2025 (8) TMI 1316 - AT - Income Tax

Assessee's thermal power project treated as existing business; P&L expenditures allowable, interest costs allowed once; remand to AO under s.57(iii)

Shapoorji Pallonji Energy (Gujarat) Private Limited Versus DCIT, Circle- 3 (3) (1), Mumbai

Shapoorji Pallonji Energy (Gujarat) Private Limited Versus DCIT, Circle- 3 (3) (1), Mumbai - TMI ISSUES PRESENTED AND CONSIDERED 1. Whether expenses debited to profit and loss account can be disallowed as pre-operative expenditure where the assessee is setting up a project but has not yet earned business revenue. 2. Whether the characterisation of receipts of Rs. 12,34,61,000 (interest on bank deposits, interest from related parties and miscellaneous income) is 'Income from Business or Profession' or 'Income from Other Sources', and the scope for deduction of finance costs under section 57(iii) when such receipts are so classified. 3. Whether mark-to-market foreign exchange gains on loans to an overseas party, arising from year-end restatement, constitute taxable income where there is no evidence that the loan was on revenue account. 4. Consequential issue: entitlement to set off brought-forward business losses in light of adjustments sustained or directed. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Allowability of expenses treated as pre-operative where business is being set up but no revenue earned Legal framework: Deductibility of expenditure depends on whether expenditure was incurred 'for the purpose of business' and whether the business has been 'set up' (established/ready to commence) as distinct from mere commencement of commercial operations; expenses incurred after the setting up and before commencement may be deductible, while those incurred prior to setting up must be capitalised. Precedent treatment: The Tribunal relied on the test articulated by the Hon'ble High Court in Western India Vegetable Projects Ltd. distinguishing 'setting up' and 'commencement', and followed a coordinate-bench Tribunal decision in Orient Green Power Co. Ltd. which held that substantial pre-commencement steps (PPA, land acquisition, approvals, staffing, purchase orders, EPC arrangements) establish that the business was 'set up' and thus revenue-nature expenses incurred thereafter are deductible. Interpretation and reasoning: The Tribunal examined documentary evidence - Power Purchase Agreement, land acquisitions, statutory permissions/clearances, acquisition of equipment, contracts, and deployment of project personnel - and concluded that these steps manifested that the project business had been established (set up) even though commercial revenue had not yet arisen. The Tribunal held that mere absence of business receipts in the year is not a condition precedent for allowance; the correct enquiry is whether the business was set up such that expenses were incurred for the purpose of business. The AO's blanket treatment of all P&L debits as pre-operative, without granular examination of nature and nexus of each expense, was found to be incorrect. Ratio vs. Obiter: Ratio - expenses incurred after business is set up and for the purpose of business are allowable even if no business receipts arise in that year; mere non-generation of revenue does not convert such expenses into pre-operative capital expenditure. Obiter - emphasis on the need for item-wise examination of nature and details of expenses by the AO, and that some items may still require capitalization depending on their character. Conclusion and directive: The Tribunal concluded that the business of setting up the thermal power project was set up and remitted the matter to the jurisdictional AO to examine the nature and details of the P&L-debited expenditures and, where established to be for the purpose of business, allow them as deductions. Grounds relating to this issue were allowed for statistical purposes and issue restored for verification. Issue 2 - Characterisation of interest and miscellaneous receipts (Rs. 12,34,61,000) as business income or income from other sources and consequent deduction of finance costs Legal framework: Income classification depends on the nature and purpose of activity giving rise to receipts; section 57(iii) permits deduction of expenditure incurred in relation to income from other sources subject to nexus. Precedent treatment: The Tribunal applied the established principle that classification must reflect nexus between receipts and the business activity; where funds are not deployed for the project or ordinary business purpose, receipts from deposits/advances are typically income from other sources. Interpretation and reasoning: The Tribunal found that the interest income arose from bank deposits and advances to sister concerns, funded by borrowed funds that were not shown to be linked to the power project and were held for general business purposes. There was no material to establish that the lending/placement of funds was for the purpose of the assessee's core business (setting up and running the power project). Therefore, such receipts could only be classified as 'income from other sources'. Given that classification, the Tribunal directed the AO to examine and allow finance costs/interest expenditure under section 57(iii) to the extent of its nexus with that other-source income, ensuring no double allowance and providing the assessee reasonable opportunity of hearing. Ratio vs. Obiter: Ratio - receipts from deposits/advances not demonstrated to be for the core business constitute income from other sources; finance costs may be deductible under section 57(iii) if nexus is established, but expenditure cannot be allowed twice. Obiter - guidance that AO must verify nexus and grant deduction either as business expenditure (if recharacterised on verification) or as allowable under section 57(iii), but only once. Conclusion and directive: The Tribunal upheld classification of Rs. 12,34,61,000 as income from other sources and remitted to the AO the question of allowance of finance costs, directing a single allowance after nexus verification and opportunity of hearing. Grounds on this issue were decided accordingly. Issue 3 - Taxability of foreign exchange gains on loans to overseas party arising from year-end restatement Legal framework: Foreign exchange gains/losses arising from restatement of monetary items are taxable or allowable depending on whether the underlying asset/liability is on revenue account; mark-to-market/accounting adjustments do not automatically become taxable unless they reflect income of a revenue nature. Precedent treatment: The Tribunal applied standard accounting/tax distinctions between revenue account transactions and capital/monetary restatements, considering the nature of the underlying loan. Interpretation and reasoning: The record did not establish that the loan to the overseas party was on revenue account. The foreign exchange fluctuation gain arose solely from year-end reinstatement using the closing exchange rate (mark-to-market). Since there was no evidence that the loan constituted a revenue transaction generating assessable income, the reprofiling gain on account of translation was not considered income chargeable to tax for the year. Ratio vs. Obiter: Ratio - translation/mark-to-market gains arising from year-end exchange rate restatement of loans not shown to be on revenue account do not constitute taxable income. Obiter - none significant beyond the directive to delete such addition in the circumstances. Conclusion and directive: The Tribunal directed deletion of the addition for foreign exchange gain. Grounds on this issue were allowed. Issue 4 - Set off of brought-forward business losses (consequential) Legal framework: Entitlement to set off brought-forward business losses is consequential upon the final determination of taxable income after allowable deductions and disallowances. Interpretation and reasoning: The Tribunal treated the issue as consequential and remitted computation to the AO to consider brought-forward losses in light of directions given on allowability of expenditures, classification of income and deletion of exchange gain. Ratio vs. Obiter: Ratio - computational and consequential; no independent substantive finding beyond directing AO to apply law consistent with the Tribunal's findings. Obiter - none. Conclusion and directive: Grounds concerning set off were allowed for statistical purposes and the AO was directed to compute total income and set off brought-forward losses in accordance with the Tribunal's directions.