Omniglobe Information Tech India ... vs Cit
2014 Latest Caselaw 3626 Del

$~55
*    IN THE HIGH COURT OF DELHI AT NEW DELHI

                                      Date of decision: 11th August, 2014

+                    INCOME TAX APPEAL 257/2012
      OMNIGLOBE INFORMATION TECH INDIA PVT LTD
                                               ..... Appellant
              Through    Mr. Ajay Vohra and Ms. Kavita Jha,
              Advocates.

                           versus

      CIT                                              ..... Respondent
                     Through        Mr. Sanjeev Sabharwal, Sr. Standing
                     Counsel.

      CORAM:
      HON'BLE MR. JUSTICE SANJIV KHANNA
      HON'BLE MR. JUSTICE V. KAMESWAR RAO

      SANJIV KHANNA, J. (ORAL)

This appeal by the assessee pertains to assessment year 2005-06

and was admitted for hearing vide order dated 19 th October, 2012, on the

following substantial question of law:-

"Did the Tribunal fall into error in holding that the assessee had setup its business w.e.f. 1.6.2004 and not w.e.f. 1.4.2004, as held in the impugned order."

2. The appellant-assessee was incorporated on 19th March, 2004, as

a subsidiary of one M/s Omniglobe International, USA, as a business

process service provider. The appellant-assessee had claimed deduction

under section 10B, of the Income Tax Act ("Act", for short), for a period

commencing from 1.4.2004 to 31.5.2004, contending that it had obtained

approval as a 100% Export Oriented Unit under STPI scheme and had

commenced operations from 1.4.2004. The Assessing Officer as well as

the Tribunal have held that the appellant assessee had commenced its

operations only from 1.6.2004, i.e. the date on which the appellant

assessee entered into "service agreement" with its parent company and,

therefore, the expenditure incurred between 1.4.2004 to 31.5.2004

should be capitalised. Tribunal, in its impugned order had also observed

that the appellant assessee had entered into a lease agreement and had

hired premises as its office, only on 15.6.2005. Commissioner of Income

Tax (Appeals), however, had decided the issue/question in favour of the

respondent assessee.

3. In order to determine and decide the controversy, we must

examine the nature of the business activity undertaken by the appellant-

assessee and the operation/activities between 1.4.2004 to 31.5.2004,

when the expenditure of Rs 59,02,448/- was incurred.

4. The appellant-assessee, as recorded above, was in the business of

voice activation and local number portability, i.e. Business Process

Outsourcing (BPO) services, which were made available to M/s

Omniglobe International, USA. The Activities fall in the category of

„service industry‟. The appellant-assessee had placed on record, before

the Commissioner of Income Tax (Appeals), a copy of the agreement

dated 30th March, 2004, between M/s Agilis Information Technologies

International Pvt. Ltd ("M/s Agilis", for short) and the appellant

company. Under the said agreement, the appellant assessee was entitled

to use to use the premises taken on lease by M/s Agilis, during 2000 hrs

to 0800 hrs. It stipulated that the appellant assessee was entitled to use

personal computers of M/s Agilis or install their new personal computers

in the premises, but upon termination of the agreement, personal

computers belonging to the assessee would be removed. The appellant-

assessee could use furniture and fixtures of M/s Agilis. However, the

appellant asseessee was to pay on pro rata basis, charges for water,

electricity, energy, or power consumed. Lastly, it was agreed that the

appellant-assessee would not use the internet facility of the provider, i.e.

M/s Agilis, but would install a separate internet link from an internet

service provider.

5. The break-up of the amount of Rs.59,02,448/-, which was

disallowed as revenue expenditure but capitalised, is as under:-

      "S.No. Expenses Head                                      Amount
      01.    Salary & Wages                                     2283936
      02     Employer Contribution to PF                          46658
      03     Employer Contribution to ESI                         46919
      04     Admin Charges PF/EDLI                                 4316
      05     ESLI Charges                                          1943


      08     House Keeping Expenses                               42493
      09     Generator Running Maintt.                            25121


       10 Employee Activities                                                           13200
      11 Uniform expenses                                                            324692
      12 Professional Charges                                                        935308
      13 Projector Hire Charges                                                         3000
      14 Electricity Charges / water / Sewerage Charges                                92070
      15 Recruitment charges                                                         447646
      16 Computer hire charges                                                       244355

      18 Filing charges                                                                 1000
      19 Computer maintenance                                                           2740
      20 Pantry Charges                                                              170485
      21 Printer Cartridge                                                             22800
      22 Office Maintenance                                                            23724
      23 Transportation charges                                                      628284
      24 Stationery                                                                    18375
      25 Lease Line Charges                                                          274331
      26 Telephone Expenses                                                            68182
      27. Printing Charges                                                              7350
      28. Travelling Expenses International                                             7732

---------------------------------------------------------------------------------

--------------------------- -------------

-------------

      Total Expenses
              expen        pertaining to April & May 04                          5902448/-
                                                                                                 "

This break-up was noticed in the assessment order itself and is not

disputed.

6. What is clearly noticeable is that the appellant-assessee had

incurred substantial expenses on wages and salary in addition to

recruitment and housekeeping expenses. Payments were also made

towards generator running maintenance, water, electricity, sewerage and

transportation charges and, importantly, the lease line charges, which

were in respect of the internet connection. The agreement between the

appellant-assessee and M/s Agilis was taken on record by the

Commissioner of Income Tax (Appeals) under Rule 46A of the Income

Tax Rules, 1962. The Tribunal has not given any adverse finding or

held that the said evidence should not have been admitted and taken on

record under the said Rules. Revenue had thereafter, filed an appeal

before the Tribunal and it was their duty to place the said agreement on

record in case they wanted to challenge the findings/observations of the

Commissioner of Income Tax (Appeals). It appears that the Revenue did

not file the said agreement and the Tribunal has recorded that they did

not have the benefit of reading the agreement. Thus, finding of the

Tribunal are without examining a vital and an important document. It is

obvious that between 1.4.2004 and 31.4.2004 the appellant assessee was

operating from some premises and therefore, they had incurred

expenditure, like electricity, water, computer hire, pantry charges, etc.

7. As per the case of the appellant-assessee, expenses incurred

during the months of April and May, 2004, were on account of training

given to the recruited employees. This is clear from the reply given by

the appellant assessee, dated 14.11.2007. The issue which arises is,

whether the business had been setup as on 1 st April, 2004 or was it setup

only on 1st June, 2004. There is a distinction between "setting up of

business" and "commencement of business". In Western Indian

Vegetable Products Ltd. Vs. Commissioner of Income Tax (Bom.),

[1954] 26 ITR 151, this distinction was highlighted and elucidated in the

following words:-

"................That is why it is important to consider

whether the expression used in the Indian statute for setting up a business is different from the expression Mr. Justice Rowlatt was considering, viz., "commencing of the business." It seems to us, that the expression "setting up" means, as is defined in the Oxford English Dictionary, "to place on foot" or "to establish", and in contradistinction to "commence". The distinction is this that 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 Section 10(2). Now, applying that test to the facts here, the company actually commenced business only on the 1st of November, 1946, when it purchased a ground-nut oil mill and was in a position to crush ground-nuts and produce oil. But prior to this there was a period when the business could be said to have been set up and the company was ready to commence business, and in the view of the Tribunal one of the main factors was the purchase of raw materials from which an inference could be drawn that the company had set up its business; but that is not the only factor that the Tribunal has taken into consideration. The Tribunal has, as pointed out in the statement of the case, scrutinised the various details of the expenses given in the order of the Appellate Assistant Commissioner and having scrutinised those expenses the Tribunal has come to the conclusion even on an interpretation more favourable to the assessee than the one we are giving to the expression "setting up" that these expenses do not show that the business was set up prior to the 1st of September, 1946. In our opinion, it would be difficult to say that the decision of the Tribunal is based upon a total absence of any evidence. As we have often said, we are not concerned with the sufficiency of evidence on a reference. It is only if there is no evidence which would justify the decision of the Tribunal that a question of law would arise which would invoke our advisory jurisdiction which after all is a very limited jurisdiction."

The said case, related to an assessee, who was engaged in the

business of manufacturing of edible oils and was in the process of setting

up of a groundnut oil mill. In that case, the moment the ground nuts, a

raw material, was purchased, it was held that business had been setup

and accordingly the expenditure incurred should be allowed as a revenue

expenditure.

8. It would be appropriate in this regard to refer to the proviso to

Section 3 of the Act, which refers to and defines the term, "previous

year" in relation to newly setup business or profession and not with

reference to the date of commencement. Section 28 of the Act

postulates that profit and gains of business or profession carried out at

any time during the previous year, shall be taxed under the head "profits

and gains of business or profession".

9. Delhi High Court in Commissioner of Income Tax Vs. Samsung

India Electronics Ltd. (ITA 131/2010) decided on July 9, 2013, had held

as under:-

"7. The aforesaid distinction is relevant when we examine and refers to the definition of „previous year‟. Following the said judgment, in the case of CIT v. L.G. Electronic (India) Ltd. [2006] 282 ITR 545 (Delhi), it has been observed that the date of setting up of business and date of commencement of business may be two separate dates. This decision in the case of L.G. Electronics (supra) has been followed in CIT v. ESPN Software India P. Ltd., [2008] 301 ITR 368 (Delhi) wherein it has been held that a

business will "commence" with the first purchase of stock- in-trade and the date on which the first sale is made is immaterial. Similarly, for manufacturing, several activities in order to bring or produce finished products have to be undertaken, but business commences when the first of such activities is taken."

10. In Commissioner of Income Tax: Delhi-I Vs. Arcane Developers

Pvt. Ltd (ITA 41/2013), decided on October 8, 2013, it was observed:-

"7.........Setting up of business takes place when the business is ready and first steps are taken. In case of real estate business, the said setting up of business was complete when first steps were taken by the respondent-assessee to look around and negotiate with parties. There can be a gap between setting up and when first steps were taken by the respondent and finalisation of the first written agreement. Business activities of the respondent did not require construction of a factory, machinery etc. Negotiations are required to enter into a written understanding and it is obvious that the loan was taken for business and to proceed further and conclude the deal. The aforesaid facts have been examined and highlighted by the first appellate authority. The said findings of fact have been affirmed by the tribunal. A pragmatic and a practical view has to be taken."

11. In Century SPG and Mfg. Co.Ltd Vs. Commissioner of Wealth

Tax [1978]112 ITR 497(Bom), it has been observed:-

"This interpretation put by this court upon the expression "set up" has been followed by the Madras High Court in the case of Ramaraju Surgical Cotton Mills Ltd. v. Commissioner of Wealth-tax [1962] 46 ITR 820.This is a case under the Wealth-tax Act and the expression " set up " came to be interpreted in the context of section 5(1)(xxi) as exemption was claimed as a new and separate unit set up after the commencement of the Act. The Madras High

Court at page 824 observes :

"Unless a factory is erected and the plant and machinery installed therein, it cannot be said to have been set up. The resolutions of the board of directors, the orders placed for purchasing the machinery, the licence obtained from the Government for constructing the factory, are merely initial stages toward, setting up, however necessary and essential they may be to further the achievement of the end. It is not, however, the actual functioning of the factory or its going into production that can alone be called setting up of the factory. The setting up is perhaps a stage anterior to the commencement of the factory."

12. This brings us to the moot question: whether the business of the

BPO (Business Process Outsourcing) had been setup by the respondent-

assessee on 1st April, 2004 or was it setup only on 1st June, 2004? We have

already quoted factual position elucidated in the assessment order to the

effect that the appellant had employed several employees and salary and

wages were paid to them. However, these employees were given training

in the months of April and May, 2004 and expenditure was incurred on

various heads, During the months of April and May, 2004, the actual BPO

services to the parent company were not rendered. When the said services

actually were rendered or the assessee did start rendering of services to a

third party, the business commenced. This, according to us, does not mean

that business had not been setup by the appellant assessee. In order to

determine whether business had been setup or not, we have to look at the

factual matrix of the case, especially, the nature and character of the

business activity with the activities actually undertaken. The appellant-

assessee had entered into an agreement with their sister concern, M/s

Agilis, to use their premises between 2000 hours to 0800 hours between

1.4.2004 and 30.6.2004. M/s Agilis was paid on pro rata basis for water,

electricity, energy and power consumption charges. Further, the

appellant assessee had to install a separate internet link from the Internet

Service Provider. The appellant-assessee had a choice to use the

personal computers of M/s Agilis or install their own. Break-up of the

expenditure of Rs.59,02,448/-, incurred during this period included

expenses for lease line charges of Rs.2,74,331/-, telephone expenses of

Rs.68,182/-, computer hire charges of Rs.2,44,355/- and some small

amounts towards computer maintenance. In addition, the appellant-

assessee had paid a substantial amount of Rs.22,83,936/- as salary and

wages to its employees. Keeping in view the nature of business activity

of the appellant-assessee, we do not think that it can be held that

training, imparting skills to employees recruited, or, testing their

performance can be treated as a pre-setup expenditure. The appellant

assessee had either employed or taken help of trainers/seniors for the

said purpose. The moment employees were recruited and enrolled, and

infrastructure to use their service was in place, setup was complete. It was

indicative of the fact that business operations had been setup. In the BPO

industry, training of employees is an important, essential and integral

element of the business activities and when the assessee has the

infrastructure in place, the business can be treated as set-up. As a service

industry, the first step is to recruit right kind of employees, then to interact,

train or check their performance. Unlike the manufacturing activity, where

requisite plant and machinery has to be procured, installed and then

business operations start, in the BPO industry, the process starts with the

recruitment of employees, who are to work in the said industry. Training

or introduction after recruitment would be akin to the trial production or the

first step in production undertaken by a manufacturer of goods. Of course

it has to be seen, whether the infrastructure to utilize their services was in

place or not. One may postpone actual rendering of services to be a zero

error company. In CIT Vs. E-Funds International India, (2007) 162

Taxman 1 (Del), the assessee was engaged in the business of information

technology like software development/consultany, business process

management and electronic banking schemes. The claim of the assessee

therein was that business of software development was setup the moment

they had employed 30-40 employees in the relevant previous year. This

claim was accepted by the High Court after noticing that the assessee had

certain infrastructure facilities at the relevant time.

13. In CIT Vs. Hughes Escorts Communications Ltd., (2009) 311 ITR

253 (Delhi), the assessee was in the business of setting up of satellite

communication systems. It was held that the first step required

was the purchase of VSAT equipment. The said purchase order was

placed on 28th July, 1994, and thereafter the assessee had obtained

license from the Department of Telecommunications, and, started

receiving satellite signals. It was held that the moment the assessee

purchased VSAT equipment, it could be said that the business had been

setup. This, it was held, was the relevant date for determining the nature

and character of expenses incurred and whether they were revenue or

capital in nature.

14. Similarly, in CIT Vs. Whirlpool of India Ltd. (2009) 318 ITR 347

(Del), the assessee was engaged in the business of providing financial

services and the same question i.e. whether the business had been setup

or not, came for consideration. It was observed that this question could

only be answered by looking at, and was dependent on, the facts of each

case. Different considerations would apply and the answer would depend

on whether the business was for manufacture of a product or for

providing services. Even in the case of services, it would depend upon

the nature of service to be rendered. In case of a financial company

authorised to advance loans for interest to facilitate customers to

purchase consumer durables, the business was setup when directors were

appointed; staff, such as regional and branch managers were appointed;

and their salaries were paid. In other words, it can be said that at that

time, the company was ready to commence business. There need not be

an actual commencement of business as such.

15. It would be appropriate, in this regard, to reproduce findings

recorded by the CIT (Appeals), who had called for the remand report

from the Assessing Officer in view of the contentions raised:-

"I have considered the comments of the AO given by him in the remand report and the rejoinder filed by the appellant on the same. During the course of remand proceedings, it is seen that appellant has submitted a note on the training imparted to the employees during the month of April and May, 2004 in the premises taken from M/s Agilis Information Technologies International Private Limited. The appellant also filed copies of the ledger accounts of pantry expenses, professional expenses, recruitment expenses, computer hire charges, transportation charges, lease line charges. Copies of the audited balance sheet of M/s Agilis Information Technologies International Private Limited and addresses of the employees who are still working with the appellant company to whom the salaries were paid in the months of April and May, 2004. The appellant has also filed the name and address of the parties to whom the expenses of pantry, professional charges, recruitment expenses, computer hire charges were paid and TDS deducted. The appellant has also filed copy of the ESI/PF paid for the month of April and May, 2004. All these comments prove that the appellant had started its business during this period and the employees and staffs were being trained to handle the business of call centre which cannot be done by a novice. The BPO business requires trained and skillful persons who cannot commence full scale on live tele-calling with the end clients till the time employees get proper training and adequate skills sets have been developed by the staffs and employees. Further, the employees have to go through the process of making and operating in a developing environment before final call etc can be made and end client can be handled. All these skills are possible only if proper training to

the staff is imparted. The fact that salaries, transportation charges, traveling expenses etc. were incurred during these two months is itself the evidence that company has started its business."

16. Before the first appellate authority, the appellant-assessee had

filed full particulars with explanation along with details of the each

employee. Bio-data of 17 employees have been enclosed. They had

also enclosed details of the recruitment agencies engaged for recruitment

of employees along with the copy of the ledger account of recruitment

charges. Details of pantry expenses and other professional expenses

including the name of the parties to whom the said expenses were paid

were filed. Details of the party to whom computer hire charges and

transportation charges were paid during the months of April and May,

2004 were also furnished. Copy of the ledger account along with tax

deducted at source was made available. CIT (Appeals) held that,

keeping in view the nature of business, the training itself was an integral

part of the business activity and the moment training commenced on the

infrastructure that was made available by M/s Agilis, the business was

setup. The agreement between the appellant-assessee and M/s Agilis

was a genuine agreement, which was clear from the nature of expenses

incurred, which included pantry expenses, computer hire charges,

transportation charges, etc.

17. The Tribunal after referring to Whirlpool of India Ltd. (supra)

allowed the appeal of the Revenue observing:-

"4.7 When we look to the facts of our case, it is clear that although the staff had been recruited, it was not ready for rendering services as the staff had to be trained with the systems. The assessee had not taken premises on rent and, therefore, installation of computer therein had not been done. Therefore, the assessee was not in a position to solicit custom till the end of May, 2004. The advances were received from the parent company but these were used for training the personnel and paying salaries and incidental charges, necessary for setting up the business. Thus, in a nutshell, it is held that a business is set up when it reaches a stage where it is in a position to procure business and not before. However, the expenditure becomes deductible from such stage irrespective of the date of actual receipt of the business. Therefore, it is held that the business had not been set up till the end of May, 2004. Accordingly, the assessee is not entitled to deduction of these expenses. It is held accordingly."

18. In view of the aforesaid discussion, we do not think that the

reasoning given by the Tribunal and the Assessing Officer shows that

the business of the appellant-assessee had not been setup. The business

of the appellant had been setup as the appellant-assessee had acquired

the necessary infrastructure from their sister concern, M/s Agilis, and

had also started making payment of salary and wages. This training was

given by professional experts under the supervision and control of the

appellant-assessee. The moment the said operations were commenced,

the business had been setup and the subsequent rendering of service to

third parties would be at a later date when the actual services were

rendered to the parent/holding company. In CIT Vs. Saurashtra

Cement and Chemical Industries Limited, (1973) 91 ITR 170 (Guj.),

the assessee had obtained mining lease for quarrying limestone and had

started mining operation, but installation of the plant and machinery for

manufacture and sale of cement was directed to be capitalised. Looking

into the business of the assessee, the High Court approved the approach

of the Tribunal that the business activities could be classified into three

stages i.e procurement of raw material; manufacture of cement; and, sale

of manufactured cement. Extraction of limestone was in the nature of

acquiring raw material, to be utilised for the manufacture of cement and

was the foundation for the second activity, i.e manufacture of cement.

Thus, depreciation allowance and development rebate was allowed for

machinery employed for extraction of limestone. The test laid down was

that the business would commence when the activity, which is first in

point of time, must necessarily precede other activities is started; as

business connotes continuous course of activity and all activities which

go up to make the business, need not be started simultaneously.

19. Similar view was again taken in Prem Conductors Private

Limited Vs. CIT, (1997) 108 ITR 654 (Guj.) wherein it has been

elucidated that one business activity might precede another and what

was required to be seen was whether one of the essential activities for

carrying on the business as a whole had or had not commenced. When

the assessee had commenced business of securing orders first and then

production, then activity of securing business actively commenced when

the said steps were taken and it did not get postponed to the date of

actual production. Referring to these decisions and other decisions,

Andhra Pradesh High Court in Commissioner of Income Tax Vs.

Sponge Iron India Limited, (1993) 201 ITR 770 observed that whether

business had commenced or not was a question of fact, but what

activities constitute commencement of business was a mixed question of

law and fact. Secondly, there was a distinction drawn between "setting

up of business" and "commencement of the business". Business is said

to be „set up‟ when it is ready to commence. Thirdly, when business

consists of continuous course of activity, all activities which go to make

up the business need not be started simultaneously. As soon as the

activity which is essential in the course of carrying on business is

started, business is said to be set up, if not commenced.

20. Upon recruitment of employees, the factum that expenditure under

the different heads, as noticed above, was incurred is indicative that

business was set up. Training to the employees was given to ensure that

when the work was undertaken and performed, there were no glitches,

trouble or problems. It is not indicative of the fact that necessary

infrastructure was not there and actual business could not have

commenced or was not set up. Training was post set up as the

employees were recruited. In case of service industry, training and up

gradation of skills of employees is a part and parcel of the business

activity, a continuous process. The business as a service provider,

cannot exist without the said activity being undertaken both at the very

initial stage and after business has commenced. Training is done to

ensure proper performance and to provide services of acceptable quality

or ensure zero or minimal errors. It is to ensure proper standards and

optimum utilisation of human resources already employed. It helps in

improving productivity, maintaining team work and strengthening bonds

inter-se. In the present case, substantial and large numbers of employees

after recruitment were kept on payroll, the appellant-assessee paid for

their Provident Fund, Employees Insurance Charges; maintenance

charges; distributed uniforms, and, pantry charges were incurred. The

details and quantum itself is indicative that the business was set up, as

training itself was integral to the setting up of business line of the

appellant-assessee. The said training continued even when the business

was in operation. It was part and parcel of the business activities as a

service provider.

21. In view of the facts of the present case, the question of law has to

be answered in favour of the appellant-assessee and against the

respondent-Revenue. No costs.

SANJIV KHANNA, J.

V. KAMESWAR RAO, J.

AUGUST 11, 2014/NA