Short Overview : Income earned during trial run is to be adjusted against pre-operative expenses and not to be added to total income.

During the assessment on the perusal of details of the expenses the assessee has shown work-in-progress (WIP). The assessee has reduced Rs. 3,69,06,885 from WIP on account of unbilled revenue from Gujarat Urja Vikas Nigam. The AO issued show cause notice to assessee to explain as to why this receipt be treated as ‘income from other sources’. The assessee filed its detailed reply and stated that the amount was earned during the testing period and is not taxable as income and has been correctly reduced from WIP.

It is held that : The income generated during trial run does not arise as the commercial operation of the assessee was not started during the period of trial and hence, the same was rightly reduced from WIP.

Decision: In assessee’s favour.

Followed: M/s. Eco Axis Systems (P) Ltd.-ITA No. 730/Mum/2013, dated 10-8-2018 for assessment year 2008-09.

IN THE ITAT, MUMBAI BENCH

PAWAN SINGH, J.M. & M BALAGANESH, A.M.

Solarfield Energy (P) Ltd. v. ITO

ITA No. 5189, 5190/Mum/2016

16 July, 2019

Appellant by: J.D. Mistry Sr. Advocate with Niraj Sheth Advocate and Dhrumil Shah CA

Respondent by: Satish Rajore Sr. Departmental Representative

Pawan Singh, A.M.

These two appeals by the assessee are directed against the order of Commissioner (Appeals)-6, Mumbai, dated 15-6-2016 & 31-5-2016 pertaining to assessment year 2012-13. Appeal in ITA No. 5189/Mum/2016 relates to assessment order passed under section 143(3), dated 26-3-2015, however, ITA No. 5190/Mum/2016 arising against the order passed on the rectification application filed under section 154 of the Act. In both the appeals the assessee has raised common grounds of appeals, therefore, both the appeals are heard and are decided by common order. The grounds of appeal taken by the assessee in ITA No 5189/Mum/2015 read as follows :–

“1: 0 Re: Interest on fixed deposits of Rs. 15,68,804 (mentioned in the assessment Order as Rs. 75.75.525) reduced from the capital-work-in-progress considered as taxable :–

1.1 The Commissioner (Appeals) has erred in confirming the action of the assessing officer in holding that the amount of Rs. 15.68,804 (mentioned in the assessment Order as Rs. 15,75.S25) being the interest earned on fixed deposits reduced from the capita I-work-in-progress as taxable.

1.2 The Appellant submits that considering the facts and circumstances of its case and the law prevailing on the subject the interest earned on fixed deposits is a capital receipt not exigible to tax and the Commissioner (Appeals) ought to have held as such.

1.3 The Appellant submits that the assessing officer be directed to delete the addition so made by him and to re-compute its total income and tax thereon accordingly.

2. Re.: Testing period revenue of Rs. 3,69,06,8557 reduced from the capital-work-in-progress considered as taxable :–

2.1 The Commissioner (Appeals) has erred in confirming the action of the assessing officer in holding that the testing period revenue of Rs. 3,69,06,8557 reduced from the capital-work-in-progress was part of its total income for the year.

1.2 The Appellant submits that considering the facts and circumstances of its case and the law prevailing on the subject the testing period revenue of Rs. 3,69,06,8557 is a capital receipt correctly deducted by it from the capital-work-in-progress and the Commissioner (Appeals) ought to have held as such.”

2. Briefly stated, the facts are that the assessee is engaged in the business of generation of solar power. The assessee is a subsidiary company of M/s. Kiran Energy Solar Power (P) Ltd. having 100% holding. The assessee filed its e-return of income for assessment year 2012-13 on 28-9-2012 declaring total income at Nil and current loss at Rs. 12,31,673. The assessment was taken up for scrutiny and assessment under section 143(3) was completed on 26-3-2015 determining the total income at Rs. 3,52,72,490 by making addition as per income based on AIR information being interest on fixed deposits with HDFC Bank amounting to Rs. 15,75,525 and unbilled revenue amounting to Rs. 3,31,98,969. Aggrieved, assessee carried the matter before Commissioner (Appeals). The appeal of the assessee did not find favour with the learned Commissioner (Appeals), who confirmed both the additions. Further, aggrieved by the order of learned Commissioner (Appeals), the assessee is before us, in this appeal.

3. We have heard the submissions of the learned Authorised Representatives (AR) for the assessee and the learned Departmental Representatives (Departmental Representative) for the revenue and gone through the orders of the lower authorities. Ground No. 1 relates to addition on account of addition on account of interest on fixed deposit reduced from work in progress. The learned Counsels appearing for the assessee, at the outset, submitted that this issues is covered in favour of the assessee by the decisions of the Tribunal in assessee’s group case in Solarfield Energy Two (P) Ltd. in ITA No. 5076/Mum/2016, dated 11-9-2017 for assessment year (AY) 2012-13. The learned Authorised Representatives for the assessee submits that the revenue has accepted the decision of the Tribunal and has not file appeal before Bombay High Court.

4. The learned Departmental Representative for the revenue after going through the contents of the decision in Solarfield Energy Two (P) Ltd. (supra), though principally agreed that identical ground of appeal was decided by the Tribunal in assessee’s group case in Solarfield Energy Two (P) Ltd. (supra). The learned Departmental Representative for the revenue submits that he supports the order of the lower authorities.

5. We have considered the submissions of the parties and perused the material on record. We have seen that issue pertaining to addition of interest on fixed deposit with HDFC Bank, is squarely covered the decision of the Tribunal, Solarfield Energy Two (P) Ltd. (supra). We also find that the facts for the year under consideration are pari materia with the facts considered by Tribunal in Solarfield Energy Two Ltd. (supra). The coordinate bench of Tribunal in Solarfield Energy Two (P) Ltd. (supra), after considering the judgment of the Hon’ble Supreme Court in the case of Tuticorin Alkali Chemicals and Fertilizers Ltd. v. CIT (1997) 227 ITR 172 (SC) : 1997 TaxPub(DT) 1304 (SC), has passed the following order :–

8. We have heard rival contentions and perused the material available on record in the light of decisions relied upon. We have also applied our mind to the decisions relied upon. Undisputed facts are, the assessee was awarded the work of setting-up of Solar Power Plant project in Rajasthan by NWIML. It is also evident, NWNL has entered into a power projects agreement with the assessee on 25-1-2012. As per the terms and conditions stipulated in the bid one of the financial criteria in Request For Selection (RFS) document requires a newly incorporated company to have the required net worth connected to the capacity of the power project. Thus, as per the pre-condition, the assessee was required to have the net worth of 60 crore. Since, the assessee was not having the required net worth it had to infuse fund for enabling itself to meet the qualification criteria and for this purpose, assessee’s parent company KESPPL stepped in and invested fund in acquiring 98,500 equity shares and 1,00,000 compulsorily convertible preference shares of the assessee company, thereby, enabling the assessee to have the required net worth. Thus, as could be seen, the infusion of fund was integrally and inextricably connected with the setting-up of the power project. As evident from the facts on record, out of the funds available with the assessee from issue of equity shares an amount of 40 crore was temporarily parked in fixed deposit with HDFC Bank Ltd. on 1-3-2012, since, wasn’t immediately required for implementation of the power project. It is also evident that the assessee only on 29-5-2012, entered into a EPC contract with Larsen & Toubro Ltd. for developing the 20 MW Solar Photo Voltaic Power Plant. These facts clearly demonstrate, the funds required for setting up of power project was temporarily parked in fixed deposit, thereby, indicating that the interest earned on such fixed deposit has an immediate and proximate nexus with the setting-up of power project. Notably, the Departmental Authorities have rejected assessee’s claim that the interest earned is a capital receipt relying upon the decision of the Hon’ble Supreme Court in Tuticorin Alkalj Chemicals and Fertilisers Ltd. (supra). On a careful reading of the said judgment, we are of the view that the ratio laid down therein will not apply to the facts of the present case. In the case of Tuticorin Alkali Chemicals and Fertilisers Ltd. (supra), the assessee has borrowed funds for setting up of a plant. However, the surplus fund available out of the borrowed fund was invested in fixed deposit and assessee earned interest. The Department held that the interest earned from fixed deposit on investment of surplus fund during the preconstruction period is assessable as income from other sources.

However, the Hon’ble Supreme Court in case of Bokaro Steels Ltd. (supra) took note of the decision In Tuticorin A/kali Chemicals and Fertilisers Ltd. (supra) referred to by the Departmental Authorities.

Further, the Hon’ble Supreme Court took note of the decision of the Hon’ble Supreme Court in Challapalli Sugars Ltd. v. CIT, (1995) 98 ITR 167 (SC) : 1975 TaxPub(DT) 275 (SC) wherein it was held that accepted accountancy rule for determining cost of fixed deposit is to include all expenditure necessary to bring such assets into existence and to pay them in working condition. In case money Is borrowed by newly started company which is in the process of constructing and erecting its plant, the interest incurred before the commencement of production on such borrowed money can be capitalized and added to the cost of fixed asset created as a result of such expenditure. Following the aforesaid reasoning, the Hon’ble Supreme Court in Bokaro Steels Ltd. (supra) held that by applying the same reasoning if the assessee receives any amounts which are inextricably linked with the process of setting-up of plant and machinery such receipts will come to reduce the cost of its assets, hence, are of capital nature. The ratio laid down by the Hon’ble Supreme Court in Bokaro Steels Ltd. (supra) was followed by the Hon’ble Delhi High Court in Indian Oil Panipat Power Consortium Ltd. (supra). The facts of this case are, the assessee a joint venture company was to set-up a power project to effectuate the purpose for which joint venture was created. The joint venture partners contributed share capital which included a sum by way of additional share capital. The said fund, though, was required for purchase of land and development of infrastructure, however, due to legal entanglement with regard to title of land, the funds were temporarily invested in fixed deposit with bank earning interest thereon. The assessee claimed such interest as capital receipt and set it off against pre-operative expenditure. However, the assessing officer assessed the interest as income from other sources.

The learned Commissioner (Appeals) having found that interest earned was inextricably linked with the setting-up of the power plant allowed the claim of the assessee following the decisions of the Hon’ble Supreme Court in Bokaro Steels Ltd. (supra). However, while deciding Department’s appeal, the Tribunal followed the decision in Tuticorin Alkali Chemicals and Fertilisers Ltd. (supra) and reversed the order of the learned Commissioner (Appeals), When the matter came up before the High Court, the High Court following the decision of the Hon’ble Supreme Court in Bokaro Steels Ltd. (supra) held that, since, the interest income was inextricably linked to the set-up of power project, it will be a capital receipt and will come to reduce the cost of the project and accordingly allowed assessee’s claim. In our view, the ratio laid down in case of Bokaro Steels Ltd. (supra) and Indian Oil Panipat Power Consortium Ltd. (supra) are squarely applicable to the facts of the present case. Undisputedly, in case of assessee, the funds invested temporarily in the fixed deposit were for the purpose of setting-up of the power project. Therefore, the interest earned is inextricably linked with the power project The other decisions relied upon by the learned Sr. Counsel including the decision in case of CIT v. Karnal Cooperative Sugar Mills Ltd. (supra) express similar view. That being the case, applying the ratio laid down in the decisions referred to above, we hold that the interest earned on fixed deposit is capital receipt and has to be set-off against pre-operatives expenditure thereby will go to reduce the cost of CWIP. Ground raised is allowed.”

6. The issue and the governing facts for the year under consideration are find to be identical to the issue decided by the Tribunal in Solar Field Energy Two (P) Ltd, a sister concern of the assessee. Therefore, consistent with the view taken by the Tribunal in the case of Solarfield Energy Two (P) Ltd. (supra), we allow the ground raised by the assessee.

7. Ground No. 2 relates to testing period revenue of Rs. 3,69,06,855. The learned AT for the assessee submits that this ground of appeal is also covered in favour of the assessee by the decisions of the co-ordinate in the following cases :–

1. M/s. Eco Axis Systems (P) Ltd.-ITA No. 730/Mum/2013, dated 10-8-2018 for assessment year 2008-09,

2. M/s. A.D. Hydro Power Ltd.-ITA No. 5007/Del/2015, dated 10-10-2018 for assessment year 2011-12,

3. Gujarat State Fertilizers & Chemicals Ltd.-ITA No. 3228/Ahd/2003, dated 28-8-2009 for assessment year 1999-2000,

8. On the other hand the learned Departmental Representative for the revenue has relied on the orders of the lower authorities. The learned Departmental Representative for the revenue further submits that the income received by the assessee before commencement of the business has to be assessed as income from ‘ other sources’ and cannot be treated as ‘business income’.

9. We have considered the submission of the parties and have gone through the order of the authorities below. During the assessment on the perusal of details of the expenses the assessee has shown work in progress (WIP). The assessee has reduced Rs. 3,69,06,885 from WIP on account of unbilled revenue from Gujarat Urja Vikas Nigam. The assessing officer issued show cause notice as to why this receipt be treated as ‘income from other sources’.

The assessee filed its detailed reply and stated that the amount was earned during the testing period and is not taxable as income and has been correctly reduced from WIP. The reply of the assessee was not accepted by assessing officer by taking view that the assessee itself stated that business has not commenced. However, the assessing officer allowed Rs. 37,07,886 being professional fee as deduction. Before learned Commissioner (Appeals) the assessee urged that as per term of EPC Contract, M/s. Larson & Turbo was required-to carry out test on commencement of the plant. In the event of failure the assessee has a right to reject the plant or ask the contractor to correct it. The purpose to carry out test was to ascertain whether the facility (i.e. Solar Plant) achieves the target performance-in accordance with the term of the contract. During the test trial the plant was connected with Gujarat Power Grid on 4-3-2012. These tests were pending to be completed as on 31-3-2012. The assessee eventually capitalised the solar power in its books of accounts on 9-7-2012 after taking the plant from EPC Contractor on completion of work and necessary performance of tests in accordance with specifications of the contract.

Accordingly it was canvassed that the assessee has not started their business in that year. The contention of the assessee was gain not acted by learned Commissioner (Appeals) holding that the income received by the assessee before the commencement of business has to be assessed as income from “other sources” and it cannot be held as non-taxable on the ground that it would go to reduce the capital work in progress. We have noted that on similar grounds of appeal the coordinate bench of Tribunal in Eco Axis System (P) Ltd. (supra) passed the following order :–

8. Having considered the facts of the case in totality, we find that the Revenue has not doubted the development of products by the assessee and allowed capitalization of expenses but at the same time the Revenue has chosen to treat the sale of demo machines to the tune of Rs. 59,20,849 and recovery of rent amounting to Rs. 64,200 as revenue receipt and added the same to the income of the assessee after allowing the expenses of Rs. 14,75,5537. The case of the assessee also finds support from the Guidance Notes issued by the Institute of Chartered Accountants of India on treatment of expenditure during construction period, which provides that if any revenue is realized during the trial run or product development stage, the same should be set off against the expenditure incurred in connection with the said project/products. The case of the assessee is also squarely covered by the decisions relied upon by the learned Authorised Representatives. In the case of International Seaports (Haldia) (P) Ltd. v. ITO (supra), the co-ordinate Bench has held as under :–

8. We have heard rival contentions of both the parties and perused the materials available on record. The learned Authorised Representatives submitted the paper book which is running from pages 1 to 113 and highlighted that to make the berth ready for commercial operations the assessee was to undertake the responsibility of completing the work in accordance to the agreement of building the berth 4A. As per the agreement trial run was the precondition before the start of the commercial operation. The assessee treated the trial run of vessels as ‘preoperative handling of the plant and income generated from such preoperative handling has been treated as ‘preoperative income’. In the books of account of the assessee for the previous year relevant to the assessment year under dispute, such preoperative income has been set off against the preoperative expenses of Rs. 3,17,02,632, which consisted of berth hire charges in the sum of Rs. 16,84,562 and Rs. 3,00,18,070 being cargo handling charges and the balance amount was capitalized to be apportioned to fixed asset. The specious finding of the assessing officer that loading and unloading of cargo during the period from 7-12-2003 to 13-1-2004 on trial basis was commercial activity of the assessee and the receipts earned there from was assessed as income from business which is totally untenable and inconsistent with the facts of the case since it was done at the behest of the Holdia Dock Complex authorities in order to establish the stability of the berth. It is an admitted fact that even during a period of test runs and experimentation, a plant may be engaged in actual production, but until the test runs are completed and the plant is properly adjusted on the basis thereof, it cannot be said to be ready for “commercial production”. The expression “Commercial Production” refers to production in commercially feasible quantities and in a commercially practicable manner.

Further, it is a correct and accepted procedure to capitalize all expenses incurred during construction period and in connection with the process of start-up and commissioning of the plant. In fact, such expenses would be incurred in order to bring the plant up to the stage at which it can commence commercial production. Thus, it is correct to capitalize the expenditure incurred on start-up and commissioning of the plant The expenditure so incurred, therefore, should be capitalized in the same way as other indirect construction expenditure. In the present context, therefore the expenditure incurred during trial run contributes to construction of the facilities at Berth No. 4A of Haldia Dock Complex as trial run activity is regarded as an activity which is necessary to prepare the asset for its intended use. This is because flaws in the facilities at Berth noticed during trial run operation are rectified to bring the Berth to its intended use.

Therefore, the expenditure incurred during trial run towards building/constructing the Berth should also be capitalized as per the requirements of Accounting Standard 166. It is also an undisputed fact that operation of cargo/vessel during trial run was directly linked with the building up of facilities in the Berth No. 4A of Haldia Dock Complex. Hence, any income earned on such operation during trial run was incidental to the building of assets for setting up the Berth.

Therefore, income earned during preoperative stage was a capital receipt, which would go to reduce the cost of asset and it is settled that the deposit of money was directly linked with the purchase of plant and machinery. Hence, any income earned on such deposits was incidental to the acquisition of assessee for setting up the plant and machinery. Thus, the interest was a capital receipt which would go to reduce the cost of the asset and learned Authorised Representatives relied on the decision of Hon’ble Supreme Court in the case of CIT v. Karnal Co-operative Sugar Mills Ltd. (2000) 243 ITR 2 (SC) : 2000 TaxPub(DT) 625 (SC) and CIT v. Bokaro Steel Limited. (1999) 236 ITR 315 (SC) : 1999 TaxPub(DT) 1094 (SC)

9. From the aforesaid discussion, we find that the assessee has made some income during the period of trial run and the same was adjusted against the pre-operative expenses. The assessing officer rejected the working of assessee and held that the income generated during the trial run income period cannot be adjusted against the preoperative expenses and the same was confirmed by the learned Commissioner (Appeals). However, we observe that it was the condition in the agreement that the trial run has to be carried out before the beginning of commercial operation. The learned Authorised Representatives drew our attention on pages 17,18,19,20,21 of the Paper Book where the requirement for the trial run was requested before the beginning of actual operation. The purpose of the trial run was to check whether there is any flaw in the system or not so that remedial action can be taken well in time in the event of any flaw in the system. So it is clear that the purpose of the trial run was to check the flaw in the system and not to begin the commercial operations. In the instant case the trial run was successfully completed on, dated 13-1-2004 without any flaw in the system.

Therefore the commercial operation began immediately thereafter on, dated 15-1-2004. Now the question here arises that in case of any flaw caught during the trial run then in that event certainly the commercial operation shall only begin after the removal of the flaw.

In view of this the income generated during trial run shall certainly be adjusted against the pre-operative expenses. Having said this we are inclined to reverse the order of the learned Commissioner (Appeals) and direct the lower authorities to adjust the trial run income from preoperative expenses of the assessee. We are relying on the judgment of the Delhi High Court in the case of CIT v. Nestor Pharmaceutical Limited (2010) 322 ITR 631 (Delhi) : 2010 TaxPub(DT) 1239 (Del-HC) where it was held that :–

“The assessee was in the business of manufacture of pharmaceutical formulation in bulk drugs and supplying drugs to the Government hospitals, institutions besides selling the product in domestic and foreign markets. It claimed the benefit under section 80-IA/80-IB of the Income Tax Act, 1961. It carried out trial production from 20-3-1998. On that basis the assessing officer treated the assessment year 1998-99 as the initial year for the benefit claimed and since this benefit was allowable for five years, according to the assessing officer, this benefit was admissible from the assessment year 1998-99 to the assessment year 2002-03. The assessee on the other hand claimed the benefit from the assessment years 1999-2000 to 2003-04. The plea of the assessee was that trial production did not amount to manufacture of its products. It was only when commercial production commenced, which, according to the assessee, commenced only in the assessment year 1999-2000 that production commenced. The Commissioner (Appeals) confirmed the order of the assessing officer but the Tribunal reversed that order holding that section 80-IA/80-IB of the Act being beneficial legislation, the benefit should be extended to the assessee. It further held that as on 20-3-1998 only trial production started which was different from commercial production and the benefit of that section should be allowed in the year in which commercial production started, i.e. in the assessment year 1999-2000 and therefore, would be extendable up to the assessment year 2003-04. On appeal :–

Held, that the initial assessment year, for the purpose of section 80-IA, was the assessment year relevant to the previous year in which the “industrial undertaking begins to manufacture or produce articles or things”. The trial production began on 20-3-1998, as per the details given in the audit report furnished by the assessee along with its returns of income for the assessment years 2003-04 and 2004-05.

There was no dispute that the first sale was made on 23-4-1998, which would be the period relevant to the assessment year 1999-2000. Merely because some closing stock was shown as on 31-3-1998, that would not lead to the conclusion that there was commercial production as well. Even for the purpose of trial production material would be needed and there would be production which would result in stock of finished goods. The evidence produced by the assessee was accepted by the tribunal as well, from which it was clear that there was only a trial production in the assessment year 1998-99 and commercial and full-fledged production commenced only in the year 1999-2000. The order of the Tribunal allowing the benefit of deduction under section 80-IA/80IB of the Act from the assessment year 1999-2000 treating it as the initial year of production to the assessment year 2003-04 was correct in law.

The Tribunal held that the assessee had not only produced the goods for trial purposes but there was, in fact, sale of one water cooler and air-conditioner in the assessment year 1998-99 relevant to the previous year/financial year 1997-98. The explanation of the assessee was that this was done to file the registration under the Excise Act as well as the Sales Tax Act. The Tribunal held that the sale of one water cooler and one air-conditioner as on 31-3-1998, for the purpose of obtaining registration of excise and sales tax was manufacture within the meaning of section 80-IA, On appeal :–

Held, that the assessee had sold one water cooler and one air-conditioner before April, 1998. Thus, the stage of trial production had been crossed and the assessee had come out with the final saleable product which was in fact sold as well. The quantum of commercial sale would be immaterial. With sale of those articles marketable quality was established, more particularly when the assessee failed to show that the dealer returned those goods on the ground that there was any defect in the water cooler or air-conditioner produced and sold by the assessee to the dealer, The Tribunal, in the circumstances, was right that the two types of conditions stipulated in section 80-IA were fulfilled with the commercial sale of the two items in that assessment year. Whether the purpose of that sale was to obtain registration of excise or sales tax would be immaterial.”

The Bombay High Court has also decided the similar issue in favour of assessee in the case of CIT v. Hindustan Antibiotics Ltd. (1974) 93 ITR 548 (Bom) : 1974 TaxPub(DT) 251 (Bom-HC) and relevant extract of the order is reproduced below :–

“The word “articles” used in the express/on “has begun or begins to manufacture or produce articles “in section 15C(2)(ii) must be interpreted regard being had to the object for which the section was enacted. The provision was enacted with a view to encouraging the establishment of new industrial undertakings and the object was sought to be achieved by granting exemption from tax on profits derived from such undertakings during the first five years. The object of the section presupposes that profits are capable of being earned.

Hence, until an assessee reaches a stage where it is in a position to decide that a final product which can be ultimately sold in the market can be manufactured it cannot be said to have started manufacture of the articles. If it becomes necessary for an assessee to produce a trial product at an earlier stage to verify whether it can be used ultimately in the manufacture of the final article, the commencement of operation for the manufacture of the trial product would not constitute commencement of manufacture of articles for the purposes of section 15C

The assessee-company undertook a project for the manufacture of penicillin. It started actual operations for the manufacture of crude penicillin in December 1954, The first samples of crude penicillin were required to be sent to U.S.A. and U.K. for obtaining certificates as to their qualities. The certificates were obtained in June, 1955, and the assessee started regular production of sterile penicillin, the only product that could be sold in the market, in August, 1955. On the question when the manufacture of sterile penicillin had started and whether the assessee was entitled to the exemption under section 15C for the assessment year 1960-61 :–

Held, on the facts, that product/on of articles by the assessee had begun only in August, 1955. The benefit of the exemption under section 15C arose to the assessee for the first time in the assessment year 1956-57 and, therefore, it was entitled to the exempt/on under sect/on 15C for the assessment year 1960-61 also.”

10. We also further observe that the facts of the case law cited by the assessing officer i.e. Tutikorin Alkali Chemicals & Fertilizers Ltd. (supra) for treating the receipts of trial run as bus/ness receipt are different from the facts of the instant case. The Apex Court in the said case has treated the interest income on the surplus fund as income from other sources because there was no nexus between the activity of the assessee and interest income. The assessee has invested idle fund for short period of time before the commencement of the business.

There was no connection between interest income and the business of the assessee. The interest income was independent and separate from the business of the assessee. However in the instant case the income generated during trial run is very much connected with the business of the assessee hence the question of recognizing the income does not arise as the commercial operation has not began. In view of above we reverse the order of the learned Commissioner (Appeals) and allow the appeal of the assessee.”

Similarly, in the case of Gujarat State Fertilizers & Chemicals Ltd. (supra)/the co ordinate Bench has held as under :–

“6. We have heard both the parties and gone through the facts of the case. Undisputedly of Ammonia-IV plant was under trial production during the year under consideration and the commercial production is yet to commence. Therefore, as concluded by the learned Commissioner (Appeals), the claims have to be considered, holding the Ammonia-IV Plant to be at the pre-commencement stage. It is well settled that under the accounting practices, all expenditure including interest cost incurred during the project construction period are accumulated and disclosed as capital work-in-progress until the assets are ready for commercial use.

Income earned from investment of surplus borrowed funds during construction/trial run period is reduced from capital work-in-progress for accounting purposes while expenditure/income arising during trial run is added to/reduced from capital work-in-progress. Hon’ble Apex Court in the case of Bokaro Steel v. CIT, (1999) 236 ITR 315 (SC) : 1999 TaxPub(DT) 1094 (SC) held that if the assessee receives any amount which are inextricably linked with the process of setting up its plant and machinery, such receipts would go to reduce the costs of assets and would be receipt of a capital nature, which cannot be taxed. In the case under consideration, undisputedly and as found by the learned Commissioner (Appeals), the plant is under testing for its efficiency prior to commencement of commercial production and the inputs and outputs have already been netted by GSFC and the net result has been capitalized. Considering the facts and circumstances of the case and the guidelines of the ICAI, we are in agreement with the learned Commissioner (Appeals) that any attempt to tax the production, which is already accounted for as input for the fertilizer plant and the captive inputs of other units utilized in Ammonia IV Plant, if not allowed to be set off against the production of the plant, would lead to a distorted picture of the accounts of M/s. GSFC, In these circumstances, especially when Revenue have not placed before us any material contrary to the aforesaid findings of the id. Commissioner (Appeals) in so far as addition of Rs. 10,99,25,676 is concerned nor pointed out any contrary decision, we have no hesitation in upholding the findings of the learned Commissioner (Appeals) while relying upon the decision of the Hon’ble Apex Court in Bokaro Steel Ltd. Therefore, ground no. 1 in the appeal of the Revenue is dismissed.

Besides, the assessee has also capitalized out of the Capital Work-in progress account in the next year as is apparent from the tax audit report filed by the assessee before us. Under these circumstances, we are not in agreement with the conclusion drawn by the Commissioner (Appeals) that the receipts from sale of 3 Alygn Machines amounting to ? 59,20,8497-and rent of f 64,200 received during the trial/demo run is revenue in nature.

Accordingly, we set aside the order of the Commissioner (Appeals) and direct the assessing officer to a/low deduction of the said receipts by way sale of machines and rent from the Product Development Expenditure Account. We order accordingly.”

7. Similarly, the Delhi Tribunal in the case of ACIT v. M/s. A.D. Hydro Power Ltd. in ITA No. 5007/Del/2015 for assessment year 2011-12 vide Order, dated 10-10-2018, after considering the judgment of the Hon’ble Supreme Court in the case CIT v. Bokaro Steel Ltd. (1999) 236 ITR 315 (SC) : 1999 TaxPub(DT) 1094 (SC), held as follows :–

“7. After considering the rival submissions made by the parties and on perusal of the relevant finding given in the impugned order, we find that, it is an undisputed fact that assessee has shown income of Rs. 3,16,68,000 pertaining to income from sale of power during trial run period has been adjusted from the expenditure incurred during construction/trial period from 17-7-2010 to 28-7-2010 amounting to Rs. 4,90,42,000 pending capitalisation. Assessing officer on one hand has added the income and on the other hand treated the corresponding expenditure as capital. We are unable to appreciate the action of the assessing officer in adding the receipts of Rs. 3,16,68,0007-as income, because if the expenses before the commencement of the business are added to the cost of assets and allowed to be capitalised then how the corresponding income from the commercial production is treated as revenue. It is also capital in nature which has to be reduced accordingly. This principle has been reiterated by the Supreme Court in the case of CIT v. Bokaro Steel Limited (1999) 236 ITR 315 (SC) : 1999 TaxPub(DT) 1094 (SC), wherein it has been held that if the assessee receives any amount which are inextricably linked with the process of setting up its plant and machinery, then such receipts will go to reduce the cost of its assets and would be receipts of a capital nature and cannot be taxed. We are of the view that, if income of Rs. 3.16 crore earned during the trial period is treated as income then corresponding expenses of Rs. 4.90 crore incurred during the trial period should also be allowed as revenue expenditure by applying the matching concept, which as discussed above will result in net loss of Rs. 1.74 crores.

Thus, the addition made by the assessing officer is unsustainable in law and on facts and hence, we do not find any infirmity in the order of the learned Commissioner (Appeals) in deleting the addition and the same is affirmed.”

8. We further find that the Kolkata Tribunal in the case of International Seaports (Haldia) (P) Ltd. v. ITO in ITA No. 1194/Kol/2010 for assessment year 2004-05, dated 20-1-2016 for assessment year 2004-05 also considered an identical issue and held as under :–

“8. We have heard rival contentions of both the parties and perused the materials available on record. The learned Authorised Representatives submitted the paper book which is running from pages 1 to 113 and highlighted that to make the berth ready for commercial operations the assessee was to undertake the responsibility of completing the work in accordance to the agreement of building the berth 4A. As per the agreement trial run was the pre-condition before the start of the commercial operation. The assessee treated the trial run of vessels as ‘preoperative handling1 of the plant and income generated from such preoperative handling has been treated as ‘preoperative income*. In the books ‘of account of the assessee for the previous year relevant to the assessment year under dispute, such preoperative income has been set off against the preoperative expenses of Rs. 3,17,02,6327, which consisted of berth hire charges in the sum of Rs. 16,84,5627-and Rs. 3,00,18,0707 being cargo handling charges and the balance amount was capitalized to be apportioned to fixed asset. The specious finding of the assessing officer that loading and unloading of cargo during the period from 7-12-2003 to 13-1-2004 on trial basis was commercial activity of the assessee and the receipts earned there from was assessed as income from business which is total jlyjj untenable and inconsistent with the facts of the case since it was tone at the behest of the Holdia Dock Complex authorities in order to establish the stability of the berth. It is an admitted fact that even during a period of test runs and experimentation, a plant may be engaged in actual production, but until the test runs are completed and the plant is properly adjusted on the basis thereof, it cannot be said to be ready for “commercial production”. The expression “Commercial Production” refers to production in commercially feasible quantities and in a commercially practicable manner. Further, it is a correct and accepted procedure to capitalize all expenses incurred during construction period and in connection with the process of start-up and commissioning of the plant. In fact, such expenses would be incurred in order to bring the plant up to the stage at which it can commence commercial production. Thus, it is correct to capitalize the expenditure incurred on start-up and commissioning of the plant. The expenditure so incurred, therefore, should be capitalized in the same way as other indirect construction expenditure. In the present context, therefore the expenditure incurred during trial run contributes to construction of the facilities at Berth No, 4A of Haldia Dock Complex as trial run activity is regarded as an activity which is necessary to prepare the asset for its intended use. This is because flaws in the facilities at Berth noticed during trial run operation are rectified to bring the Berth to its intended use. Therefore, the expenditure incurred during trial run towards building/constructing the Berth should also be capitalized as per the requirements of Accounting Standard 166. It is also an undisputed fact that operation of cargo/vessel during trial run was directly linked with the building up of facilities in the Berth No. 4A of Haldia Dock Complex.

Hence, any income earned on such operation during trial run was incidental to the building of assets for setting up the Berth. Therefore, income earned during preoperative stage was a capital receipt, which would go to reduce the cost of asset and it is settled that the deposit of money was directly linked with the purchase of plant and machinery.

Hence, any income earned on such deposits was incidental to the acquisition of assessee for setting up the plant and machinery. Thus, the interest was a capital receipt which would go to reduce the cost of the asset and learned Authorised Representatives relied on the decision of Hon’ble Supreme Court in the case of CIT v. Karnal Co-operative Sugar Mills Ltd. (2000) 243 ITR 2 (SC) and CIT v. Bokaro Steel Limited (1999) 236 ITR 315 (SC) : 1999 TaxPub(DT) 1094 (SC).

9. From the aforesaid discussion, we find that the assessee has made some income during the period of trial run and the same was adjusted against the pre-operative expenses. The assessing officer rejected the working of assessee and held that the income generated during the trial run income period cannot be adjusted against the preoperative expenses and the same was confirmed by the learned Commissioner (Appeals). However, we observe that it was the condition in the agreement that the trial run has to be carried out before the beginning of commercial operation. The learned Authorised Representatives drew our attention on pages 17,18,19,20,21 of the Paper Book where the requirement for the trial run was requested before the beginning of actual operation. The purpose of the trial run was to check whether there is any flaw in the system or not so that remedial action can be taken well in time in the event of any flaw in the system. So it is clear that the purpose of the trial run was to check the flaw in the system and not to begin the commercial operations. In the instant case the trial run was successfully completed on, dated 13-1-2004 without any flaw in the system. Therefore the commercial operation began immediately thereafter on, dated 15-1-2004, Now the question here arises that in case of any flaw caught during the trial run then in that event certainly the commercial operation shall only begin after the removal of the flaw. In view of this the income generated during trial run shall certainly be adjusted against the pre-operative expenses. Having said this we are inclined to reverse the order of the learned Commissioner (Appeals) and direct the lower authorities to adjust the trial run income from preoperative expenses of the assessee. We are relying on the judgment of the Delhi High Court in the case of CIT v. Nestor Pharmaceuticals Limited (2010) 322 ITR 631 (Delhi) : 2010 TaxPub(DT) 1239 (Del-HC) where it was held that :–

“The assessee was in the business of manufacture of pharmaceutical formulation in bulk drugs and supplying drugs to the Government hospitals, institutions besides selling the product in domestic and foreign markets. It claimed the benefit under section 80-IA/80-IB of the Income Tax Act, 1961. It carried out trial production from 20-3-1998. On that basis the assessing officer treated the assessment year 1998-99 as the initial year for the benefit claimed and since this benefit was allowable for five years, according to the assessing officer, this benefit was admissible from the assessment year 1998-99 to the assessment year 2002-03. The assessee on the other hand claimed the benefit from the assessment years 1999-2000 to 2003-04. The plea of the assessee was that trial production did not amount to manufacture of its products. It was only when commercial production commenced, which, according to the assessee, commenced only in the assessment year 1999-2000 that production commenced. The Commissioner (Appeals) confirmed the order of the assessing officer but the Tribunal reversed that order holding that section 80-IA/80-IB of the Act being beneficial legislation, the benefit should be extended to the assessee. It further held that as on 20-3-1998, only trial production started which was different from commercial production and the benefit of that section should be allowed in the year in which commercial production started, i.e. in the assessment year 1999-2000 and, therefore, would be extendable up to the assessment year 2003-04. On appeal ;

Held, that the initial assessment year, for the purpose of section 80-IA, was the assessment year relevant to the previous year in which the “industrial undertaking begins to manufacture or produce articles or things”. The trial production began on 20-3-1998, as per the details given in the audit report furnished by the assessee along with its returns of income for the assessment years 2003-04 and 2004-05. There was no dispute that the first sale was made on 23-4-1998, which would be the period relevant to the assessment year 1999-2000. Merely because some closing stock was shown as on 31-3-1998, that would not lead to the conclusion that there was commercial production as well. Even for the purpose of trial production material would be needed and there would be production which would result in stock of finished goods. The evidence produced by the assessee was accepted by the tribunal as well, from which it was clear that there was only a trial production in the assessment year 1998-99 and commercial and full-fledged production commenced only in the year 1999-2000. The order of the Tribunal allowing the benefit of deduction under section 80-IA/80IB of the Act from the assessment year 1999-2000 treating it as the initial year of production to the assessment year 2003-04 was correct in law.

The Tribunal held that the assessee had not only produced the goods for trial purposes but there was, in fact, sale of one water cooler and air-conditioner in the assessment year 1998-99 relevant to the previous year/financial year 1997-98. The explanation of the assessee was that this was done to file the registration under the Excise Act as well as the Sales Tax Act. The Tribunal held that the sale of one water cooler and one air-conditioner as on 31-3-1998, for the purpose of obtaining registration of excise and sales tax was manufacture within the meaning of section 80-lA. On appeal :–

Held, that the assessee had sold one water cooler and one air-conditioner before April, 1998. Thus, the stage of trial production had been crossed and the assessee had come out with the final saleable product which was in fact sold as well. The quantum of commercial sale would be immaterial. With sale of those articles marketable quality was established, more particularly when the assessee failed to show that the dealer returned those goods on the ground that there was any defect in the water cooler or air-conditioner produced and sold by the assessee to the dealer. The Tribunal, in the circumstances, was right that the two types of conditions stipulated in section 80-1 A were fulfilled with the commercial sale of the two items in that assessment year.

Whether the purpose of that sale was to obtain registration of excise or sales tax would be immaterial.”

The Bombay High Court has also decided the similar issue in favour of assessee in the case of CIT v. Hindustan Antibiotics Ltd. (1974) 93 ITR 548 (Bom) : 1974 TaxPub(DT) 251 (Bom-HC) and relevant extract of the order is reproduced below :–

“The word “articles” used in the expression “has begun or begins to manufacture or produce articles “in section 15C(2)(ii) must be interpreted regard being had to the object for which the section was enacted. The provision was enacted with a view to encouraging the establishment of new industrial undertakings and the object was sought to be achieved by granting exemption from tax on profits derived from such undertakings during the first five years. The object of the section presupposes that profits are capable of being earned. Hence, until an assessee reaches a stage where it is in a position to decide that a final product which can be ultimately sold in the market can be manufactured it cannot be said to have started manufacture of the articles. If it becomes necessary for an assessee to produce a trial product at an earlier stage to verify whether it can be used ultimately in the manufacture of the final article, the commencement of operation for the manufacture of the trial product would not constitute commencement of manufacture of articles for the purposes of section 15C.

The assessee-company undertook a project for the manufacture of penicillin. It started actual operations for the manufacture of crude penicillin in December 1954. The first samples of crude penicillin were required to be sent to U.S.A. and U.K. for obtaining certificates as to their qualities. The certificates were obtained in June, 1955, and the assessee started regular production of sterile penicillin, the only product that could be sold in the market, in August, 1955. On the question when the manufacture of sterile penicillin had started and whether the assessee was entitled to the exemption under section 15C for the assessment year 1960-61 :–

Held, on the facts, that production of articles by the assessee had begun only in August, 1955. The benefit of the exemption under section 15C arose to the assessee for the first time in the assessment year 1956-57 and, therefore, it was entitled to the exemption under section 15C for the assessment year 1960-61 also.”

10. We also further observe that the facts of the case law cited by the assessing officer i.e. Tutikorin Alkali Chemicals & Fertilizers Ltd. (supra) for treating the receipts of trial run as business receipt are different from the facts of the instant case. The Apex Court in the said case has treated the interest income on the surplus fund as income from other sources because there was no nexus between the activity of the assessee and interest income. The assessee has invested idle fund for short period of time before the commencement of the business. There was no connection between interest income and the business of the assessee. The interest income was independent and separate from the business of the assessee. However in the instant case the income generated during trial run is very much connected with the business of the assessee hence the question of recognizing the income does not arise as the commercial operation has not began. In view of above we reverse the order of the learned Commissioner (Appeals) and allow the appeal of the assessee.”

9. In view of the above and being consistent with the earlier view taken by the co-ordinate benches of the Tribunal, we are of the view that the income generated during trial run does not arise as the commercial operation of the assessee was not started during the period of trial, thus, the ground of appeal raised by the assessee is allowed.

10. In the result, appeal filed by the assessee is allowed.

ITA No. 5180/Mum/2016 (against order under section 154)

11. The facts leading the file the present appeal are that on receipt of the assessment order passed under section 143(3), dated 26-3-2012, the assessee filed an application under section 154 of the Act, dated 27-10-205, contending that the additions made on account of interest income of Rs. 15,68,804 and addition of unbilled revenue are covered by the decision of Supreme Court in Bokaro Steel Ltd. (1999) 236 ITR 315 (SC) : 1999 TaxPub(DT) 1094 (SC). The application of the assessee was rejected by assessing officer. On further appeal before learned Commissioner (Appeals) the action of the assessing officer was sustained. Thus, further aggrieved the assessee has filed present appeal before Tribunal.

12. Considering the facts that we have already allowed the appeal of the assessee in ITA No. 5189/M/2017, therefore, the adjudication of the grounds of appeal raised in the present appeal has become academic.

13. in the result the appeal of the assessee is treated as allowed.