of funds. The fact that the two divisions are located, at different sites did not affect the outcome since marketing of the final products of both divisions was carried out under the supervision and control of the same set of executives at the head office.
This judgment is an answer to the wrong approach adopted by the authorities below by not treating the expenditure as revenue expenditure only because the unit was to be set up in Karnataka, which was geographically at a distance from the existing unit.
11. We are supported in our view by yet another judgment of the Supreme Court in the case of Veecumsees v. CIT [1996] 220 ITR 185. That was also a case where the assessee was carrying on jewellery business commencing exhibition of cinematographic films. Capital was borrowed for constructing cinema theatre and interest on borrowed capital was treated as business income deductible under section 36(1)(iii) of the Income-tax Act, 1961.
We, thus, answer Question No. 1 in favour of the assessee and against the revenue.
12. Insofar as the second question is concerned, the facts leading to the said question are recapitulated below.
13. The appellant company had engaged the services of McKinsey & Co., an international firm of consultants for carrying out a detailed study on the various aspects relating to the operations of the appellant company and to suggest measures for improving the operational efficiency and profitability of the appellant company. Based on a review of the cost benefit analysis, the said assignment for carrying out the detailed operational efficiency and profitability study was, however, terminated shortly after the mandate had been given. In respect of the work already done by the said McKinsey & Co. until the date of the termination of the mandate, a sum of Rs. 74,04,128 was paid by the appellant to the said McKinsey & Co. In the previous year relevant to the assessment year 2000-01, the said payment was claimed deduction by the appellant.
14. Vide order dated 31-12-2002 passed by the Assessing Officer under section 143(3) of the Act, the Assessing Officer, being of the view that the appellant had failed to establish that the payment made to M/s. McKinsey & Co. was revenue in nature and that since the appellant itself had treated the said expenditure as deferred revenue expenditure, disallowed the said expenditure of Rs. 74,04,128 holding the same to be capital expenditure.
15. Appeals preferred by the appellant before the CIT(A) as well as the Tribunal were dismissed and this is how the appellant has filed the present appeal under section 260A of the Act raising the aforesaid question of law.
16. The argument of the appellant before the Tribunal, and before us, was that the purpose of the said operational efficiency and profitability study was to improve and enhance the nature and profits of the appellant company. It was also submitted that the said expenditure was not incurred with a view to acquiring any capital asset or enduring advantage in the capital field. The Tribunal, however, rejected this submission of the appellant on the ground that there was no written agreement between the appellant and M/s. McKinsey & Co. based on which the Tribunal could have ascertained the scope of the study and that it was only in a situation where the assignment had actually been completed and put in practice that the Tribunal could have determined whether the said study, in fact, resulted in enhancing the productivity and profitability of the company. Since the assignment was, in fact, never completed and put into practice, the Tribunal came to the conclusion that the appellant had not been able to prove that the payment of consultancy fee was for enhancing productivity and profitability of the appellant company. The Tribunal, accordingly, concluded that the aforesaid expenditure in respect of consultancy fee paid to M/s. McKinsey & Co. could not be treated as revenue expenditure.
17. This approach of the Tribunal is not correct in law. Interestingly, the Tribunal has accepted the fact that even when there was no formal written agreement with M/s. McKinsey & Co., the report was submitted by the said company for the task assigned. This report was produced before the Assessing Officer/CIT(A). The Tribunal noted that as per the assessee, the perusal of the report clearly indicated that the engagement was for the purpose of improving the operational efficiencies of the assessee and enhance the profitability of the existing business. In these circumstances, not much importance could be attached to the fact that there was no written agreement with the said consultants to ascertain the scope of the study when such scope of study could very well be discerned from the report submitted by the consultants. To remove any doubts, learned counsel for the appellant produced the report given by the said consultants for our perusal as well and reading thereof confirms the contention of the appellant.
18. The helplessness shown by the Tribunal, for want of written agreement, was, therefore, clearly inappropriate. Once it is accepted as a fact that the assignment given to the said consultants was for the purpose of improving operational efficiencies and was not to incur any enduring benefit in capital field but to carry on the existing business more efficiently and profitably, the irresistible conclusion which follows is that such expenditure was allowable as business expenditure. [See CIT v. Praga Tools Ltd. [1986] 157 ITR 282 (AP) and CIT v. Crompton Engineering Co. Ltd. [2000] 242 ITR 317 (Mad.)].
Therefore, this question has also to be answered in favour of the assessee and against the revenue.
19. Resultantly, the appeal stands allowed and the orders of the authorities below are set aside. The appellant shall be entitled to treat the aforesaid expenditure for the relevant assessment year as revenue expenditure.
[Citation : 333 ITR 18]
