REPLACEMENT OF PARTS OF A TEXTILE MILL FOR SPINNING YARN IS NOT REVENUE EXPENDITURE UNDER SEC.37 OF INCOME TAX ACT, 1961

[Mr. M. GOVINDARAJAN]

In income tax matters disputes arised in deciding whether the expenditure is of revenue nature or capital nature. In 'Commissioner of Income Tax V. Saravana Spinning Mills P. Ltd.,' [2007 -TMI - 1775 - SUPREME COURT OF INDIA] the Supreme Court held that the expenditure is deductible under Sections 37 of the Income Tax Act ('Act' for short) only if it-

>> is not deductible under Sections 30 to 36;

>> is of a revenue nature;

>> is incurred during the current accounting year; and

>> is incurred wholly and exclusively for the purpose of the business.

In 'Lakshmiji Sugar Mills P. Co., V. Commissioner of Income Tax AIR 1972 SC 159 it has been held by Supreme Court that bringing into existence a new asset or an enduring benefit for the assessee amounts to capital expenditure. In 'Ballimal Naval Kishore V. Commissioner of Income Tax [2008 -TMI - 5557 - SUPREME Court] 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.

In 'Commissioner of Income Tax V. Loyal Textile Mills Ltd.,'- [2008 -TMI - 9763 - MADRAS High Court] the High Court held that the expenditure on replacement of machinery was revenue nature. The High Court further held that the expenditure on replacement of machinery was capital or revenue nature was not determined by the treatment given to it by the assessee in the books of account 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.

In this article the subject taken for discuss is replacement of parts of a textile mill for spinning yarn is not revenue expenditure under Sections 37 of Income Tax Act, 1961 with reference to decided case laws.

In 'Saravana Spinning Mills P. Ltd.,' [2007 -TMI - 1775 - SUPREME COURT OF INDIA]  it was held 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, it is an independent and separate machine. 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.

In 'Commissioner of Income Tax V. Sri Mangayarkarasi Mills P. Ltd.,' - [2009 -TMI - 34189 - SUPREME COURT] the respondent in this appeal is engaged in the manufacture and sale of cotton yarn. During the assessment year 1995-96, the assessee claimed certain amount 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. The Assessing Officer held that 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 Assessing Officer disallowed the above claim of the assessee and held the said expenditure to be of a capital nature. He 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 Sections 31 of the Act or as revenue expenditure under Sections 37 of the Act. He further held that the assessee could claim depreciation on the said assets as per the Income Tax Rules.

The respondent filed appeal before the Commissioner of Income Tax (Appeals), Madurai. He allowed the appeal holding that replacement of machinery by the assessee in this case constituted revenue expenditure. 

The Revenue went in appeal before the Tribunal against the order of Commissioner of Income Tax (Appeals). The tribunal followed the decision of 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 therefore upheld the order of the Commissioner of Income Tax (Appeals) and dismissed the appeal of the revenue.

The Revenue again filed an appeal under Sections 260A of the Act before the High Court of Judicature at Madras. The High Court dismissed the appeal filed by the Revenue and held that the expenditure on replacement of machinery was revenue in nature. Aggrieved against the order of High Court the Revenue filed the present appeal before Supreme Court.

The Revenue submitted the following before Supreme Court:

>>> 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;

>>> 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';

>>> 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;

>>> The courts below had gone wrong in equating the complicated machinery of a spinning mill with a tube light in relying on the Board's Circular No.69, dated 27.11.1957, on tube lights which stated that only first time of purchase of a tube light amounts to capital expenditure, and subsequent replacement would only be revenue expenditure;

The respondent assessee submitted the following before Supreme Court:

>>> 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;

>>> 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';

>>> The Board's Circular No. 69, dated 27.11.1957 is still valid as per which, replacement of worn out parts, even if the same is in a textile mill, would constitute revenue expenditure;

>>> The argument of enduring benefit to the respondent taken by the appellant is no longer good law.

The Supreme Court after taken into consideration the contentions of both parties held as follows:

>>> The entire textile mill machinery cannot be regarded as a single asset, replacement of parts of which can be considered to be fore the mere purpose of 'preserving or maintaining' the 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 brining 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 purchase an enduring benefit of better and more efficient production over a period of time. For these reasons the expenditure made by the assessee cannot be allowed as a deduction under Sections 31 of the Act.

>>> Thus it is clear that the expenditure of the assessee here is not of a revenue nature and thus, cannot be claimed as a deduction under Sections 37 of the Act;

>>> 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 was actually revenue expenditure.

Therefore the Supreme Court set aside the impugned judgment of the High Court thereby restoring the judgment of the Assessing Officer disallowing the claim of deduction of the respondent.