1. The following question of law has been referred to us in this reference by the Income-tax Appellate Tribunal at the instance of the assessee under s. 256(1) of the I. T. Act, 1961 :
'Whether, on the facts and in the circumstances of the case, in computing the income of the company the sum of Rs. 92,400 is deductible ?'
2. A few facts may be stated :
3. We are concerned in this reference with the assessment year 1962-63, for which the accounting year is the year ending on March 31, 1962. The assessee is a limited company, which was formerly acting as the managing agents of Shreeram Mills. The assessee-company thereafter established a factory for manufacturing tools under the trade name of Hansa Tools, which factory went into production in August, 1961. The factory was at Udhna in Surat District (State of Gujarat). the assessee-company had earlier approached the Gujarat Electricity Supply Board for getting power supply, and on 14th July, 1960, the board communicated to the company its willingness to provide necessary supply on condition that the company paid a sum of Rs. 92,400 towards the estimated cost of laying a new 22 KV single circuit line from Tapti sub-station to the Udhna Control Room over a length of about five miles. The additional facilities to be provided were to cost the board about Rs. 1,80,000, which, according to the board, was required to be shared between the assessee-company and another consumer named in the said letter, so that the cost to the assessee would come to Rs. 92,400. The relevant portion of the letter of the board in this connection has been fully extracted in the order of the Tribunal and it clearly indicates that notwithstanding that the cost is fully borne by the assessee and M/s. Adarsh Chemicals, the service line shall remain the property of the board by whom it is to be maintained.
4. The assessee-company and, presumably, Messrs. Adarsh Chemicals also agreed to the condition and paid the agreed amount and in due course the lines were laid and the company started getting electric supply to run the factory.
5. In the accounts of the assessee-company the expenditure of Rs. 92,400, being the contribution made to the board, was debited as a revenue item. The ITO disallowed the same, holding that it was in the nature of a capital expenditure. The assessee-company carried the matter in appeal to the AAC, who agreed with the conclusion of the ITO but on a slightly different footing. According to him, these were expenses incurred for the initiation of business or installation of the factory. Accordingly, the amount of Rs. 92,400 was required to be regarded as a capital expenditure.
6. The matter was thereafter carried in second appeal to the Tribunal. The Tribunal also concurred with the ITO and the AAC, observing that the expenditure in this case was incurred to enable the company to start its factory and it was not an expenditure incurred in the course of running the factory. Further, according to the Tribunal, this must be regarded as a capital expenditure despite the fact that the asset on which the expenditure is incurred was not the property of the assessee. It is the correctness of this conclusion of the Tribunal which is impugned in the reference.
7. Mr. Kolah appearing on behalf of the assessee-company submitted that the decision of the Tribunal and the approach of the revenue run counter to the well-settled distinction between the setting up of a business and the commencement thereof, which was pointed out by this High court as far back as in 1954 in Western India Vegetable Products Ltd. v. CIT : 26ITR151(Bom) . It was observed by Chagla C.J. (at page 158) :
'... 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 s. 10(2).'
8. The aforesaid decision of the Bombay High Court, which appears to us to have stood the test of time, came to be considered and approved by the Supreme Court in CWT v. Ramaraju Surgical Cotton Mills Ltd. : 63ITR478(SC) , where Bhargava J., delivering the judgment of the Supreme Court, observed (p. 482) :
'The word 'set up' in the principal clause, in our opinion, is equivalent to the word 'established', but operations for establishment cannot be equated with the establishment of the unit itself or its setting up.'
9. After referring to the decision of the Bombay High Court in Western India Vegetable Products' case : 26ITR151(Bom) , Bhargava J. continues (p. 482) :
'These operations for establishment of the unit cannot be simultaneous with the setting up of the unit, as urged on behalf of the Commissioner, but must precede the actual setting up of the unit. In fact, it is the operations for establishment of a unit which ultimately culminates in the setting up of the unit.'
10. The question then is : Was the assessee-company's unit of Hansa Tools set up at the time when the expenditure was incurred According to Mr. Kolah, the question was required to be considered and answered from a businessman's point of view, adopting a commonsense approach, and not in the manner in which the revenue wants us to answer the same. In connection with this submission he referred us to several decisions of the Gujarat High Court, to which brief reference may now be made.
11. The first of these decisions is CIT v. Sarabhai Sons Pvt. Ltd. : 90ITR318(Guj) . The Gujarat High Court was considering expenses incurred for obtaining land on lease, for placing orders for machinery and purchasing raw materials. In its view these were merely operations for the setting up of the business; and, on the facts, at the stage at which these expenses were incurred, the new business could not be said to have been set up. The test which was indicated by Chagla C.J. in Western India Vegetable Products' case : 26ITR151(Bom) and approved by the Supreme Court in Ramaraju Surgical Cotton Mills' case : 63ITR478(SC) was extracted at page 321 of the aforesaid decision and thereafter applied. The court observed that the new business which was sought to be established by the assessee before it was the business of manufacturing scientific instruments and communication equipment, and it could not be said to be ready to discharge the function for which it was being established, viz., manufacture of scientific instruments and communication equipment by merely obtaining land on lease from the Gujarat Industrial Development Corporation or appointing a qualified man as general manager or placing orders for purchase of raw materials and stores and ordering out the necessary machinery and equipment. In the view of the Gujarat High Court, these were merely operations for the setting up of the business, and the business could be set up only as a culmination of these operations when all that was necessary for the setting up of the business was done.
12. We were also referred to a later decision of the Gujarat High Court in Prem Conductors Pvt. Ltd. v. CIT : 108ITR654(Guj) , where it was observed that if the business of the assessee consists of different categories, then it could be said to have set up its business from the date when one of the categories of its business is started. It was not necessary, according to the Gujarat High Court, that all the categories of its business activities must start either simultaneously or that the last stage must start before it can be said that the business was set up. According to the Gujarat High Court, the test to be applied is as to when a businessman would regard a business as being commenced and the approach must be from a commonsense point of view. It is this approach, which Mr. Kolah on behalf of the assessee has commended to us, and his submission was that if this approach is adopted and properly applied right from the initial stage of the activity, the assessee must be deemed to have set its business which was ultimately to culminate in the production of tools.
13. A similar case came up for consideration before a Division Bench of this court in Income-tax Reference No. 72 of 1967, CIT v. Industrial Solvents and Chemicals Private Ltd., decided by Kantawala C.J. and Desai J. on 20th June, 1978 (since reported in : 119ITR608(Bom) . The earlier decision of the Bombay High Court in Western India Vegetable Products' case : 26ITR151(Bom) , the decision of the Supreme Court in Ramaraju Surgical Cotton Mills' case : 63ITR478(SC) and four decisions of the Gujarat High Court, viz., Sarabhai & Sons Pvt. Ltd.'s case : 90ITR318(Guj) , CIT v. Saurashtra Cement and Chemical Industries Ltd. : 91ITR170(Guj) , Sarabhai Management Corporation Ltd. v. CIT : 102ITR25(Guj) and Prem Conductors Private Ltd.'s case : 108ITR654(Guj) , were cited before the said Division Bench and have been noted in the judgment given. In Industrial Solvents and Chemicals Private Ltd.'s case : 119ITR608(Bom) the case of the assessee was that it must be deemed to have set up its business of producing industrial solvents, viz., ether, at least when the machinery was installed. However, even this submission was negatived by the Division Bench applying the test earlier propounded in Western India Vegetable Products' case : 26ITR151(Bom) and holding that for a manufacturing company or a unit thereof till some end product is or can be obtained, it cannot be said that the company or unit is ready to commence production. On the facts as were found by the Tribunal it was ascertained by the High Court that although machinery had been installed in December, 1960, or January, 1961, there was no worthwhile production till August, 1961; and even though this production of August, 1961, was sub-standard, the court found in favour of the assessee (to a limited extent) that it must be deemed to have set up its business when it could produce a limited quantity of the end product (though of a sub-standard quality) on this date. Thus, even the installation of machinery simpliciter was, in the special circumstances of the case, regarded as part of the operations for the setting up and not equivalent to the setting up of the business. We have applied the test propounded in this decision in a very recent decision given by this very Bench, viz., Income-tax Reference No. 85 of 1970, CIT v. Forging & Stamping Pvt. Ltd., decided on 29th January, 1979 (since reported in : 119ITR616(Bom) . In the said case, it was held that the assessee had set up its business when it received power connection and not earlier although the machinery had been installed earlier and trials had taken place with the help of a generator.
14. In the matter being considered presently by us, the facts are more hopeless for the assessee than were the facts in the aforesaid two cases, viz., Industrial Solvents and Chemicals Private Ltd.'s case : 119ITR608(Bom) and Forging and Stamping's case : 119ITR616(Bom) . In our opinion, considering the test laid down in Western India Vegetable Products' case : 26ITR151(Bom) as applied in the aforesaid two cases, viz., ITR No. 72 of 1967 CIT v. Industrial Solvents and Chemicals P. Ltd. : 119ITR608(Bom) and ITR No. 85 of 1970 CIT v. Forging and Stamping Pvt. Ltd. : 119ITR616(Bom) , it is impossible to hold that the present assessee could be regarded as having set up its business which was of producing tools when it incurred the expenditure of Rs. 92,400. In this view of the matter, the decision of the Tribunal would be required to be upheld since the assessee cannot claim deduction of this amount as a revenue expenditure till it could be regarded as having set up the business.
15. In this view of the matter, the question referred to us is answered in the negative and in favour of the Commissioner.
16. The assessee will pay to the Commissioner the costs of the reference.