Facts of the Case

The petitioner, a joint venture company incorporated to redevelop railway stations, filed its return declaring losses for AY 2013–14. The Assessing Officer disallowed deductions claimed towards:

  • Depreciation
  • Preliminary expenses
  • Employees’ remuneration

The AO treated certain receipts as “income from other sources” and held that the business had not been set up. A revision petition under Section 264 was also rejected by the Principal Commissioner of Income Tax (PCIT), who concluded that essential elements required for business establishment were incomplete during the relevant year.

The petitioner challenged this order before the Delhi High Court.

Issues Involved

  1. Whether the petitioner had “set up” its business during the relevant assessment year.
  2. Whether expenses incurred prior to commencement but after setting up are allowable under Section 37(1).
  3. Whether the PCIT was justified in rejecting the revision under Section 264.

Petitioner’s Arguments

  • The petitioner was a service-oriented Special Purpose Vehicle (SPV) and not a manufacturing entity; hence, strict criteria of commencement do not apply.
  • Business was already set up as:
    • Key personnel were appointed
    • Draft development agreements were prepared
    • Tendering processes were initiated
  • In service industries, preparatory activities themselves indicate business setup.
  • Relied on precedents establishing that setting up is distinct from commencement, and expenses incurred in this stage are deductible.

Respondent’s Arguments

  • The Revenue argued that:
    • No substantial business activity had commenced
    • Essential components like financial advisory services and consultants were incomplete
    • Mere appointment of staff or preliminary actions do not amount to “setting up”
  • Hence, expenses could not be allowed as business deductions. 

Court’s Findings / Order

The Delhi High Court held:

  • There is no rigid test to determine when a business is set up; it depends on the nature of the business.
  • In service-oriented entities, preliminary and preparatory steps may constitute setting up.
  • The petitioner had:
    • Appointed key managerial personnel
    • Initiated tendering processes
    • Begun preparatory work aligned with its business objectives

Therefore, the business was “set up” during the relevant year, even if full operations had not commenced.

Final Order

  • The Court set aside the orders of the AO and PCIT
  • Directed allowance of deduction claims
  • Matter remanded for giving appropriate tax effect

Important Clarification by Court

  • “Setting up” ≠ “Commencement of business”
  • Expenses incurred after setting up but before commencement are allowable
  • The test varies based on nature of business (service vs manufacturing)
  • Preliminary activities like hiring staff, planning, and initiating contracts can establish business setup

Sections Involved

  • Section 37(1): General business expenditure
  • Section 35D: Amortization of preliminary expenses
  • Section 143(3): Assessment
  • Section 264: Revision by Commissioner

Link to download the order -https://delhihighcourt.nic.in/app/case_number_pdf/2019:DHC:1770-DB/PRJ26032019CW67822018.pdf

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