2010 (10) TMI 419 - HC - Income Tax

Capital or revenue expenditure - Scrutiny - whether or not 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 - assessee has not credited 75 per cent. of the investment allowance claimed to the investment allowance reserve account - An order of reference is neither a judgment of the Supreme Court within the meaning of article 141 of the Constitution of India nor an opinion of that court under article 143 of the Constitution of India - ince the judgment of the Supreme Court in Shri Shubhlaxmi Mills Ltd. 1989 -TMI - 5274 - SUPREME Court remains a binding precedent till it is overruled by a larger Bench of the Supreme Court failure on the part of the assessee to debit the investment allowance claimed to the profit and loss account and to credit 75 per cent. thereof to the investment allowance reserve account would disentitle them from claiming the benefit of investment allowance or to be subsequently granted an opportunity to create such a reserve within the meaning of the Explanation to section 32A(4) of the Income-tax Act in the year in which the said machines were purchased - Decided against the assesssee

Issues Involved:
1. Whether the expenditure of Rs. 36,36,386 was a capital expenditure or current repairs.
2. Whether the assessee should be allowed an opportunity to create an investment allowance reserve under section 32A(4) of the Income-tax Act, 1961.

Detailed Analysis:

1. Capital Expenditure vs. Current Repairs
The first issue pertains to whether the expenditure of Rs. 36,36,386 incurred by the assessee was capital expenditure or in the nature of current repairs. The assessee, a private limited company, claimed the expenditure as current repairs in its return of income for the assessment year 1984-85. The Income-tax Officer (ITO) observed that the expenditure was towards machinery that was independent and not a subordinate part of a bigger machine. The ITO treated the expenditure as capital expenditure, allowing depreciation thereupon.

The Commissioner of Income-tax (Appeals) [CIT(A)] upheld the ITO's view, and the Income-tax Appellate Tribunal (ITAT) also confirmed this by stating that the expenditure was due to modernization and replacement of old machinery, which amounted to capital expenditure.

The Supreme Court in CIT v. Sri Mangayarkarasi Mills P. Ltd. [2009] 315 ITR 114 and CIT v. Saravana Spinning Mills P. Ltd. [2007] 293 ITR 201 clarified that each machine in a textile mill is an independent entity and replacement of an old machine with a new one constitutes bringing a new asset into existence, not repairs. The High Court observed that the speed frames, ring frames, and tandem breaker cards were replacements and not repairs, thus the expenditure incurred was to bring a new asset into existence.

The Court concluded that the expenditure was capital in nature, providing the assessee an enduring benefit of better and more efficient production, and did not amount to "current repairs."

2. Opportunity to Create Investment Allowance Reserve
The second issue involves whether the assessee should be given an opportunity to create an investment allowance reserve under section 32A(4) of the Income-tax Act. The assessing authority treated the expenditure on new machinery as capital expenditure but did not allow the assessee an opportunity to create the necessary investment allowance reserve.

The CIT(A) rejected the assessee's contention, holding that there was no need to give such an opportunity under the circumstances. However, the ITAT held that the assessee should have been allowed an opportunity within the meaning of the Explanation to section 32A(4).

Section 32A(4) requires that an amount equal to 75% of the investment allowance to be actually allowed must be debited to the profit and loss account and credited to a reserve account. The Explanation allows the Assessing Officer to provide an opportunity to the assessee to credit a further amount to the investment allowance reserve account if a higher deduction is admissible on the basis of the total income computed by the Assessing Officer.

In this case, the assessee did not credit 75% of the investment allowance to the reserve account. The High Court referred to the Supreme Court's decision in Shri Shubhlaxmi Mills Ltd. v. Addl. CIT [1989] 177 ITR 193, which held that the creation of a reserve fund in the relevant previous year is mandatory. The Court noted that the Explanation to section 32A(4) applies only where some amount is debited and credited, but a higher deduction is admissible. Since the assessee neither debited the investment allowance to the profit and loss account nor credited any sum to the reserve account, they were not entitled to claim the benefit of investment allowance.

The Court concluded that the assessee's failure to make the necessary book entries disentitled them from claiming the benefit of investment allowance and that the Tribunal was not justified in directing that the assessee should be given an opportunity to create such a reserve.

Conclusion
Both questions referred for the Court's opinion were answered against the assessee and in favor of the Revenue. The expenditure of Rs. 36,36,386 was held to be capital expenditure, and the assessee was not entitled to an opportunity to create an investment allowance reserve under section 32A(4) of the Income-tax Act. The referred case was disposed of accordingly.

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