Income Tax---

----Depreciation---Actual cost---Capitalisation of pre-operative expenses-- General principles---Interest paid to partners and expenditure connected with dealings in raw materials---Expenditure had no direct or indirect nexus with setting up of business of installation of machinery---Expenditure could not be capitalised and added to actual cost of machinery---Indian Income Tax Act,

Broadly speaking outlay is deemed to be capital when it is made for the initiation of the business, for extension of a business, or for a substantial replacement of equipment. However, this test must be applied with great circumspection, because expenses for the initiation or extension of a business can also be on revenue account. It is now well-settled by a number of decisions that none of- the tests to distinguish capital from revenue expenditure is conclusive or of universal application:

Held, that in these cases, no material had been brought to justify the finding that the payment of interest to the partners had any nexus, direct or indirect., with the setting up. of the business or the installation of the machinery. Similarly, it was not clear how expenditure connected with dealings in raw materials for the period prior to the start of business could be said to be a capital expenditure. The Tribunal was not right in law in holding that the expenditure incurred on payment of interest to partners and dealings in raw materials should be capitalised as pre-operative expenses for the purpose of allowing depreciation.

Travancore-Cochin Chemicals (P.) Ltd. v. CWT (1967) 65 ITR 651 (SC) and Western. India Vegetable Products Ltd. v. CIT (1954) 26 ITR 151 (Bom.) ref.

K. K. Vidyarthi and S. K. Sharan for the Commissioner.

L. K. Bajla for the Assessee.

JUDGMENT

AFTAB ALAM, J.---These cases have come on reference made as directed by this Court under section 256(2) of the Income Tax Act, 1961, at the instance of the Revenue. These cases relate to the. assessment years 1978-79, 1979-80 and 1980-81. The three appeals arising for the aforesaid assessment years were disposed of by the Income-tax Appellate Tribunal by a common order. Three reference cases were, therefore, filed in this Court though they involved a common-question of law. According to the Court's direction, the Income-tax Appellate Tribunal, Patna Bench, Patna, made a statement of the case and referred the following common question of law for the opinion of this Court.

"Whether, on the facts and in the circumstances of the case, the Tribunal is right in law in holding that the expenditure incurred on payment of interest to partner and dealings in raw materials should be capitalised as pre-operative expenses for the purpose of allowing depreciation?"

The material facts can be briefly stated as follows. At the material time, the assessee-firm was engaged in the business of manufacture and sale of Fawrah (udal). The account for the pre-operative period was closed on December 6, 1997, and a fresh account was started from December 7, 1977, the date from which the firm commenced its business. In its first account for the assessment year 1978-79, the assessee claimed depreciation on a sum of Rs.6,12,070 being the cost of machinery. On scrutiny, the Assessing Officer found that the actual cost of machinery amounted to Rs.5,72,004 over which a sum of Rs.40,066 was added as "pre-operative expenses". A further examination of the "pre-operative expenses" disclosed that it included a sum of Rs.25,226 as interest paid to the partners, as also expenses connected with the dealings in raw materials for the period prior to the start of the. business. The Income-tax Officer deducted an estimated sum of Rs.30,000 from the account of pre-operative expenses shown by the assessee and allowed only the sum of Rs.10,066 to be added as pre-operative expenses to the actual cost of machinery for the purpose of allowing depreciation at 10 percent. According to the Income-tax Officer, the interest of partners and expenses connected with the dealings in raw materials were not in a real sense pre operative expenses incurred for installation or machinery.

On appeal, the Appellate Assistant Commissioner upheld the assessment order passed by the Income-tax Officer. The assessee took the matter before the Income-tax Appellate Tribunal, Calcutta-Bench "R". Before" the Tribunal, it was contended on behalf of the assessee that all the expenses incurred for the setting up of the business were capital expenditure on which the assessee was entitled to depreciation and in that view the Income-tax Officer was not justified in disallowing the claim of the assessee to the extent of Rs.30,000. Upholding the assessees contention the Tribunal held that the expenditure incurred prior to the setting up of the business cannot be allowed as revenue expenditure and the same is necessarily to be capitalised. The claim of the assessee was consequentially upheld and the Income-tax Officer was directed to capitalise the amount claimed by the assessee and to allow the consequential depreciation. In support of its view, the Tribunal relied upon the decisions in Western India Vegetable Products Ltd. v. CIT (1954) 26 ITR 151 (Bom.) and Travancore-Cochin Chemicals (P.) Ltd. v. CWT (1967) 65 ITR 651 (SC).

I am unable to see how those decisions help the assessee in this case. The decisions cited by the Tribunal examined the question and laid down the law on the question as to when a business is set up. The controversy involved in these case is not with respect to the date when the assessee's business was set up. The question is whether all expenses, regardless of their nature, incurred before the commencement of the business must necessarily be capitalised. In this regard, it is indeed true that broadly speaking outlay is deemed to be capital when it is made for the initiation of the business, for extension of a business, or for a substantial replacement of equipment. however, this test must be applied with great circumspection, because expenses for the initiation or extension of a business can also be on revenue account. It is now well-settled, by a number of decisions that none of the tests to distinguish capital from revenue expenditure is conclusive or of universal application.

In these cases, no material had been brought to our notice to justify the finding that the payment of interest to the partners had any nexus direct or indirect with the setting up of the business or the installation of the' machinery. In the facts and circumstances of the case, I am rather inclined to accept the contentions of the Revenue that the so-called expenditure by way of payment of interest to the partners was not an expenditure or investment at all but it was simply appropriation and allocation of available funds between the partners themselves. I am, therefore, of the view that so far as the amount of Rs.25,206 is concerned, the Assessing Officer and the appellate authority rightly did not allow it to be added to the actual cost of the machinery for capitalisation and for claiming depreciation of the rate of 10 percent. Similarly, I am unable to see how expenditure connected with dealings in -raw materials for the period prior to the start of business can be said to be capital expenses.

For the reasons stated, I answer the question in the negative, that is to say, against the assessee and in favour of the Revenue:

S. N. JHA, J.---I agree.

M.B.A./3371/FCReference answered.