Business expenditure – Year in which expenditure is deductible – Business – Difference between setting up and commencement of business – Incorporation as company, opening of bank account, training of employees and lease agreement in accounting year relevant to A.Y. 2012-13 – Licence for business obtained in February, 2012 – Assessee entitled to deduction of expenditure incurred for business in A.Y. 2012-13

Business expenditure – Year in which expenditure is deductible – Business – Difference between setting up and commencement of business – Incorporation as company, opening of bank account, training of employees and lease agreement in accounting year relevant to A.Y. 2012-13 – Licence for business obtained in February, 2012 – Assessee entitled to deduction of expenditure incurred for business in A.Y. 2012-13

The assessee was incorporated on 24th November, 2010. The first meeting of its board of directors was held on 29th November, 2010 when certain decisions were taken, including, according to the assessee, setting up of its business; appointment of the chief executive officer and the principal officer; approval of the draft application for obtaining a broker’s licence in the prescribed form under Regulation 6 of the IRDA (Insurance Brokers) Regulations, 2002 (in short ‘2002 Regulations’) [this application had to be filed for obtaining the licence]; a decision as to the registered office of the assessee; and a decision concerning the opening of a current account with HDFC Bank at Surya Kiran Building, 19, K.G. Marg, New Delhi 110001.

On 29th November, 2010 itself, an agreement was executed between the assessee and Maruti Suzuki India Limited (MSIL). Via this agreement, the persons who were employees of MSIL were sent on deputation to the assessee and to meet its objective, were made to undergo a minimum of 100 hours of mandatory training as insurance brokers. These steps were a precursor to the application preferred by the assessee with the Insurance Regulatory and Development Authority (IRDA) for issuance of a direct-broker licence. The application was lodged with the IRDA on 1st December, 2010. While this application was being processed, presumably by the IRDA, the assessee took certain other steps in furtherance of its business. Accordingly, on 1st June, 2011, the assessee executed operating lease agreements for conducting insurance business from various locations across the country. Against these leases, the assessee is said to have paid rent as well. The assessee set up 29 offices in 29 different locations across the country for carrying on its insurance business. The assessee was finally issued a direct broker’s licence by the IRDA on 2nd February, 2012.

For the A.Y. 2011-12, the assessee filed return of income on 30th September, 2011 declaring a business loss amounting to Rs. 57,582. For the A.Y. 2012-13, the return of income was filed on 29th September, 2012 declaring a net loss of Rs. 2,78,22,376. In this return, the assessee claimed the impugned deduction, i. e., business expenses amounting to Rs. 2,77,99,046. The A.O. held that since the licence was issued by the IRDA on 2nd February, 2012, the assessee’s business could not have been set up prior to that date, and therefore the entire business expenditure amounting to Rs. 2,78,22,376 was required to be disallowed and capitalised as pre-operative expenses.

The Commissioner (Appeals) upheld the order of the A.O. The Tribunal sustained the view taken by both the Commissioner of Income-tax (Appeals) as well as the A.O.

The Delhi High Court allowed the appeal filed by the assessee and held as under:

‘i) The Income-tax Act, 1961 does not define the expression “setting up of business”. This expression finds mention though (sic) in section 3 of the Income-tax Act, 1961 which defines “previous year”. The previous year gets tied in with section 4 of the Act, which is the charging section. In brief, section 4, inter alia, provides that income arising in the previous year is chargeable to tax in the relevant assessment year. Firstly, there is a difference between setting up and commencement of business. Secondly, when the expression “setting up of business” is used, it merely means that the assessee is ready to commence business and not that it has actually commenced its business. Therefore, when the commencement of business is spoken of in contradiction to the expression “setting up of business”, it only refers to a point in time when the assessee actually conducts its business, a stage which it necessarily reaches after the business is put into a state of readiness. A business does not, metaphorically speaking, conform to the “cold start” doctrine. There is, in most cases, a hiatus between the time a person or entity is ready to do business and when business is conducted. During this period, expenses are incurred towards keeping the business primed up. These expenses cannot be capitalised.

ii) The assessee did all that was necessary to set up the insurance broking business. The assessee after its incorporation opened a bank account, entered into an agreement for deputing employees (who were to further its insurance business), gave necessary training to the employees, executed operating lease agreements, and resultantly set up offices at 29 different locations across the country. Besides this, the application for obtaining a licence from the IRDA was also filed on 1st December, 2010. The Authority took more than a year in dealing with the assessee’s application for issuance of a licence. The licence was issued only on 2nd February, 2012 although the assessee was all primed up, i. e., ready to commence its business since 1st June, 2011, if not earlier. The assessee was entitled to deduction of the expenses incurred for the business in the A.Y. 2012-13.’