Facts of the Case

  1. The assessee company was engaged in the business of prospecting and exploration of ores and minerals.
  2. The assessee filed its return declaring a loss of ₹3,00,52,260.
  3. During the relevant year, the assessee changed its accounting policy regarding expenditure incurred on exploration activities.
  4. Earlier, such expenditure was capitalized as work-in-progress; however, during the year under consideration, the expenditure was charged to the Profit & Loss Account.
  5. The assessee explained that:
    • It was engaged only in exploration and prospecting activities.
    • It was not engaged in commercial production of any mineral.
    • The accounting policy was changed to align with the worldwide policy followed by the Rio Tinto Group.
    • The revised accounting treatment reflected a true and fair view of its financial position.
  6. The Assessing Officer rejected the claim and held that:
    • The change in accounting policy was intended to circumvent Section 35E.
    • The business of the assessee had not commenced.
    • Exploration activities alone could not be regarded as commencement of business.
  7. The Commissioner of Income Tax (Appeals) deleted the addition made by the Assessing Officer.
  8. The Revenue preferred an appeal before the Income Tax Appellate Tribunal, which upheld the order of the CIT(A).
  9. Aggrieved by the Tribunal’s decision, the Revenue filed an appeal before the Delhi High Court.

Issues Involved

  1. Whether Section 35E of the Income-tax Act, 1961 was applicable to the assessee company.
  2. Whether exploration and prospecting activities constituted commencement of business.
  3. Whether expenditure incurred on prospecting activities could be disallowed on the ground that commercial production had not commenced.
  4. Whether the change in accounting policy adopted by the assessee was merely a device to avoid the application of Section 35E.

Petitioner’s Arguments (Revenue)

The Revenue contended that:

  1. The CIT(A) and the Tribunal failed to appreciate the provisions of Section 35E of the Income-tax Act.
  2. The assessee altered its accounting policy only to avoid the restrictions imposed under Section 35E.
  3. If the expenditure continued to remain capitalized, deduction would be governed by Section 35E and would be allowable only upon commencement of commercial production.
  4. Since the assessee had not reached the stage of earning revenue from mining operations, its business had not commenced.
  5. The accounting policy change was a colourable device adopted to claim business losses capable of being carried forward.

Respondent’s Arguments (Assessee)

The assessee submitted that:

  1. Its business was confined to prospecting and exploration of ores and minerals.
  2. It was not engaged in mining operations or commercial production of minerals.
  3. Exploration activity itself constituted an independent business activity.
  4. The company had obtained approval from the Foreign Investment Promotion Board (FIPB) only for prospecting activities.
  5. Any mining activity would require separate governmental approval.
  6. Since commercial production was not contemplated under its approved objects, Section 35E had no application.
  7. The accounting policy change was bona fide and in accordance with recognized accounting standards.

Court Findings / Order

The Delhi High Court dismissed the Revenue’s appeal and held as follows:

1. Prospecting and Exploration Constituted the Assessee’s Business

The Court observed that the Memorandum of Association clearly established that the assessee’s principal object was prospecting and exploration of ores and minerals.

The company was not authorized to undertake mining activities without obtaining separate approvals.

Accordingly, the Tribunal was correct in holding that the assessee had commenced its business.

2. Section 35E Operates Only When Commercial Production Commences

The Court examined Section 35E(1), Section 35E(2), and Section 35E(5)(b).

It held that the entire deduction mechanism under Section 35E revolves around the “year of commercial production.”

Unless commercial production commences, the provisions become unworkable.

3. No Possibility of Commercial Production

The Court noted that:

  • The objects of the assessee company did not include mining or commercial production.
  • FIPB approval was restricted to prospecting activities.
  • Separate approval would be necessary for mining operations.

Therefore, there was no possibility of commercial production as contemplated under Section 35E.

4. Section 35E Not Applicable

Since commercial production was neither undertaken nor contemplated by the assessee, Section 35E could not be invoked.

The Court upheld the findings of the Tribunal and CIT(A).

Final Order

The appeal filed by the Revenue was dismissed.

The Court held that no substantial question of law arose for consideration.

Important Clarification

This judgment clarifies that:

  • Section 35E is triggered only where commercial production of minerals commences.
  • Prospecting and exploration activities can themselves constitute an independent business.
  • Mere absence of commercial production does not imply that business has not commenced.
  • Where the assessee is engaged exclusively in exploration and prospecting and there is no possibility of commercial production, Section 35E cannot be applied.

Sections Involved

  • Section 35E(1) of the Income-tax Act, 1961
  • Section 35E(2) of the Income-tax Act, 1961
  • Section 35E(5)(a) of the Income-tax Act, 1961
  • Section 35E(5)(b) of the Income-tax Act, 1961
  • Section 35E(5)(c) of the Income-tax Act, 1961

Link to download the order -https://delhihighcourt.nic.in/app/case_number_pdf/2010:DHC:505-DB/BDA28012010ITA5472009.pdf

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