This is an appeal by assessee against the order of the Commissioner of Income Tax (Appeals)-5, Hyderabad, dated 31-05-2016 for the AY. 2006-07 on the issue of reopening of assessment and consequent disallowance of loss claimed during the year.
2. Briefly stated, assessee-company is engaged in the business of research and analytical testing in connection with pharmacopeial and other related process and testing highly characterized specimens of drug substances and dietary supplements and their ingredients etc. The assessee is a 100% subsidiary of USP holding LLC, USA and performs services entirely for the holding company. Assessee was incorporated on 27th May, 2005 and has entered into a master service agreement with the holding company on 01/06/2005. It inaugurated its facility at ICICI Knowledge Park on 8th February, 2006 and claimed that the laboratory was fully functional by 8th February, 2006. For the year ending 31/03/2006, assessee filed its return of income declaring a loss of Rs. 2,04,42,891/-. The AO originally completed the assessment u/s 143(3) of the Act on November 25, 2011 allowing such loss subject to few disallowances. Later, assessment was reopened on the reason that the annual report of the company mentioned that business activity of the company commenced on 1st April, 2006 and hence, there is no business activity during the FY 2005-06. Due to this, AO was of the view that loss of Rs. 1,98,46,456/- has to be treated as preoperative expenses and the entire expenses has to be disallowed. In response to the reasons recorded for initiation of reassessment proceedings, assessee filed its objections stating that there is no fresh material available on record to form an opinion that the income has escaped assessment. It was submitted that all the information was already submitted at the time of original assessment proceedings. However, AO rejected the objections by a speaking order dated 12/06/2011 and completed reassessment u/s 143(3) r.w.s. 147 of the Act on August 29, 2011, disallowing the entire expenditure claimed by the company as preoperative expenditure.
3. Assessee contended before the CIT(A) that the reopening is bad in law and it is based on mere change of opinion and relied on various case law. With reference to the merits of the case, it was submitted that assessee is in testing services and fully functional laboratory was inaugurated on 8th February, 2006 and majority of the equipment was installed and due to late arrival of material for testing, tests started on 1st April, 2006, which is the date of starting of commercial operations, but, assessee’s business has commenced during the year under consideration. It also made alternation contention that the commencement of the business has to be taken into consideration from the date of entry into agreement with the foreign company i.e. 01/06/2005 or from the date of starting laboratory i.e. on 8th February, 2006.
4. CIT(A) did not agree with the contentions of the assessee and rejected the grounds raised by the assessee and upheld the action of the AO. Ld. CIT(A) also did not agree that the amount disallowed should be capitalized to the assets and depreciation should have been allowed on the assets put to use by the assessee company on the reason that it is premature to give such direction when assets are not yet used.
5. Assessee is aggrieved and raised the following substantive grounds of appeal:
“1. The order of the Learned Commissioner of Income-tax (Appeals)-5 ['CIT(A)'], dated 31 May 2016 in upholding the disallowances made by the Deputy Commissioner of Income Tax, Circle 3(3), Hyderabad ('AO') is contrary to law and facts of the case.
2. The Ld. CIT (A) erred in conf irming the action of the Ld. AO for reopening the assessment without appreciating the facts of the case.
3. Without prejudice to the above ground, the Ld. CIT (A), in the facts and circumstances of the case, erred in upholding the order of the Ld. AO in disallowing the entire expenditure claimed by the Appellant.
4. Without prejudice to the above grounds, the Ld. CIT(A), in the facts and circumstances of the case, erred in dismissing the alternative plea of the Appellant to allow the expenditure incurred from 8 February 2006 to 31 March 2006.
5. Without prejudice to all the above grounds, the Ld. CIT(A) erred in not determining the capitalization of the expenditure to the cost of the assets for allowing depreciation under section 32 of the Act.
The Appellant craves leave to add, alter, amend or withdraw all or any of the above grounds of appeal at or before the time of hearing of the appeal.”
6. Ld. Counsel for the assessee referring to the original assessment order submitted that assessee’s business has commenced during the year and the AO has examined all the issues and allowed loss as claimed. He referred to the assessment order where AO has disallowed certain expenditure like payment for share capital, penalty u/s 201(1A) to submit that AO has examined all the issues and then only he has completed the assessment, therefore, there is no ‘tangible material’ to reopen the assessment subsequently by the AO and facts do not come with in the purview of ‘tangible information’ as held by the Hon’ble Supreme Court in the case of CIT Vs. Kelvinator of India Ltd., [2010] 187 Taxman 312.
6.1 With reference to the merits, ld. Counsel referred to various explanations given to the AO in the course of proceedings to submit that assessee’s laboratory was fully functional and due to non-availability of certain raw material, the commercial operations considered were fully operational from 1st April, 2006, but, it does not mean that assessee was not ready before that date. He has submitted that in case of Omniglobe OBE Information Tech India P. Ltd. Vs. CIT, [2014] 369 IT 0001 (Delhi), the Hon’ble Delhi High Court has considered setting up of business and commencement of business and held that upon recruitment of employees and expenditure under different heads was incurred is indicative that business was set up. It was concluded that business as service provider, cannot exist without said activity being undertaken both at very initial stage and after business has commenced.
6.2 Ld. Counsel also relied on the decision of Hon’ble Delhi High Court in the case of CIT Vs. ESPN Software India (P.) Ltd., [2009] 184 Taxman 452 (Delhi) for a similar proposition that assessee has commenced its business when it acquired licence, therefore, there is no infirmity with regard to the findings of the authorities below.
6.3 Ld. Counsel also relied on the decision of Prem Conductors Pvt. Ltd. Vs. CIT, [1977] 108 ITR 654 (Guj.) for the proposition that when a business is established and is ready to start business, it can be said to be set up. 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 all the other activities is started.
6.4 Ld. Counsel also relied on the decision of Hon’ble Madras High Court in the case of CIT Vs. Club Resorts (P) Ltd., [2006] 287 ITR 552 to submit that for the purpose of development of the projects of construction, the assessee has to necessarily maintain regular staff members and incur expenditure on the same. Therefore, the said expenditure is revenue in nature and allowable as deduction as it was held that there was commencement of business. First stage of development of time share unit involves setting up operating offices for soliciting customers.
6.5 In a nutshell, it was submitted that original assessment was completed by the AO after due examination and has correctly allowed loss as claimed, as business was set up during the year and any other view would be within the purview of ‘change of opinion’, which does not permit reopening of assessment.
6.6 Thus, both on merits as well as on law, ld. Counsel submitted that action of the authorities below is not proper/valid.
7. Ld. DR, on the other hand, submitted that the AO has not formed any opinion, therefore, the principles laid down by the Hon’ble Supreme Court in the case of Kelvinator of India Ltd. (supra) does not apply. He referred to the detailed order of CIT(A) to submit that reopening of assessment is justified and he also referred to nature of expenditure claimed by the assessee, as discussed by the CIT(A), and that assessee has not commenced the business during the current assessment year, but, has commenced on 1st April, 2006 pertaining to the next assessment year.
7.1 In reply, ld. Counsel however submitted that staff for technical lab was also employed and salary expenditure was claimed. In addition, there are orders placed for obtaining raw material while miscellaneous raw material was already purchased and put to use. All activities are activated much before February 8, 2006, but, assessee has only stated commercial operation on 1st April, 2006 as fullfledged business activity.
8. I have considered rival contentions and perused the documents on record. The assessment in this case has been completed u/s 143(3) and as seen from the order of the AO, he has examined various expenditure claims and disallowed two of the items, which would not have come to the knowledge but for the verification of the expenditure claims. Not only that, annual report and other documents placed on record indicate that assessee has correctly claimed the revenue expenditure. The issue of commencement of business is necessary to examine for allowing expenditure. It is the first year of business commencement and the AO will certainly examine the commencement of business before allowing loss or profit of the year. Therefore, it cannot be said that AO has not applied his mind when he allowed the loss as claimed with certain disallowances.
8.1 The Hon’ble Supreme Court in the case of Kelvinator of India Ltd. (supra) has held as under:
“Prior to Direct Tax Laws (Amendment) Act, 1987, reopening could be done under two conditions and fulfillment of the said conditions alone conferred jurisdiction on the AO to make a back assessment, but in s. 147 (w.e.f. 1st April, 1989), they are given a go by and only one condition has remained, viz., that where the AO has reason to believe that income has escaped assessment, confers jurisdiction to reopen the assessment. Therefore, post 1st April, 1989, power to reopen is much wider. However, one needs to give a schematic interpretation to the words "reason to believe" failing which, s. 147 would give arbitrary powers to the AO to reopen assessments on the basis of "mere change of opinion", which cannot be per se reason to reopen. The conceptual difference between power to review and power to reassess should also to be kept in mind. The AO has no power to review; he has the power to reassess. But reassessment has to be based on fulfillment of certain pre-condition and if the concept of "change of opinion" is removed, as contended on behalf of the Department, then, in the garb of reopening the assessment, review would take place. One must treat the concept of "change of opinion" as an in-built test to check abuse of power by the AO. Hence, after 1st April, 1989, AO has power to reopen, provided there is "tangible material" to come to the conclusion that there is escapement of income from assessment. Reasons must have a live link with the formation of the belief. Under the Direct Tax Laws (Amendment) Act, 1987, Parliament not only deleted the words "reason to believe" but also inserted the word "opinion" in s. 147. However, on receipt of re-presentations from the companies against omission of the words "reason to believe", Parliament re-introduced the said expression and deleted the word "opinion" on the ground that it would vest arbitrary powers in the AO. Appeals are therefore dismissed-CIT vs. Kalvinator of India Ltd. (2002) 174 CTR (Del)(FB) 617 and CIT vs. Eicher Ltd. (2007) 213 CTR (Del) 57 affirmed.”
8.2 The Hon’ble Delhi High Court (Full Bench) in the same case reported at [2002] 256 ITR 0001 has examined the contention of the revenue that AO has not expressed any opinion and issue that he has not expressly stated the opinion. The findings of the Hon’ble Delhi High Court in paras 22 & 23 are as under:
“22. We are unable to agree with the submission of Mr. Jolly to the effect that the impugned order of reassessment cannot be faulted as the same was based on information derived from the tax audit report. The tax audit report had already been submitted by the assessee. It is one thing to say that the AO had received information from an audit report which was not before the ITO but it is another thing to say that such information can be derived by the material which had been supplied by the assessee himself .
23. We also cannot accept submission of Mr. Jolly to the effect that only because in the assessment order, detailed reasons have not been recorded on analysis of the materials on the record by itself may justify the AO to initiate a proceeding under s. 147 of the Act. The said submission is fallacious. An order of assessment can be passed either in terms of sub-so (1) of s. 143 or sub-so (3) of s. 143. When a regular order of assessment is passed in terms of the said sub-so (3) of S. 143 a presumption can be raised that such an order has been passed on application of mind. It is well known that a presumption can also be raised to the effect that in terms of d. (e) of S. 114 of the Indian Evidence Act the judicial and off icial acts have been regularly performed. If it be held that an order which has been passed purportedly without application of mind would itself confer jurisdiction upon the AO to reopen the proceeding without anything further, the same would amount to giving premium to an authority exercising quasi judicial function to take benef it of its own wrong.”
8.3 In conclusion, the Hon’ble Delhi High Court has held that an assessment cannot be reopened on a mere change of opinion; reason to believe that the income chargeable to tax has escaped assessment is one of the conditions precedent for invoking the jurisdiction of the AO for reopening assessment u/s 147. Considering the principles laid down by the Hon’ble Surpeme Court, it cannot be stated that AO has not examined this issue, which is very obvious not only from the annual report but also from various expenditure claims made during the year. Thus, I am of the opinion that there is no ‘tangible material’ to come to a different opinion or to take a different opinion. The very basis of earlier opinion being reviewed by the AO in the reassessment proceedings will certainly come into the domain of the ‘review of the order’ by the successive officer. Review of the order cannot be done in the form of reopening of assessment without there being any tangible material to form a different opinion, when the assessment is reopened within the four years from the end of the assessment year. In this case, since the assessment being reopened is within the four years from the end of the assessment year, the principles laid down by the Hon’ble Supreme Court that there should be ‘tangible material’ to form a different opinion would certainly come into play, since the very same material, which was examined at the time of original assessment, is the basis for recording reasons by the AO before the reopening of assessment. I am of the view that the conditions of section 147 have not been satisfied in this case. Accordingly, reopening per se is bad in law.
8.4 Even coming to the merits, it cannot be stated that assessee has not commenced business during the impugned AY. This is a fact on record that assessee commenced its lab facility, which is its main activity on 8th February, 2006 i.e. almost 50 days prior to the close of the accounting year. Not only there is an evidence that employees have been recruited and paid salaries to them, but also orders for procurement of raw material have been placed and some of the raw material purchased and utilized during the year and Assessee’s claim of depreciation was allowed by the AO in the original assessment. In view of that facts, as placed on record and following the principles of law as established in various decisions some of which relied on by the ld. Counsel in his arguments, I am of the view that assessee has commenced its business activity during the year under consideration and on merits, assets have been put to use.
8.5 In view of the facts and law involved, I am of the opinion that reopening of assessment is bad in law and accordingly, impugned orders of AO and CIT(A) are set aside and the original assessment is restored. Thus, ground Nos. 2 & 3 are allowed and ground Nos. 4 & 5 are alternative in nature, needs no adjudication seperately.
9. In the result, appeal of the assessee is allowed.
The order pronounced in the open court on 5th May, 2017.