It is quite natural that the promoters of a proposed company would normally incur expenses in the nature of preliminary expenses towards the incorporation of a company, which would be dealt as per the provisions stated under section 35D of the income tax Act before ascertaining the taxable income of the previous years commenced on or after the date of commencement of business. The nature of preliminary expenses is entirely different from the pre-operative expenses which would normally be incurred after the date of incorporation but before the date of commencement or setting up of the business of the company
The treatment of Preoperative expenses both under the income tax laws and the applicable accounting standards and practices is purely based on the nature of expenses and the date of incurrence as detailed below
1. If the pre-operative expenses are of revenue nature, the possibility of claiming those expenses under section 37 of the income tax Act is highly debatable because the Section 3 of the Income-tax Act clearly says that previous year begins only on the date of commencement of business ,and hence, any expenses incurred before the date of commencement of business cannot be considered as expenses incurred during the previous year under section 37 of the Act. Besides these revenue nature pre –operative expenses are not eligible as preliminary expenses under the Income tax Act because the nature of preoperative expenses would not fit into the definition of Preliminary expenses as defined under section 35D of the Income tax Act.
2. We are now asking ourselves that what would be the fate of those revenue pre-operative expenses incurred before the date of commencement or setting up of the business .Could it be totally ignored while computing the taxable income of the assessee by assuming it as Sunk Cost. If we totally ignore those revenue nature pre-operative expense while concluding the income tax memo by treating it as sunk costs, or in other words if the carry forward loss resulted in the particular financial year (which precedes the actual date of commencement or setting up of the business), after having charged all these revenue nature pre-operative expenses in profit and loss of the year, is totally ignored while filing income tax return of the company without claiming eligible carry forward loss in the return of income filed with the tax authority, the promoters of the company would simply question the logic behind treating these revenue pre-operative expenses as sunk because whatever amount spent for the business prior to commencement should have been either treated as business expenses while concluding the income tax return of the company which might resulted into carry forward business loss or considered as expenses of capital nature incurred towards acquisition of assets or completion of any construction activity during the year.
3. As explained above treating the preoperative expenses as business expenses either under section 37 or 35D of the Income tax Act would not be tenable because of the reason which is stated as above ,i.e., expense incurred after incorporation but prior to the date of commencement of setting up of the business would not fall under the definition of previous year as defined under section 3 of the Act, the only option available in the hands of company is to treat these revenue pre-operative expenses as expenses which are eligible to be apportioned among all relevant assets acquired in the relevant years, but before doing so we need to consider the relevant provisions of AS 10 which states in the Paragraph 9.2 of AS 10, Administration and other general overhead expenses are usually excluded from the cost of fixed assets because they do not relate to a specific fixed asset, however, in some circumstances, such expenses as are specifically attributable to construction of a project or to the acquisition of a fixed asset or bringing it to its working condition, may be included as part of the cost of the construction project or as a part of the cost of the fixed asset. So all the revenue pre-operative expenses may not necessary be the expenses incurred towards acquisition of fixed asset or bringing it to its working condition ,and hence we need to establish before apportioning the pre-operative expenses among all the assets that the pre-operative expenses are such that these have been incurred towards acquisition of fixed asset or bring it to its working condition, otherwise it would be dealt differently at the time of income tax assessment by the assessing officer
4. Pre-operative expenses of capital nature would be straight away eligible as expenses incurred towards construction of a project or acquisition of assets without much debate on its capitalisation .
5. The logic behind treatment of pre-operative revenue expenses as sunk as explained above, after having debited these expenses into the profit and loss account of the company during the financial year which precedes the date of commencement of business, without claiming the right of carry forward of business loss which might happen because of charging in or routing these pre-operative expenses through the profit and loss account , would not match with the underlying object ,intended to be served , which would be similar to the object that is being served by the income tax provision contained in the section 35D which supports claim of the preliminary expenses thereunder. That is , the intention of law makers allowing the assessee to charge the preliminary expenses incurred prior to the date of incorporation in the profit & loss account over the period of 5 previous years ,which would normally commence on or after the date commencement of business, notwithstanding the fact that those claimable preliminary expense having been incurred during the financial year which would not strictly fall under the definition of previous year as defined under section 3 of the Income tax Act could be easily understandable in the sense that the assessees should not be deprived of their inherent right of claiming the genuine business related expenses irrespective of these expense incurred prior to the date of incorporation while finalising the taxable returnable of income of the years commenced after the date of commencement or setting up of the business as per the applicable income tax provisions stated under sections 30-47 of the Income tax Act
6. Even though the allowability of pre-operative expense as a genuine business expenditures under section 37 is highly contentious one , there would be a remote possibility of claiming it as business expenditure either prior to or after the date of commencement if we could substantiate the intended purpose of laws as interpreted above by stretching the income tax provisions contained in the section 37 of the income tax beyond the limited purposes meant to be served ; but claiming the pre-operative expenses as expenses incurred towards the acquisition of fixed assets or construction of an activity as explained above would not lead to much debate as compared to claiming it under section 37 of the Income tax Act
Article for CA Club by CA. Vaiyapuri Kannan. R ,
B.Com . FCA, ACS, ACMA,
Chennai
CAclubindia
