Rajendra, Accountant Member.
1. Challenging the orders, dated 28-03-2014, of the CIT(A)-2, Mumbai the Assessee has filed the present appeal. Assessee-company is in the business of setting up of new hotels, investment in hotel project and derives income comprising of interest income on debentures and gain on redemption of short term mutual fund investment. It filed its return of income on 2-9-2009 declaring total income of Rs. 3,17,333/-.The Assessing Officer (AO) completed the assessment under section 143(3), vide order dated 19/12/2011, determining the income of the assessee at Rs. 30.63 lakhs. As both the grounds of appeal are interlinked, so, first we would like to narrate the facts leading to file the appeal before us.
2. First Ground of appeal is about disallowance of expenditure amounting to Rs. 27.46 lakhs. During the assessment proceedings, the AO found that the assessee had earned interest income on debentures and had earned profit on sale of mutual fund units aggregating to Rs. 31.36 lakhs. He held that income earned by the assessee on account of interest and from sale of units of mutual fund was to be assessed under the head other sources. He further found that it had claimed expenditure of Rs. 27.46 lakhs against the said income. The AO was of the opinion that all the items of expenditure were of capital nature and included preliminary expenditure. Therefore, he held that deduction was not allowable against the income assessable under the head 'other sources'.
3. Aggrieved by the order of the AO, assessee preferred an appeal before the First Appellate Authority (FAA). It also relied upon certain case laws and stated that there was a distinction between setting up of business and commencement of business. After considering the order of the AO and submission of the assessee, he held that the assessee had not commenced its business activities, that the expenditure incurred by it indicated that they were pre-operative and preliminary in nature, that the expenses had been incurred prior to commencement of business, that expenditure could not be treated as revenue expenditure, that same could not be set off against income earned under the head other sources, that the assessee had made alternate contention before the AO that certain preliminary expenses such as expenditure pertaining to ROC fee was allowable under section 35D of the Act. He held that as per the Act deduction of such expenditure @ 1/1Oth of such expenditure was allowable for over a period of 10 years, that the first year of such deduction would be the year in which business undertaking would commence its operations, that the assessee had not commenced its business during the year under appeal, that claim made by it had to be deferred to a later year, that similarly the expenditure incurred under the head professional fee would also be allowed in the year of commencement of operations. With regard to other expenses like miscellaneous expenses, he held that same were not attributable to earning of income under section 56 of the Act, that the expenditure incurred by the assessee were in the nature of preoperative expenditure and not allowable. He, finally, upheld the disallowance made by the AO.
4. During the course of hearing before us, the Authorised Representative(AR) argued that the assessee was in the business of hotels, that it was incorporated in the month of June 2006, that it was a subsidiary of company located in Cyprus, that the Foreign Investment Promotion Board (FIPB) had approved the proposal submitted by it about making investment in hotel business, that the approval was received in April, 2008, that after the approval the assessee made investment and started its business activities, that expenditure incurred by it was necessary for running its business, that all the expenses were of revenue nature that even income was considered arising out of other sources, that the principles of netting had to be applied. He referred to para 4.15 of the statement of facts and stated that assessee had made an alternate claim before the FAA. He referred to the case of Multi Act Reality Enterprises (P.) Ltd. [IT Appeal No. 7274/Mum/2011, AY 2008-09, dated 28-08-2015] Preimus Investment & Finance Ltd v. Dy. CIT  63 taxmann.com 23 (Mum.-Trib).
The DR stated that business had not started, the expenses incurred by assessee were of capital nature, that the object of the assessee was to operate and run hotels and restaurants, that it was not in the business of selling of mutual funds, that the business was not ready to start, that deductions available under section 57 only were allowable in such cases.
5. We have heard the rival submissions and perused the material before us. We find that the first issue to be decided, in the appeal before us, is whether the business was setting up in the year under consideration or not? The concept of setting up of a business and a commencement of a business has been deliberated by the Hon'ble Courts of more than one occasions. In the case of Commissioner of Income Tax v. Sponge Iron India Ltd.  201 ITR 770/67 Taxman 437 (AP) has held as under:
"The following are the principles applicable to determine whether a business has commenced: (i) whether a business has been commenced or not is a question of fact. However, what activities constitute commencement of business is a mixed question of law and fact and it has to be decided on the facts of each case; (ii) there is a distinction between setting up of business and commencement of business. A business is said to be set up when it is ready to commence; (iii) where the business consists of a continuous course of activities, for commencement of business all the activities which go to make up the business need not be started simultaneously. As soon as an activity which is the essential activity in the course of carrying on the business is started, the business must be said to have commenced. The following are the principles applicable to determine whether a business has commenced: (i) whether a business has been commenced or not is a question of fact. However, what activities constitute commencement of business is a mixed question of law and fact and it has to be decided on the facts of each case; (ii) there is a distinction between setting up of business and commencement of business. A business is said to be set up when it is ready to commence; (iii) where the business consists of a continuous course of activities, for commencement of business all the activities which go to make up the business need not be started simultaneously. As soon as an activity which is the essential activity in the course of carrying on the business is started, the business must be said to have commenced."
In the case of Commissioner of Income Tax v. Forging & Stamping (P.) Ltd.  119 ITR 616 (Bom.) the Hon'ble jurisdictional High Court has defined the phrase setting up of business in following manner:-
"If a question arises as to whether a particular business can be said to have been set up in the relevant assessment year, that question will have to be determined on the facts and circumstances appearing in each case. When a business is established and is ready to commence business, then it can be said of that business that it is set up. In the case of a manufacturing company, the installation and erection of machinery is not sufficient by itself and till some end product is or can be obtained, it cannot be said that the company is ready to commence production and it is the readiness to commence production which is equivalent to the setting up of the business."
In the case of Western India Vegetable Products Ltd, the assessee-company was incorporated on the 29-12-1945 with the object of running an oil mill and it obtained a certificate of commencement of business on 20-04-1946. In the AY 1947-48, the AO disallowed all the expenses incurred by the company prior to 1-11-1946, which was the date when it purchased the groundnut oil mill. The FAA held that the expenses incurred after getting the certificate of commencement of the business should be treated as expenses incurred for the purposes of carrying on the business in the year of account. The Tribunal, taking into consideration the date of first purchase of raw materials and the details of the expenses incurred by the company, came to the conclusion that all expenses incurred after 1-9-1946, should be allowed. Deciding the matter, the Hon'ble jurisdictional High Court in Western India Vegetable Products Ltd v. Commissioner of Income Tax  26 ITR 151 (Bom.) held as under:
"There is a clear distinction between a person commencing a business and a person setting up a business and for the purposes of the Indian Income-tax Act the setting up of the business and not the commencement of the business that is to be considered. It is only after the business is set up that the previous year of that business commences and any expense incurred prior to the setting up of a business would not be permissible deduction. 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. There may however be an interval between the setting up of the business and the commencement of the business and all expenses incurred during that interval would be permissible deductions that the company actually commenced business only on 1st November, 1946, when it purchased the groundnut oil mill, but prior to this date there was a period when the business could be said to have been set up and the company was ready to commence business and that there was evidence before the Tribunal to hold that the assessee company set up its business as from 1st September, 1946."
Facts of the case of Carefour WC & India (P.) Ltd. v. Dy. C/F 368 ITR 692/228 Taxman 261 (Mag.)/53 taxmann.com 289 (Delhi) were that the assessee-company was incorporated on 19/09/2007. Even before the incorporation, correspondence had been made with well known companies. It rented out office premises in the month of October, 2007. A bank account was opened on 4/10/2007. Employees were also appointed during that period. Tax deduction at source for the employees was also placed on record. Registration under the Shops and Establishments Act was also effected. Deciding the matter, the Hon'ble Delhi High Court held that these activities were the first stage activities which would lay the foundation for placing orders for procuring the stock and storing them in a warehouse or shop followed by the third stage of marketing them. For the assessee, a foreign entity, without establishing itself under the local laws, appointing personnel, identifying prospective manufacturers, clients, etc., obtaining storage facilities followed by stock-in-trade, the business of trading could not commence. The exercise was a precursor to commencement but post-set up. The activities demonstrated the setting up of the business by the assessee with a commitment to commence the business.
We would also like to refer to the case of Omni Globe Information Tech India (P.) Ltd. v. Commissioner of Income Tax  369 ITR 1/ 68 taxmann.com 112 (Delhi)of the Hon'ble Delhi High Court. In that matter the assessee was incorporated on 19.03.2004, as a subsidiary as a business process service provider. It entered into an agreement with its sister concern, to use its premises between 8 p.m. and 8 a.m. between 1.04.2004 and 30.06.2004. Sister concern was paid on pro rata basis for water, electricity, energy and power consumption charges. Further, the assessee had to install a separate internet link from the internet service provider. It had a choice to use the personal computers of the sister concern or install its own. It paid a substantial amount as salary and wages to its employees and claimed exemption under section 10B for the period commencing from 1.4.2004, to 31.05.2004, contending that it had obtained approval as a 100% export oriented unit under the STPI scheme and had commenced operations from April, 2004.The AO as well as the Tribunal held that the assessee had commenced its operations only from 1.06.2004, Le., the date on which the assessee entered into the "service agreement" with its parent company. On appeal the Hon'ble High Court held that the business of the assessee had been set up on 1.04.2004, as the assessee had acquired the necessary infrastructure from its sister concern, A and had also started making payment of salary and wages, that training was given by professional experts under the supervision and control of the assessee, that the moment the operations were commenced, the business had been set up. It further held as under:
"There is a distinction between "setting up of business" and "commencement of business". The proviso to section 3 of the Income-tax Act, 1961, refers to and defines the term "previous year" in relation to newly set up business or profession and not with reference to the date of commencement. 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. In order to determine whether business had been set up or not, the factual matrix of the case, especially, the nature and character of the business activity with the activities actually undertaken must be considered. Different considerations would apply and the answer would depend on whether the business was for manufacture of a product or for providing services."
In the matter of Pr. Commissioner of Income Tax v. Facor Power Ltd.  380 ITR 474/237 Taxman 613/66 taxmann.com 178 (Delhi), the Hon'ble Delhi High Court has held that the test that is required to be employed is whether the activity which is taken up for setting up of the business and the funds which are garnered are inextricably connected to the setting up of the business.
From the above discussion, it is clear that there is difference between actual commencement of a business and setting up of a business. It is only after the business is set up, that the expenses incurred in the business can be claimed as permissible deduction under section 37 of the Act. For the commencement of a business, there must be in place some income-generating asset or income-earning structure. In some cases, there may a gap or an interval between setting up and commencement. When the business is set up is a mixed question of law and fact and depends upon the line, nature and character of the business or professional activity. For example, for manufacturing business, purchase of new material or electricity connection may be the relevant point to determine the setting up. But, in the case of a property dealer, the moment he puts up a chair and table or starts talking, his business is set up. 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 a 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 setting 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 list of activities is not exhaustive and the facts of each case have to be considered. A trader before the actual purchase would possibly interact and negotiate with manufacturers, landlords, conduct due diligence to identify prospective customers, spread awareness, etc. These are all an integral part and parcel of the business of a trader. The activities continue even post-first sale/purchase. When the first steps are taken by a trader, the business is set up commencement of purchase and then sales is post-set up.
5.1. We find that AO and the FAA had taken note of expenditure incurred only they had dealt with the concept of setting up of business and commencement of business. We find that after getting approval from FIPB the assessee had made downstream investments of Rs. 22.3 crores in a Bangalore based Hospitality Venture, that for acquisition of a plot of land it had provided Rs. 20 crores as application money in a JV, that had started consultation and preparing feasibility reports. In our opinion, the accrual or receipt of income is not the only criteria to decide the taxability of the assessees. Business is a complex commercial activity and it takes quite a long time to start the practical operations Therefore, such an issue has to be decided after considering the surrounding circumstances. In the appeal before us, the AO and the FAA have held that expenses incurred were pre-operative period Besides, the assessee is a company and it has to incur certain expenses for functioning of corporate entity After considering the cumulative effect of all these factors, we are of the opinion that the assessee had set up the business and that expenditure incurred by it has to be allowed as business expenditure - except for the expenditure incurred on account of ROC charges for increase in authorised capital. In its letter to the AO, dated 28.11.2011, the assessee had agreed that it had no objection if the disputed demand was disallowed. We direct the AO to allow the remaining expenses. First Ground is allowed in favour of the assessee, in part.
6. Second Ground of appeal is upholding the assessment of income of Rs. 31.36 lakhs under the head income from other sources as against business income claimed by the assessee. He held that income arising out of interest on debentures of convertible (Rs. 4.70 lakhs) and profit on sale of units of mutual fund (Rs. 26.66 lakhs) were assessable under the head other sources in view of specific provisions of section 56 of the Act.
Confirming the order of the AO, the FAA held that income arising out of interest and sale of units of mutual fund were assessable under the head other sources in view of specific provisions of section 56 of the Act.
7. During the course of hearing before us, the AR argued that the auditors had given specific d
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irection the notes on accounts about the disputed amount, that the assessee had carried on business of an investment company, that income was rightly shown under the head income from business. He referred to page-3 of the paper book. He further stated that even income was considered arising out of other sources principles of netting had to be applied. He referred to paragraph 4.15 of the statement of facts and stated that assessee had made an alternate claim before the FAA. The DR stated that business had not started, the expenses incurred by assessee were of capital nature, that the object of the assessee was to operate and run hotels and restaurants, that it was not in the business of selling of mutual funds, that the business was not ready to start, that deductions available under section 57 only were allowable in such cases. 8. We have heard the rival submissions and perused the material before us. We find that the assessee company was incorporated to carry on business of setting up of new hotels and investment in hotel projects. It had never applied to RBI for getting a certificate of registration as NBFC. Just because it sold some debentures it cannot be treated an NBFC or an investment company. In our opinion, activity of receiving interest income or receiving some profit on redemption of short term mutual fund investment was not in nature of business. In other words, income arising out of above two activities cannot be termed business income and that the revenue authorities have rightly taxed it under the head income from other sources. Confirming the order of the FAA, we decide second ground of appeal against the assessee. As far as netting of interest is concerned, it is found that the FAA has not dealt with the issue. In our opinion, even if income is to be assessed under the head income from other sources, benefit of netting of income cannot be denied to the assessee. AO is directed accordingly. Second ground of appeal is decided in favour of the assessee, in part. 9. As a result, appeal filed by the assessee stands partly allowed.