1. This is an appeal filed by Electrolytic Foil Ltd. of Hyderabad against the orders of the Commissioner (Appeals) for the assessment year 1976-77.
2. The assessee is a company engaged in the manufacture of electrolytic foils.
3. The first ground relates to the question as to when the assessee's business was set up. According to the assessee, the business was set up from 1-4-1975, the beginning of the accounting year, while according to the ITO, it was set up only on 15-10-1975, the date on which commercial production had commenced. The ITO disallowed the expenditure as between 1-4-1975 and 15-10-1975 as 'pre-production expenses'. The first appellate authority summarised the assessee's arguments to mean that there was 'some hitch in the know-how'. Since, admittedly, the production commenced only in October, 1975, he was of the view that the business was set up only during this month. He purported to rely on the decision of the Supreme Court in CWT v. Ramaraju Surgical Cotton Mills Ltd.  63 ITR 478 and the decision in CIT v. Sarabhai Sons (P.) Ltd.  90 ITR 318 (Guj.). He confirmed the order of the ITO and the assessee is in second appeal.
4. The learned representative for the assessee drew our attention to a number of facts which were furnished before the ITO but did not find a place in the orders of authorities below. The assessee-company was incorporated on 4-3-1972. The assessee had completed the construction of the building and erection of entire machinery even by January, 1975 well before the end of the preceding accounting year, March, 1975. The raw materials were already both imported (value Rs. 1,35,301) and locally purchased (Rs. 28,243) and these amounts were already in opening stock during the year as is evident from the statement of the accounts already on record. The director's report on record for the year reads as under : Your directors are glad to inform you that the company commenced production from 1-4-75 but had to encounter problems in the process which were overcome and regular production started on 15-10-1975.
The factory had the privilege of having been officially inaugurated by Sri J. Vengalarao, the Chief Minister of our State, on 25-11-1975 and delivered the first sample to the chief guest, Mr. P.P. Nambiar, Managing Director, Keltron.
During the year the company supplied to various customers samples of its products for approval and it is hoped that they would accept the same. Your directors are also negotiating with Keltron Component Complex Ltd., Trivandrum, not only for obtaining bulk orders but also making our unit an ancillary to theirs. Keltron Complex Ltd. will be manufacturing capacitors in collaboration with Sorague Electro Mag, Belgium and our samples have been to Belgium for their approval. The company to date has already got commitments from Atlas India Radio, Remco, Bangalore, for 3 tonnes order each with those and also expected order from Keltron and others. The company can look forward for a sizable turnover around 10 tonnes in the next financial year.
The assessee had arrangement for technical know-how from Central Electro Chemical Research Institute, Karaikudi, at the instance of National Research Development Corporation of India which was the owner of patents relating to the invention. The assessee had filed as enclosures to its letter dated 6-9-1979 to the ITO, the correspondence between the Institute at Karaikudi and the assessee. On 4-1-1975, the assessee wrote as under : We are glad to inform you that we have received the high purity aluminium foil from abroad. Our plant is ready and we would like to go into production as early as possible.
Therefore, we request you to depute Mr. Narasimhan, scientist to our company by 25th January, 1975 so that we can start the production as soon as he comes here.
According to the assessee, it was clear from this letter what was pending was only the arrival of the scientist from Karaikudi for commissioning the plants. The institute replied on 16-1-1975 as under : Please refer to your letter dated 4-1-1975. We are happy to note that you have almost completed erection of your plant and ready to start production. We will only be too happy to depute Mr. Narasimhan for the purpose. In the meanwhile, we would like to clarify that the equipments and chemicals as per list attached is ready with you.
Further, kindly, indicate that the work as indicated by Shri R. Radhakrishanan when he visited you (list attached) has been completed. This would facilitate in fully utilising services of our scientists when they are deputed to your works.
The list of further things that were expected to be done on an earlier visit during October-November 1974 was enclosed to the above letter.
The reply of the managing director on 3-4-1975 shows that all the expected things were completed by this date. Power and water were already available. Chemist was appointed. After saying that scientists' arrival was expected, the managing director stated in the said letter dated 3-4-1975 as under : We are practically ready with all things including raw materials and we are eagerly waiting for your arrival to go into production.
In fact, even prior to the detailed reply in the nature of a report confirming completion of all the requirements of the institute, the assessee had also given a general reply on 7-3-1975 and 20-3-1975. The executive director's letter dated 7-3-1975 reads as under : We have completed all the formalities to run our plant. And at present we are in need of Mr. K.R. Narasimhan to run our plant.
Therefore, we request you to kindly depute him for a period of one month. We have also employed two chemists to assist him. We will appreciate if he is sent here on 20th March, 1975 We are glad to inform you that we have got the power connection to factory and also we have completed all the preliminary work as indicated in your letter dated 10th January, 1975.
Now we are enclosing herewith our draft No. DD/O, dated 20-3-1975 for Rs. 3,000 (Rupees three thousand only) in your favour on Indian Bank, towards expenses for deputation of your scientist Mr. K.R. Narasimhan.
We would request you to kindly depute Mr. K.R. Narasimhan by the end of this month. So that we can go into production immediately.
It is, therefore, clear that in the month of March itself, it was argued, the plant was ready for production with sufficient quantity of raw material in hand. What was required to be done further before commercial production could start was only rectification of 'current feeding arrangement'. The time-lag between 'setting up' and commercial production was explained by the assessee in the following words : The plant was ready by April 1975 but actual production could start only in October 1975. During the initial trial runs, the company had to waste lot of imported foil as scrap while taking out preliminary runs as the heating system was not perfected. Because of heavy heat losses due to imperfect lagging, the temperature necessary in the various processing tanks could not be attained. Further, the current feeding system had to be altered as the foil was getting cut while feeding the normal current. The institute required time to study the same at their end before a trial design for processing 10 inches wide foil could be recommended. So the subsequent few trial runs were taken at the institute with the 10 inches wide foil provided by the company. The directors of company were also present during these trials. The institute then agreed to spare the arrangement got ready at their end and the actual production of the finished product satisfying the specifications was started in October 1975 with the necessary current feeding arrangements sent by the institute.
Orders for raw materials had been placed and they had even arrived.
There was opening stock of indigeneous raw materials to the extent of Rs. 1,63,544 as at the beginning of the accounting period. The learned representative, on the above facts, claimed that the business had already commenced at the beginning of the year itself. He relied upon the decisions in CIT v. Saurashtra Cement & Chemical Industries Ltd.  91 ITR 170 (Guj.), Prem Conductors (P.) Ltd. v. CIT  108 ITR 654 (Guj.), Sarabhai Management Corpn. Ltd. v. CIT  102 ITR 25 (Guj.) and CIT v. Industrial Solvents & Chemicals (P.) Ltd.  119 ITR 608 (Bom.).
5. The learned departmental representative claimed that the facts clearly showed that the assessee was not able to run the machinery for technical reasons. Only from 15-10-?975 the production could be started and that regular production started from that date. Neither, acquisition of raw materials nor even installations of machinery could justify the inference that the business had been set up unless it was in a position to manufacture some quantities even if small. He claimed that the facts in the cases cited on behalf of the assessee were different and that the rationale of those decisions could only support the ITO's inference. He also relied upon the decision of the Gujarat High Court in Sarabhai Sons (P.) Ltd.'s case (supra) where obtaining of lease and raw materials were not sufficient to justify the inference that the business had been started earlier.
6. We have carefully considered the records as well as the arguments.
We do find that the assessee had installed the machinery by 1-4-1975 and also considered itself as having commenced production on 1-4-1975.
It had raw materials to the extent of about Rs. 1.5 lakhs from imports and purchases even in an earlier year in stock as on that date. If the machinery installed were capable of producing the goods, we are of the view that the assessee can be stated to have set up the business. No doubt, the assessee was in a position to start 'regular production' with effect from 15-10-1975 and delivered the first sample in the same month. It is because of some hitches that the machinery which was ready, could not start functioning. It is the nature of the hitches which should help determination of the issue before us as to the actual date of setting up of the business. The elaborate documentation available on the records indicates that the assessee considered itself fully equipped for the purpose of manufacture. A detailed questionnaire was issued by Central Electro Chemical Research Institute, Karaikudi, as to the minutest details regarding the readiness of the company to start manufacturing. The reply furnished suggests that all the requirements were complied with. A necessary raw material which had to be imported was already available. On 1-4-1975, the assessee wrote to the institute about the receipt of high purity aluminium foil from abroad and added 'our plant is ready and we would like to go into production as early as possible'. This communication further requested the scientist to be deputed by 25-1-1975 so that 'we can start production as soon as he comes'. The institute was also willing to depute the scientist as requested. On 10-1-1975, the assessee again wrote to the institute 'we have completed all the formalities to run our plant'. On 20-3-1975, the assessee again wrote to the institute informing that power connection had since been received and all the preliminary work required had also been completed. All the three dates fell prior to the accounting period. As mentioned earlier, the delay as between 1-4-1975 and October 1975 for 'regular' production was due to the heavy heat losses on account of imperfect lagging. All that was required was that the current feeding system required change of foil and this took sometime. Whether this delay could be taken as a ground for holding that the business, had not been set up is a question which now arises for consideration. As for the decision of the Gujarat High Court in Sarabhai Sons (P.) Ltd.'s case (supra) the facts are not comparable because the assessee relied upon the fact of having placed orders for raw materials and machinery as sufficient ground for claiming that the business had been set up. The High Court observed that merely obtaining land on lease and placing orders for machinery and raw materials did not amount to setting up of business but that they were merely operations for the setting up of the business. The assessee's facts, in our opinion, are much stronger. The raw materials were already available with the assessee. The machinery had been installed and were ready for production. In Saurashtra Cement & Chemical Industries Ltd.'s case (supra), the activity for extracting lime stone by quarrying was considered to be an independent activity and that such activity would be enough for holding that the assessee was in business, though the assessee was established for the manufacture and sale of cement. In Sarabhai Management Corpn. Ltd.'s case (supra), the business was one of hiring out accommodation and it was held that the acquisition of property, therefor and putting up the necessary building was good enough to be treated as grounds for holding that the business had been set up though the actual hiring operations were still to be carried out. The Gujarat High Court in Prem Conductors (P.) Ltd.'s case (supra), pointed out that the test to be applied in such cases is to consider when a businessman would regard a business as being commenced and the approach must be from a commonsense point of view. The orders having been secured, it was held that the business activity of the company had already started, since sale is one of the activities. No doubt, in this case the factor which influenced the High Court was that the assessee had taken over a going concern. The Bombay High Court in Industrial Solvents & Chemicals (P.) Ltd.'s case (supra) reviewed the decisions on the subject and found that experimental production on a trial basis had yielded some output though not of large quantity and that such trial runs on the facts and in the circumstances of the case could be taken as constituting business though output was of sub-standard varieties on the date when such output was received.
Though, no doubt, the facts of these cases are not strictly comparable, it is clear that the inference has to be based on relevant facts in each case. The assessee had not obtained orders in this case but had sufficient stock of raw materials with reference to the actual requirements and had installed its machinery to an extent that it could go ahead with production as at the beginning of the accounting year.
Some hitch developed but that hitch was not such as to require any major changes but only setting right the current feeding system, so that there was no appreciable loss of energy. Under these circumstances, we consider it possible to hold that the assessee had set up its business on 1-4-1975 inasmuch as all the formalities, were complete even by the end of the immediately preceding accounting year.
It was said so in its correspondence with the institute which was its technical sponsor. The directors' report for the very first year had assumed that the company had started production on 1-4-1975. Since, the matter has to be looked at from the commonsense and business point of view, we find it possible to accept the assessee's case. In the view we have taken, it is not necessary to consider the alternative ground urged on behalf of the assessee that in the event of any expenditure being disallowed as relating to the period before setting up of the business, such disallowable amount should be allowed to be capitalised and depreciation allowed thereon.
7 and 8. [These paras are not reproduced here as they involve minor issues.] 9. The last contention is that the assessee is a small scale industry and that it is entitled to investment allowance inasmuch as it satisfies the other conditions for eligibility of investment allowance.
The first appellate authority found that there is a definition of small scale industry in Explanation to Section 32(1)(vi) of the Income-tax Act, 1961 ('the Act') which requires that the aggregate value of the machinery and plant installed should not exceed Rs. 7.5 lakhs.
Admittedly, the assessee's assets exceed this limit. But it is the assessee's case that the assessee is a small scale industry for the purposes of the Industries (Development and Regulation) Act, 1951.
Since the Act has its own definition of a small scale industry, we have no doubt that the first appellate authority was justified in rejecting the claim of the assessee. It could not have the benefit of investment allowance.
10. In the result, the appeal is partly allowed in the manner indicated in the preceding paragraphs.