Depreciation not allowable on assets never been put to use

ITAT CHENNAI BENCH ‘B’

Superfil Products Ltd.

versus

Assistant Commissioner of Income-tax

IT Appeal NO. 2053 (MDS.) OF 2011
[A.Y. 1998-99]

Date of Pronouncement- 12.10.2012

ORDER

Challa Nagendra Prasad, Judicial Member

This is an appeal filed by the assessee against the order of the Commissioner of Income Tax (Appeals)-VI, Chennai dated 25.10.2011 in ITA No.423/10-11 for the Asst. Year 1998-99. The first issue in the grounds of appeal of the assessee is that the Commissioner of Income Tax (Appeals) has erred in confirming the dis allowance of Rs. 43,88,823/- made by the Assessing Officer by treating the said expenditure as capital in nature.

2. The facts of the case are that the assessee a company engaged in the business of manufacture and sale of Nylon Yarn, filed its return of income on 30.11.1998 for the Asst. Year 1998-99 declaring a total income of Rs. 37,23,570/-. The assessment was completed under sec.143(3) of the I.T. Act on 27.3.2001. While completing the assessment, the Assessing Officer disallowed Rs. 13,94,779/- out of Rs. 43,88,823/- being the expenditure incurred on expansion of project, holding that the said expenditure was incurred in earlier Asst. Year and did not pertain to the Asst. Year 1998-99. The Assessing Officer also disallowed depreciation of Rs. 55,74,831/- claimed on Thermopac Machine, holding that the capital work-in-progress incurred by the assessee for expansion-cum-diversification project includes machinery called Thermopac Machine installed in the site during the Asst. Year 1997-98, machinery was sitting idle as the project was abandoned by the assessee. Therefore, the assessee is not entitled for depreciation on such machinery since such machinery was not used by the assessee during the Asst. Year 1998-99. The assessee filed appeal before the Commissioner of Income Tax (Appeals) against these dis allowances. The Commissioner of Income Tax (Appeals) vide his order dated 10.10.2001 deleted the dis allowance of Rs. 13,94,779/- made towards prior period expenses. However, he sustained the dis allowance of depreciation on Thermopac Machine. The assessee carried on the matter further to this Tribunal against the dis allowance of depreciation sustained by the Commissioner of Income Tax (Appeals). The Revenue filed appeal before this Tribunal against deletion of prior period expenses of Rs. 13,94,779/. This Tribunal, vide its consolidated order dated 12.6.2006 in ITA No. l422/Mds/2001 and ITA No. 51/Mds/2002 disposed of the appeals filed by the assessee and the Revenue respectively. This Tribunal, by its above order, restored dis allowance of depreciation of Rs. 55,74,831/- on Thermopac Machine and dis allowance of prior period expenses of Rs. 13,94,779/- to the file of the Assessing Officer to decide the issues afresh in accordance with law. The Assessing Officer passed Asst. order on 12.9.2007 giving effect to the order of this Tribunal dated 12.6.2006. While passing the consequential Assessment Order, the Assessing Officer disallowed the entire pre- operative expenditure of Rs. 43,88,823/- on the ground that the sais expenditure was in the nature of capital expenditure. He also disallowed depreciation on Thermopac Machine of Rs. 55,74,831/- holding that the machinery was not used by the assessee and the assessee had, in fact, abandoned the new project for which the machinery was procured and, therefore, not entitled for depreciation.

3. The assessee filed appeal before the Commissioner of Income Tax (Appeals) contending that the Assessing Officer erred in exceeding the directions given by the Tribunal and disallowing the expenditure of Rs. 43,88,823/- treating it as capital expenditure. The assessee also contended that the Assessing Officer erred in not allowing depreciation on Thermopac Machine. The Commissioner of Income Tax (Appeals) held that the Assessing Officer has correctly examined the allow ability of expenditure of Rs. 43,88,823/- as directed by the Tribunal and the Assessing Officer did not exceed the directions of the Tribunal. The Commissioner of Income Tax (Appeals) further held that the said expenditure was incurred by the assessee for setting up of new project and since this project was abandoned and the expenditure incurred on the abandoned project partook the nature of capital expenditure, he confirmed the dis allowance of Rs. 43,88,823/- made by the Assessing Officer. While coming to the said conclusion, the Commissioner of Income Tax (Appeals) placed reliance on the decision of Hon’ble Jurisdictional High Court in the case of EID Parry (India) Ltd. v. CIT [2002] 257 ITR 253 (Mad.).

4. The Commissioner of Income Tax (Appeals) also confirmed the dis allowance of depreciation on Thermopac Machine as the said machinery was not put into use by the assessee and further held that the assessee could not controvert the view of the Assessing Officer that an asset not ready for use can claim the beneficial interpretation of passive use for claiming depreciation. Against this order of the Commissioner of Income Tax (Appeals), the assessee is in appeal before us.

5. The Counsel for the Assessee submits that the Assessing Officer went beyond the directions of the Tribunal while disallowing the entire expenditure of Rs. 43,88,823/-. The Counsel for the Assessee submits that in the original assessment, the Assessing Officer disallowed expenditure of Rs. 13,94,779/- on the ground that this expenditure pertains to prior period and the Assessing Officer himself had allowed Rs. 29,94,044/- as allowable expenditure for the Asst. Year 1998-99. The Counsel for the Assessee submits that this Tribunal has remitted the matter to the file of the Assessing Officer only to examine the admissibility of the expenditure of Rs. 13,94,779/- which was originally disallowed by the Assessing Officer but not the entire expenditure of Rs. 43,88,823/-. Therefore, the Assessing Officer should have confined the dis allowance only to the extent of expenditure of Rs. 13,94,779/- while completing the assessment as per the directions of the Tribunal. The Counsel for the Assessee submits that in remand proceedings the assessee cannot be put into a worst situation than that of the situation at the time of original assessment. Therefore, the Counsel for the Assessee submits that the Assessing Officer has travelled beyond the directions of the Tribunal while disallowing the expenditure of Rs. 43,88,823/-.

6. Coming to the allow ability of expenditure, the Counsel for the Assessee submits that all these expenses incurred are in the nature of revenue. Therefore, they have to be allowed as deduction even though the project was abandoned subsequently.

7. The Departmental Representative supporting the order of the Commissioner of Income Tax (Appeals) submits that the entire expenditure was incurred towards new project for manufacture of Multi Filament Yarn and this expenditure was reflected under capital work-in-progress by the assessee in its books of account. The learned Departmental Representative submits that since this expenditure was incurred for a new project which was abandoned later by the assessee the said expenditure was capital expenditure and cannot be allowed as deduction.

8. We have heard both sides, perused the material on record and the orders of the authorities below. With regard to the dis allowance of expenditure of Rs. 43,88,829/-, we hold that the Assessing Officer should have confined himself in examining the issue of allow ability of expenditure only to the extent of Rs. 13,94,779/- as this Tribunal directed him to examine the issue of allow ability of expenditure only to the extent of Rs. 13,94,779/- in accordance with law as the subject matter in the appeal filed by the Department before his Tribunal was for the expenditure of Rs. 13,94,779/- only. Therefore, we hold that the Commissioner of Income Tax (Appeals) is not justified in holding that the Assessing Officer is correct in examining the allow ability of expenditure of Rs. 43,88,823/-. Therefore, the Assessing Officer should restrict the dis allowance of expenditure only to the extent of Rs. 13,94,779/- Coming to the allow ability of the expenditure, we find that the said expenditure was incurred during the previous year 1996-97 relevant to the Asst. Year 1997-98 for expansion of new project and this project was later abandoned in the year 1999. In an identical situation, the Hon’ble Jurisdictional High Court in the case of EID Parry (India) Ltd. (supra) has held as under:-

“It is clear from the assessee’s own case that the expenditure was incurred for the purpose of setting up a new project. The expenditure had been incurred in the years prior to the assessment year in question. The assessee’s case that it subsequently abandoned that project does not on that score convert what was an expenditure in the nature of capital expenditure into a revenue expenditure. The setting up of a new project was clearly in the capital field and not in that of revenue. The abandonment of that project is the abandonment of a project on which capital expenditure had been incurred. The expenditure incurred on that capital project was not something which could be regarded as revenue expenditure laid out exclusively and wholly for the purposes of business of the assessee as what the assessee was trying to start was a new business for the manufacture of a new product. The expenditure incurred therein was clearly capital expenditure and not revenue expenditure.

4. Counsel for the assessee relied on the decision of the Supreme Court in the case of B. K. Ltd. v. V.P. Gupta, CIT [1978] 113 ITR 647. The court there was not concerned with the assessee starting a new industrial project, and subsequently abandoning the same. The case there concerned a trader who had, while retaining the same management and control of the business, sought to carry forward the losses in the import business of an earlier year against the profit of the export business of a latter year. He was allowed to do so after the court found that the two businesses, one which had been discontinued and one which was latter started, in fact, constituted the same business.

5. Here, it is evident that the assessee is engaged in the manufacture of other products and wanted to add a new product “methanol” and for that purpose had incurred expenditure by way of entering into a collaboration agreement for purchase of machinery but had abandoned the same. The fact that the assessee continued to carry on its old business does not on that score render the expenditure incurred by it in the setting up of a new project for the manufacture of a new product, a revenue expenditure.

6. The Supreme Court in the case of Swadeshi Cotton Mills Co. Ltd. v. CIT [1967] 63 ITR 65, considered the case of an assessee who was carrying on the business of manufacture and sale of cloth and other textile goods and who had entered into contract for the purchase of textile machinery for the purposes of expanding its factory. The assessee therein subsequently cancelled the contracts and paid compensation to the contracting parties. The amount so expended by the assessee was held by the Supreme Court to be an expenditure in the capital field and not revenue expenditure. The ratio of that case is clearly attracted to the facts of the case here. While in the case of Swadeshi Cotton, payment had been made with the object of avoiding unnecessary investment in capital assets, here the expenditure had been incurred for the purposes of setting up the project, but that expenditure was unfruitful, as the project was not established but was abandoned. The abandonment was obviously to avoid any further expenditure being incurred, and to avoid any other adverse effects by reason of incurring of additional expenditure which the assessee itself thought would no longer be beneficial to pursue. Such expenditure incurred by it for a new project which was in the nature of capital expenditure remains such, and by claiming it in a subsequent year as revenue expenditure, the assessee cannot convert what was capital expenditure into revenue expenditure.”

In view of the above decision of the Hon’ble Jurisdictional High Court, we hold that the expenditure incurred by the assessee on the new project as capital in nature. The Assessing Officer is directed to restrict to the dis allowance to Rs. 13,94,779/- only as against Rs. 43,88,823/- made in the consequential Assessment Order.

9. With regard to the dis allowance of depreciation on Thermopac Machine, the Counsel for the Assessee submits that depreciation is allowable on the machinery which was installed and it was used for the business of the assessee even though the project could not take off due to various factors. The Counsel for the Assessee relying on the decision of Hon’ble Supreme Court in the case of CIT v. Shaan Finance (P.) Ltd. [1998] 231 ITR 308 submits that once the machinery is used for the purpose of business of the assessee, depreciation has to be allowed on such machinery. The Counsel for the Assessee submits that even otherwise, depreciation is allowable as passive user though the machinery was not put into operation as the new project was abandoned.

10. The Departmental Representative relied on the orders of Commissioner of Income Tax (Appeals). He submits that the concept of passive user does not apply to a new project which was abandoned. The Departmental Representative submits that since the machinery was never put to use by the assessee, no depreciation is allowable. The Departmental Representative relied on the decision of Hon’ble Bombay High Court in the case of B. Malani & Co. v. CIT [1995] 79 Taxman 398 and the decision of Nagpur Bench of the ITAT in the case of Bhikaji Venkatesh v. CIT [1937] 5 ITR 626 in support of his contention.

11. We have heard both sides, perused the material on record and the orders of the lower authorities. The Assessing Officer disallowed depreciation on this machinery holding that the assessee company started the expansion and diversification Project in the year 1996. As on 31.3.1998, the total expenditure incurred on this project was Rs. 306.51 lakhs. The expenditure which includes both capital and revenue is carried forward by the assessee under the head “capital work-in-progress’. This project was finally shelved in the year 1999 since it is not viable as per Directors’ Report. The capital work-in-progress includes Thermopac machine which was installed at site during the previous year relevant to the Asst. Year 1997-98. As the project did not take off, this machinery was sitting idle and the assessee claimed 100% depreciation on the same relying on judgments which allowed depreciation on assets for passive use. The Assessing Officer observed that the doctrine of passive user applies in a case where the machinery was already in use for some time and subsequently there is a stoppage in the business activity due to low demand for its goods etc., in the market and for any other reason if this machine has to be stopped during this period of interregnum, then the doctrine of passive user applies so that the assessee can claim depreciation over such stand-still machinery. He observed that in the case of the assessee, the project had not even started off. Therefore, the Assessing Officer held that no depreciation is allowable on an asset which has not even been ready for use. The Commissioner of Income Tax (Appeals) confirmed the dis allowance agreeing with the view of the Assessing Officer.

12. The machinery which was purchased by the assessee in the course of expansion of new Project was installed in the year 1996-97 relevant to the Asst. Year 1997-98. There is nothing on record to suggest that the assessee had put the machinery to use during the Asst. Year 1998-99. It appears that the assessee had claimed 100% depreciation as the project was completely abandoned later in the year 1999. Since the machinery was never put to use by the assessee no depreciation is allowable for the Asst. Year 1998-99. The case law relied on by the Counsel for the Assessee in the case of Shaan Finance (P.) Ltd (supra) has no application to the facts of the case of the assessee. Therefore, we hold that the assessee is not entitled for depreciation on Thermopac machine. The ground raised by the assessee on this issue is dismissed.

13. In the result, the appeal filed by the assessee is partly allowed.