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Case Name : Commissioner of Income Tax, Madurai Vs M/s. Sri Mangayarkarasi Mills (P) Ltd. (Supreme Court of India)
Appeal Number : Civil Appeal No. 4579 of 2009
Date of Judgement/Order : 21/07/2009
Related Assessment Year :

The assessee incurred expenditure on replacement of machinery in a textile mill and claimed the same as revenue expenditure on the ground that it was merely for replacement of spare parts in the spinning mill system and did not give rise to a new asset. In the books, the expenditure was capitalized. The CIT (A), ITAT and High Court decided in favour of the assessee. However, on appeal by the revenue, HELD, reversing all the lower authorities:

(i) Each machine in a textile mill is a separate and independent item though it is a part of the integrated process of manufacture of yarn and is integrally connected to the other machines in the mill for production of the final product. The machine cannot be treated as a mere part of an entire composite machinery of the spinning mill.

(ii) To constitute “current repairs” u/s 31 the expenditure must be incurred to ‘preserve and maintain’ an already existing asset and not to bring a new asset into existence or to obtain a new advantage. For determination of ‘current repairs’ the question whether the expenditure is revenue or capital is not the proper test. However, as the machine was an independent entity, its’ replacement brought into existence a new asset and was not current repairs.

(iii) The expenditure was also not “revenue” u/s 37 (1) as the replacement brought into existence a new asset and also gave rise to an enduring benefit.

(iv) Though accounting practices may not be the best guide in determining the nature of expenditure, the fact that the assessee treated the expenditure as an addition to the existing assets shows that the claim for deduction under the Act was made merely to diminish the tax burden and not under the belief that it was actually revenue expenditure.

FULL TEXT OF THE JUDGEMENT

IN THE SUPREME COURT OF INDIA

CIVIL APPELLATE JURISDICTION

CIVIL APPEAL NO.4579 OF 2009

[Arising out of SLP©No.13264 of 2007]

Commissioner of Income Tax, Madurai ..Appellant

Versus

M/S. Sri Mangayarkarasi Mills (P) Ltd…Respondent

J U D G M E N T

TARUN CHATTERJEE, J.

1. Leave granted.

2.   This   appeal   has   been   filed   by the   appellant   to   challenge   the  judgment and order of the High Court of Madras dated 18th  of  December,   2006   whereby   the   High   Court   had   dismissed   the  appeal   filed   by   the   revenue   holding   that   the   expenditure   on  replacement   of   machinery   was   revenue   in   nature   and   thus, allowable   as   deduction   under   the   Income   Tax   Act,   1961 (hereinafter referred to as the ‘Act’).

3. The relevant facts as arising from the case made out by the parties, leading to the filing of this appeal, and which will help us in understanding the controversy involved, can be summarized  as under :-

The Respondent in this appeal is engaged in the manufacture and sale of cotton yarn. During the assessment year 1995-1996 the assessee   claimed   an   amount   of   Rs.   61,   28,150/-,   being expenditure   incurred   on   replacement   of   machinery,   as   revenue expenditure.   The   assessee   believed   that   such   expenditure  was merely expenditure on replacement of spare parts in the spinning mill system and, therefore, amounted to revenue expenditure.

4.     The Assessing Officer (AO) did not, however, accept this view of  the   assessee   because,   according   to   him,   each   machine   in   a spinning mill does a different function and the product from one machine is taken and manually fed into another machine and the output   is   taken,   all   the   machines   are,   thus,   not   integrally connected.   Based   on   this   reasoning,   the   AO   disallowed   the above claim of the assessee and held the said expenditure to be of a capital nature. The AO, in passing this order dated 31st  of  December,   1997,   followed   the   decision   of   the   Income   Tax Appellate Tribunal (ITAT) Madras “C” Bench in the case of M/s. Nagammal   Mills   Ltd. V.  DCIT dated   31st  of   October,   1997(rendered   in   I.T.A.   No.   2774/Mds/93/90-91)   and   also   the decision of this Court in  Ballimal Naval Kishore and Another v.  CIT (224   ITR   414) in   which   it   was   held   that   any   capital expenditure   claimed   by   the   assessee   for   acquiring   plant   and machinery,   buildings,   fixed   assets,   etc.,   cannot   be   treated   as repairs or renewals, and, therefore, it cannot be held as revenue expenditure in the year of acquisition of such fixed assets. The AO   further   held   that   the   assessee   had   treated   the   said expenditure as capital expenditure by capitalizing the assets in the books of account and had, thus, shown profit in its profit and loss account to third parties, like bankers, financial institutions, creditors, shareholders, etc. However, from the tax point of view, the   respondent   wanted   to   reduce   the   net   profit   and   the   total taxable   income   by   claiming   such   huge   expenditure   in   the statement   of   total   income   computation   for   acquisition   of   fixed assets, as revenue expenditure. Therefore, he disallowed such           expenditure of the assessee to be covered under section 31 of the Act or as revenue expenditure under section 37 of the Act.  The AO further held that the assessee could claim depreciation on the said assets as per the income tax rules.

5.     An appeal was preferred by the Respondent against the said order of the AO before the Commissioner of Income Tax (CIT) (Appeals)-I, Madurai. The Commissioner of Income Tax (CIT) (Appeals)-I, Madurai, by its order dated 12th of March, 1998 in Appeal No. 324/97-98, allowed the appeal of the assessee, inter alia, holding that replacement of machinery by the assessee in this case constituted revenue expenditure. In allowing the claim of the assessee, the CIT (Appeals) followed its own order for the Assessment   Year   1991-92   wherein   a   similar   allowance   was granted in favour of the assessee.

6.     Against this order of the CIT (Appeals), the revenue department went in appeal before the Tribunal. The appeal was disposed of by the ITAT, Chennai Bench-C in ITA No. 1139/Mad/1998 by its order   dated   16th of   June,   2004.   The   tribunal   followed   the decision of the Madras High Court wherein it was decided that replacement   of   ring   frame   is   only   replacement   of   part   of   the machinery in the textile mills. The tribunal, thus, upheld the order of the CIT (Appeals) and dismissed the appeal of the revenue.

7. Aggrieved by the said order of the Tribunal, the revenue filed an appeal under section 260A of the Act before the High Court of Judicature at Madras.

8.   The High Court, relying on its own decision in CIT v. Janakiram Mills Ltd. (275 ITR 403) and CIT v.  Loyal Textile Mills Ltd. (284   ITR   658), by   its   order   dated   18th of   December,   2006, dismissed   the   appeal   filed   by   the   revenue   and   held   that   the expenditure   on   replacement   of   machinery   was   revenue   in nature. The High Court further held that the question whether the   expenditure   on   replacement   of   machinery   was   capital   or revenue in nature was not determined by the treatment given to it by the assessee in the books of accounts or in the balance sheet. The claim has to be determined only by relying on the provisions of the Act and not by the accounting practice followed by the assessee.

9. The main question that needs to be decided in this appeal may be formulated as follows: –

“Whether   expenditure   incurred   on   replacement   of machinery, in the facts and circumstances of this case, amounts   to   ‘revenue   expenditure’   deductible   under section 37 of the Act or ‘current repairs’ deductible under section 31 of the Act.”

10.It is pertinent to mention here that the respondent only stated  that its claim was limited to the expenditure being of a revenue nature and thus allowable under section 37 of the Act. Nowhere had   the   Respondent   claimed   that   the   said   expenditure amounted   to   ‘current   repairs’   under   section   31   of   the   Act. Further, the appellant itself had restricted the issue to that of revenue expenditure in its appeal to the High Court of Madras, against   which   it   has   now   filed   this   appeal.   According   to   the Respondent,   there   is   no   issue   regarding   the   expenditure amounting to ‘current repairs’ under section 31 of the Act. We are not inclined to uphold this submission of the Respondent. The   fact   that   the   appellant   has   contended   before   the   courts below that each of the item of machinery in a spinning mill is independent, that the respondent has argued against it, and has given evidence to try to support its contention, and also that the  assessee believes that replacement is only of spare parts in the entire system of the spinning mills, makes it clear that a question has arisen here as to whether replacement of one or more items of   machinery   amounts   to   repair   of   the   entire   integrated machinery   of   the   spinning   mill   or   acquisition   of   a   new independent machinery.

11. The learned counsel for the appellant submitted that the courts below erred in rejecting the contention of the department that 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. The Madras High Court has held in the case of Commissioner of Income Tax vs. Madras Cements Ltd..(255 ITR 245) that each item of machinery in a cement factory has to be   considered   as   being   independent machinery.   Learned counsel for the appellant, further, contended that the scheme of production in a textile mill is similar to the integrated scheme of production   in   a   cement   factory,   where   no   independent commodity can be said to have been produced before it, which is a ground in a roller mill. As per the learned counsel for the appellant, the courts below erred in distinguishing this decision of   the   Madras   High   Court.   Thus,   given   that   each   item   of machinery is independent, the replacement of any such machine will amount to acquisition of a new asset and not ‘repair’ of the entire   integrated   machinery   of   the   spinning   mill.   In   this connection, reliance was placed on a decision of this Court in Ballimal Naval Kishore (supra) wherein it is clearly held that ‘current repairs’ under the Act means expenditure on machinery, plant   or   furniture   which   is   not   for   the   purpose   of   renewal   or restoration but which is only for the purpose of preserving or maintaining an already existing asset and that does not bring a new asset into existence or does not give to the assessee a new or different advantage. Learned counsel for the appellant further contended   that   replacement   of   old   machinery   with   new machinery cannot be considered as current repairs as such or even revenue expenditure, since it gives an enduring benefit to the assessee. Also, if in every case such replacement is allowed as revenue expenditure the principle of allowing depreciation will lose its significance. Learned counsel further submitted that the courts below erred in overlooking the definitions of ‘assets’ and ‘block of assets’ under explanation 3 of section 32(1)(ii) of the Act and thus, misconstruing the provision for composition of the ‘block of assets’ as per the definition of ‘written down value’ as given under section 43(6)(C) of the Act, which aid the charging section 28, as to the assessability of income from business and profession. Learned counsel for the appellant further contended that   the   courts   below   had   gone   wrong   in   equating   the complicated   machinery   of   a   spinning   mill   with   a   tube-light   in relying on the Boards’ Circular No. 69 dated 27th of November, 1957 on “tube-lights” which stated that only first time purchase of a   tube-light   amounts   to   capital   expenditure,   and   subsequent replacement would only be revenue expenditure. Lastly, learned counsel for the appellant emphasised that the reliance on the decision in Janakiram Mills (supra) case by the High Court was misplaced, in as much as the High Court had failed to appreciate that an appeal had already been filed against it before this Court and thus the decision of the High Court in the Janakiram Mills (supra) case was not final and binding.

12. The   learned   counsel   for   the   respondent   submitted   that   the respondent had incurred expenditure for replacing the old and worn   out   parts   of   machinery   of   the   spinning   mill.   They   are merely parts of the spinning mill, dependent on other parts of the textile   mill,   and   the   replaced   machinery   cannot   function independently. Further, the learned counsel for the respondent argued   that   the   High   Court   rightly   distinguished   the  Madras Cements   Ltd. (supra) case   because   in   that   case   the   whole plant   was   relocated   and   in   its   place   a   whole   new   plant   was installed. The learned counsel for the respondent further argued that   the   case   of  Ballimal   Naval   Kishore (supra) is   not applicable   here   because   in   that   case   a   ginning   factory   was converted to a cinema theatre and what the assessee there did was not replacement of machinery parts of an integrated plant but total conversion into a theatre. The learned counsel for the respondent has contended that the provisions relating to ‘assets’ and ‘block of assets’ are immaterial in the instant case, which deals   with   revenue   expenditure   on   replacement   of   machinery and would not come under ‘block of assets’. Further, the learned counsel for the respondent also relied on the Boards’ Circular No.   69   dated   27th  of   November,   1957   which,   the   respondent claimed, is still valid and as per which, replacement of worn out parts,   even   if   the   same   is   in   a   textile   mill,   would   constitute revenue expenditure.  The  learned  counsel  for  the  respondent has also argued that the argument of enduring benefit to the respondent,  taken  by the appellant,  is  no longer a  good law. Lastly,   learned   counsel  for   the  respondent   submitted   that   the High Court was right in relying on its own judgment in the case of Janakiram Mills Ltd. (supra) because this Court, by its order dated 21st  of August, 2007 in Civil Appeal No. 7594/2005, has already pronounced upon the validity of the judgment of the High Court in that matter and has disposed of the appeal in the same.

13.   We   have   heard and   considered all   these   contentions   of   the learned counsel for the parties and also perused the materials on record and also examined the impugned order passed by the High Court.

14. The   first   issue   that   needs   to   be   resolved   is   whether   each machine in a textile mill is an independent item or merely a part of a complete spinning mill, which only together are capable of manufacture, and there is no intermediate marketable product produced.   In   our   view,   this   issue   has     been   satisfactorily answered   by   the   recent   decision   of   this   Court   in CIT v. Saravana Spinning Mills (P) Ltd. ((2007) 7 SCC 298). In that case this Court has held unambiguously that “each machine in a segment of a textile mill has an independent role to play in the mill and the output of each division is different from the other.” Dealing with a ring frame in a textile mill, this Court has held that it   is   an   “independent   and   separate”   machine.   Further,   it   is accepted   that   each   machine   in   a   textile   mill   is   part   of   the integrated process of   manufacture   of   yarn   and   is   integrally connected to the other machines in the mill for production of the final product. However, this interconnection does not take away the independent identity and distinct function of each machine. Thus,   each   machine   in   a   textile   mill   should   be   treated independently   as   such   and   not   as   a   mere   part   of   an   entire composite machinery of the spinning mill. As stated above, it can   at   best   be   considered   part   of   an   integrated   manufacture process employed in a textile mill.

15. Moving on to the issue of ‘current repairs’ under section 31 of the Act, the decision of this Court in CIT v. Saravana Spinning Mills (P) Ltd. (supra) is again relevant. This court has laid down that   in   order   to   determine   whether   a   particular   expenditure amounts to ‘current repairs’ the test is “whether the expenditure is incurred to ‘preserve and maintain’ an already existing asset and not to bring a new asset into existence or to obtain a new advantage.   For   ‘current   repairs’   determination,   whether expenditure is revenue or capital is not the proper test.” It is our opinion that the entire textile mill machinery cannot be regarded as   a   single   asset,   replacement   of   parts   of   which   can   be considered to be for mere purpose of ‘preserving or maintaining’ his asset. All machines put together constitute the production process and each separate machine is an independent entity. Replacement   of   such   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. Also, a new asset in a textile mill is not only for temporary use. Rather it gives the purchaser an enduring benefit of better and more efficient production over a period of time. Thus, replacement of assets as in the instant case cannot amount to ‘current repairs’. The decision in  Saravana Mills (supra) case clearly mentions that replacement of a derelict ring frame by a new one does not amount to ‘current repairs’. Further in  Ballimal Naval Kishore (supra) this Court has held  that a new asset or new/different advantage cannot amount to ‘current repairs’,  which has been subsequently approved in the Saravana Mills (supra) case. For these reasons, the expenditure made by the assessee cannot be   allowed  as   a   deduction   under   section   31   of   the   Act.   The judgment   of   this   Court   in   the  Saravana   Mills (supra) case mentions two exceptions in which replacement could amount to current repairs, namely:

  • “Where old parts are not available in the market (as seen in the case of CIT v.  Mahalakshmi Textile Mills Ltd.(AIR 1968 SC 101), or
  • Where old parts have worked for 50-60 years.”

In the instant case, the assessee has not claimed any of the above stated exceptions. The Saravana Mills (supra) case also restricts the scope of ‘current repairs’ to repairs made to machinery, plant and/or furniture. In this case, replacement of machine can at best amount to a repair made to the  process of manufacture of yarn.  Further this court   has   also   observed   in  Saravana     Mills (supra) case   that   if replacement   was  held  to  be  ‘current   repair’   in  such  cases,  section 31(i) will be completely redundant and absurdity will creep in because repair   implies   existence   of   a   part   of   the   machine   which   has malfunctioned, which is impossible in the case of such replacement. Thus,   this   replacement   expenditure   cannot   be   said   to   be   ‘current repairs’ after the decision in the Saravana Mills (supra) case.

16. Given that section 31 of the Act is not applicable to the said expenditure of the assessee, the next issue is whether it can be considered ‘revenue expenditure’ of the nature envisaged under section 37 of the Act. The  Saravana Mills (supra) case holds that expenditure is deductible under section 37 only if it (a) is not deductible under sections 30-36, (b) is of a revenue nature, (c) is incurred during the current accounting year and (d) is incurred wholly and exclusively for the purpose of the business. We are satisfied that the assessees’ expenditure satisfies requirements (a), (c) and (d) as stated above. The dispute is with respect to the nature of expenditure, that is, whether it is revenue or capital in nature.

17. We are of the opinion that the expenditure of the assessee in this   case   is   capital   in   nature   and   there   is   sufficient   judicial precedent   to   support   this   view.   In   the   case   of  Travancore Cochin Chemicals Ltd. V.  CIT ((1997) 2 SCC 20) this Court held that expenditure is of a capital nature when it amounts to an enduring advantage for the business and repair is different from bringing   a  new  asset  for   the   business.   Further,   in  Lakshmiji Sugar Mills (P) Co. v. CIT (AIR 1972 SC 159) it has been held by   this   Court   that   bringing   into   existence   a   new   asset   or   an enduring   benefit   for   the   assessee   amounts   to   capital expenditure.   We   have   already  explained   why   replacement,   in this case, amounts to bringing into existence a new asset and also an enduring benefit for the assessee. It is clear then that expenditure of the assessee here is not of a revenue nature and thus, cannot be claimed as a deduction under section 37 of the Act.

18.   As far as reliance on the High Court decision in  Janakiram Mills (supra) case is concerned, the  Saravana Mills (supra) case has clearly set aside the said judgment of the Madras High Court   by   its   finding   on   the   scope   of   ‘current   repairs’   under section 31 of the Act. In CIT v. Ramaraju Surgical Cotton Mills (MANU/SC/8156/2007), where this court decided on the validity of the Madras High Court judgment in Janakiram Mills (supra), this court clarified that this High Court judgment has been set aside in the Saravana Mills (supra) case mainly on the ground that section 31 and section 37 of the Act, operate in different spheres and the tests applicable to section 31 cannot be read into   section   37   of   the   Act.   Further,   even   in   the  Ramaraju (supra) case,   where   this   Court   distinguished   the  Saravana Mills (supra) case   on   the   ground   that   that   appeal   was   with respect to deduction only under section 37 of the Act unlike the Saravana Mills (supra) case, this court set aside the High Court judgment   in  Janakiram   Mills (supra) case   and   remitted   the matter to the Commissioner (Appeals) to dispose of the matter in accordance   with   law.   In   the   light   of     the   observations   made herein   above,   it   is   thus   clear   that  the   High   Court   decision   in Janakiram Mills (supra) case is not good law on which reliance may be placed.

19.Consideration of the definition of ‘assets’ and ‘block of assets’ and the concept of depreciation under the Act is not required to be   decided   upon   whether   the   expenditure   incurred   by   the assessee is a deductible expenditure or not. Hence we are not inclined to discuss the same.

20. It is clear on record that the assessee has sought to treat the said   expenditure   differently   for   the   purposes   of   computing   its profit and for the purpose of payment of income tax. The said expenditure   has   been   treated   as   an   addition   to   the   existing assets in the former and as revenue expenditure in the latter.  Though   accounting   practices   may   not   be   the   best   guide   in determining   the   nature   of   expenditure,   in   this   case   they   are indicative of what the assessee itself thought of the expenditure it   made   on   replacement   of   machinery   and   that   the   claim   for deduction under the Act was made merely to diminish the tax burden, and not under the belief that it was actually revenue expenditure.

21. For the reasons aforesaid, we set aside the impugned judgment of   the   High   Court,   thereby   restoring   the   judgment   of   the   AO disallowing the claim of deduction of the respondent.

22. The appeal is accordingly allowed. There will be no order as to costs.

…………….………J.          ……………………J.

[Tarun Chatterjee]      [Aftab Alam]

New Delhi;

July 21, 2009

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