Replacement of machinery parts is revenue expenditure

Ambica Alloys & Steel India Ltd. Vs DCIT (ITAT Ahmedabad)

ITAT Held that replacement of parts of an existing machinery in the course of their working will be a revenue expenditure.

Facts-

The assessee is engaged in manufacturing of steel products of MS Angel, MS Channel and MS Beam. During the course of assessment, the AO noticed that the assessee had debited expenses amounting to 50,97,107/- as expenses on account of purchase of Rolling Mill Rolls and claimed the same as revenue expenditure. The AO issued show cause notice, requiring the assessee to explain why the claim of expenditure on account of purchase of rolls should not be disallowed as revenue expenditure as the use of metal rolls in the rolling mill/steel industries is of enduring benefit and accordingly, higher rate of depreciation at 80% has been specified in the Act.

Being aggrieved by the order of AO, assessee preferred an appeal before CIT(A). CIT(A) upheld the order. Accordingly, assessee preferred the present appeal.

Conclusion-

We are of the considered view that the assessee in the instant set of facts is eligible to claim deduction of expenditure on purchase of Rolling Mill Rolls as revenue expenditure. The only reason why the claim of a revenue expenditure of the assessee was sought to be disallowed was that since the Income Tax Act specified rate of 80% for claim of depreciation in respect of the above assets, the assessee was not eligible to claim the same as revenue expenditure. We note that in the instant set of facts, the revenue has not been able to independently bring anything on record to substantiate that any enduring benefit accrued to the assessee by way of incurring this expenditure on purchase of Rolling Mill Rolls. Accordingly, in our considered view, in the instant set of facts assessee is eligible to claim deduction of expenses as revenue expenditure.

FULL TEXT OF THE ORDER OF ITAT AHMEDABAD

This is an appeal filed by the assessee against the order of the ld. Commissioner of Income Tax (Appeals)-1, Ahmedabad in Appeal no. CIT(A)-1/DCIT, Circle-1(1)(1)/702/2014-15 vide order dated 29/02/2016 passed for the assessment year 2012-13.

2. The assessee has taken the following grounds of appeal:-

“The following grounds are without prejudice to each other. The learned CIT (A) / AO, erred in

1. In not appreciating, the facts that, the assesse has rightly claimed depreciation at the rate of 15% on electric installation and therefore addition made of Rs. 4,172/- is required to be deleted.

2. In confirming the addition of Rs. 20,67,537/-. The lower authority has totally erred in not appreciating the facts that the rolling mills rolls is required to be consumed and therefore the assesse has rightly claimed the same as business expenditure and therefore the lower authority has erred in granting the depreciation only. It is prayed that the addition made may please be deleted.”

3. At the outset, before us, Ld. Counsel for the assessee has submitted that he shall not be pressing ground number 1. Accordingly, ground number 1 of the assessee’s appeal is being dismissed as withdrawn/not pressed.

Ground number 2: disallowance of expenditure under the “head repairs and maintenance” of Rs. 20,63,537/-

4. The brief facts in relation to this ground of appeal are that the assessee company is engaged in manufacturing of steel products of MS Angel, MS Channel and MS Beam. During the course of assessment, the AO noticed that the assessee had debited expenses amounting to Rs. 50,97,107/- as expenses on account of purchase of Rolling Mill Rolls and claimed the same as revenue expenditure. The AO issued show cause notice, requiring the assessee to explain why the claim of expenditure on account of purchase of rolls should not be disallowed as revenue expenditure as the use of metal rolls in the rolling mill/steel industries is of enduring benefit and accordingly, higher rate of depreciation @80% has been specified in the Act. Before the AO, the assessee submitted that the assessee had purchased Metal Rolls which are used as consumables in the process of production and are shown under the head “Repairs and Maintenance”. The assessee is engaged in the business of manufacturing of steel products. During the process of production, the rolls which were used to avoid friction in the machinery suffered damage and thus the assessee needed frequent replacement in the mills. So, the expense is in the nature of current repairs and is of a revenue nature. Further, the assessee submitted that there is no increase in capacity of production, but it was only replacement of worn-out parts of the machine. The assessee relied on various case laws in support of his contention that the claim of expenditure as revenue expenditure of the assessee is allowable in the instant set of facts. The Ld. Assessing Officer however rejected the assessee’s contention and held that the assessee is eligible to claim depreciation on the rolling mills @80% and assessee is not eligible to claim deduction thereof as revenue expenditure. The AO made the following observations while passing the order:

“As per new Appendix-1 of Income Tax Rules, 1962 which is table of rates at which depreciation is admissible and which is effected from A.Y.2006-07 onwards, it is found that vide SI. No.lll (8)(vii) of Part A” (tangible assets) the depreciation at the @80% has been provided on “iron and steel Industry¹– mills rolls. The item of the assesses is exactly the same ‘for which it has claimed the expenditure in full, Further the steel rolls are clearly fixed assets and, for that reason, it has been mentioned in the Depreciation schedule. The periodical or frequent replacement does not make any capital expenditure as Revenue Expenditure¹ where the replacement brings into existence and additional, benefit or advantage of an enduring nature which travels beyond a short period of time. Further, to hold expenditure on purchase of any item as ‘Capital Expenditure’, it need to be a self-contained unit, but it may be a Part of bigger machine or it may even be- one used in conjunction with, one or more machines. It is also pertinent to note here that The expenditure on steel rolls in the iron, steel industry is being treated as capital expenditure. For the sake of example, M/S The Tinplate Company of India, which is a. Tata Group Company, in its accounts has treated the Steel Rolls as capital expenditure. The Id. AR on being confronted further could not produce any explanation except reiterating the earlier.

In view of the above, the claim of the assessee is disallowed as revenue expenditure and the same is liable to be treated a capital expenditure. Accordingly, the depreciation @80% is allowed on the total expenditure of Rs.50,97,107/- on account of purchase of rolls. The difference amount of Rs.20,63,537/- worked out as under is disallowed:xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx”

5. In appeal, the assessee reiterated the arguments before Ld. CIT(A).

However, he rejected the assessee’s contention and upheld the order of the AO, with the following observations:

“3.4 After going though the facts of the case, it is seen that the steel roll are used regularly and have life span of less than one year but the mere fact cannot change the nature of expenditure. In fact, these are aspects are relevant when the rate of depreciation on fixed assets are prescribed and the same has been duly taken care of by providing accelerated rate of depreciation @80%. As per new Appendix-1 of Income Tax Rules, 1962 which is table of rates at which depreciation is admissible and which is effected from A.Y.2006-07 onwards, it is found that vide SI. No.lll (8)(vii) of Part A” (tangible assets)the depreciation at the@80% has been provided on “iron and steel Industry’- mills rolls. The item of the appellant is exactly the same ‘for which it has claimed the expenditure in full, further the steel rolls are clearly fixed assets and, for that reason, it has been mentioned in the Depreciation schedule. The periodical or frequent replacement does not make any capital expenditure as Revenue Expenditure’ where the replacement brings into existence and additional, benefit or advantage of an enduring nature which travels beyond a short period of time. The judicial ratio cited by the appellant are not at all applicable to the facts of the case there is straight provision for the@80% has been provided on “iron and steel Industry’- mills rolls. It’s difficult to agree with the view of the appellant. The reasoning and the express provisions in this aspect leads to the conclusion that the stand of the AO is correct. The disallowance made by the AO is confirmed. The ground of the appellant is dismissed.”

6. Before us, counsel for the assessee reiterated the arguments taken before the Revenue Authorities and reiterated that rolling mills are subject to frequent wear and tear and hence are eligible to be claimed as revenue expenditure under the head “Repairs and Maintenance”. He submitted that the case of the assessee is directly covered by the Calcutta Tribunal decision in the case of DCIT v. M/s. Jindal India Ltd. in I.T.A Nos. 368 & 369/Kol/2010, wherein on identical facts, the issue has been decided in favour of the assessee. Ld. Counsel for the assessee submitted that no enduring benefit accrues to the assessee and the expenditure is eligible to be claimed as Revenue expenditure in the instant facts. In response, Ld. Departmental Representative relied on the observations made by Ld. CIT(A) in the appeal order.

7. We have heard the rival contentions and perusal the material on record. We note that in the case of DCIT v. M/s. Jindal India Ltd. in I.T.A Nos. 368 & 369/Kol/2010, theKolkata Tribunal made the following observations on this issue:

We further find force in the contention of the Ld. Counsel for the  assessee that since in this case rolls used in iron and steel industries  are the parts of the machinery and are replaced very frequently  during the year the expenses incurred on replacement of the rolls is  allowable as current repairs, therefore, cannot be disallowed simply  because assessee was entitled to get 80% depreciation on this item  u/s. 32 of the Act.  The Hon’ble Delhi High Court in the case of CIT Vs. Hi Line Pens Pvt. Ltd. (Supra) has held as under :

“Held, that the replacement was not of the premises but of certain “parts” such as the internal wires and GI Pipes. The analogy of replacement of the entire machine was not applicable to the case of the assesee. It was not the intention of the assessee to bring about any new capital asset. The expenses incurred by the assessee were towards repairing the premises taken on lease so as to make them more conducive to its business activity. Such expenses could fall within the expression of repairs to the premises as appearing in section 30(a)(i). Once the assessee’s claim falls within that provision there was no question of considering the question of applicability of section 32. Thus, the Tribunal rightly agreed with the view taken by the Commissioner (Appeals) and held in favour of the assessee.” In view of the above, we find no infirmity in the orders of the Ld. CIT(A) in deleting the additions for both the assessment years. Therefore, the grounds of appeal of the revenue for both the assessment years are dismissed.

8. Again, in the case of CIT v. Malhotra Industrial Corpn.[2003] 127 Taxman 545 (Punjab & Haryana), assessee was running a steel rolling mill. The Tribunal’s finding was that assessee’s business required frequent replacement of rolls and, therefore, expenditure incurred thereon would certainly fall in nature of current repairs, as same did not result in creation of capital asset or benefit of enduring nature. The High Court held that Tribunal was justified in treating expenditure on purchase of rolls as revenue in nature.

9. We further note that the ITAT Kolkata in the case of M/S Akshay Steel Works Pvt. Ltd. vs Dcit, Cir-3, Kolkata in ITA number 823/Kol/2015 on identical facts has decided the issue in favour of the assessee with the following observations:

“7.3 We have heard the rival submissions. We find that the assessee had installed one Rolling Mill for manufacture of rolled products i.e Angles, Channels, Round Bar, Flat Bar, Square Bar, Octagonal Bar, Hexagonal Bar etc . In the rolling mill, the assessee uses ‘Steel Rolls’ which is an integral part of the machinery. In the process of manufacture of rolled products, the raw materials (mild steel billets / mild steel ingots) are fed into the heating furnace where it is heated at the requisite temperature. The red hot raw materials (ingots and billets) are then passed through a series of rolling stands fitted with steel rolls which keeps rotating and exerts pressure on the hot raw material which elongates the stock to desired shapes and sizes for manufacture of desired rolled products. In the process, the red hot raw materials are compressed between two rotating steel rolls for reducing its cross section. After the rolling process, the hot rolled products are subjected to process of cooling and thereafter sent for sizing, bundling , etc. From the aforesaid manufacturing process, it was explained by the ld AR that the steel rolls get worn out warranting frequent replacement in 2 to 6 months. We find from the explanation of the aforesaid manufacturing process, steel rolls are not independent machinery but instead they are only part of a rolling mill. It does not contribute for the increase in production capacity of the products manufactured by the assessee company. Hence there is no enduring benefit or advantage derived by the assessee company in this regard. The replacement of steel rolls are merely operational expenses incurred in the ordinary course of business by the assessee. Moreover, from the details of replacement of steel rolls as tabulated hereinabove, it could be safely concluded that the steel rolls were replaced by the assessee on a regular basis and hence we hold that merely because the same is found as a separate line item in the Appendix I of Depreciation Rates Schedule, it does not take the character of capital expenditure automatically. We hold that since it is not a capital expenditure at all vis a vis the facts of the instant case and the manufacturing process involved therein, the explanation to section 30 and 31 of the Act brought into the statute with effect from 1.4.2003 would not be applicable to the facts of the instant case.

10. The Delhi High Court in the case of Commissioner of Income Tax- 4 Vs. Super Cassettes Industries Ltd. (Delhi High Court) in ITA No. 171/2010 vide order dated 17-10-2011 held that replacement of parts of an existing machinery in the course of their working will be a revenue expenditure. The Hon’ble High Court observed as below while passing the order:

4. The Assessing Officer did not controvert or deny the aforesaid factual position projected by the assessee that the moulds in question were integral part of the injection moulding machines and had to be replaced by new moulds due to normal wear and tear. The assessee had purchased injection moulding machines which included the moulds and these were treated as capital assets, but once the moulds were replaced by new moulds, the expenditure incurred on new moulds was treated by the assessee as revenue expenditure. The stand taken by the Assessing Officer/ Revenue was that moulds have been classified as a capital asset specifically in the depreciation schedule in the Income Tax Rules, 1962 and the rate of depreciation is specified @ 40% and, therefore, the moulds are capital asset and purchase price of the moulds cannot be treated as revenue expenditure.

……

5. The reasoning is fallacious; the schedule or rate of depreciation cannot decide whether a particular expenditure in the hands of an assessee is revenue or capital expenditure. Same asset can be stock in trade in the hand of one assessee and a capital asset in hands of another assessee. The schedule does not decide whether an asset purchased is a capital asset. Merely because moulds have been classified and mentioned in the schedule relating to depreciation in the Income Tax Rules, it does not mean that the purchase price of the moulds in all cases has to be treated as a capital expenditure. It would depend upon the facts and circumstances of each case whether the purchase price of moulds is to be capitalised or treated as revenue expenditure. Purchase price of moulds cannot be regarded as a capital expenditure if the replaced mould is an integral part of an existing injection moulding machine. In such cases a new asset does not come into existence but the expenditure incurred is towards purchase of parts for repair or maintenance of existing machinery. (Difference between repair and maintenance is not relevant and urged in the present appeals). No new or fresh advantage of enduring benefit materialises but the purpose is to preserve and maintain an already existing asset. The expenditure incurred on replacement of the moulds is in the nature of replacement of parts of the old machines which continues to exist and remains the capital asset. The tribunal in the impugned order has rightly relied upon the decision of this Court in Commissioner of Income-Tax Vs. Jagatjit Industries Ltd. [2000] 241 ITR 556, wherein it has been held as under:- “Whether on given set of facts, replacement of certain items, forming an integral or important part of the machinery would be revenue expenditure or capital expenditure is primarily a question of fact, to be decided in the context of the business carried on by an assessee. Merely, because the benefit accruing by the expenditure is of enduring nature, is by itself not a conclusive test to hold it as a capital expenditure (see Empire Jute Co. Ltd. v. CIT [1980] 124 ITR 1 (SC)]. Normally initial investment on machines and their parts will be in the nature of capital expenditure but replacement of parts of an existing machinery in the course of their working will be a revenue expenditure. In the instant case having regard to the nature of the business of the assessee and applying the principle of law enunciated in Mysore Spun Concrete Pipe Pvt. Ltd.’s case [1992] 194 ITR 159 (Kar), the Tribunal has reached a conclusion that the moulds in question do not enhance the capacity of the existing machines and are merely replacements for the moulds damaged during the process of manufacture of glass. It is also evident from the format of the question proposed by the Revenue, that finding of the Tribunal to the effect that the expenditure in question was incurred by the assessee on the ‘replacement’ of the moulds is not under challenge.

7. In view of the findings recorded by the tribunal, we do not think that any question of law arises for consideration and the appeals are accordingly dismissed without any order as to costs.

11. In view of the consistent position taken by various Courts/Tribunals, we are of the considered view that the assessee in the instant set of facts is eligible to claim deduction of expenditure on purchase of Rolling Mill Rolls as revenue expenditure. The only reason why the claim of a revenue expenditure of the assessee was sought to be disallowed was that since the Income Tax Act specified rate of 80% for claim of depreciation in respect of the above assets, the assessee was not eligible to claim the same as revenue expenditure. We note that in the instant set of facts, the revenue has not been able to independently bring anything on record to substantiate that any enduring benefit accrued to the assessee by way of incurring this expenditure on purchase of Rolling Mill Rolls. Accordingly, in our considered view, in the instant set of facts assessee is eligible to claim deduction of expenses as revenue expenditure. In the result, ground number 2 of the assessee’s appeal is allowed.

12. In the result, the appeal of the assessee is partly allowed.

Order pronounced in the open court on 27-07-2022