This Reference Application is directed against order dated 05.11.2009 of Income Tax Appellate Tribunal Lahore Bench, Lahore (Appellate Tribunal), whereby appeal filed by the taxpayer was allowed in following terms:-

5. After hearing the arguments advanced by rival parties and perusal of relevant record, the following observations have been made by us:-

i) The impugned order passed in the instant case is contrary to facts of the case as on page-2 the learned CIT(A) has denied declaration of any income/loss by the assessee despite the fact that on page-1 of the same order he has admitted the disclosure of loss of Rs.(9,989,397) while discussing brief facts of the case. Furthermore, till conclusion of the impugned order, he kept on threating the return filed by the assessee without disclosure of any loss therein, which resulted an arbitrary decision passed by him.

ii) While disallowing set off of interest income against business loss he has not only ignored the established law enunciated by the legislature u/s 34 of the Ordinance, 1979 but also established history of assessees own case pertaining to assessment years 2000-01 and 2001-02 whereby under the identical circumstances of the case set off of interest income against business loss was allowed by the first appellate authority vide order dated 20.06.2006 (copy placed on file) against which no appeal was preferred by the department before the ITAT. In other words, the department also admitted the said decision passed by first appellate authority.

iii) The issue under consideration already stands resolved in favour of the assessee by the ITAT in reported as well as unreported judgments referred before us by the learned AR wherein it has been held in an unequivocal manner that in case of business loss declared by the assessee, the interest income would be set off against such loss and balance loss would be carried forward to the next year.

[Emphasis supplied]

SUBJECT-MATTER ISSUE

2. Matter pertains to the Assessment Year 2002-2003. Following question of law is proposed and pressed for our determination,

Whether under the facts and in the circumstances of the case, the learned ITAT was legally justified to allow set off of interest income against business loss and to carry forward the balance loss to the next year ignoring the facts that no business was conducted by the assessee for the assessment year 2002- 2003 and pre-commencement expenses of business which are of capital nature were claimed to declare business loss?

SUBMISSIONS:

3. Learned counsel for the applicant department contends that no commercial business was conducted by the taxpayer during the Income year 2001-2002, and no question for assessment of gains and profits arises for determining Income from Business. Adds that trial production and expenses incurred thereupon were pre-commencement expenses, and classifiable as capital expense and required to be capitalized as cost of the project. Submits interest income was in fact and law Income from other sources in terms of clause (b) of sub-section (2) of section 30 of the Income Tax Ordinance, 1979 (Ordinance, 1979), which material fact was not appreciated by the Appellate Tribunal.

4. Conversely, learned counsel for the taxpayer emphasized that project was established, and trial-production had commenced, and the expense incurred for payment of electricity and gas consumed are operating expense - coming in the ambit of revenue expense - and have had to be accounted for the purposes of assessing income. And the consequent loss had to be adjusted against the interest income, with balance loss to be carried forward to next year. Learned counsel emphasized that in terms of section 34 of the Ordinance, 1979, income from one head could be employed for adjusting loss, accrued under other head of income. Reference, in this behalf, is made on following decisions,

COMMISSIONER OF INCOME TAX, COMPANIES ZONE- I, LAHORE. Versus. Messrs GRAYS LEASING COMPANY LIMITED (2005 PTD 2093);

UCH POWER (PVT.) LTD. and others. Versus. INCOME TAX APPELLATE TRIBUNAL and others (2010 PTD 1809);

LUCKY CEMENT LTD. Versus. COMMISSIONER INCOME TAX, ZONE COMPANIES, CIRCLE-5, PESHAWAR (2015 PTD 2210);

C.I.T. CO., ZONE-I, LAHORE. Versus. Messrs GULISTAN POWER GENERATION LTD., LAHORE (2017 PTD 844).

Determination:

5. Arguments heard.

6. Decision of Appellate Tribunal is examined, which is found erroneous and illegal. Section 34 of Ordinance, 1979 is not attracted to the facts and circumstances of the case, when no business was conducted for the purposes of section 22 and 23 of the Ordinance, 1979. Fundamentally two issues need determination. Firstly, what it meant to be the setting-up/establishment of business, in the context of expenses incurred and status thereof, and secondly whether section 34 of the Ordinance, 1979 is attracted. Determination of the first issue would also consequently decide qua the scope of pre-operative expenditure - allegedly undertaken during trial production.

7. It is not the case of the taxpayer that commercial production was carried out - it was noted by the CIR (Appeals) that no business was conducted during period under consideration and the expenses incurred were of pre-commencement nature and had to be capitalized. No income/ loss under the head Income from business was declared. Mere carrying out of trial-production would not be construed that business was established, for the purposes of section 22 and 23 of the Ordinance, 1979 - gains and profits to be earned from the income of the business, whereby no commercial production was carried out, is distinct from the interest income in this case. Meaning/concept of setting-up of business is aptly discussed in the case of COMMISSIONER OF INCOME-TAX. v. L. AND T. MCNEIL LTD. ([1993] 202 ITR 662), relevant passage therefrom is reproduced hereunder,

We have carefully considered the rival submissions. The question as to when the business can be said to have been set up is no more res integra. Setting up a business means to establish a business. As observed by Chagla C.J., in Western India Vegetable Products Ltd. v. CIT (1954) 26 ITR 151, 158.

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.

In the above case, Chagla C.J., also dealt with the treatment of the expenditure incurred after the setting up of the business but before it is commenced and observed (at page 158):

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).

This view was approved by the Supreme Court in CWT v. Ramaraju Surgical Cotton Mills Ltd. [1967] 63 ITR 478. In the above case, the controversy before the Supreme Court was whether the new unit started by the assessee was set up after commencement of the Wealth-tax Act, 1957, so as to quality the assessee for exemption from wealth-tax under section 5(1)(xxi) of the Wealth-tax Act, 1957. The assessee in that case was carrying on the business of manufacture of absorbent cotton wool. In March, 1955, the board of directors of the assessee- company resolved to establish a new spinning unit for which a licence was obtained from the Government of India in August, 1955. The assessee placed orders for purchase of necessary spinning machinery and plant in the months of January and February, 1956. The construction of the factory buildings was taken in hand in March, 1956, and these constructions were completed by December, 1957. The erection of the spinning machinery and plant in the building was completed in several stages commencing from June, 1957. A licence from the Inspector of Factories for working was obtained in June, 1958. The Wealth-tax Act had come into force with effect from April 1, 1957. The question before the Supreme Court was whether on these facts a new spinning unit could be said to have been set up by the assessee before April 1, 1957. The Supreme Court approved the decision of this court in Western India Vegetable Products Ltd. v. C1T [1954] 26 ITR 151, and observed (at page 481 of 63 ITR):

A unit cannot be said to have been set up unless it is ready to discharge the function for which it is being set up. It is only when the unit has been put into such a shape that it can start functioning as a business or a manufacturing organization that it can be said that the unit has been set up.

It was further observed (age page 482)

Operations for the establishment of a unit, from the very nature of that expression, can only signify steps that have to be taken to establish the unit. The word set up in our opinion, is equivalent to the word established, but operations for establishment cannot be equated with the establishment of the unit itself or its setting up.

This court in CIT v. Industrial Solvents and Chemicals Pvt. Ltd. [1979] 119 ITR 608, was again called upon to decide a somewhat similar controversy. Applying the principles laid down in Western India Vegetable Products Ltd. s case [1954] 26 ITR 151 (Bom), to the facts of the case it was observed (at page 614 of 119 ITR):

In our case, the activity of the assessee-company was to produce industrial solvents, viz., ether. Can the assessee- company be said to be ready to commence its business, viz., production of ether, merely when the machinery was installed or even when the plant was charged initially with 200 gallons of raw material? In our opinion, when the question is so put, the answer is obvious and the answer is that till some end-product which is the business of the company is or can be obtained, it cannot be said that the company is ready to commence production and it is such readiness to commence production which has been indicated in Western India Vegetable Products Ltd. s case [1954] 26ITR 151 (Bom), as equivalent to the setting up of the business.

Thus, the principles for determining when a business can be said to have been set up are well-settled. 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, as observed by this court in CIT v. Forging and Stamping Pvt. Ltd. [1979] 119 ITR 616, will have to be determined on the facts and circumstances in each case.

8. In view of the facts of the case at hand, there was no evidence that commercial production was carried out or any business, for the purposes of computing any income/loss, was conducted. Expenses incurred being the pre-commencement expenses - and not construable as loss for allowing adjustment against interest income.

9. The question of status of income and chargeability to tax, before commencement of the business, is elaborated in the case from a neighbouring jurisdiction, reported as TUTICORIN ALKALI CHEMICALS AND FERTILIZERS LTD. v. COMMISSIONER OF INCOME-TAX ([1997] 227 ITR 172) = (1998 PTD 900) and relevant passages read as,

The basic proposition that has to be borne in mind in this case is that it is possible for a company to have six different sources of income, each one of which will be chargeable to income-tax. Profits and gains of business or profession is only one of the heads under which the companys income is liable to be assessed to tax. If a company has not commenced business, there cannot be any question of assessment of its _ profits and sains of business. That does not mean that until and unless the company commences its business, its income from any other source will not be taxed. If the company, even before it commences business, invests the surplus funds in its hands for purchase of land or house property and later sells it at profit, the gain made by the company will be assessable under the head Capital gains. Similarly, if a company purchased a rented house and gets rent, such rent will be assessable to tax under section 22 as income from house property. Likewise, a company may have income from other sources. It may buy shares and get dividends. Such dividends will be taxable under section 56 of the Act. The company may also, as in this case, keep the surplus funds in short-term deposits in order to earn interest. Such interest will be chargeable under section 56 of the Act.

There are specific provisions in the Income-tax Act for setting off loss from one source against income from another source under the same head of income (section 70), as well as setting off loss from one head against income from another (section 71). In the facts of this case the company cannot claim any relief under either of these two sections, since its business had not started and there could not be any computation of business income or loss incurred by the assessee in the relevant accounting year. In such a situation, the expenditure incurred by the assessee for the purpose of setting up its business cannot be allowed as deduction, nor can it be adjusted against any other income under any other head.

[Emphasis supplied]

10. Judgments referred are distinguishable on facts. The case of LUCKY CEMENT LTD (supra) is distinguishable, wherein issue of pre-commencement expenses was not the subject matter of controversy. Likewise, the case of Messrs GRAYS LEASING COMPANY LIMITED (supra) is not relevant to the facts of the case at hand where business had not commenced and no question of computation of business income or loss incurred arose during relevant income year - so section 34 of Ordinance, 1979 is not attracted The ratio in the case of UCH POWER (PVT.) LTD (supra) is not applicable, where question of exemption of income in terms of clause 176 of the Second Schedule Part-1 to the Ordinance, 1979 was subject of dispute and interest/profit earned against investments/bank accounts was classified as separate income covered under section 30 of the Ordinance, 1979. The case of Messrs GULISTAN POWER GENERATION LTD., LAHORE (supra) is also distinguishable, wherein subject-matter controversy was not common to the facts of this case.

11. Appellate Tribunal erred in law while allowing adjustment of alleged pre-operative expenses, guised/claimed as loss, - not otherwise covered within the ambit of section 22 or 23 of the Ordinance, 1979 - against interest income, which for all intent and purposes, in the context of the facts of the case, is Income from other sources. Section 34 of the Ordinance, 1979 has no relevance and applicability, which is reproduced hereunder,

34. Set-off of losses. Where a assessee sustains a loss (not being a loss to which Section 36 or Section 37 applies) in any assessment year under any head of income specified in Section 15, he shall [subject to clause (v) of sub-section (1) of Section 23] be entitled to have the amount of the loss set off against his income (other than income to which sub-section (7) or (9) of Section 12 applies), if any, under any other head assessable for that assessment year.

12. It is evident that for attracting section 34, ibid, taxpayer must sustain a loss - as consequence of business undertaken for gains and profits - and no such loss is calculable in this case. Expenses incurred for trial production being in the nature of pre-operative expenditure, are not classifiable as loss. No question of adjustment of income from one head against another head of income arises in this case. In view of the aforesaid, we declared order dated 05.11.2009 of the Appellate Tribunal illegal erroneous.

13. Question of law is answered in the negative. This reference application is decided in favour of the department and against the taxpayer.

14. Office shall send a copy of this order, under seal of the Court, to learned Appellate Tribunal, in terms of sub-section (5) of section 133 of Income Tax Ordinance 2001.

Order accordingly.