1. By this reference under s. 256(1) of the I. T. Act, 1961, the following question of law has been referred to us for our consideration;
'Whether, on the facts and in the circumstances of the case, the assessee-company had set up business in February, 196 ?'
2. It may be stated before discussing the facts and the rival contentions that the matter had come up earlier before this court on 8th July, 1977, when after some arguments it was remanded to the Tribunal with a direction that the Tribunal should submit a supplementary statement of case recording its findings as to from what date or month between February, 1961, and September, 1961, the assessee-company obtained a reasonable quantity of the finished product irrespective of whether it was in an marketable state or not. Pursuant to this direction given by the order dated 8th July, 1977, the supplementary statement of case has been duly sent to us by the Income-tax Appellate Tribunal.
In order to understand the rival contentions a few facts may be stated :
We are concerned with the assessment year 1962-63, the relevant accounting year being the year ending 30the September, 1961. The assessee is a private limited company which was incorporated on 1st August, 1959. The construction of the building and the erection of the plant and machinery developed by Shree Ram Institute of Delhi were completed by the end of December, 1960, or January, 1961. The business of the assessee was to manufacture industrial solvents and the machinery which was installed would, it was expected, produce ether. For the purpose of such manufacture the assessee required denatured spirit or alcohol as raw material and in January, 1961, the assessee acquired 5,000 gallons of alcohol. It is on record that the plant was initially charged with about 200 gallons of raw material on 5th February, 1961, and it has been found by the Tribunal that on 42 different occasions during the relevant accounting year the company had charged its plant and machinery with the raw material. In all, 4,980 gallons of denatured sprit had been used up. The company got the finished product but it was not in a marketable condition and hence there were no sales of the finished product in the relevant accounting year. However, large expenses amounting in the aggregate to Rs. 1,79,541 had been incurred and they were claimed as a revenue loss. After the machinery had been installed, correspondence had been exchanged between the assessee-company and Shree Ram Institute, which was made part of the statement of case. This correspondence clearly indicates that the installed plant was not giving any production and expert advice was sought for necessary rectification.
3. Considering the facts and the correspondence the ITO came to the conclusion that the erection of the plant was completed only by the middle of March, 1961, but that thereafter trials were started, which continued right up to September, 1961. He was of the view accordingly that those were in the nature of experiments made by the assessee-company and that there had been no production during the accounting year. Hence, the ITO held that the company had not commenced its business at any time during the year of account. Accordingly, the expenses claimed were disallowed on the basis that this was expenditure only on experiments preparatory to the commencement of the business and not for carrying on the business.
4. The assessee carried the matter to the AAC, before whom the assessee relied on the decision of the Bombay High Court in Western India Vegetable Products Ltd. v. CIT : 26ITR151(Bom) and contended that its business can be said to have been set up when it was ready to commence production, whether the production was successful or otherwise. After considering the facts before him the AAC found that the erection of the plant was completed in December, 1960/January, 1961, that denatured spirit to the extent of 5,000 gallons was received in January, 1961, and that the first issue of 200 gallons for charging the plant was on 5th February, 1961. He accepted the contention of the assessee and held that the business had been set up in February, 1961, when trial runs had commenced. He, accordingly, set aside the assessment order and directed the ITO to determine the admissible business loss and also to determine the depreciation and development rebate admissible to the assessee-company.
5. The revenue carried the matter in appeal to the Income-tax Appellate Tribunal. The Tribunal considered the rival arguments and upheld the submissions made before it on behalf of the assessee. In the opinion of the Tribunal even if the trial runs proved unsuccessful or resulted in the production of the finished products which were not marketable, still the assessee could be said to have commenced its business. In conclusion, it agreed with the views of the AAC that the assessee had set up its business in February, 1961, and that it was entitled to the allowance of the expenses incurred for the business purpose. In the order of the Tribunal, it was observed that during this period the company had got the finished product but it was not in a marketable state. In the said order, however, the Tribunal had not given the date or even the month when the company had got the finished product. Accordingly, as stated earlier, a direction was given to it on 8th July, 1977, to submit a supplementary statement of case. In para. 4 of the supplementary statement of case submitted the Tribunal has observed that from the material on record it appeared that the assessee did obtain some quantity of the finished product on the running of its factory on some days between 19th August, 1961, and 11th September, 1961. According to the Tribunal, the finished product obtained by the assessee could be termed as sub-standard ether. The Tribunal was not able to give any finding even by an estimate on the extent or the quantity of the finished product obtained and, therefore, observed further that it was not established that the assessee had obtained a reasonable quantity of the finished product in the relevant previous year.
6. Mr. Joshi on behalf of the revenue submitted that, in view of the clear finding now given in the supplementary statement of case, the Tribunal was in error in upholding the decision of the AAC that the business had been set up in February, 1961. It is obvious that the view of the AAC confirmed by the Tribunal in the impugned order was that as soon as the trial runs commenced with the charging of the plant by 200 gallons of raw material, i.e., denatured spirit, the plant or business could be said to have been set up.
7. Mr. Joshi submitted that on the facts as now found in the supplementary statement of case it would not be possible to sustain the view and since the assessee had failed to obtain a reasonable quantity of the finished product (even though of sub-standard) in the accounting year, it would not be possible to conclude that it had set up its business in the said year. In the alternative, it was urged that in view of the clear finding that some quantity of the finished product was obtained from the running of the factory between 19th August, 1961, and 11th September, 1961, the earliest date which could be given as the date on which the assessee could have set up its factory was 19th August, 1961. On the other hand, Mr. Patel on behalf of the assessee has urged that there was a clear finding that the erection of the plant had been completed by the end of December, 1960, or January, 1961. He drew our attention to various facts and circumstances noted by the AAC in his order and submitted that from a businessman's point of view the plant could be said to have been set up in February, 1961, when the initial quantity of 200 gallons of raw material, viz., denatured spirit, were charged and the plant commenced its trial operations.
8. Our attention was drawn at the bar to a number of decided cased in which this question has come up for consideration. Some of the cases involved consideration of s. 3(1)(d) of the I. T. Act, 1961, which is equivalent to s. 2(11) of the Indian I. T. Act, 1922. The latter provision came to be considered by a Division Bench of this court in Western India Vegetable Products Ltd. v. CIT : 26ITR151(Bom) , which has been regarded as the leading authority, in which the distinction between the setting up of a business and the commencement of the business was brought out by the following passage (p. 158) :
'It seems to us that the expression 'setting up' means, as is defined in the Oxford English Dictionary, 'to place on foot' or 'to establish', and in contradistinction to 'commence'. The distinction is this, that when a business is established and is ready to commence business, then it can be said of that business that it is set up. But before it is ready to commence business it is not set up. But there may be an interregnum, there may be an interval between a business which is set up and a business which is commenced and all expenses incurred after the setting up of the business and before the commencement of the business, all expenses during the interregnum, would be permissible deductions under section 10(2).'
9. The test propounded by the Bombay High Court in the aforesaid decision was approved by the Supreme Court in CWT v. Ramaraju Surgical Cotton Mills Ltd. : 63ITR478(SC) .
10. We were also referred to four decisions of the Gujarat High Court on which considerable reliance was placed by the assessee, viz., (1) CIT v. Sarabhai Sons Pvt. Ltd. : 90ITR318(Guj) , (2) CIT v. Saurashtra Cement and Chemical Industries Ltd. : 91ITR170(Guj) , (3) Sarabhai Management Corporation Ltd. v. CIT : 102ITR25(Guj) and (4) Prem Conductors Pvt. Ltd. v. CIT : 108ITR654(Guj) .
11. In the last mentioned case a Division Bench of the Gujarat High Court has referred to all the previous decisions of the said High Court as also the decision of the Bombay High Court in Western India Vegetable Products Ltd's case : 26ITR151(Bom) and of the Supreme Court in CWT v. Ramaraju Surgical Cotton Mills Ltd. : 63ITR478(SC) .
12. In Sarabhai Sons Pvt. Ltd.'s case : 90ITR318(Guj) , it was observed that the new business could not be said to be ready to discharge the function for which it was established, namely, manufacture of scientific instruments and communication equipment, until the machinery necessary for the purpose of manufacture was installed. It was held that obtaining land on lease, placing orders for machinery and raw materials were merely operations for the setting up of the business. It was observed (at page 322) :
'It is only when the machinery was installed that the business could be said to be put into such a shape that it could start functioning as a manufacturing organisation.'
13. It was contended, relying upon this observation, that this case was an authority for the proposition that as soon as the machinery was installed, it must be held that the business had been set up. We are afraid that this does not amount to a fair reading of the observations above quoted; these have been understood by the very High Court in Prem Conductors Pvt. Ltd.'s case : 108ITR654(Guj) and, in this manner, viz., that it had been held that only when the business could start functioning as a business or a manufacturing organisation that it could be said to have been set up (see observations at the foot of page 659 of the report).
14. As far as the two other decisions of the Gujarat High Court are concerned, viz., Saurashtra Cement's case : 91ITR170(Guj) and Sarabhai Management Corporation's case : 102ITR25(Guj) , we find that they are not of great assistance in determining the questions referred to us, as the activities of the assessee-companies were of a totally different kind, and in both the cases it was held by the court that there was more than one activity which consideration affected the answer to be given to the question under consideration, viz., when was the business set u In Press Conductors Pvt. Ltd. v. CIT : 108ITR654(Guj) , there was a totally different situation as the company was set up to take over an existing running factory. In our case, the activity of the assessee-company was to produce industrial solvents, viz., ether. Can the assessee-company be said to be ready to commence its business, viz., production of ether, merely when the machinery was installed or even when the plant was charged initially with 200 gallons of raw materia In our opinion, when the question is so put, the answer is obvious and the answer is that till some end product which is the business of the company is or can be obtained, it cannot be said that the company is ready to commence production and it is such readiness to commence production which has been indicated in Western India Vegetable Products Ltd.'s case : 26ITR151(Bom) as equivalent to the setting up of the business.
15. Once we come to the conclusion that mere installation and erection of the machinery is not sufficient by itself, we will have to examine the facts of our case to come to a fair conclusion on the question of setting up of the business. In this connection, the finding of the Tribunal to be found in para. 4 of the supplementary statement of case and annex.'B' to the same afford us useful guidance.
16. Annexure 'B' to the supplementary statement of case contains extracts from the log records and reports of the assessee-company regarding the production process. The first relevant report pertains to the period from 9th June, 1961, to 24th June, 1961. It was submitted by the learned advocate for the assessee that the report for this period should be sufficient for us to come to the conclusion that at any rate by this date some quantity of the finished product had been obtained and the factory has commenced running. We are afraid we cannot accept any such submission. In fact a fair reading of the report for the period and the correspondence annexed to the statement of case would seem to suggest that although the plant was being operated, the rate of the end product obtained was hopelessly low in securing any material result (to paraphrase the last paragraph of the report). This must be read to indicate that almost nothing was obtained.
17. However, when one turns to the next report which is for the period 19th August, 1961, to 11th September, 1961, a different picture emerges. The extracts from the log records would show, as has been observed in the report, that ether had been formed in reasonable quantities in the reactor from out of the alcohol fed as raw material. It is on the basis of this report that the Tribunal in its supplementary statement of case has given a finding that some quantity of finished product was obtained from the running of the factory between 19th August, 1961, and 11th September, 1961.
18. It is true that when the end product obtained during this period was sent to the analysts, Italab Private Ltd., for analysis, it was opined by the laboratory that the sample did not comply with the prescribed standards of quality of B. P. test 1958 with respect to non-volatile matter. As a matter of fact, even earlier some ether obtained in June, 1961, was submitted to the same analysts and an identical conclusion had been reached by them. The position then is that in August, 1961, the plant had commenced operation but the end product was sub-standard and hence obviously not marketable. It is in this context that Mr. Joshi on behalf of the revenue has urged that even in August, 1961, the business of the assessee could not be said to have been set up, although the plant was being worked, inasmuch as a proper standard marketable end product had not been obtained. We are afraid that if this test as suggested by counsel is accepted, we would be taking an unrealistic view of the requirements of the statutory provisions.
19. In each case the question as to when the business can be said to be set up will be required to be answered on the facts of that case, which facts have to be found by the Tribunal and indicated in the statement of case and the supplementary statement of case submitted to us. On the facts of the case as submitted to us by the Income-tax Appellate Tribunal (which are binding on us and have not been challenged by either party) we think that the proper view to take would be to hold that the assessee could be regarded as having set up its business by 19th August, 1961, which would mean that it would be entitled to the expenses incurred thereafter as expenses incurred in the course of its business.
20. The result of the foregoing discussion would be that the order of the Tribunal, which sustained the order of the AAC giving directions to the ITO as found in para. 5 of his order cannot be sustained. The admissible business loss will have to be calculated by the ITO bearing in mind the aforesaid date we have indicated (i.e., 19th August, 1961) and on the same basis he will determine the depreciation and development rebate admissible to the assessee-company.
In the result, the question referred to us is answered as follows :
On the facts and in the circumstances of the case, the assessee must be regarded as having set up its business by 19th August, 1961, and not in February, 1961.
21. The fair order as to costs would be to direct both the sides to bear their own costs of the reference. Order accordingly.