Commnr. Of I.T., Madurai vs M/S. Sri Mangayarkarasi Mills (P) Ltd

REPORTABLE 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

JUDGMENT

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 :-

2

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 3

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 4

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 5

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 6

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 an 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 7

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 8

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 9

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 10

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 11

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 12

considered to be for mere purpose of `preserving or maintaining'

this 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:

13

7 "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

7 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 14

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 15

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 16 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.

17

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. [Tarun Chatterjee]

New Delhi; ........................J. July 21, 2009 [Aftab Alam]