Income Tax Appellate Tribunal - Chennai
Assistant Commissioner Of Income Tax vs Prabhu Spg. Mills (P) Ltd. on 30 November, 2007
Equivalent citations: (2008)113TTJ(CHENNAI)372
ORDER
T.R. Sood, A.M.
1. This appeal by the Revenue is directed against the order of the CIT(A) dt. 14th Oct., 2005 for the above assessment year. The Revenue has raised the following grounds:
Ground 1:
(a) The learned CIT(A) has not considered the elaborate reasons given by the AO why the expenses on replacement of machinery should be treated as capital in nature.
(b) As per the decision of the apex Court in the case of Ballimal Nawal Kishore and Anr. v. CIT only expenses on current repairs alone can be allowed as revenue expenditure and not expenses on replacement of machinery.
(c) In the case of CIT v. Madras Cement Ltd. the Hon'ble Madras High Court has held that expenses on replacement of machinery which can function independently is to be treated as capital in nature.
(d) The CIT(A) erred in placing reliance on the judgment of the Madras High Court in the case of CIT v. Janakiram Mills Ltd. as the decision in Janakiram Mills case (supra) has not reached finality and the Department has filed appeal before the Supreme Court.
Ground 2:
The learned CIT(A) erred in holding that excise duty and sales-tax are to be excluded from the turnover to work out deduction under Section 80HHC.
Ground 3:
The learned CIT(A) erred in directing that Section 80-IA deduction should be allowed on the eligible profits without reducing the deduction given under Section 80HHC.
2. Ground 1:
The brief facts of the case are that during the year assessee company made an investment of Rs. 2,58,21,005 in plant and machinery and claimed that capital outlay as revenue expenditure under the head "Modernization and replacement". As per details filed, this represented purchase of three cone winding machines. The AO was of the opinion that purchase of these machines was in the nature of capital assets and gave enduring economic benefits to assessee over a period of time. Upon enquiry, it was submitted on behalf of the assessee as under:
During the year company has modernized three new cone winding machines by replacing the three old cone winding machines. (Copy of statement showing the details of machinery modernized is enclosed).
The cost of old replaced machinery is Rs. 2,65,000 and depreciation claimed so far is Rs. 1,86,049.37. They are removed from the block of assets in the books. Copy of statement showing the cost and depreciation claimed so far is enclosed.
The replaced machineries are dismantled and kept in stock and sold in subsequent years. WDV of replaced machineries of Rs. 78,950.63 is removed for income-tax depreciation from block of assets. (Copy of statement showing the cost, depreciation claimed and WDV is enclosed).
The capacity of the textile mill is reckoned with installed capacity of the spindles. In our case the capacity in the beginning of the year and at the end of the year is only 38416 spindles. Therefore, if the installed capacity is increased there can be a capital expenditure involved in it. So long as it remains the same expenditure incurred is only in the nature of current repairs and is allowable as a revenue expenditure.
Our company is a textile mill and several High Courts and the Supreme Court have decided that replacement of any machinery which is forming part of the unit as whole is only a replacement expenditure.
3. Reliance was also placed on various case law. AO considered the submissions in details and pointed out that Madras High Court in the case of CIT v. Madras Cement Ltd. had held that the asset cannot be equated to the whole of production facilities and expenditure was not incurred for replacement of the part of entire plant. He analyzed the other case law also and ultimately held that sum invested by the assessee in the purchase of machinery was only a capital expenditure. However, he also observed that assessee was entitled to depreciation and accordingly depreciation was allowed.
4. Before CIT(A) various detailed submissions were made and reliance was also placed on the decision of Madras High Court in the case of CIT v. Jankiram Mills Ltd. (supra). The learned CIT(A) did not go into the various submissions but followed the decision of CIT v. Jankiram Mills Ltd. case (supra) cited supra whereby expenditure incurred on replacement of worn out machinery was held to be revenue expenditure and allowed assessee's claim. In fact he observed in para 3.3.2 as under:
After detailed deliberation which need not and therefore, not being discussed here for the sake of brevity, Hon'ble Madras High Court has upheld the above finding of the Tribunal and the appeal filed by the Revenue was dismissed. The facts of the present appeal have been verified and found to be exactly similar to the facts of the case decided by Hon'ble Madras High Court. Therefore, being the decision of the jurisdictional High Court, I am bound to follow this decision.
Before us, the learned Departmental Representative submitted that decision of Madras High Court in case of CIT v. Jankiram Mills Ltd. (supra) has been reversed by Hon'ble Supreme Court in case of CIT v. Saravana Spinning Mills (P) Ltd. and therefore now the issue stands covered in favour of the Revenue.
5. On the other hand, the learned Counsel of the assessee objected to this proposition and submitted that issue raised by Revenue in its appeal is different from the issue considered by Hon'ble Supreme Court in the case of CIT v. Saravana Spinning Mills (P) Ltd. (supra). He referred to the decision of Supreme Court in case of CIT v. Saravana Spinning Mills (P) Ltd. (supra) and pointed out that, in that case the Supreme Court has gone to consider the meaning of "current repairs" and ultimately held as under:
(ii) That to decide the applicability of Section 31(i) the test was not whether the expenditure was revenue or capital in nature, but whether the expenditure was 'current repairs'. The basic test was to find out whether expenditure was incurred to 'preserve and maintain' an already existing asset, and the expenditure must not be to bring a new asset into existence or to obtain new advantage.
(iii) That each machine including the ring frame was an independent and separate machine capable of independent and specific function and, therefore, the expenditure incurred for replacement thereof would not come within the meaning of 'current repairs'. The replacement of the ring frame constituted substitution of an old asset by a new asset, and, therefore, the expenditure incurred by the assessee did not fall within the meaning of current repairs' in Section 31(i).
6. He further pointed out that all through, the claim of the assessee was made under Section 37. For this purpose he referred to the copy of the annual accounts which were filed during the course of hearing and invited our attention to p. 13 of the annual accounts which is a copy of the P&L a/c for the year ending 31st March, 2002 where modernization and replacement expenses have been separately shown at Rs. 2,58,21,005. Then he submitted that at p. 18 of the annual reports, repairs and maintenance of machinery was separately claimed at Rs. 37,31,426 which is clubbed in Schedule XVI containing other manufacturing expenses. Then, he referred to assessment order and submitted that para 3 of the order very clearly shows that claim was made on purchase of three new born machinery as revenue expenditure. In fact, para 3 of the assessment order reads as under:
During the previous year relevant to the asst. yr. 2002-03 the assessee company made investment of Rs. 2,58,21,005 in plant and machinery and claimed that capital outlay as revenue expenditure under the head 'Modernisation and replacement'. As machineries under the head 'Replacement and modernization' as per the details filed the assessee has purchased three cone winding during the year.
He also referred to ground No. 2 raised before the CIT(A) which reads as under:
The write off of expenditure being modernization and replacement of machinery in P&L a/c is only revenue expenditure allowable under the Act.
7. He submitted that the above ground clearly shows that assessee claimed writing off of the modernization and replacement of machinery as revenue expenditure and, therefore, it cannot be said that the same was claimed as current repairs. Lastly, he referred to the decision of the Supreme Court in the case of CIT v. Romarqju Surgical Cotton Mills (2007) 212 CTR (SC) 345 : (2007) 294 ITR 328 (SC). In that case Supreme Court itself noted that a decision has been rendered in case of CIT v. Saravana Spinning Mills (P) Ltd. (supra) under Section 31, but Sections 31 and 37 operate in different fields and that is why Supreme Court has segregated the appeals where claim was made for purchase of certain assets as replacement and to decide the issue whether such claim was allowable under Section 37 or not and after detailed discussion, the matter was sent back to the file of CIT(A) as requisite details were not available before the Supreme Court.
8. He also referred to the decision of the Hon'ble Madras High Court in the case of CIT v. Sri Karthikeya Spg. & Wvg. Mills Ltd. which is directly on the point, wherein it was held that purchase of draw frame was a revenue expenditure. This also shows that the assessee can make a separate claim for purchase of assets as revenue expenditure if the conditions prescribed under Section 37 of the Act are fulfilled. He again referred to the decision of the Hon'ble Supreme Court in the case of CIT v. Ramarqju Surgical Cotton Mills (supra) wherein it was observed that there are a number of tests required to be considered while deciding whether the expenditure was revenue or capital in nature. He submitted that the Hon'ble Supreme Court could not decide this issue because relevant particulars were not available before the Hon'ble Supreme Court, whereas all particulars in this case were available before the lower authorities as well as the Tribunal. Since the decision of Madras High Court in the case of CIT v. Janakiram Mills Ltd. (supra) was available, the CIT(A) merely followed that decision instead of going into the details in respect of other issues raised by the assessee.
9. The learned Counsel for the assessee explained to us the various functions of cone winder. He submitted that cone winding is the last process of making yarn out of cotton. When cotton is converted into yarn after spinning the same which is the stage immediately before cone winding, in the next stage, this yarn is wound up in cops which is a small plastic cone shaped gadget. Thus, spun yarn is wound in the cones from cops to make it marketable and usable by the consumer. He explained that in manual cone winding (i.e., old cone winding machines), each cone can accommodate 1 kg. of yarn and can accept from 20 cops of 50 gms. each. Further, when each empty cop is changed with the loaded cop in the manual cone winder, the ends of thread or yarn were tied manually which lead to knots after every 50 gms. of yarn which results in 20 knots in 1 kg. of yarn. He pointed out that this yarn was not easily acceptable in the market in the modern times because these 20 knots create hindrance in production of cloth and thus, this product was increasingly not being accepted in the market. In the meantime auto cone winders were available in the market. In auto cone winder, the technical use is called fusing of yarn ends to avoid knots. Moreover, in such cone winder each cone contains upto 2.4 kgs. of yarn. In auto cone winding another advantage was that contamination was removed from the yarn. Though auto cone winder costs several times more than manual cone winder, it was still necessary to go in for auto cone winder. This is so because consumers in the market were using hi-tech knitting and weaving machines to convert yarn into cloth and such machines do not allow yarn with any knots. In export markets, cones of 1 kg were not being accepted because foreign customers were accepting only yarn of 2 kgs. or more. In this background, it had become necessary to go in for auto cone machines and the assessee was compelled by the business circumstances to go in for such machinery.
10. Now, the question is whether replacement of manual cone machines with auto cone winders should be treated as revenue expenditure or capital expenditure. One of the principal tests laid down by the Hon'ble Supreme Court as well as Hon'ble Madras High Court was that if it leads to increase in manufacturing capacity of the assessee, then it would constitute capital expenditure.' Otherwise, it would constitute revenue expenditure. In this regard he referred to p. 22 of the paper book where the quantitative details are given. He brought to our attention that installed capacity which is measured in terms of spindles remained the same at 38,416 from 31st March, 2001 to 31st March, 2002. He then referred to p. 51 of the paper book and submitted that capacity increased to 39,472 as on 31st March, 2003, but this was because more machines were added which becomes clear from the schedule of fixed assets. He also referred to p. 45 of the paper book and submitted that during the year ending 31st March, 2003, no amount was claimed on account of modernization and replacement expenses. He also pointed out that another relevant test would be how many machines have been changed. He submitted that in the case before us, only three machines being auto cone winders were replaced in place of three old manual cone winders out of the total of 250 machines. Hence, this cannot be called replacement on account of capital because there is no increase in the machineries.
11. The learned Counsel for the assessee further submitted that the expenditure incurred on machines which are meant for modernization of the unit or up-gradation of the technology has been shown as revenue expenditure under the head "Modernization and replacement" and not all the machines have been claimed as revenue expenditure. In this regard, he referred to p. 15 of the annual accounts report which is a copy of the fixed assets schedule, which shows that machinery worth Rs. 23,42,51,075 was capitalized. He further referred to p. 55 of the paper book showing details of the machines. This means that the assessee has himself treated the major expenditure incurred on purchase of machinery as capital expenditure. He also submitted that machineries purchased on account of modernization and latest technology constitute less than 10 per cent in terms of value and less than 1 per cent in terms of number of machines. Therefore, the same should be treated only as replacement on revenue account.
12. The learned Counsel for the assessee furnished a chart showing comparison between auto cone winder versus manual cone winder and submitted that though capital cost is very heavy in the case of auto cone winders, the assessee has not derived any advantage in terms of cost reduction by installing auto cone winders. In fact, the cost per unit is increased from Rs. 3,531.50 to Rs. 6,022.75, leading to an additional expenditure of Rs. 2,491.20. Still the assessee had to go in for these auto cone winders because knotted yarn was not acceptable in the market and, therefore, at best it can constitute up-gradation of technology by installing auto cone and the same should be treated as revenue expenditure only.
13. While referring to the case law, he first of all cited the decision of the Hon'ble Supreme Court in the case of Alembic Chemical Works Co. Ltd. v. CIT and brought to our attention, the following observation of the Court:
In Assam Bengal Cement Companies Ltd. v. CIT , this Court observed:
If the expenditure is made for acquiring or bringing into existence an asset or advantage for the enduring benefit of the business it is properly attributable to capital and is of the nature of capital expenditure. If, on the other hand, and it is made not for the purpose of bringing into existence any such asset or advantage but for running the business or working it with a view to produce the profits, it is a revenue expenditure.
The aim and object of the expenditure would determine the character of the expenditure whether it is capital expenditure or a revenue expenditure.
He also brought to our attention the following observation in this case:
As observed by the Supreme Court in the decision in Empire Jute Co. Ltd. v. CIT , that there may be cases where expenditure, even if incurred for obtaining an advantage of enduring benefit, may, nonetheless, be on revenue account and the test of enduring benefit may breakdown. It is not every advantage of enduring nature acquired by an assessee that brings the case within the principles laid down in this test. What is material to consider is the nature of the advantage in a commercial sense and it is only where the advantage is in the capital field that the expenditure would be disallowable on an application of this test...
He then emphasized that from the facts involved in this case before us, it is clear that the purpose was not to make addition to the capacity or acquire advantage of enduring benefit but purchase was made for the running of the business, because in the absence of installation of these auto cones, the assessee would not have been able to sell the yarn in the market. He also emphasised that the advantage etc. has to be in the commercial sense as observed in this judgment. He then strongly relied on the decision of the Hon'ble Madras High Court in the case of CIT v. Sri Karthikeya Spg. & Wvg. Mills Ltd. (supra) where it was clearly held that the expenditure on replacement of draw frames was of revenue nature. He also relied on the decision in the case of CIT v. Vanaja Textiles Ltd. (1994) 118 CTR (Ker) 372 : (1994) 208 ITR 161 (Ker) wherein it was held that the expenditure incurred on renovation and replacement of the old and worn out machinery along with modernization of machinery was imperative for running of the business smoothly and effectively and would constitute revenue expenditure. He then referred to the decision of the Hon'ble Punjab & Haryana High Court in the case of CIT v. Indian Woollen Textile Mills (P) Ltd. 1978 CTR (P&H) 1 : (1978) 112 ITR 441 (P&H) wherein it was held that the expenditure on replacement of semiautomatic looms for automatic ones was allowable expenditure under Section 37(1) of the Act. Similarly, in the case of CIT v. Sakthi Textiles Ltd. it was held that the expenditure incurred on installation of over-head cleaner, speed frames and humidification plant was revenue expenditure allowable under Section 37 of the Act as they were only replacement of the existing machinery. He also relied on the following judgments:
(i) Assam Bengal Cement Co. Ltd. v. CIT ;
(ii) Empire Jute Co. Ltd. v. CIT .
14. The learned Departmental Representative, on the other hand, referred to p. 2 of the assessment order and invited our attention to the note submitted by the assessee. He particularly referred to point 5 of the note which reads as under:
Our company is a textile mill and several High Courts and the Supreme Court have decided that replacement of any machinery which is forming part of the unit as whole is only a replacement expenditure.
He submitted that this explanation will make it clear that the assessee was claiming the expenditure only on account of current repairs. Then he referred to p. 15 of the assessment order and submitted that the AO mainly discussed the issue on repairs only. He referred to the grounds raised before the CIT(A) and submitted that ground No. 4 was clearly referring to current repairs. In fact, before the CIT(A), the assessee has raised other grounds also but the decision rendered by him was given on current repairs because the CIT(A) has followed the decision of the Hon'ble Madras High Court in the case of CIT v. Janakiram Mills Ltd. (supra) which stands covered by the decision of the Hon'ble Supreme Court in the case of Saravana Spg. Mills (P) Ltd. (supra). All these things clearly point out that the issue involved is only allowance of current repairs and that issue is covered in favour of the Revenue by the decision of the Hon'ble Supreme Court in the case of Saravana Spg. Mills (P) Ltd. (supra).
15. In any case, even if the claim is treated as one made under Section 37 of the Act, the claim of the assessee is not allowable. First of all it is pertinent to note that the old machine was costing only Rs. 2.60 lakhs approximately whereas the new machine is costing Rs. 2.60 crores approximately which means it is a case of putting up a new machine by the assessee. He further submitted that old machine was purchased about ten years ago by the assessee and the new machine by which the machinery has been replaced is more efficient and automatic and this would constitute an enduring benefit to the assessee. He referred to the observations made by the AO in para 20 of the assessment order where he has noted that AS 6 to 10 issued by the ICAI which make it clear that expenditure on replacement of new machineries in place of the old ones is never, to be allowed as revenue expenditure.
16. He further submitted that the concept of repairs and replacement cannot be stretched beyond a particular point. In this regard he referred to the decision of the Hon'ble Supreme Court in the case of Ballimal Nawal Kishore and Anr. v. CIT . He also submitted that whenever a new and automatic machine is installed the quality of the product increases leading to the enhanced profitability. In this regard he referred to p. 45 of the paper book and pointed out that sales have gone up from Rs. 69.34 crores to Rs. 71.73 crores from the year ending 31st March, 2002 to 31st March, 2003 but wages have gone down from Rs. 47.63 lakhs to Rs. 38.34 lakhs. Since the machine was installed in the financial year 2001-02, these figures clearly show that efficiency has gone up. Then he referred to the annual report for the year ending 31st March, 2004 and submitted that sales had gone up from Rs. 71.63 crores to Rs. 83.08 crores from the year ending 31st March, 2003 to 31st March, 2004 and here also, wages had almost remained same at Rs. 38.34 lakhs in the year ending 31st March, 2003 to Rs. 39.30 lakhs in the year ending 31st March, 2004. Then he referred to the annual accounts for the financial year 2004-05 and submitted that the processing charges have gone down from Rs. 8.17 crores to Rs. 5.92 crores which means that the efficiency of these machines must have increased.
17. The learned Departmental Representative also referred to various case law. He invited our attention to the decision in the case of Modi Spg. & Wvg. Mills Co. Ltd. v. where even amount spent towards cost of marble, charges for cutting stones and renovating of administrative block was held to be not allowable as current repairs. Then he referred to the decision of Hon'ble Supreme Court in the case of Pingle Industries Ltd. v. CIT wherein it was observed that enduring benefit does not mean everlasting. It only means that life of machinery is going to be for many years. He also submitted that even the magnitude of the payment should be taken as one of the tests for determining whether the expenditure relates to capital field or revenue field. Then he referred to the decision of the Hon'ble Bombay High Court in the case of Gopal Mills Co. Ltd. v. CIT wherein it was observed that even if no new asset comes into existence, still such expenditure could constitute capital expenditure. In that case, a pit was filled up which was causing nuisance to the neighbourhood, but such expenditure was held to be on capital account. He further referred to the decision of the Hon'ble Kerala High Court in the case of Veeraraghavan v. CIT wherein it was held that expenditure incurred for claiming a piece of land over which license had been granted to the assessee to install a petrol pump was held to be capital expenditure. He also referred to the decision of the Hon'ble Allahabad High Court in the case of Harijan Evam Nirbal Varg Avas Nigam Ltd. v. CIT (1996) 131 CTR (All) 183 : (1996) 218 ITR 622 (All), where even the purchase of carpet was held to be capital expenditure. He also referred to the decision of Hon'ble Supreme Court in the case of CIT v. Mir Mohammad Ali where it was held that meaning of the machinery would include parts of machinery also. Then he referred to the decision of the Delhi Bench of the Tribunal in the case of Asian Hotels Ltd. v. Dy. CIT where renovation made to the hotel is held to be capital expenditure. While concluding his arguments, the learned Departmental Representative strongly supported the order of the AO and submitted that in view of the above decisions, modernization and replacement expenditure should be held to be incurred on capital account.
18. In reply, the learned Counsel for the assessee submitted that the learned Departmental Representative has wrongly compared the figures of wages. In fact, expenditure on wages has increased from Rs. 1.58 crores to Rs. 1.66 crores and the figures pointed out by the learned Departmental Representative relate to welfare expenses. Similarly, he referred to the annual accounts for the asst. yr. 2003-04 and submitted that wages have gone down from Rs. 1.66 crores to Rs. 1.57 crores. No doubt, as pointed out by him, the expenditure on wages might have gone down marginally because of automatic winding machines, but the total cost had increased because of increased electricity expenditure which becomes clear from Schedule XTV and the total expenditure on power and fuel had gone up from Rs. 8.66 crores to Rs. 9.05 crores. This only shows that no cost advantage was derived by the assessee by installation of the auto cone winders. It was a mere case of survival in the business because the assessee would not have been able to sell the thread with knots but for the decision to go in for auto cone winder.
19. The learned Counsel for the assessee further contended that the case law referred to by the learned Departmental Representative are clearly distinguishable and have been considered by the Hon'ble Supreme Court in the decision cited supra. However, as far as the issue regarding magnitude of payment is concerned, the Hon'ble Supreme Court in the case of P.H. Divecha and Anr. v. CIT has clearly observed in para 13 of the judgment that it may also be stated as a general rule that the fact; that the amount involved was large or that it was periodic in character has no decisive bearing upon the matter. In this case also, the Hon'ble Supreme Court has considered whether a particular receipt was capital or revenue in nature. This principle was reiterated by the Hon'ble Supreme Court again in the case of M.K. Bros. (P) Ltd. v. CIT while deciding the issue whether a particular expenditure incurred was of capital nature or revenue nature. While concluding his arguments, the learned Counsel for the assessee submitted that on the basis of case law cited by him and the facts of the case before us, the expenditure is clearly of revenue nature and the same is also covered by the decision of the Hon'ble jurisdictional High Court in the case of Sri Karthikeya Spg. & Wvg. Mills Ltd. (supra).
20. We have considered the rival submissions carefully in the light of the material on record as well as judgments cited by the parties. From the copy of annual accounts at p. 13, it becomes absolutely clear that the assessee had debited the expenditure incurred on purchase of auto cone winders as "Modernization and replacement expenses". Repairs and maintenance were also incurred and at p. 18 of the annual accounts the assessee claimed a sum of Rs. 37,31,425 as repairs and maintenance to machinery along with repairs and maintenance of other items separately.
21. Further, para 3 of the assessment order and ground 2 of the appeal before the CIT(A) read as under:
During the previous year relevant to the asst. yr. 2002-03 the assessee company made investment of Rs. 2,58,21,005 in plant and machinery and claimed that capital outlay as revenue expenditure under the head 'Modernization and replacement'. As per the details filed the assessee has purchased three cone winding machineries under the head 'Replacement and modernization' during the year.
The write off of expenditure being modernization and replacement of machinery in P&L a/c is only revenue expenditure under the Act.
22. It is obvious that the assessee never claimed modernization and replacement expenditure as current repairs and basically, the claim was made as revenue expenditure on account of purchase of machinery for the purpose of replacement under Section 37. Since CIT(A) has observed in para 3.3.2 that there was no purpose to discuss various deliberations in detail and for the sake of brevity he had followed the decision of Hon'ble Madras High Court in case of CIT v. Janakiram Mills Ltd. (supra). Simply because the learned CIT(A) has given relief on the basis of decision of Madras High Court in case of CIT v. Janakiram Mills Ltd. (supra) does not mean that assessee had made a claim under Section 31 in respect of current repairs.
23. We further find that Hon'ble Supreme Court in the case of CIT v. Ramaraju Surgical Mills (P) Ltd. (supra) had clearly observed as under:
At the outset it may be stated that vide the judgment dt. 10th Aug., 2007, in civil appeals Nos. 7604-05 etc. of 2005 in the case of CIT v. Saravana Spinning Mills (P) Ltd., this Court has set aside the impugned judgment herein of the Madras High Court in the case of Janakiram Mills Ltd., principally on the ground that Section 31 and Section 37 of the IT Act, 1961, operate in different spheres and the tests applicable to Section 31 cannot be read into Section 37 of the IT Act.
However, we segregated the present civil appeal No. 7594 of 2005 from the earlier batch of civil appeal Nos. 7604-05 of 2005 as we were told that in the present case the assessee M/s Ramaraju Surgical Cotton Mills had claimed deduction only under Section 37 of the IT Act.
Having heard learned Counsel for the parties we are of the view that in the present case it is not clear as to the ground on which the assessee had claimed deduction under Section 37. Before us it has been urged on behalf of the assessee that expenditure incurred on replacement of assets without increase in the production capacity is revenue in nature. However, there is no such ground taken in the memo of appeal filed by the assessee before the CIT.
The above findings of the Hon'ble Supreme Court clearly show that in some cases, the issue can be different and claim may be considered under Section 37 of the Act. As observed by us, the assessee debited this amount under modernization and replacement expenditure and repairs were claimed separately and even the AO himself noted in para 3 of the assessment order that the claim was under modernization and replacement. Even if the AO has discussed the concept of current repairs, the nature of claim will not change. We have also perused the grounds of appeal raised before the CIT(A) in this regard which are as under:
1. The AO has erred in treating the expenditure on modernization and replacement of machinery as capital nature.
2. The write off of expenditure being modernization and replacement of machinery in P&L a/c is only revenue expenditure allowable under the Act.
3. The appellant company is a textile mill and several High Courts and the Supreme Court have decided that replacement of any machinery which is forming part of the unit as a whole, is only replacement expenditure.
4. Current repairs are incurred to improve the working condition of the plant by increasing the efficiency. So, whenever replacement of machinery takes place, there will certainly be improvement in the quality.
5. The capacity of the textile mill is reckoned with the installed capacity of the spindles. In the appellant's case the capacity has not increased and remained the same at 38,416 spindles. Therefore, only if the installed capacity is increased because of modernization and replacement there can be a capital expenditure involved in it. So long as it remains the same, expenditure incurred is only in the nature of 'current repairs' and so allowable as revenue expenditure.
6. The Supreme Court, Madras High Court and various Benches of Tribunal, Madras have consistently held that replacement of machinery in a textile mill has to be treated as revenue expenditure, so long as the modernization and replacement expenditure does not contribute to the increase in the spindlage and the textile mill as a whole is to be treated as one unit.
7. This view has been accepted by the Tribunal, Madras in our own group case of M/s Sivarqj Spinning Mills (P) Ltd., ITA Nos. 1427 to 1429/Mad/2002. dt. 28th Feb., 2003 for the asst. yrs. 1993-94 to 1995-96.
Ground 2 above clearly shows that the assessee debited and claimed expenditure on modernization and replacement of machinery only under Section 37 of the Act. In view of these facts, we are of the view that the issue to be decided by us is whether the claim made by the assessee under modernization and replacement can be treated as revenue expenditure under Section 37 or is in the nature of capital expenditure.
25. We have perused all the judgments cited by the parties and we are of the view that most of the judgments stand on their own facts and need not be discussed individually. However, we find that whether a particular expenditure incurred is revenue or capital has been discussed elaborately by the Hon'ble Supreme Court in the following three cases, viz.:
1. Empire Jute Co. Ltd. v. CIT (supra);
2. Alembic Chemical Works Co. Ltd. v. CIT (supra);
3. Assam Bengal Cement Co. Ltd. v. CIT (supra).
26. In the case of Empire Jute Co. Ltd. v. CIT (supra), it was mainly observed that:
(a) there is no universal formula which can provide ready answer to the problem. No touch stone has been devised to determine this problem and every case has to be decided on its facts keeping the broad principles enunciated by the Courts and the nature of expenditure.
(b) the test given by Viscount Cave of enduring nature is applicable to all cases. The Court observed as under:
Now so long as the expenditure in question can be clearly referred to the acquisition of an asset which falls within one or the other of these two categories, such a test would be a critical one. But this test also sometimes breaks down because there are many forms of expenditure which do not fall easily within these two categories and not infrequently, as pointed out by Lord Radcliffe in Commr. of Taxes v. Nchanga Consolidated Copper Mines Ltd. (1965) 58 ITR 241 (PC); the line of demarcation is difficult to draw and leads to subtle distinctions between profit that is made 'out of assets and profit that is made 'upon' assets or 'with' assets. Moreover, there may be cases where expenditure, though referable to or in connection with fixed capital, is nevertheless allowable as revenue expenditure.
(c) the nature of advantage has to be considered from the commercial sense.
(d) where the advantage is in the capital field the expenditure would be disallowable and if the advantage consists merely for facilitating the assessee's trading operation or enable the management and conduct of the assessee's business to be carried on more efficiently and more profitably while leaving the fixed capital untouched, the expenditure would be on revenue account.
(e) reference was made to the following statement of Dixon J. in the case of Hailstorm's Property Ltd. v. Federal Commr of Taxation (72 CLR 634):
What is an outgoing of capital and what is an outgoing on account of revenue depends on what the expenditure is calculated to effect from a practical and business point of view rather than upon the juristic classification of the legal rights, if any, secured, employed or exhausted in the process.
27. The Hon'ble Supreme Court in Alembic Chemical Works Co. Ltd. v. CIT (supra) laid down the following principles:
(a) If the area of improvisation is only part of the existing business, or that the entire gamut of the existing manufacturing operations for the commercial production had not become obsolete of inappropriate in relation to the exploitation of the new product of high yielding variety and when it did not require an erection and commissioning of a totally new and different type of plant and machinery the expenditure incurred is revenue in nature.
(b) Mere improvement in or updating of a process would not necessarily be inconsistent with the relevance and continuing utility of an existing infrastructure, machinery and plant of the assessee.
(c) It is unrealistic to ignore the rapid advances in research and to attribute a degree of insurability and permanence with the technical know-how at any particular stage in this fast changing area of medical science.
(d) The rapid strides in science and technology in the field should make us a little slow and circumspect in too readily pigeon-hole an outlay such as this as capital.
(e) The improvisation in the process and technology in some areas of enterprise was supplemental in the existing business and there was no material to hold that it amounted to a new or fresh venture.
(f) What was stipulated was an improvement in the operations of the existing business and its efficiency and profitability not removed from the area of the day-to-day business of the assessee's established enterprise.
(g) The financial outlay under the agreement was for the better conduct and improvement of the existing business and should therefore be held to be revenue expenditure.
(h) The once for all' payment of test is also inconclusive. What is relevant is the purpose of outlay and its intended object and effect considered in a common-sense way having regard to the business realities. In a given case, the test of enduring benefit might breakdown.
28. The Hon'ble Supreme Court in the case of Assam Bengal Cement Co. Ltd. v. CIT (supra) held as follows:
(a) The question, however, arises for consideration is, whether expenditure is incurred, while the business is going on and is not incurred either for extension of the business or for the substantial replacement of its equipment. If an expenditure is made for acquiring or bringing into existence an asset or advantage for the enduring benefit of the business it is properly attributable to capital and is of the nature of capital expenditure. If on the other hand, it is made not for the purpose of bringing into existence any such asset or advantage, but for running the business or working it with a view to produce the profits it is a revenue expenditure.
(b) The aim and object of the expenditure would determine the character of the expenditure, whether it is a capital expenditure or a revenue expenditure. The source or manner of payment would, then be of no consequence.
(c) These tests are thus mutually exclusive and have to be applied to the fact of each particular case, in the manner above indicated.
(d) One has therefore got to apply these criteria, one after the other, from the business point of view and come to the conclusion whether on a fair appreciation of the whole situation the expenditure incurred in a particular case is of the nature of capital expenditure or revenue expenditure.
(e) The question has all along been considered to be a question of fact to be determined by the IT authorities on an application of the broad principles laid down above and the Courts of law would not ordinarily interfere with such findings of facts if they have been arrived at on a proper application of those principles.
(f) One has to look into the character of the payment and therefore the "once and for all" payment may not be a relevant test.
In nutshell, the above principles show that the nature of expenditure has to be determined in an individual case depending upon the surrounding circumstances of such expenditure and while considering such surrounding circumstances, the developments in business and scientific field have to be considered.
Now we will proceed to examine the circumstances and facts of the assessee's case in the light of the above principles.
29. We find that the assessee had installed manual cone winding machines which were leading to two defects; (i) when yarn was spinned and went into the winding process in manual cone winding, each cone could take only 1 kg. of yarn and could accept yarn from 20 cops of 50 gms. each. The yarn was manually joined through knots leading to 20 knots. In the meantime most of the knitting manufacturers had installed advanced machines which were not accepting the knotted yarn for knitting of cloth. However, such knotted yarn and that too with 1 kg of each cone was not acceptable in the export market. At the same time in the market auto cone winders were available which were used in the process of fusing of yarn which led to joining of the yarn without any knots and such cone could contain 2.4 kgs. of yarn which was easily saleable in the market. The assessee installed such auto cone winders by replacing the old manual cone winders. We are of the view that this has only led to improvising the product which is saleable in the market. Otherwise, the business of the assessee would have, over a period of time declined. It was merely a question of survival in the sense, auto cone winders which resulted into production of knitted yarn which was not easily saleable in the market.
30. A question had also arisen whether the installation of such automatic cone winders has resulted into any cost advantage to the assessee and in response a chart was filed by the learned Counsel for the assessee which was not controverted by the learned Departmental Representative. The chart reads as under :
Cost involved in modernisation of the machinery
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Sl. Nature Autoconer Manual cone winder No.
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Disadvantages
1. Initial cost Cost of the machine Rs. 10,000.00 Rs. 4,00,000 Unit of Perday Rate Amount Perday Rate Amount measure Recurring Expenses
2. Electricity charges Units 360 4.20 1,512.00 247.50 4.20 1,039.50
3. Production In 40s Kgs. 1,350 1500
4. Cost of repairs & maintenance I to IV year V to VIII year Rs. 160 160 40 40 From IX year Rs. 355 (incremental) 195 89 49 onwards Rs. 479 (incremental) 124 120 31
5. Cleaning & Person 0.75 175.0 131.25 0.3 175 52.5 Maintenance
6. Interest on Rs. 12% 3,288 12% 132 investment Advantages Cost of operationg Person 3.5 175.0 612.5 12.5 175.0 2,187.5 labour Additional expenses 6,022.75 3,531.50 due to auto coner 2,491.25
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Quality of yarn Result Knotless yarn & With knots & uncleared
Contamination cleared yarn
Marketability Knot-less yarn is essential Cannot be exported
in the market
Density of package More uniform Un-uniform
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31. From the above chart it becomes clear that though capital cost in replacing the manual cone winders is very high, it has not given any cost advantage to the assessee and because of heavy interest on investment and additional electricity expenditure, the cost per unit has increased from Rs. 3,531 to Rs. 6,022 which clearly shows that no cost advantage was derived by the assessee. We further find that there is no reduction in wages as argued by the learned Departmental Representative. In fact, he had wrongly referred to the welfare expenses. The wages had actually increased from Rs. 1,46,45,198 in the financial year 2000-01 to Rs. 1,58,45,406 in the financial year 2001-02 which clearly shows that expenditure on wages has actually increased. Therefore, it cannot be said that by incurring expenditure on replacement of auto cone winders, the assessee has got no cost advantage.
32. One of the most important criteria for determining the nature of expenditure would be to see the change in the installed capacity of the assessee as observed by the Hon'ble Madras High Court in the case of Sri Karthikeya Spg. & Wvg. Mills Ltd. (supra). In this case, p. 19 of the annual accounts very clearly gives the details of installed capacity under quantitative particulars, details of which are given at pp. 19 to 22 of the paper book. The installed capacity which is measured in spindles remain unchanged at 38,416 spindles as on 31st March, 2002 from 31st March, 2001.
33. The Hon'ble Madras High Court in the case of CIT v. Sri Karthikeya 'Spg. & Wvg. Mills Ltd. (supra) had held that expenditure incurred on cost of replacement of draw frames would be revenue expenditure because the same had not led to any increase in the installed capacity.
34. We find no force in the submission of the learned Departmental /Representative that since the machinery costed a large sum, it should be held to be capital expenditure because the Hon'ble Supreme Court in the case of P.H. Divecha and Anr. v. CIT (supra) had very clearly observed that:
It may also be stated as a general rule that the fact that the amount involved was large or that it was periodic in character has no decisive bearing upon the matter.
This position was reiterated in the case of M.K. Bros. v. CIT (supra) wherein it was held that:
It may also be stated as a general rule that the fact that the amount involved was large or that it was periodic in character has no decisive bearing upon the matter.
We also find that the Hon'ble Supreme Court in the case of Alembic Chemical Works Co. Ltd. v. CIT (supra), while considering the expenditure incurred in purchase of pilot machines which improvised the production facilities of the assessee, had held that:
That the improvisation in the process and technology in some areas of the enterprise was supplemental to the existing business and there was no material to hold that it amounted to a new or fresh venture. The further circumstance that the agreement pertained to a product already in the line of the appellants established business and not to a new product indicated that what was stipulated was an improvement in the operations of the existing business and its efficiency and profitability not removed from the area of the day-to-day business of the appellant's established enterprise. The financial outlay under the agreement was for the better conduct and improvement of the existing business and was revenue in nature and was allowable as a deduction in computing the business profits of the appellant.
In view of the above detailed discussions, we hold that expenditure incurred by the assessee on purchase of new auto cone winders would constitute revenue expenditure. Therefore, we confirm the order of the CIT(A) on this issue.
35. The next ground in this appeal is that the CIT(A) erred in holding that excise duty and sales-tax are to be excluded from the turnover to work out deduction under Section 80HHC of the IT Act.
36. After hearing both the parties, we find that this issue is squarely covered against the Revenue by the judgment of the Hon'ble Supreme Court in the case of CIT v. Lakshmi Machine Works , wherein it was held that:
The principal reason for enacting a formula in Section 80HHC of the IT Act, 1961, is to disallow a part of the concession thereunder when the entire deduction claimed cannot be regarded as relating to exports. Therefore, while interpreting the words total turnover' in the formula in Section 80HHC one has to give a schematic interpretation. The various amendments made therein show that receipts by way of brokerage, commission, interest, rent, etc., do not form part of business profits as they have no nexus with the activity of export. The amendments made from time to time indicate that they became necessary in order to make the formula workable. If so, excise duty and sales-tax also cannot form part of the 'total turnover' under Section 80HHC(3) : Otherwise, the formula becomes unworkable.
Same view has been taken by the Hon'ble Madras High Court in the case of CIT v. Sundaram Clayton Ltd. . Respectfully-following the above decisions, we decide this issue against the Revenue.
The last ground is that the CIT(A) erred in directing that deduction under Section 80-IA should be allowed on the eligible profits without reducing the deduction given under Section 80HHC of the Act.
37. After hearing both the parties, we find that this issue is squarely covered in favour of the Revenue by the Chennai Special Bench decision of the Tribunal in the case of Asstt. CIT v. Rogini Garments (2007) 111 TTJ (Chennai)(SB) 274 : (2007) 294 ITR 15 (Chennai)(SB)(AT). In this case, it was held that full effect has to be given to the specific provision of Section 80-IA(9) of the IT Act and, therefore, before allowing deduction under Section 80HHC, deduction allowed under Section 80-IA has to be reduced. Respectfully following the above decision of the Tribunal, we decide this issue in favour of the Revenue.
In the result, the appeal filed by the Revenue is partly allowed.