Spare parts of fixed assets like buildings, furniture, plant and machinery:
For the purpose of carrying any business certain fixed assets like buildings, furniture, plant and machinery etc. are required. For smooth running of business, these assets have to be maintained properly and for that purpose preventive maintenance, servicing and repair is required. In case of break-down, urgent repair may be required. For this purpose one has to keep spare parts required for the purpose of repair by replacing damaged or broken parts. Sometimes a part may be repairable, but it may take time to repair and refit, therefore, spare part is kept to use immediately and then the old part is repaired and kept ready for use in future.
Ground realities:
Requirement of spare parts is felt everywhere where there are use of fixed assets and number of assets are high. When some spare parts of equipment are prone to damages, requirement to keep spares or standby equipments is more important.
Office spares: Suppose an office has ten AC chambers, twenty fans, twenty computers, five printers, kitchen or pantry. It will be desirable to keep some spares like mouse, key board, cables and connecters, hard disks for back-up as well as stand-by arrangements, switches and regulators, bulbs and tube lights, fuses for electrical equipments, UPS wheels of revolving chairs, in kitchen- knives, spare utensils, gas cylinder etc. These are required for the purpose of smooth functioning.
Domestic spares: even in case of domestic requirement for personal use we find that one has to keep some spare parts for ready to use in case of need. For example, even in his home any one would prefer to have some spare parts or extra sets (as stand by) of items like bulbs, tube lights, telephone instrument, extra utensils, gas cylinder, fuse for electrical equipments, wheels of chairs ,knives.
When spares are not readily available:
The requirement of keeping spare parts becomes more important when spare parts are not readily available. This can be due to distance, delivery time required, holidays, and urgency of spares. In case of old models of equipment, many times spare parts are also not available after some time, once the model is discontinued by manufacturer.
Old or new equipment as spares:
When many number of equipment of the same model are in use, and spare parts are not available, then in some situations it can be decided that one or two pieces be dismantled and parts obtained on such dismantling be used as spare parts for remaining equipments. For example in the example given above, suppose all twenty computers are of same make and model or are such that many parts used in them are similar and interchangeable. Now suppose spare parts are not available, then it can be decided to dismantle one computer and use its parts to repair other computers.
Many times in case of urgency such decisions are taken and then steps are taken to procure more spare parts, if available or old or new equipment to use their parts as spare parts.
Ground realities and practical aspects:
These are ground realities and practical aspects. It is necessary that the accountant, the tax manager and the tax officer must also know these aspects. It cannot be left to meet exigencies only when a need or problem arise. One has to have foresight, to plan for spare parts.
Accounting:
When a person adopts cash basis of accounting, spare parts can be charged to the expenditure account as and when payment is made for spares. In case of very uncertain items also and petty items of spares in a small organization such expenses can be charged to expenditure account as and when incurred. This is because the spares can be used any item, they are kept ready for use and the costs are not significant. For example a doctor , an advocate or a CA cannot be expected to keep inventory of spare parts and make accounting adjustments only on consumption. Particularly when method of accounting is adopted is cash basis.
In case of manufacturing concerns also if costs are not significant spares can be charged to expenditure account. However, generally considering requirement of internal check and control and materiality, inventory of spare parts is maintained, and expenses are charged when the spares are issued to shop floor for use.
We can find difference in approach in the same organization for example the head office may not keep inventory of spares parts for office requirement like computer parts, electrical fittings etc. this is because small inventory is kept and spare parts are is used regularly and the amount involved is not significant. Therefore, internal check and control can be maintained only by controlling purchases. However, in the factory of the same organization detailed inventory is maintained and expenses are charged on issue of spares for use.
Case before Karnataka High Court:
The judgment reported as Dr. Aswath N. Rao v. ACIT [2010 -TMI - 76068 - HIGH COURT OF KARNATAKA] is on issue of old equipment purchased for use as spare parts of existing equipments in use. The factsa re as follows:
Assesses is a doctor and specialist as Cardiologist.
He follows cash system of accounting.
Assessment year is 2001-02 and previous year ended on 31.03.2001.
He incurred expenses and made full payment for purchase of second hand medical equipment from USA on 31.3.2001, the equipment was received in India during April 2001 that is after close of the previous year.
Yet he claimed the expenditure as allowable expenditure.
He has installed equipment both in Mangalore and Mysore for the purpose of investigation concerning cardiac problem.
These machineries are old.
Machines often go out of order.
Spare parts are not readily available in India
He use to buy second hand machines and after bringing them into India he use spare parts after dismantling machineries purchased by him from USA.
When he had been to USA in March, 2001, he purchased second hand machines in order to dismantle the same and then to use spare parts of it for his old equipments.
The A.O., the CIT(A) as well as the Tribunal did not allow the claim of assessee on the ground that during the relevant assessment year old machineries purchased by the assessee had not reached Bangalore, therefore the said claim has to be disallowed and that if at all the assessee is entitled to his claim same can be considered for the next assessment year.
Being aggrieved by the concurrent findings, the assessee preferred appeal before the high Court. The question of law considered by the Court is as follows:
1. Whether the tribunal was right in coming to the conclusion that Commissioner of Income-Tax (Appeals) was empowered to give a finding that the expenditure was capital in nature, when such issue was not before it;?
2. Whether the amount spent by the assessee towards the purchase of a second hand machinery for the purpose of dismantling the same and use the parts of it as spare parts to the existing machinery is allowable expenditure as a renewable expenditure or not?
After analyzing facts and considering undisputed facts and circumstances, as discussed earlier in this write-up, the court considered ths issue on the following lines:
| Courts observation |
Author's observation |
| a. The appeal was admitted without considering the substantial questions of law arises in this appeal though the same has been formulated by the appellant in the appeal memo.
b. Therefore, we have to examine the questions of law arise in this appeal. |
This can lead to possible litigation by revenue that if the appeal was not admitted without consideration as to whether there is substantial question of law, the precondition to answer to such questions are not met. And the court was not justified in answering the question. It would have been better situation, if the court first held that the questions involved are substantial question of law. |
| Accordingly, court considered that the court is required to answer the substantial questions of law in this appeal and then answered the questions framed by the appellant in appeal memo. |
Thus, the admittance of appeal itself can be challenged by the revenue on technical ground. |
| Court heard the counsel for the parties. |
It seems that the counsel of revenue has not raised the objection as per observations made by author. |
| Contentions on behalf of assessee are as follows: |
These are basically on undisputed facts in the case and other aspects relating to spare parts as discussed by author earlier. |
| That the expenditure incurred by the assessee for the purchase of old second hand machinery at USA is to use the same as spare parts to the existing old machineries installed in Bangalore and Mysore by the assessee. |
This can be applicable in other situations also for example, the example of computers as discussed earlier. |
| Since spare parts are not available, the only course open to the assessee was to purchase second hand machinery and use it as and when the equipments of the assessee worn out on account of its usual wear and tear. |
This can happen in case of many old equipments production of which has been discontinued by their manufacturers. |
| The assessee being a cardiologist cannot be expected to send his equipment for repairs only these machineries are worn out. |
The aspect of urgency can be applicable in other cases also. |
| Considering the nature of his profession, machineries are required to be repaired forthwith and such repairs cannot be done immediately on account of non-availability of that spare parts in India. |
The aspect of urgency and commercial expediency will be applicable in other cases also. |
| If the reasoning of the assessing officer is accepted, the assessee being a cardiologist would be unable to treat the patients immediately if his equipment installed in Bangalore and Mysore are worn out because of its usual wear and tear. |
The reasoning of the AO are many times due to ignorance of practical aspects and many times as they deliberately ignore the ground realities just for sake of disallowing the expenditure. |
| In the circumstances, is it possible for a cardiologist to buy second hand machineries from USA after the machine is worn out and replace the spare parts. |
This question is equally applicable in other situations also. Is it possible for A CA to wait for purchasing a new keyboard and mouse then use the computer after some time. Commercial expediency require that some spares are kept or that mouse or key board is taken from other computer and use the particular desired computer in which relevant data are saved. |
| That purchase of such machinery to use it as spare parts and keep the spare parts in advance is for the advantage of the patients. |
This can be applicable in many other situations also. |
| The assessee is maintaining cash system method of accounting, therefore, as and when demands are made to purchase spare parts are to be treated expenditure incurred on the date of purchase. |
Cash basis accounting was important. In case of mercantile basis the decision can be different based on other aspects like materiality, matching principal etc. |
| That the revenue has not disputed the payment made by the assessee in order to purchase the second hand machinery at USA in the month of March, 2001. |
There appears no reason to dispute payment. The assessee should not leave scope for such disputes. |
| It is also contended that even though the machinery has arrived at Bangalore Airport in the next assessment year, same cannot be a ground for the revenue to reject the contention of the assessee. |
In case of different method of accounting the treatment may differ. |
| He further contends that the Commissioner of Income Tax (Appeals) has committed an error in treating the expenditure as a capital in nature as the purpose of purchasing the machinery is to use the same as spare parts to the existing old equipment and purchase of spare parts to the existing machinery cannot be considered as a capital expenditure and it has to be treated as revenue expenditure for the maintenance of the machineries. |
The CIT(A) was not justified to treat expenses as capital expenses in the circumstances. He could have do so if he had material that the old machine itself was used as machine and not as spares in future.
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Therefore he contends that question No. 1 has to be answered in favour of the assessee.
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In view of cash basis of accounting the expenditure was expenditure in the year of payment. Under mercantile basis, the expenditure will be booked when spares are issued for use at the shop floor / work station. |
| He further contends that when the full sale consideration is paid, the goods purchased by him is passed on to the assessee since title to the goods is on to the assessee, the moment the goods are sold by the vendor of the assessee that too after complete payment of the entire sale consideration. |
Full actual payment may not be necessary, in case the vendor has allowed credit. The material aspect is the transfer of property. In case property is not transferred then the payment made will not be expenditure but advance. |
| He contends that this aspect of the matter has not been considered by the assessing officer so also by the Commissioner of Income-Tax (Appeals) and the tribunal therefore he requests to set aside of the orders and answer the questions of law in favour of the assessee. |
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| Contentions and arguments on behalf of revenue: |
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| The amount paid by the assessee to purchase second hand equipment at USA in the month of March,2001 cannot be considered as an expenditure incurred by the assessee towards the maintenance of the machinery. |
When machine is purchased for use as spares, the expenses are for maintenance of other machines which are in use. It is not case of revenue that the machine purchased was used as machine and not as spares. |
| when spare parts purchased, same has to be used as and when machineries are worn out, therefore he contends that the assessee's transaction cannot be treated as an allowable transaction for the relevant assessment year. |
In case of deprecation allowance use of machine acquired is necessary. Not when the machine is purchased to dismantle and use its parts as spare parts for existing machines already in use. |
| Machinery is said to have arrived at Bangalore Airport in next year the case of the assessee has to be considered only for the next assessment year. |
It would be so if mercantile system of accounting and maintaining inventory of spares was in vogue. |
| He further contends that since machinery was in transit, it cannot be considered as a transaction taken place at relevant point of time. |
When payment is made, the spares being in transit is not relevant in cash system of accounting. |
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| Courts reasoning's and decision: |
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| The court answered both questions in favour of the assessee for the following reasons: |
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| Un disputed facts are that the assessee is a cardiologist, and that he has installed two machineries for the purpose of his profession one at Bangalore and another at Mysore. |
There must be old machines for which spares are required. |
| It is also not the case of the revenue that the equipments installed by the assessee both in Bangalore and Mysore are not old. |
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| If old machineries are being used by the assessee, considering the nature of profession of the assessee, one cannot say that the assessee has to wait till the machineries are worn out and send it for repairs. |
This is applicable in case of any machine. Though, degree of urgency may differ. |
| If old machineries are being used by the assessee, considering the nature of profession of the assessee, one cannot say that the assessee has to wait till the machineries are worn out and send it for repairs. |
This is applicable in case of any machine. Though, degree of urgency may differ. |
| When the spare parts are not available in India as a prudent doctor and wise man has rightly purchased second hand machineries in USA in anticipation that such machineries are required to be used as spare parts in order to serve the patients. |
This can be applicable in other cases also. |
| Therefore, purchase of second hand machineries by the assessee by paying cash in USA has to be taken; as a transaction took place during the relevant assessment year and it cannot be considered as a transaction for the future assessment year. |
Payment is relevant in cash basis. |
| When the entire sale consideration is paid and when the machinery purchased by him has been despatched by the vendor from USA, sale transaction is completed and as per the provisions of the Sale of Goods Act, title to the goods has been passed on to the assessee and he has become the owner of the second hand machineries purchased by him to use them as spare parts even though the goods have been reached Airport at Bangalore in the month of August, 2001 and it is to be noted that when actually goods were delivered to the assessee is not the criteria to consider the sale transaction. |
Assessee purchased spares in PYE 31.03.01 and made payment so the cost is allowed in cash system of accounting. |
| We could have appreciated the contention of the revenue provided these second hand machineries had been purchased by the assessee only to use them as machineries and not as spare parts. |
s.32 for deprecation allowance require actual use of new machine and it is not applicable when machine is used as spares. |
| Therefore, we are of the opinion that second hand machinery purchased by the assessee ought to be considered as spare parts for the existing old machineries and has to be considered as allowable expenditure on revenue side. |
Machine purchased for use as spares is to be considered as spare parts. |
| So far as the first question is concerned, we are of the view that when an assessee purchased the spare parts for the existing machineries, same cannot be treated as capital expenditure and it has to be treated as revenue expenditure since these spare parts are purchased for the maintenance of the existing equipments. On this question, revenue cannot dispute the legal position. |
Cost of spare parts is revenue expenditure.
However, if the assessee follow charging of spares on consumption, then matter can be viewed differently. |
Conclusions:
Spare parts purchased for up-keep, repair and maintenance are generally revenue expenditure. In case of cash system of accounting, when payment is made, expenses are allowable.
In case of mercantile system of accounting also cost of spare parts can be considered as revenue expenses when such expenses are incurred. However, in case of large organizations where cost of sapres are substantial and a large inventory is to be maintained, generally cost of spare parts is charged to expenses when spare parts are issued to the shop floor for use.
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