Facts of the Case

The assessee company, Carrefour WC&C India Private Limited, was incorporated on 19 September 2007 for carrying on wholesale trading activities in consumer goods and related products.

During Assessment Year 2008-09, the assessee claimed business expenditure amounting to Rs. 9,03,03,547/- and declared business loss after adjustment of income from other sources.

The assessee contended that substantial preparatory and foundational business activities had already been undertaken, including:

  • incorporation of the company,
  • appointment of employees and directors,
  • opening of bank accounts,
  • acquisition of office premises,
  • negotiations and correspondence with suppliers,
  • obtaining registration under Shops and Establishments Act,
  • purchase of office equipment and infrastructure.

However, the Assessing Officer disallowed the expenditure on the ground that no actual trading activity had commenced and no stock was purchased during the relevant year. The CIT(A) and ITAT affirmed the disallowance holding that the business had not been fully set up.

Issues Involved

  1. Whether the assessee had “set up” its business during the relevant previous year.
  2. Whether actual purchase and sale of goods is mandatory for determining setting up of business.
  3. Whether business expenditure incurred prior to commencement of actual trading operations is allowable under Section 37(1) of the Income Tax Act.
  4. Whether preparatory and foundational business activities constitute setting up of business for claiming deduction of expenses.

Petitioner’s Arguments

The assessee argued that the authorities below failed to appreciate the legal distinction between “setting up” of business and “commencement” of business.

It was submitted that the business had already been set up as the company had:

  • established office premises,
  • hired key managerial and technical personnel,
  • opened bank accounts,
  • initiated supplier negotiations,
  • undertaken business development activities,
  • acquired infrastructure and fixed assets,
  • obtained statutory registrations.

The assessee contended that actual trading or purchase of stock is not a prerequisite for setting up of business. It was argued that the company was fully ready and capable of commencing business operations during the relevant previous year.

Reliance was placed on several judicial precedents including:

  • Western India Vegetable Products Ltd. v. CIT
  • ESPN Software India Pvt. Ltd. v. CIT
  • CIT v. Whirlpool of India Ltd.
  • CIT v. Dhoomketu Builders & Development Pvt. Ltd.
  • CIT v. Samsung India Electronics Ltd.

Respondent’s Arguments

The Revenue contended that the assessee had not commenced actual trading activities and therefore the business could not be considered as set up.

It was argued that:

  • no stock was purchased,
  • no warehouse or retail outlet existed,
  • no sale or purchase transactions occurred,
  • correspondence with suppliers alone was insufficient.

The Revenue maintained that a wholesale trading business can only be said to be set up once infrastructure for storage and actual trading operations becomes functional.

Court Findings / Observations

The Delhi High Court extensively analyzed the distinction between “setting up” and “commencement” of business.

The Court held that:

  • A business may be considered “set up” even before actual commercial operations begin.
  • For a trading concern, preparatory activities such as market research, negotiations with suppliers, hiring employees, obtaining registrations, opening offices, and creating infrastructure are integral parts of business establishment.
  • Actual purchase and sale of goods is relevant for commencement of business but not necessarily for setting up of business.
  • The Tribunal erred in treating actual purchase of stock as the sole criterion for determining whether business was set up.

The Court observed that a prudent trader would necessarily undertake substantial preparatory activities before commencing actual trading transactions. Such activities constitute setting up of business under the Income Tax Act.

Court Order

The Delhi High Court allowed the appeal in favour of the assessee and held that the business of the assessee had been set up during the relevant previous year.

The order of the Income Tax Appellate Tribunal dated 16 August 2013 was set aside.

The Court answered the substantial question of law in favour of the assessee and against the Revenue.

Important Clarification

The judgment clearly clarifies that:

  • “Setting up of business” is distinct from “commencement of business”.
  • Actual sales or purchases are not mandatory for claiming business expenditure.
  • Once the assessee is in a state of readiness to commence business operations, the business can be treated as set up.
  • Preparatory activities undertaken with commercial intent are sufficient for allowing deduction of business expenditure under Section 37(1).

This judgment is highly significant for startup entities, trading concerns, infrastructure companies, and newly incorporated businesses claiming pre-operative business expenditure.

Sections Involved

  • Section 3 – Previous Year
  • Section 28 to Section 43D – Computation of Business Income
  • Section 37(1) – Allowability of Business Expenditure
  • Section 260A – Appeal before High Court
  • Section 271(1)(c) – Penalty Proceedings

Link to download the order -  https://delhihighcourt.nic.in/app/case_number_pdf/2014:DHC:4885-DB/VKR22092014ITA422014.pdf

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