Court allows business and advertising expenses, rejects Revenue’s capital asset argument.

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Case Name

Principal Commissioner of Income Tax vs. Miele India Pvt. Ltd. (High Court of Delhi)

ITA 144/2020 & & CM Nos.7635-36/2020

Date: 25th March 2021

Key Takeaways

• Setting-up vs. Commencement: The court clarified that there’s a difference between “setting up” a business and “commencing” business. Expenses incurred after the business is set up, even if before full-scale operations, can be deductible.
• Advertising Expenses: Advertising costs, even if they help build goodwill, are not automatically capital expenses. If they don’t create a new capital asset, they can be deducted as business expenses.
• Section 37 of the Income Tax Act, 1961: The court emphasized that business expenses wholly and exclusively for business purposes are deductible under this section, unless they result in a capital asset.
• Findings of Fact: The court respected the factual findings of the lower authorities (CIT(A) and Tribunal) that the business was set up before the disputed assessment year.

Issue

Were the pre-operative and advertising expenses incurred by Miele India Pvt. Ltd. allowable as business deductions, or should they be treated as capital expenses because they allegedly created a capital asset (goodwill)?

Facts

• Parties: Miele India Pvt. Ltd. (the taxpayer/assessee) and the Principal Commissioner of Income Tax (the Revenue).
• Timeline: The dispute concerns Assessment Year (AY) 2010-2011.
• Background: Miele India Pvt. Ltd. was incorporated in 2007 and took several steps to set up its business, including obtaining PAN/TAN, executing lease deeds, hiring employees, making purchases, and even making some sales before the disputed year.
• Dispute: The Assessing Officer (AO) disallowed pre-operative expenses (Rs. 3.5 crore) and advertising expenses (Rs. 60 lakh), arguing these were either incurred before business commenced or were capital in nature (i.e., for building goodwill).
• Appeals: The taxpayer appealed, and both the Commissioner of Income Tax (Appeals) [CIT(A)] and the Income Tax Appellate Tribunal (ITAT) ruled in its favor. The Revenue then appealed to the High Court.

Arguments

Revenue (Tax Department)

• Pre-operative Expenses: Claimed that business had not commenced until the “experience centre” (physical outlet) was launched on 29.10.2009, so expenses before that date were not deductible.
• Advertising Expenses: Claimed these were incurred to build goodwill (a capital asset), so they should not be allowed as revenue (business) expenses.
• Legal Support: Cited cases like Commissioner of Wealth Tax v. Ramaraju Surgical Cotton Mills Ltd., (1967) 63 ITR 478 (SC); Marvel Polymers Pvt. Ltd. v. Commissioner of Income Tax-II, (2007) 165 Taxman 618 (Delhi); and Akzo Nobel Car Refinishes India § Ltd. v. Deputy Commissioner of Income Tax, Circle 1(2), New Delhi, (2008) 25 SOT 226 (Delhi).

Taxpayer (Miele India Pvt. Ltd.)

• Setting-up vs. Commencement: Argued that business was “set up” earlier, as shown by incorporation, lease deeds, hiring, purchases, and even sales before the experience centre opened.
• Advertising Expenses: Claimed these were ordinary business expenses, not capital in nature, and should be allowed under Section 37 of the Income Tax Act.
• Legal Support: Cited Carefour WC & C India § Ltd. v. Deputy Commissioner of Income Tax, (2015) 53 taxmann.com 289 (Delhi); Commissioner of Income Tax v. L.G. Electronics (India) Ltd., (2005) 149 Taxman 166 (Delhi); and Commissioner of Income Tax v. Citi Financial Consumer Fin Ltd., (2012) 20 taxmann.com 452 (Delhi).

Key Legal Precedents

• Commissioner of Wealth Tax v. Ramaraju Surgical Cotton Mills Ltd. (1967) 63 ITR 478 (SC)
• Marvel Polymers Pvt. Ltd. v. Commissioner of Income Tax-II (2007) 165 Taxman 618 (Delhi)
• Akzo Nobel Car Refinishes India § Ltd. v. Deputy Commissioner of Income Tax, Circle 1(2), New Delhi (2008) 25 SOT 226 (Delhi)
• Carefour WC & C India § Ltd. v. Deputy Commissioner of Income Tax (2015) 53 taxmann.com 289 (Delhi)
• Commissioner of Income Tax v. L.G. Electronics (India) Ltd. (2005) 149 Taxman 166 (Delhi)
• Commissioner of Income Tax v. Citi Financial Consumer Fin Ltd. (2012) 20 taxmann.com 452 (Delhi)

The court distinguished the Revenue’s cited cases, emphasizing that the facts here showed the business was already set up before the experience centre opened. The court also relied on precedents that clarified the difference between “setting up” and “commencement” of business, and that advertising expenses are not capital unless they create a new asset.

Judgement

• Decision: The High Court ruled in favor of Miele India Pvt. Ltd.
• Reasoning: The court found that the business was “set up” before the experience centre opened, as evidenced by incorporation, lease deeds, hiring, purchases, and sales. Therefore, expenses incurred after the business was set up were deductible.
• Advertising Expenses: The court held that advertising expenses, even if they help build goodwill, are not capital expenses unless they create a new capital asset. Since there was no evidence of a new capital asset, these were allowable as business expenses under Section 37 of the Income Tax Act.
• Outcome: The court upheld the decisions of the CIT(A) and the Tribunal, allowing the deductions and dismissing the Revenue’s appeal.

FAQs

Q1: What is the difference between “setting up” and “commencement” of business?

A: “Setting up” means the business is ready to start operations (e.g., incorporation, hiring, leasing premises), while “commencement” is when actual business activity (like sales) begins. Expenses after “setting up” can be deductible, even if before full-scale operations.

Q2: Are advertising expenses always capital expenses?

A: No. Advertising expenses are generally revenue (business) expenses unless they create a new capital asset. Just building goodwill through advertising does not make it a capital expense.

Q3: Why did the court allow the deductions?

A: The court found that the business was already set up before the disputed year, and the expenses were incurred wholly and exclusively for business purposes, not for creating a capital asset.

Q4: What does this mean for other businesses?

A: Businesses can claim deductions for expenses incurred after they are “set up,” even if they haven’t started full-scale operations. Advertising expenses are generally deductible unless they create a new asset.

Q5: What sections of the Income Tax Act were discussed?

A: The main section discussed was Section 37 of the Income Tax Act, 1961, which allows deductions for business expenses not being capital or personal in nature.

1. Admit.

2. The following substantial questions of law are framed for

consideration by this Court:

(i) Whether the Income Tax Appellate Tribunal [in short ‘Tribunal’]

erred in deleting the addition made qua pre-operative expenses by holding

that the expenses incurred, in that behalf, were legitimate business

expenditure?

(ii) Whether in the facts and circumstances of the case, the Tribunal was

justified in deleting the addition made qua advertising expenses by failing to consider the fact that these expenses were incurred to build goodwill, which is, a capital asset?

3. With the consent of counsel for parties, the appeal is taken up for

hearing and final disposal.

4. In order to adjudicate upon the questions of law framed above, it

would be necessary to sketch out the broad contours of the case.

4.1. These questions of law concern the assessment year [in short ‘AY’]

2010-2011. The assessee had filed its return on 27.09.2010, wherein it had

declared a loss of Rs.7,83,71,011/-. The return filed by the assessee was

processed under Section 143(1) of the Income Tax Act, 1961 (in short ‘the

Act’). Unfortunately, for the assessee, its case was picked up for scrutiny

and accordingly, notice under Section 143(2) of the Act was issued.

4.2 Consequent thereto, an assessment order was framed on 19.03.2014

under Section 143(3) of the Act. The said assessment order determined a

loss of Rs.3,66,79,080/-.

4.3 Pertinently, while framing the assessment under Section 143(3) of the

Act, the assessing officer made additions concerning the following:

(i) Pre-operative expenses amounting to Rs.3,50,51,978/-.

(ii) Advertising expenses amounting to Rs.60,39,950/-.

4.4. The assessee, being aggrieved by the order dated 19.03.2014 passed

under Section 143(3) of the Act, preferred an appeal with the Commissioner

of Income Tax (Appeals) [in short ‘CIT(A)]. The CIT(A) allowed the

assessee’s appeal.

4.5. It is against this order of the CIT(A) that the revenue preferred an

appeal before the Tribunal. The Tribunal vide order dated 11.04.2019

dismissed the revenue’s appeal and sustained the order of the CIT(A).

5. Mr. Shlok Chandra, who appears on behalf of the revenue, has

assailed the order of the Tribunal in respect of two issues, adverted to

hereinabove, i.e. deletion of the addition made by the assessing officer [in

short ‘AO’] towards pre-operative expenses and advertising expenses by

putting forth the following submissions.

5.1. The assessee is in the business of trading and therefore, expenses

incurred prior to the commencement of business were rightly added back by

the AO. In support of this plea, it was pointed out that the AO has indicated

that the assessee in his written note had stated that its business commenced

on 29.10.2009. It was submitted that the ‘experience centre’ was launched

only on 29.10.2009 and therefore, that had to be taken as the actual date

when the assessee had set-up its business.

5.2. The mere fact that the assessee obtained stock of the goods, that it

intended to trade in, was not enough. Since the assessee is a trading entity, it

needed an outlet such as an experience centre for conducting its business;

which, as indicated above, was set-up only on 29.10.2009.

5.3. The assessee could not have sold the goods, otherwise, than via a

physical outlet, as it had no online presence. In support of these

submissions, reliance was placed by Mr. Chandra on the following

judgments:

(a) Commissioner of Wealth Tax v. Ramaraju Surgical Cotton Mills

Ltd., (1967) 63 ITR 478 (SC).

(b) Marvel Polymers Pvt. Ltd. v. Commissioner of Income Tax-II,

(2007) 165 Taxman 618 (Delhi).

(c) Akzo Nobel Car Refinishes India (P.) Ltd. v. Deputy Commissioner

of Income Tax, Circle 1(2), New Delhi, (2008) 25 SOT 226 (Delhi).

5.4. Insofar as the other issue is concerned, the only argument which was

advanced was that the Tribunal had erred in deleting the addition made qua

advertising expenses by ignoring the fact that the said expenses had been

incurred to build goodwill. In other words, the argument was that if the

expenses were capital in nature, it could not have been treated as revenue

expenses.

6. On the other hand, Mr. Piyush Kaushik, who appears on behalf of the

assessee, submitted that there is a difference between the setting-up of

business and commencement of business; as long as the assessee is ready to

carry on business and there are facts and circumstances obtaining in a case,

which point in this direction, then, it can be safely concluded that the

business has been set-up and, therefore, any expenses incurred would have

to be allowed as a deduction.

6.1 In support of this plea, reliance was placed on the remand report filed

by the AO before the CIT(A). Based on the contents of this report, it was

sought to be demonstrated that several steps have been taken by the assessee

to set-up the business in the previous AYs, which included placing orders in

the domestic market. The emphasis was laid on the fact that there was no

prohibition in the assessee carrying on its trading activity in the domestic

market and therefore, the argument advanced on behalf of the revenue that

the goods in which the assessee dealt in were also obtained from its holding

company albeit on or after 29.10.2009 had no relevance in the given

circumstances.

6.2. In support of this plea, reliance was placed on the following

judgments:

(i) Carefour WC & C India (P.) Ltd. v. Deputy Commissioner of

Income Tax, (2015) 53 taxmann.com 289 (Delhi).

(ii) Commissioner of Income Tax v. L.G. Electronics (India) Ltd.,

(2005) 149 Taxman 166 (Delhi).

6.3 It was further contended that since the findings of fact have been

returned in this behalf, both, by the CIT(A) and the Tribunal, this Court

while adjudicating upon the instant appeal ought not to disturb those

findings.

6.4. Insofar as the other issue is concerned, which is, the deletion of

addition made on account of advertising expenses, it was submitted that the

view taken by the CIT(A) and the Tribunal should be sustained. The

advertising expenses were incurred wholly and exclusively for the business

of the assessee and therefore, ought to be allowed as a deductible expense

under Section 37 of the Act. In support of this submission, reliance was

placed on the judgment rendered in Commissioner of Income Tax v. Citi

Financial Consumer Fin. Ltd., (2012) 20 taxmann.com 452 (Delhi).

6.5. In effect, the submission was that the substantial questions of law

framed should be decided in favour of the assessee.

7. We have heard the learned counsel for the parties and perused the

record. Insofar as the issue concerning pre-operative expenses is concerned,

it would be important to advert to the factual information set out in

paragraph 10 of the order of the CIT(A); none of which, is disputed, before

us.

“Particulars AY 2008-09 AY 2009-10 AY 2010-11

Date of Incorporation 27 Sept.07

Date of allotment of PAN 15 Jan., 08

Date of allotment of TAN 21 Jan., 08

Importer Exporter Code (IEC) 7 Nov., 08

Lease Deed executed with Regus Business Centr 16 June, 08

Date of joining of MD 2 June, 08

Lease Deed executed for premises at 16 Dec., 08

Commercial Plot, Jasola

Receipt of share application from Imanto AG July 2008

Resolution for opening of Bank Account 2 Aug., 08

Agreement for outsourced employees (including drivers, advisors positioned at dealer’s sites and chef) 22 Sept., 08

Date of hiring of 6 senior employees Middle of the year

Date of first local purchase 27 Nov., 08 Sales 4 Dec., 08 & 26 March 09

Date of Customer Orders received from Dawar International electronics Pvt. Ltd. 2 Jan., 09 & 22 Jan., 09

Date of various purchase orders raised on miele & Cie KG 18 March 2009

18 May, 09 & 14 July 09

Date of agreement with R&P Management Communications Pvt. Ltd. 1 Aug., 09

Date of invoice raised by Miele & Cie KG pursuant to purchase order dated 18 March 2009 5 Aug., 09

Date of import of products for demonstration purposes from Miele & Cie Kg. 19 Aug., 09

Date of receipt of consignment from Miele & Cie KG against invoice dated 5 August 2009 22 Sept., 09

Distribution of product catalogues/information brochures for soliciting customer orders Throughout the year

Date of launch of Experience Centre

for dissemination and advertisement,

publicity and marketing of products

to potential customers (wrongly

treated as commencement of

business by the ld. AO in the

assessment order) 29 Oct., 09

Date of invoice raised on Dawar International Electronics Pvt. Ltd. 28 Nov.,

09, & 24 Dec., 09 & 30 Dec., 09”

7.1. A perusal of the information set out hereinabove would show that the

assessee had obtained the Importer Exporter Code [in short ‘IEC’] on

07.11.2008; the assessee had executed a lease deed with Regus Business

Centre on 16.06.2008; a lease deed qua a commercial plot located at Jasola,

Delhi was executed by the assessee on 16.12.2008; the assessee had entered

into an agreement for outsourced employees (which included drivers,

advisors positioned at the dealer’s site and chef) on 22.09.2008; the assessee

had hired six senior employees between the financial year [in short ‘FY’]

2008-2009; the first local purchase was made on 27.11.2008; local sales

were made by the assessee on 04.12.2008 and 26.03.2009; orders were

received from Dawar International Electronics Pvt. Ltd. on 02.01.2009 and

22.01.2009; and purchase orders were raised on the assessee’s holding

company on 18.03.2009.

7.2. We have, consciously, only adverted to the steps taken by the assessee

in the previous AY i.e. 2009-2010. We also note that there is a reference to

certain steps which the assessee had taken in AY 2008-2009 such as getting

itself incorporated and having a PAN number and TAN number allotted to

it.

7.3. This apart, there are certain steps that the assessee took in the subject

AY, i.e., AY 2010-2011, which included raising purchase orders on its

holding company, the details of which are given in the tabular chart,

extracted hereinabove.

7.4 The reason that we have only emphasised on the steps taken by the

assessee in the previous AY, i.e., AY 2009-2010 is to show that, both,

CIT(A) and the Tribunal were correct in concluding, in our view, that the

assessee had set-up its business and was ready to carry on the same in the

previous AY, i.e., AY 2009-2010.

7.5 Therefore, Mr. Chandra’s submission that the business of the assessee

was set-up only on 29.10.2009, in our opinion, is not correct. This

submission of Mr. Chandra is predicated on one singular fact, which is, that

the assessee had launched its experience centre i.e. physical outlet on

29.10.2009.

7.6 It is correctly argued by Mr. Kaushik that there is a difference

between setting-up of business and commencement of business. The fact

that the assessee had executed lease deeds for its premises, engaged senior

employees, carried out local purchase, and sales could not have been

possible had it not set-up its business.

7.7 Therefore, on facts, in our view, the judgments cited by Mr. Chandra

are distinguishable. The fact that the assessee had set-up an experience

centre in the FY 2009-2010, which was another mode or platform for selling

its goods, cannot have us hold that the assessee had not set-up its business in

the previous AY. Therefore, the stated absence of the assessee on an online

platform, in our view, is non-sequitur in the fact situation obtaining in the

instant case.

8. Insofar as the second issue is concerned, which relates to the

advertising expenditure, the submissions made on behalf of the revenue by

Mr. Chandra, lacked conviction. Although, Mr. Chandra, did draw our

attention to the AO’s view qua the issue, which was, that the advertising

expenditure had been incurred to build a brand, i.e., goodwill and therefore,

should not be allowed as a deduction, it does not impress us. There is

nothing on record to show that the expenditure incurred by the assessee,

towards advertising, was not laid out or expended, wholly and exclusively,

for the purposes of business. The expenditure incurred, in our view, being a

business expenditure, which was incurred wholly and exclusively for the

purposes of business, and did not lead to the creation of a capital asset in the

assessment year in issue, ought to have been allowed by the AO.

8.1 The rationale adopted by the A.O. for disallowing the expenditure was

completely flawed. Goodwill, which is built, based on the reputation

acquired by the business over the years, is an intangible asset, which is

monetized, ordinarily, when the business is sold. Therefore, for the A.O. to

disallow advertising expenditure on this basis was completely erroneous.

8.2. Thus, the deletion of the addition made by the A.O. qua expenditure

incurred on advertising both by the CIT(A) and the Tribunal, to our minds,

was in order. The extent of expenditure on advertising does not, in our view,

decide as to whether the expenditure incurred is of a revenue nature or of a

capital nature. There is nothing on record, as indicated above, to show that a

capital asset was created. In sum, it fulfilled the criteria for allowability of

such expenditure, as provided, in Section 37 of the Act1

. The expenditure

was incurred for the subject AY and, therefore, the addition made by the

A.O. was rightly deleted by the CIT(A); a decision which was sustained by

the Tribunal.

9. Thus, for the foregoing reasons, we are of the view that both the

questions of law have to be answered in favour of the assessee and against

the revenue. It is ordered accordingly.

10. The appeal is disposed of in the aforesaid terms. Consequently, the

pending applications shall also stand closed.