These two appeals, one filed by assessee against order of CIT(A), New Delhi, passed in Appeal No. 18/03-04, dt. 27th Oct., 2003 and other filed by Revenue against order of CIT(A), New Delhi, passed in Appeal No. 12/02-03, dt. 31st Oct., 2002 were heard together and are being disposed off by this single order for sake of convenience because issue involved in both appeals i.e. whether assessee is entitled to claim expenditure aggregating to Rs. 5,20,22,092 in asst. yr. 2000-01 and Rs. 5,31,22,080 in asst. yr. 1999-2000 is allowable as business expenditure under s. 37(1) of IT Act, 1961, is identical. Briefly stated, facts are that assessee filed return of income for asst. yr. 2000-01 declaring loss of Rs. 5,20,22,092 and loss of Rs. 5,31,22,080 in asst. yr. 1999-2000. assessee company is engaged in business of primary purpose grass roots exploration programme as laid down in memorandum of understanding signed on 26-10-1994 between assessee, BHPM & HZL. As per MOU, purpose of work was studying and identifying potential deposits of commercially viable minerals like lead, zinc, copper, gold and associated minerals within prospective geological terrains o f Rajasthan. After considering various clauses of MOU and after studying activities taken by assessee company, AO reached conclusion that work done was in nature of pre-feasibility studies and so after considering various clauses of MOU executed between assessee and HZL, AO held that from scope of project and profile of transactions, expenses were not allowable as business expenditure because same could be only considered as pre-commencement expenses. Thereafter, he disallowed loss claimed by assessee in both asst. yrs. 1999-2000 and 2000-01 under consideration before us. & 4. Aggrieved with orders of AO, assessee filed two separate appeals before CIT(A). CIT(A), in asst. yr. 2000-01, after considering submissions of assessee and examining terms of MOU between assessee and HZL, firstly came to conclusion that allowable expenditure on prospect of certain mineral was governed by s, 35E of Act and second on considering various case laws relied upon by assessee and AO, c m e to conclusion that expenditure incurred by assessee in exploration of minerals could only be allowed as per provisions of s. 35E/37 of Act i.e. when new company for commercial exploitation of minerals, comes into existence. Thereafter, CIT(A) concluding that as new company has not come into existence for above purpose so these expenses incurred by assessee were not allowable as deduction and so AO was justified in disallowing loss claimed by assessee. However, in asst. yr. 1999-2000, CIT(A) allowed expenditure claimed by assessee by making following relevant observations in his order: "I have considered issues brought in appeal. I am in agreement with appellant that order does not clearly bring out reasons as to why expenses were disallowed, even if they were considered to be pre- commencement expenses. case law cited by appellant, especially cases Franco Tosi Ingegneria (2000) 241 ITR 268 (Mad) and CIT vs. Seshasayee Brothers (P) Ltd. (1981) 20 CTR (Mad) 299: (1981) 127 ITR 218 (Mad), have been gone through. When issues therein are juxta positioned with facts of instant case, it appears that in this case also business had been set up, in fact had commenced. It appears that AO has been guided by terms pre-feasibility studies . In business of exploration, it is indeed necessary to carry out pre-feasibility studies. entire gamut of activities cannot start at one go. Unless pre-feasibility studies reveal viability of project and possibility of minerals being found, actual exploration cannot start. Thus concept of pre-feasibility is somewhat unique t o exploration business and may be somewhat akin to market research undertaken prior to start of actual business. But once results are positive, entire operation begins and accounts of pre-commencement period will merge with subsequent periods. I also have no doubt that business in this case had been set up at least when Reserve Bank of India had granted permission to allow setting up of Project Office in 1997, if not in 1994 when agreement was entered into with Hindustan Zinc Ltd. question thus is of allowing expenditure incurred in period between these two landmarks. In view of cases cited and peculiar nature of appellant s business, I am of view that expenses are allowable, even if it is pre-commencement of view that expenses are allowable, even if it is pre-commencement expenditure . It is also being kept in mind that this is third year of business being set up, and in earlier assessment years, Department has accepted returns, thereby allowing claim of expenditure and losses returned in asst. yrs. 1997-98 and 1998-99. There does not appear to be any justification for disallowing same in this year, and addition on account of same is therefore deleted and loss returned is directed to be carried forward." Before us, learned Authorised Representative for assessee, referring to pp. 32 to 38 of paper book, submitted that this MOU was executed between assessee and HZL on 26th Oct., 1994. He further submitted that, as per cl. 11 of this MOU at p. 35 of paper book, this entire expenditure regarding project was to be borne by assessee until completion of pre-feasibility study. Thereafter, each party was to contribute towards project expenditure in proportion to its participating interest. Then again referring to cl. 9 at p. 34 of paper book, Authorised Representative for assessee submitted that HZL was to simply provide assessee assistance for exploration. Participating interest of assessee, BHPM, and HZL would be in ratio of 60 per cent and 40 per cent respectively. He further contended that in instant case, assessee s business was set up in February, 1997 which is clear from letter issued by Reserve Bank of India placed at p. 28 of paper book which indicates that permission was granted to assessee to open project office in India to execute contract with HZL. He further contended that during asst. yrs. 1999-2000 and 2000-01, impugned expenditure incurred by assessee, after setting up of business of assessee, was allowable to assessee under s. 37(1) of Act as revenue expenditure/business expenditure. In order to support his contentions that assessee s project was set up in February, 1997, he placed reliance on p. 44 of paper book indicating that this feasibility project was to be completed in four phases i.e. I, II, III and IV and same were completed before asst. yrs. 1999-2000 and 2000-01 under consideration before Tribunal. Hence, expenditure is allowable to assessee under s. 37(1) of Act. In support of his contention, he relied upon judgment of Madras High Court in case of CIT vs. Franco Tosi Ingegneria (supra). He further contended that for asst. yr. 1999-2000, CIT(A) has rightly allowed expenditure claimed by assessee whereas in asst. yr. 2000-01, CIT(A) has wrongly disallowed claim of assessee merely placing reliance on provisions of s. 35(E) of Act which are not applicable to case of assessee, firstly, because assessee was foreign company whereas this section was only applicable to Indian Companies. Secondly, expenditure which was to be amortized by Indian Company was also to be specified. On other hand, learned Departmental Representative for Revenue submitted that in instant case, facts of this case require to be examined very carefully because there is MoU between two parties which also does not create any legal obligations upon assessee towards HZL. Presently, there was no joint venture company of assessee as entire project has been abandoned by assessee because project undertaken by assessee was not viable. In instant case, even if s. 35(E) of Act is not strictly applicable to assessee company because it is foreign company, still allowability of expenditure under s. 37 of Act could be considered only when project was set up and ready to commence production. He further contended that these expenditures incurred by assessee were merely pre- commencement expenditure, so, same were capital in nature and cannot be allowed to assessee as business expenditure. In support thereof, he relied upon decision of Delhi High Court in case of Triveni Engg. Works Ltd. vs. CIT (1999) 152 CTR (Del) 433: (1998) 232 ITR 639 (Del). He further submitted that since project has been terminated, this expenditure could not have been allowed to assessee and in support thereof he has relied upon case of apex Court in case of CIT vs. Gemini Cashew Sales Corpn. (1967) 65 ITR 643 (SC), in case of Ram Chandra Munna Lal vs. CIT (1949) 17 ITR 394 (Punj) and 109 ITR 309 (Mad) (sic). learned Authorised Representative for assessee, countering arguments of assessee placed reliance upon case of apex Court in case of CIT vs. Malayalam Plantations Ltd. (1964) 53 ITR 140 (SC) and Calcutta High Court in case of Indian Steel and Wire Products Ltd. vs. CIT (1994) 121 CTR (Cal) 335: (1994) 208 ITR 740 (Cal) and submitted that this expenditure incurred by assessee was allowable under s. 37(1) of Act. incurred by assessee was allowable under s. 37(1) of Act. We have considered rival contentions of both parties, perused records and carefully gone through orders of tax authorities below as well as case law relied upon by both parties which was applicable to facts of this case and relevant for deciding issue under consideration before us. As per provisions of s. 37(1) of IT Act, 1961, any expenditure laid out or expended wholly and exclusively for purposes of business or profession shall be allowed in computing income chargeable under head Profits and gains of business or profession". On examining decisions of various High Courts it becomes clear that for considering whether expenditure claimed by assessee is revenue o r capital in nature, we are required to look into various factors like what constituted business of assessee. When business of assessee commenced or was set up. What is distinction between setting up of business and commencement of business. When business is said to have been established and ready to commence. Thus, when business is established and ready to commence operation, 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. There may, however, be interval between setting up of business and commencement of business and all expenses incurred during that interval would be permissible deduction. When business is established and is ready to start business it can be said to be set up. business must be put into such shape that it can start functioning as business. In order to see what constituted business of assessee we have to look into each and every activity of assessee which is essential for purpose of carrying on business of assessee and we have to also look as to which activity of assessee is integral part of business of assessee so that we can arrive at conclusion that in view of that activity assessee could be said to have commenced its business. business cannot be said to have been set up unless it is ready to discharge function for which it is being set up. It is only when business has been put to such shape that it can start functioning as business that it can be said that business has been set up. Hence it can be summarized that there is clear distinction between commencing of business and setting up of business and for purposes of s. 37(1) of IT Act, 1961 setting up of business and not commencement of business is to be considered. It is only after business is set up that previous year of business commences and any expenses incurred prior to setting up of business would not be permissible deduction. When business is established and is ready to commence business than 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. Hence, in instant case we are required to determine what was business of assessee and, in particular, activities which constituted such business. Now reverting to facts of instant case of assessee, we find that assessee is engaged in business of prospecting, exploration, developing, extracting and processing of minerals and mineral ores. It means these entire business activities of assessee can be divided into two categories. First, prospecting and exploration; second, developing, extracting and processing of minerals and mineral ores. In instant case, admittedly, assessee has carried out first part of activity, i.e. prospecting and exploration, in four stages and thereafter assessee company had closed its Indian project office on 24th Dec., 2003 and assessee abandoned second part of business activity. From these facts it is further clear that except opening its project office in India to execute contract with HZL in February, 1997 on basis of letter issued by Reserve Bank of India no further step was taken by assessee in direction of carrying out second part of activity, which, in fact, was actual activity of business of assessee as assessee had to do extraction and processing of minerals and mineral ores. It further means that first part of business activity of assessee was only in form of preparing project report for purpose of studying and identifying potential deposits of commercially viable minerals. question arises whether expenditure incurred by assessee on preparing such project report was allowable to assessee as business expenditure under s. 37(1) of IT Act, 1961. reliance placed by assessee is mainly on decision of Madras High Court in case of Fanco Tosi Ingegneria (supra), wherein assessee was held to be entitled to expenditure incurred holding that assessee has commenced its business in India from incurred holding that assessee has commenced its business in India from 13th April, 1981, when it secured and accepted letter of intent from Neyveli Lignite Corporation and not from October, 1981 when it opened its site office, is of no assistance to assessee because in that case issue before Hon ble High Court Was whether assessee had commenced its business in India from 13th April, 1981, when it secured and accepted letter, or from date 1st Oct., 1981, when assessee opened its site office, because commencement of business or setting up of business was not issue to be considered by Hon ble High Court. Whereas in decision of jurisdictional High Court of Delhi in case of Triveni Engineering Works Ltd. (supra) their Lordships while considering nature of expenditure incurred on preparation of project reports being capital or revenue clearly laid down that test to discriminate between capital and revenue expenditure is not straight. item of expenditure though incurred wholly and exclusively for purpose of business may nevertheless be inadmissible as allowance, if it is of capital nature. border line between capital expenditure and revenue expenditure is blurred one. Different minds may come to different conclusions and may yet have valid reasons justifying each of two view-points. amount spent on project reports was not for purpose of facilitating assessee s existing trading operations or enabling management and conduct of assessee s business to be carried on more efficiently or more profitably, while leaving fixed capital untouched. If only project reports had been successfully accepted and put into implementation, assessee would have gone into manufacturing of new product which would have certainly required investment of fresh capital and coming into existence of additional fixed assets. expenditure was, therefore, attributable to capital having been incurred with view to bringing asset or advantage into existence and having enduring benefit. Merely because project did not materialize, nature of expenditure would not change to revenue. We have already mentioned that in instant case, in fact, real business of assessee is of extracting, developing and processing of minerals and mineral ores. For doing this business some infrastructure was required to be set up for commencing business, whereas, in instant case it has neither been pleaded by assessee nor any evidence has been brought on record to show that some expenditure has been incurred by assessee for bringing into existence such infrastructure. only step taken by assessee in instant case is setting up of its project office in order to explore possibility of minerals in licensed area given to assessee, on which impugned expenditure has been incurred and deduction for same has been claimed as revenue expenditure under s. 37(1) of IT Act, 1961. On carefully examining facts we are clear in our mind that neither real business of assessee can be said to have set up or commenced or ready to commence because there is no such infrastructure by which assessee can immediately start business of extraction, developing and processing of minerals and mineral ores for commercial purpose. Hence applying ratio of decision of jurisdictional High Court of Delhi in case of Triveni Engg. Works Ltd. (supra), it is held that expenditure claimed by assessee in preparation of project report with view to explore possibility of minerals and mineral ores in licensed area is not revenue expenditure and same has been rightly disallowed by AO and sustained by CIT(A) for asst. yr. 2000-01 and wrongly deleted by CIT(A) in asst. yr. 1999-2000. Accordingly, order of CIT(A) for asst. yr. 2000-01 is upheld and order of CIT(A) for asst. yr. 1999-2000 is set aside for reasons mentioned hereinabove, Before parting we may mention that s. 35E has been wrongly applied by CIT(A) in asst. yr. 2000-01 in instant case of assessee because this section only applies to Indian companies, whereas, admittedly, assessee company in appeal is foreign company to which section has no application. Even during course of arguments learned Departmental Representative for Revenue conceded on this point. Hence, though s. 35E is not applicable in case of assessee for considering claim of impugned expenditure by assessee but for detailed reasoning given in our order hereinabove, we reiterate that for asst. yrs. 2000-01 and 1999-2000 assessee is not entitled to claim deduction for impugned expenditure incurred for completion of project report. Consequently, ground of appeal taken by assessee in regard to s. 35E allowed and other remaining grounds of appeal are rejected. grounds of appeal taken by Revenue are allowed. In result appeal filed by assessee is partly allowed and appeal filed by Revenue is allowed. *** BHP MINERALS INTERNATIONAL EXPLORATION INC. v. DEPUTY DIRECTOR OF INCOME TAX (INTERNATIIONAL TAXATION)