Facts of the Case

Marvel Polymers Pvt. Ltd. was incorporated with the object of carrying on the business of manufacturing footwear and footwear parts and also engaging in trading activities. For Assessment Year 1998-99, the company claimed various business expenditures, including depreciation, in its profit and loss account.

The Assessing Officer disallowed the claimed expenditure on the ground that the assessee had neither set up nor commenced its business during the relevant previous year. According to the Assessing Officer, the company was not carrying on any actual business activity that would justify deduction of expenses.

On appeal, the Commissioner of Income Tax (Appeals) accepted the assessee’s contention and held that the business had commenced during the relevant year. Consequently, the expenditure claimed by the assessee was allowed.

The Revenue challenged this decision before the Income Tax Appellate Tribunal (ITAT). The Tribunal reversed the order of the Commissioner (Appeals) and held that the assessee had not commenced business during the relevant previous year. Aggrieved by the Tribunal’s decision, the assessee filed an appeal before the Delhi High Court under Section 260A of the Income-tax Act, 1961.

Issues Involved

  1. Whether the assessee had set up its business during the relevant previous year.
  2. Whether the assessee had commenced business activities during the relevant previous year.
  3. Whether the assessee was entitled to claim business expenditure and depreciation despite the absence of substantial business operations.
  4. Whether any substantial question of law arose from the Tribunal’s findings warranting interference by the High Court.

Petitioner’s (Assessee’s) Arguments

The assessee contended that several facts clearly demonstrated that its business had been set up and had commenced during the relevant previous year. It relied upon the following circumstances:

  • Completion certificate had been obtained for the factory building.
  • Electricity connection had been secured.
  • Excise licence had been obtained.
  • Registration as a Small Scale Industry had been granted by the Director of Industries.
  • Registration with the Sales Tax Department had been obtained.
  • Raw materials had been purchased.
  • Registration with the Regional Provident Fund Commissioner had been secured.
  • A transaction involving purchase and sale of footwear had been undertaken.

Based on these activities, the assessee argued that its business infrastructure was operational and business activities had effectively commenced, making the claimed expenditure allowable.

Respondent’s (Revenue’s) Arguments

The Revenue argued that the activities relied upon by the assessee were merely preparatory in nature and did not establish actual readiness or commencement of business operations.

It was submitted that:

  • The only trading transaction was a solitary purchase and sale of 84 pairs of footwear.
  • The transaction was undertaken merely to obtain Sales Tax registration and was not part of genuine trading operations.
  • The excise licence was granted only on 31 March 1998, the last day of the relevant previous year.
  • No labour or workforce was employed during the relevant previous year.
  • Employees were recruited only from 1 April 1998.
  • Provident Fund registration also became effective from 1 April 1998.
  • No manufacturing activity could realistically be undertaken without manpower and operational readiness.

Accordingly, the Revenue maintained that the assessee had neither set up nor commenced business during the relevant year and was therefore not entitled to deduction of expenditure.

Court Findings

The Delhi High Court examined the factual findings recorded by the Tribunal and observed that the Tribunal had duly considered all relevant material on record.

Trading Activity

The Court noted that the only transaction undertaken by the assessee was the purchase of 84 pairs of footwear for ₹2,660 and their subsequent sale for ₹3,127. The assessee itself admitted that such transaction was undertaken to facilitate registration with the Sales Tax Department.

The Court held that this isolated transaction could not be regarded as genuine commencement of trading activity and could not be relied upon to establish business operations.

Manufacturing Activity

The Court observed that although the assessee had obtained a completion certificate, electricity connection, and certain statutory registrations, crucial operational requirements were absent.

Important factors considered by the Court included:

  • Excise licence was granted only on 31 March 1998.
  • No workers or employees were available before that date.
  • Employees were recruited only from 1 April 1998.
  • Provident Fund registration became effective only from 1 April 1998.
  • There was no evidence of substantive manufacturing operations during the relevant year.

The Court held that the cumulative effect of these facts indicated that the business was not ready to discharge the functions for which it was established. Therefore, the business could not be regarded as having been set up or commenced during the relevant previous year.

Important Clarification by the Court

The Court relied upon the Supreme Court judgment in Commissioner of Wealth Tax, Madras v. Ramaraju Surgical Cotton Mills Ltd. [1966] 62 ITR 21, which drew a distinction between:

  • Setting up of business, and
  • Commencement of business.

The Supreme Court had explained that “setting up” is a stage anterior to “commencement”. A business can be regarded as set up when it is ready to commence operations, even if actual production has not yet begun.

However, the Delhi High Court clarified that a business cannot be said to be set up merely because certain licences, registrations, or infrastructure have been obtained. The unit must be in a position to perform the business functions for which it was established.

Since the assessee lacked employees and operational readiness, it could not be regarded as ready to commence manufacturing activities during the relevant previous year.

Court Order

The Delhi High Court held that:

  • The view taken by the Income Tax Appellate Tribunal was a plausible and reasonable view based on the facts on record.
  • The assessee had failed to establish that its business was ready to commence operations during the relevant previous year.
  • No substantial question of law arose for consideration under Section 260A of the Income-tax Act, 1961.

Accordingly, the appeal filed by the assessee was dismissed and the Tribunal’s order was upheld.

Sections Involved

  • Section 260A, Income-tax Act, 1961 – Appeal to High Court.
  • Section 37(1), Income-tax Act, 1961 – Allowability of business expenditure.
  • Section 32, Income-tax Act, 1961 – Depreciation.
  • Principles relating to “Setting Up of Business” and “Commencement of Business” under the Income-tax Act.

Link to download the order -
https://delhihighcourt.nic.in/app/case_number_pdf/2007:DHC:811-DB/MBL25072007ITA6122006.pdf

Disclaimer

This content is shared strictly for general information and knowledge purposes only. Readers should independently verify the information from reliable sources. It is not intended to provide legal, professional, or advisory guidance. The author and the organisation disclaim all liability arising from the use of this content. The material has been prepared with the assistance of AI tools.