Pre operative exp of revenue nature

This query is : Resolved

CA Tejas Andharia (Querist)
Follow

24 May 2013 A company was incorporated in FY 2011-12. Then the company has incurred during the year FY 2012-13 some expenses as audit fees, legal fees, bank charges etc. These are all revenue exp. But the company starts its operations in April-2013, so expenses incurred in FY 2012-13 are pre-operative (revenue) in nature. No income is there in FY 2012-13. All expenses incurred during FY 2012-13 satisfies the conditions of Section 37(1) of the I T Act, 1961. So may I show the total of them as loss in the return of income for FY 2012-13? so that I can set off the same in FY 2013-14 I T Return where they may be some profits.

Please give your opinion only if you have the reference of some section of I T Act, 1961 or some case law of similar nature.

Guest

Guest (Expert)

24 May 2013 You can follow this link to get your answer.

https://www.caclubindia.com/experts/amortisation-of-pre-operative-expenses-in-case-of-p-ltd-co-85406.asp

Message likes : 1 times

CA Tejas Andharia

CA Tejas Andharia (Querist)
Follow

25 May 2013 Thanks Mr. Ashish for the useful link.

Now section 3 of income tax act reads as "For the purposes of this Act, "previous year" means the financial year immediately preceding the assessment year :
Provided that, in the case of a business or profession newly set up, or a source of income newly coming into existence, in the said financial year, the previous year shall be the period beginning with the date of setting up of the business or profession or, as the case may be, the date on which the source of income newly comes into existence and ending with the said financial year."

Now I want to say that the company in my question is the trading company which does not require any capital assets installation etc. So, company can said to have commenced the business merely by making efforts for trading. There is no need to purchase and sale when they believe some deal to be non profitable, but the management actively ask for the rates of goods in market everyday, so constructively it can be said that the company has commenced the business. So, in my opinion, such a trading company can show the revenue nature expenses as valid business exp. and can claim them u/s. 37

What do you say?

Upgrade to CAclubindia Pro. Subscribe Now!

Asha Kanta Sharma

Asha Kanta Sharma

(Expert)
Follow

10 August 2024 To address your question regarding the treatment of pre-operative expenses and their potential claim under the Income Tax Act, 1961, here's a detailed explanation:

### **Treatment of Pre-Operative Expenses**

#### **1. **Understanding Pre-Operative Expenses:**

- **Pre-operative Expenses:** These are expenses incurred before the commencement of business operations. They include costs such as audit fees, legal fees, and bank charges that are related to setting up the company but do not directly generate income.

#### **2. **Tax Treatment of Pre-Operative Expenses:**

- **Section 37(1) of the Income Tax Act, 1961:** This section allows for the deduction of any expenditure (not being a capital expenditure) that is incurred wholly and exclusively for the purpose of the business. However, for new businesses, the deduction of pre-operative expenses might not be allowed in the year they are incurred if the business has not yet commenced.

- **Commencement of Business:** According to Section 3 of the Income Tax Act, the previous year is considered to be the financial year immediately preceding the assessment year. For a newly set-up business, the previous year starts from the date the business is set up and ends on March 31 of that financial year.

#### **3. **Claiming Pre-Operative Expenses:**

- **Deduction in the Year of Incurrence:** Generally, expenses incurred prior to the commencement of the business are not deductible in the year they are incurred. These expenses should typically be capitalized and amortized over a period of time, starting from the year the business commences.

- **Section 35D and 35DDA:** In some cases, pre-operative expenses can be amortized over a period of five years under Section 35D or 35DDA if they relate to the setting up of a business or project.

#### **4. **Treatment of Expenses if Business is Considered Commenced:**

- **Active Business Operations:** If the company is actively engaged in setting up its operations, even without generating revenue, the expenses incurred in setting up the business can sometimes be argued as necessary for the business and hence deductible. However, the Income Tax Department typically requires proof of actual commencement of business activities.

#### **5. **Claiming Expenses in the Year of Commencement:**

- **Inclusion in Profit and Loss Account:** The pre-operative expenses should generally be capitalized and then claimed as a deduction in the year the business commences. These expenses would be included in the profit and loss account of the first year in which the business starts operations.

### **Case Law and Provisions:**

1. **Case Law:**
- **CIT vs. R.M. Amin (1970):** The court held that pre-operative expenses should be capitalized and not claimed in the year they are incurred.

2. **Relevant Sections:**
- **Section 35D:** Allows amortization of preliminary expenses over a period of five years.
- **Section 35DDA:** Provides for amortization of expenses in respect of a business reorganization.

### **Steps to Follow:**

1. **Capitalization:** Capitalize the pre-operative expenses and record them as an asset on the balance sheet.

2. **Amortization:** Start amortizing these expenses from the year the business commences. The amortized amount can be claimed as a deduction in the profit and loss account.

3. **Documentation:** Maintain proper documentation and records to justify the expenses and their relevance to the commencement of business.

### **Summary:**

- **Pre-operative Expenses:** Generally, these should be capitalized and claimed as a deduction starting from the year the business commences operations.
- **Claiming in the Year Incurred:** If you claim these expenses in the year they are incurred, it may not be permissible unless the business is considered to have commenced as per the legal standards.

Consulting with a tax professional or accountant is advisable to ensure compliance with the tax laws and to accurately determine the treatment of pre-operative expenses.