I.T.A. NO.1726/KB OF 1986-87, DECIDED ON 1ST AUGUST, 1991. VS I.T.A. NO.1726/KB OF 1986-87, DECIDED ON 1ST AUGUST, 1991.
1991 P T D (Trib) 1043
[Income Tax Appellate Tribunal Pakistan]
Before Muhammad Mujibullah Siddiqui, Judicial Member and Manzurul Haque,
Accountant Member
I.T.A. No.1726/KB of 1986-87, decided on 01/08/1991.
Income Tax Ordinance (XXXI of 1979)---
----S. 23(1)(xviii)---Preliminary expenses---Definition---Preliminary expenses which are necessarily incurred for the purpose of forming a new company can be capitalized at the option of an assessee and the amount so expended can be included in the cost of plant and machinery---Expenses to be so included enumerated.
Preliminary expenses include the law costs, registration fees, and other expenses incidental to the formation or promotion of a company. Hence they are also called formation expenses and promotion expenses. Such expenditure is, of course, capital expenditure; but it is usually written off to revenue over a period of years, three, five or seven, according as the amount is small, large, or very large. The balance of the account appears each year on the assets side of the balance-sheet until the amount is finally extinguished.
Preliminary expenses are expenses, which must necessarily be for the purpose of forming a new company. The following items are usually included under this head:--
(1) Cost of registering the company.
(2) Stamp duty and fees on the nominal capital.
(3) Fees and stamp duties on the documents filed with the Registrar.
(4) Cost of preparing and printing the Memorandum and Articles of Association.
(5) Cost of preparing all preliminary agreements including stamp duties.
(6) Cost of preparing, printing and circulating the Prospectus.
(7) Valuers' fees for valuing assets proposed to be acquired.
(8) Accountants' charge for certifying profits.
(9) Cost of preparing and printing Share Certificates, Letters of Allotment, Debentures, Trust Deed etc.
(10) Cost of the Books of Accounts, Statutory and Statistical Books and the Company's Seal.
As the amount expended under this head is of a non-recurring nature and as it results in getting the Share Capital subscribed, it is deemed desirable not to charge the whole of it to the first year's Revenue Account, but to distribute it over a reasonable number of years, say from 3 to 5 years.
It may be pointed out that there is nothing in the Companies Act to compel a company to write off its Preliminary Expenses within any stated number of years, and the expenditure under this head may be permanently capitalised and shown as an asset in the Balance-Sheet, if a company so desires. In any case, it would be a fictitious and an intangible asset, and as the permanent capitalising of such an item cannot be said to be a sound or a prudent measure from the viewpoint of finance or accounting, it would seem desirable to extinguish it from the books as early as the net profits would admit.
The total amount of Preliminary Expenses or so much of it as has not been written off must be shown separately on the assets side of the Balance Sheet.
Some specific and particular expenses are to be included only in preliminary expenses. Thus, the contention that all expenses irrespective of their nature are to be included in the preliminary expenses does not appear to be sound proposition.
Preliminary expenses are necessarily incurred for setting up of a business and commencement thereof. According to the principles of accountancy if certain expenditure is laid out for acquiring some initial assets or advantages on the basis of which the business is to be launched it would be a capital expenditure. Thus, preliminary expenses which relate to the acquisition of a capital asset and which would result either in the coming into being of a business asset or its expansion or improvement, would be treated of a capital nature. It will be allowed to be added to the capital cost of an asset for the purpose of allowing depreciation.
Preliminary expenses which are necessarily incurred for the purpose of forming a new company can be capitalized at the option of an assessed and the amount so expended can be included in the cost of plant and machinery but only such expenses shall be included therein as are enumerated above.
Western India Vegetable Products Ltd. v. C.I.T. (1954) 26 ITR 151 distinguished.
Carter's Advanced Accounts by Douglas Garbutt, 1974 Edn., pp. 1908 1909 and Jamshed R. Batliboi on Advanced Accounting, 29th Edn., p. 347 quoted.
Ch. Nazir Ahmed, D.R. for Appellant.
Halimur Rehman Khan, I.T.P. for Respondent.
Date of hearing: 29h June, 1991.
ORDER
This appeal is directed against the order dated 29-7-1986 by the learned C.I.T.(A) Zone-II, Karachi in I.T.A. No.C.I.T./Z-2/47/85 pertaining to the assessment year 1982-83.
2. Briefly stated the relevant facts are that the assessee (hereinafter referred to as the respondent) is a private limited company engaged in the business of manufacturing and marketing of polythene bags. The respondent company was incorporated with effect from 23-12-1980. The respondent filed return of income for the first time on 15-1-1983 for the period ending 30-6-1982, showing a total loss of 7,66,939. During the course of proceedings the assessing officer observed that in the cost of plant and machinery the appellant claimed a sum of Rs.1,00,679 representing preliminary expenses incurred before start of the business of company. The assessing officer held that the preliminary expenses are not allowable and, therefore, reduced this amount from the value of cost of plant and machinery and consequently reduced the depreciation claimed. The respondent being aggrieved with this treatment preferred first appeal contending that the preliminary expenses incurred prior to the commencement of commercial production were rightly capitalized in the cost of plant and machinery. Reliance was placed on decision of the Bombay High Court in the case of Western lndia Vegetable Products Ltd. v. CIT, (1954) 26 I.T.R. 151. It has been held in this case that, "there may, however, be are interval between the setting up of the business and the commencement of the business and all expenses incurred during that interval would be permissible deduction:' The learned C.I.T. (A) by placing reliance on the above dictum laid down by the Bombay High Court held that the preliminary expenses are in actual fact expenses on account of administration incurred prior to the commencement of commercial production and, therefore, were rightly included in the cost of machinery and depreciation claimed. The learned C.I.T. (A), therefore, directed the I.T.O. to add an amount of Rs.1,00,679 to the cost of machinery and allow depreciation thereon. This time the department felt aggrieved and preferred this second appeal before us contending that the learned C.I.T. (A) was not justified in directing that the preliminary expenses be added to the cost of machinery and depreciation be allowed. The plea taken by the Department is that incurring the expenses prior to the commencement of the commercial production created no asset of lasting nature.
3. We have heard Mr. Ch. Nazir Ahmad, learned Representative for the Department and Mr. Halimur Rehman Khan, learned ITP for the respondent. Our findings are as under:
FINDINGS
4. The learned D.R. has submitted that no asset of lasting nature was created with the expenses incurred by respondent by incurring expenses prior to the commencement of the commercial production and, therefore, the expenses could neither be allowed as revenue expenditure nor as capital expenses. He has fully supported the assessing officer and has contended that the assessing officer was perfectly justified in excluding the expenses incurred prior to the commercial production in the cost of plant and machinery. He has further contended that the learned C.I.T. (A) has misdirected in directing for adding the preliminary expenses of Rs.1,00,679 to the cost of machinery and for allowing depreciation thereon by misreading of facts and the law as laid down by the Bombay High Court.
5. On the other hand, Mr. Halimur Rehman Khan, learned Representative for the respondent has fully supported the impugned direction of learned CJ.T.(A) and has submitted that all the expenses incurred before the commercial production come within the purview of preliminary expenses and the learned C.I.T.(A) has, therefore, rightly directed to add the expenses towards the cost of machinery. Mr. Halimur Rehman Khan has reiterated the submissions made before the learned C.I.T.(A) and has placed reliance on the judgment of Bombay High Court referred to above.
6. We have carefully considered the contentions raised by the learned representatives for the parties and have gone through the judgment of Bombay High Court relied upon by the learned C.I.T. (A) and the learned counsel for the respondent. A perusal of the above judgment shows that an entirely different question was canvassed before and considered by the Bombay High Court. The question before the Bombay High Court was not about the capitalization of the preliminary expenses but about the allow ability of the expenses after setting up of the business. The Bombay High Court considered the following question:--
"Whether there was evidence before the Tribunal to hold that the assessee company set up its business as from Ist of September, 1946?"
7. While considering the above question the Bombay High Court made various observations including the observation on which the learned C.I.T. (A) has placed reliance. Thus, the observation made by the High Court which led the learned C.I.T. (A) to a conclusion that preliminary expenses claimed by 'the respondent can be added to the cost of plant and machinery was totally irrelevant in the facts and circumstances of the present case. We would also like to observe that the observation of High Court in respect of the allow-ability of expenses was in fact in the nature of obiter dictum as it was not directly related to the question, which the Bombay High Court in fact considered and answered in the final analysis.
8. Be that as it may, the fact remains that the learned C.I.T.(A) misdirected in placing reliance on an observation of the Bombay High Court which was not relevant at all to the issue under consideration. However, it is not the end of matter because preliminary expenses are necessarily incurred for setting up of a business and commencement thereof. According to the principles of accountancy if certain expenditure is laid out for acquiring some initial assets or advantages on the basis of which the business is to be launched it would be a capital expenditure. Thus, preliminary expenses which relate to the acquisition of a capital asset and which would result either in the coming into being of a business asset or of its expenses or improvement, it would be treated of a capital nature. It will be allowed to be added to the capital cost of an asset for the purpose of allowing depreciation. However, we are not persuaded to agree with the contention of Mr. IIL Halimur Rehman Khan that all the expenses incurred prior to the commencement of business, irrespective of the nature of expenses can be added to the cost of plant and machinery by treating the same as capital expenditure and depreciation thereon is to be allowed. The nature of preliminary expenses are defined in Carter's Advanced Accounts by Douglas Garbutt (1974 Edition) at page 1908-9 as follows:--
"Preliminary expenses.--These include the law costs, registration fees, and other expenses incidental to the formation or promotion of a company. Hence they are also called formation expenses and promotion expenses. Such expenditure is, of course, capital expenditure; but it is usually written off to revenue over a period of years, three, five or seven, according as the amount is small, large, or very large. The balance of the account appears each year on the assets side of the balance-sheet until the amount is finally extinguished:"
The preliminary expenses are defined by Jamshed R. Batliboi in his book Advanced Accounting (29th Edition) on page 347 as follows:-
"Preliminary expenses.--These are expenses which must necessarily be incurred for the purpose of forming a new company. The following items are usually included under this head:--
(1) Cost of registering the company.
(2) Stamp duty and fees on the Nominal Capital.
(3) Fees and stamp duties on the documents filed with the Registrar.
(4) Cost of preparing and printing the Memorandum and Articles of Association.
(5) Cost of preparing all preliminary agreements including stamp duties.
(6) Cost of preparing, printing and circulating the Prospectus.
(7) Valuers' fees for valuing assets proposed to be acquired.
(8) Accountants' charge for certifying profits.
(9) Cost of preparing and printing Share Certificates, Letters of Allotment, Debentures, Trust Deed etc.
(10) Cost of the Books of Accounts, Statutory and Statistical Books and the Company's Seal.
As the amount expended under this head is of a non-recurring nature and as it results in getting the Share Capital subscribed, it is deemed desirable not to charge the whole of it to the first year's Revenue Account, but to distribute it over a reasonable number of years, say from 3 to 5 years.
It may be pointed out that there is nothing in the Companies Act to compel a company to write off its Preliminary Expenses within any stated number of years, and the expenditure under this head may be permanently capitalised and shown as an asset in the Balance-Sheet, if a company so desires. In any case, it would be a fictitious and an intangible asset, and as the permanent capitalising of such an item cannot be said to be a sound or a prudent measure from the viewpoint of finance or accounting. It would seem desirable to extinguish it from the books as early as the net profits would admit.
The total amount of Preliminary Expenses or so much of it as has not been written off must be shown separately on the assets side of the I Balance-Sheet."
9. The nature of preliminary expenses as defined by the learned Authors above shows that some specific and particular expenses are to be included only in preliminary expenses. Thus, the contention of Mr. Halimur Rehman Khan that all expenses irrespective of their nature are to be included in the preliminary expenses does not appear to be sound proposition. Mr. Halimur Rehman Khan has submitted that all the expenses such as entertainment etc. should be included in the preliminary expenses but he has not produced any authority in support of his contention. As already observed he has placed reliance on the judgment of Bombay High Court cited above but the above judgment is not applicable to the facts of the present case.
10. As a result of above discussion it is held that preliminary expenses which are necessarily incurred for the purpose of forming a new company can be capitalized at the option of an assessee and the amount so expended can be included in the cost of plant and machinery but only such expenses shall be included therein as are enumerated by the learned two authors cited above.
11. We have asked Mr. Halimur Rehman Khan to furnish details of preliminary expenses which the respondent included in the cost of plant and machinery but he is not able to furnish details. The learned D.R. is also unable to give the details of expenses and consequently the impugned direction of learned C.I.T.(A) is hereby vacated and the finding of assessing officer on the issue of capitalising of preliminary expenses is set aside with the direction to decide the issue afresh in the light of above discussion. The assessee is directed to furnish full particulars of' the expenses and the I.T.O. is directed to allow the expenses falling within the purview of preliminary -expenses, as explained above, to be capitalised and the depreciation thereon should be allowed. The expenses falling outside the purview of preliminary expenses as explained above may be disallowed.
12. The appeal is allowed accordingly.
M.BA./1207/T Appeal allowed.