Facts:- M/s. Sri Mangayarkarasi Mills (P) Ltd. (“assessee/SMMP Ltd.”), engaged in the manufacture and sale of cotton yarn, incurred expenditure on replacement of machinery. While on one hand, SMMP Ltd. capitalized the said expenditure in its books of account and in its return of income, on the other, the same was claimed as revenue expenditure on the basis that such expenditure was merely incurred on replacement of spare parts in the spinning mill system.
The Assessing Officer disallowed the claim of the assessee. The Commissioner of Income-tax (Appeals), however, allowed the claim of the assessee, which was upheld by the Income-tax Appellate Tribunal and the High Court. The Revenue, thereafter, filed an appeal before the Supreme Court against the order of the High Court.
Issue before the Supreme Court:- Whether expenditure incurred on replacement of machinery is revenue expenditure deductible under section 37 of the Income-tax Act, 1961 (“the Act”) or „current repairs? deductible under section 31 of the Act?
- Each item of machinery in a textile mill should be treated as independent and not an integral part of the whole plant of the spinning mill. Consequently, replacement of any such machine of the mill would amount to acquisition of a new asset and not repair of the entire integrated machinery of the spinning mill.
- Repairs can be said to be carried out when the expenditure is incurred only for the purpose of preserving or maintaining an existing asset and not for renewal or restoration of an asset which is the case of the assessee, wherein by replacement of old machinery with new machinery, it has derived benefit of enduring nature.
- The replaced machinery cannot be treated as independent as it entails merely replacing the old and worn out parts of the machinery of spinning mill which is in turn dependant on other parts of the textile mill.
- Reliance was placed on Circular No. 69 dated 27 November 1957 issued by the Central Board of Direct Taxes, as per which replacement of worn out parts in a textile mill would constitute revenue expenditure.
- Argument of the revenue of enduring benefit is no longer a good law.
Ruling of the Supreme Court
- Placing reliance on the decision of Supreme Court in the case of Saravana Spinning Mills P. Ltd. (7 SCC 298) (2007), it held that each machine in a textile mill has an independent role to play in the mill and each machine is part of the integrated process of manufacture of yarn and is integrally connected to the other machines in the mill. However, this interconnection does not take away the independent identity and distinct function of each machine. Replacement of the machine can at best amount to a repair made to the process of manufacture of yarn.
- Each machine in a textile mill should be treated independently and not as a mere part of an entire composite machinery of the spinning mill.
- Replacement of an old machine with a new one would constitute the bringing into existence of a new asset in place of the old one and not repair of the old and existing machine. It therefore cannot amount to current repairs.
- Expenditure incurred by the assessee was capital in nature as it amounted to enduring advantage for the business in the form of efficient production over a period of time.
- Though accounting practices may not be the best guide in determining the nature of expenditure, they are indicative in nature.