The major question is when a business can be considered as set up and commenced. The concept of setup and commencement will differ industry to industry. Expenditure is deductible under the Income-tax Act, 1961 only after a business is set up. The difficult question pertains to the date on which the business is deemed to be set up. As per Section 3 of the Income-tax Act, 1961 previous year is the period beginning with the date of setting up of the business.
Setting up and commencement of business are different. Setting up is capacity to start its earning capacity whereas commencement is actual commercialisation of the business.
There is a distinction between “setting up “of business and “commencement “of business. “Setting up” of business is relevant under the Income-tax Act, 1961 and not “commencement “of business. The expression “setting up” means “to place on foot” or “to establish” in contradiction to the expression “commencement”. Certain essential activities in the course of carrying on a business can be said to be determinative of whether the business has been “set up” and it is ready to commence. The criteria to determine when a business can be said to have been “set up” will be based on the facts of case and dependent on the type of business. It is also decided principle of law that once the business is set up, all the expenses should be allowed.
Section 3 of the Income-tax Act, 1961 which defines “previous year”, in context of first year of business operation, states that the previous year shall start from date of “setting up” of business. Accordingly, date of setting up assumes importance because expenses prior to setting up of business will not be covered under section 37 of Income-tax Act, 1961. This is however subject to section 35D of Income-tax Act, 1961 wherein specifically provision has been made by legislature for allowance of preliminary (pre-operative) expenses.
There is always a dispute whether all expenses should be allowed u/s 37(1) of the Income-tax Act, after setting up of a business or after the commencement of business.
The Hon’ble Delhi High Court in the case of Carre four WC & C India (P.) Ltd. v. Dy. CIT [IT Appeal No. 42/2014, dated 22-09-2014] made the following observation on setting up of business: –
“The present assessee i.e., Carrefour was engaged and incorporated for carrying on trading activities in different commodities. The word ‘trade’ even though not defined in the Act is used to denote operations of a commercial character by which a trader provides to customer for reward, some kind of goods or services. In other words, when the trader starts providing such goods and services, the business is said to have commenced but the same may not hold good for set up of a business, which is a stage before the commencement.
To set up a business, the following activities become relevant: –
‘Preparation of a business plan; establishment of a business premises; research into the likely markets or profitability of the business; acquiring assets for use in the business; registration as an entity and under the local laws etc.’ The said list of activities are not exhaustive and facts of each case need to be considered. Indeed, purchase of goods would amount to commencement of business, but before the said act, spade work and efforts to commence have to be undertaken. A trader before actual purchase would possibly interact and negotiate with manufacturers, landlords, conduct due diligence to identify prospective customers, spread awareness etc. These are all integral part and parcel of the business of a trader. The said activities continue even post first sale/purchase. When first steps are taken by a trader, the business is set up, commencement of purchase and then sales is post set up.”
Further the court held that the above lists of activities are not exhaustive and facts of each case need to be considered.
The Hon’ble Gujarat High Court in the case of CIT v. Saurashtra Cement & Chemical Industries Ltd. [1973] 91 ITR 170 made the following observation on setting up of business: –
It is necessary in order to determine this question to consider what constituted the business of the assessee. Loosely, it may be said that the business of the assessee was manufacture and sale of cement. But in determining questions arising under fiscal legislation, loose use of expression often tends to confound the real issue. To determine what the business of the assessee was, we must consider what are the activities which constituted such business without being misguided by loose expressions of vague and indefinite import. The activities which constituted the business of the assessee were divisible into three categories: the first category consisted of the activity of extraction of limestone by quarrying leased area of land. This activity was necessary for the purpose of acquiring raw material to be utilised in manufacture of cement. The second category comprised the activity of manufacture of cement by user of the plant and machinery set up for the purpose; and the third category consisted of the activity of selling manufactured cement. These three activities combined together constituted the business of the assessee. Each one of these activities was as much essential for the purpose of carrying on the business of the assessee as the others. If the assessee ceased to carry on any one of these activities, the business would come to an end. Each one of these activities constituted an integral part of the business of the assessee. Why then can it not be said that the assessee commenced its business when it started the first of these activities? The activity of quarrying the leased area of land and extracting limestone from it was as much an activity in the course of carrying on the business as the other two activities of manufacture of cement and sale of manufactured cement. The business could not in fact be carried on without this activity. This activity came first in point of time and laid the foundation for the second activity and the second activity, when completed, laid the foundation for the third activity. The business consisted of a continuous process of these three activities and when the first activity was started with a view to embarking upon the second and the third activities, it clearly amounted to commencement of the business.
It may be that the whole business was not set up when the activity of quarrying the leased area of land and extracting limestone was started. That would be set up only when the plant and machinery was installed, the manufacture of cement started and an organisation for sale of manufactured cement was established. But, as pointed out above, business is nothing more than a continuous course of activities and all the activities which go to make up the business need not be started simultaneously in order that the business may commence. The business would commence when the activity which, is first in point of time and which must necessarily precede the other activities is started. Take, for example, a case where an assessee engages in the business of a trader which consists of purchasing and selling goods. The assessee must necessarily purchase goods in order to be able to sell them and purchase of goods must, therefore, necessarily precede their sale. Can it be said in such a case that when the assessee purchases goods for the purpose of sale, he does not commence his business? Is it necessary that he must start the activity of selling goods before he can be said to have commenced his business?
Some of silent features emerged from various courts judgments about the date of setting up of business, which are as under:
Business may commence when activity which is first in point of time and which must necessarily precede other activities is started provided there is a proximate connection between activity which is first in point of time and subsequent activities which go to make up business.
When a business is established and is ready to commence business, t can be said that the business is set up.
There is distinction between setting up and commencement of business. When a business is established and is ready to commence business , it can be said that the business is set up. The Income is taxable from the date on which the business is set up, similarly all expenditure incurred for the purpose of the business and all allowances and deductions under the Income-tax Act are allowable from the date of the setting up of the business though the actual commencement of the business may be at the late point of time. Therefore, it is necessary to determine when the assesse has set up its business . There are various court decisions on this point which unfortunately do not lay down any specific and clear cut test to determine the date of setting up of the business. Now the author tries to find out when the business is set up on the basis of various court judgments.
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