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Introduction
It is quite common among the businessmen involved in a manufacturing activity
to carry out replacement of parts or machines in a production system. The very
word ‘replacement’ would only refer to a situation where it would mean that an
existing facility is maintained at its level of efficiency. In other words,
such replacement of parts or machines would not result in enhancement of
production capacity. Whether such replacement cost is to be treated as revenue
or capital expenditure is always a controversial issue. It is quite common for
the Revenue to treat such expenditure as capital in nature and administer
depreciation allowance, only. An assessee would always put forth his argument
that such replacement cost is only to maintain the existing level of
efficiency of his manufacturing facility and would not result in any increase
in its production capacity, thereby claiming it to be revenue in nature. In
this context, it is quite pertinent to examine the current judicial thinking
on this issue.
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Judicial precedence
This issue came up before the Hon’ble Madras High Court in the case of CIT vs.
Janakiram Mills Ltd. (2005) 275 ITR 403, Mad. It was held by the Court that
even replacement of core machinery when it forms part of the continuous
process industry, the same is to be allowed as revenue expenditure. The block
of assets system should make no difference with this inference. It was held
that though such replacement costs may be qualified as current repairs u/s 31,
the same would be equally eligible for deduction u/s. 37 of the Act. The Court
distinguished earlier Supreme Court Ruling in Ballimal Naval Kishore vs. CIT
(1997) 224 ITR 414 and clarified that the Apex Court judgment applies only to
cases of replacement of ‘entire manufacturing facility’. It was observed that
the Courts cannot ignore the advancement in science and technology and
accordingly, identify the thin line of demarcation between capital and revenue
expenditure.
2.1 It is important to distinguish between what is ‘current repairs’
and what is an ‘item of expenditure’ allowable u/s 37 of the Act. Finance Act,
2003 amended sections 30 and 31 relating to deductions for repairs of
buildings and machinery, plant & furniture to provide that current repairs
shall not include any expenditure in the nature of capital expenditure. The
words ‘current repairs’ and ‘capital expenditure’ are contradicting terms. In
view of the same, it was widely debated among the professional circles whether
the Explanations have served any additional purpose. In other words, even in
the absence of the Explanations bringing out the amendment to sections 30 &
31, the import of contradiction was intact. Accordingly, it was also felt that
the amendment did not bring in any new ratio and thereby, the plethora of case
law in this context was intact for reliance. It is appropriate to discuss the
characteristic of enduring nature in respect of particular expenditure to
decide whether the same is capital or revenue.
2.2 Landmark judgment of the Apex Court in Empire Jute Co. Ltd. vs. CIT
(1980) 124 ITR 1 is of immediate relevance in this context. It was
categorically held that every enduring advantage may not result in capital
asset and if the same is not capital asset, the relating expenditure is to be
allowed in the revenue field. If the enduring advantage resulting in
expenditure, allows an assessee to carry on business smoothly in an efficient
manner, the same cannot be said to have created a new asset. Accordingly, the
ratio to be applied as mentioned above would hold good irrespective of the
volume of expenditure. In appreciating whether a new asset has been created,
it is directly relevant to verify whether the expenditure resulted in
increasing the production capacity of the assessee.
2.3 The guidelines laid down by the Supreme Court in Alembic Chemical
Works Co. Ltd. vs. CIT (1989)177 ITR 377 are of absolute relevance which
provided that the test of ‘manufacturing capacity increase’ is to be carried
out for identifying capital expenditure. Relying on this ratio, cost of
installation of Water Treatment Plant and Fume Extraction Plant which resulted
in improvement of operations of existing systems with greater efficiency in
avoiding health hazards etc. and also complying with statutory requirements
was allowed only as revenue expenditure, as the same did not increase the
productive capacity in any manner — CIT vs. Steel Complex Ltd. (1999) 238 ITR
1054, (Ker).
2.4 Having discussed the prerequisite criteria for allowance of
expenditure as a revenue item, it is critical to look at what is allowable as
current repairs u/s. 31. If a claim is made u/s 31, then an assessee needs to
ensure that his claim fits within the framework of the existing provisions of
sec. 31. Although, such a claim, if not allowed u/s 31, can still be
entertained u/s 37, is secondary when the claim is confined to sec. 31. ln
Janakiram Mills case (supra) replacement of whole machinery which formed part
of continuous process industry was allowed as revenue expenditure. In other
words, all machines involved in the process are treated as one plant. The
Hon’ble Madras High Court while allowing the expenditure u/s 31 also approved
the same as allowable u/s 37 of the Act. It is in this context, one needs to
appreciate whether an assessee’s of claim u/s 31 would be supported by a
standby claim u/s 37 though not apparently claimed by the assessee. Subsequent
developments in the judicial thinking as per Apex Court’s judgments are of
immediate importance in this context
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CIT vs. Saravana Spinning Mills (2007) 292 ITR 201
The issue regarding replacement cost of ring frames which had worn out in a
textile mill as current repairs u/s 31(i) came up before the Hon’ble Supreme
Court. Assessee claimed the whole textile mill as a plant and the ring frames
were one of the 25 machines which constituted one single process. Replacement
of ring frames was treated by the assessee as replacement of old parts which
had become derelict. After Assessing Officer rejected assessee’s contention,
all Appellate Authorities from ClT(A) to the High Court approved assessee’s
claim by holding that process of converting cotton into yarn was continuous
interlinked process. It was also observed that the ring frames could not work
independently and could work as a part of single unit and allowed expenditure
as deductible u/s 31(i) of the Act.
3.1 On an appeal by the Revenue, the Hon’ble Supreme Court rejected the
contention of the assessee that the manufacturing process in the textile mill
as one continuous integrated process. Certificate issued by South India
Textile Research Association (SITRA) has been ignored. It was held that to
allow deduction u/s 31(i), the test was not whether the expenditure was
revenue or capital in nature, but whether the expenditure was current repairs.
Each ring frame was identified as a separate functional machine and the s.e.
rejected the expenditure as current repairs. The issue was not dealt with from
the context of sec. 37 at all. In other words, whether the expenditure is
capital or revenue has not been dealt with and only the simple question
whether expenditure is to be treated as current repairs alone has been
answered. It was held that the expenditure under question was not to be
treated as current repairs. It was observed even if the expenditure is revenue
in nature, it may not fall in the connotation of current repairs.
3.2 While holding the above position. it was held by the Apex Court
that decision of Janakiram Mills (supra) of Madras High Court has been
reversed. It was also observed that its own earlier judgments in New Shorrock
Spinning and Mfg. Co. Ltd. vs. CIT (1956) 030 ITR 038 (Bom) and CIT vs.
Mahalakshmi Textile Mills Ltd. (1967) 066 ITR 0710 (SC) have been
distinguished and continued to be good law.
3.3 CIT vs. Ramaraju Surgical Cotton Mills (2007) 294 ITR 328 : In
another judgment of the Apex Court, the issue of the replacement cost of
assets without increase in production capacity was dealt with under the
context of sec. 37 of the Act. It was observed by the Apex Court that Madras
High Court Judgment in Janakiram Mills has been set aside by the same Court in
Saravana Spinning Mills case (supra). It is done as there was confusion
between the tests to be applied in respect of sec. 31 vis-a-vis the case of
sec. 37 of the Act. Without expressing any opinion, the Court remanded the
matter to Commissioner (Appeals) for fresh examination of the tenability of
assessee’s claim. Mutual claims made by the Assessee and the Revenue were not
addressed by the Court and Commissioner (Appeals) was directed to examine the
matter uninfluenced by any observations made by the High Court in this case.
Both the Assessee and the Revenue were given liberty to adduce additional
evidences before the Commissioner.
3.4 Summing up the ratio laid down by both the above Apex Court’s
judgments, it is to be analyzed as under:
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Saravana Mills case is solely on the issue of
current repairs u/s 31(i) and allowability u/s 37 was not under discussion
at all. In other words, the expenditure under question was not dealt with
from the context of capital or revenue.
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Textile Mill was not accepted as a single
process industry.
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Earlier judgments of Apex Court in New
Shorrock Spinning (supra) and Mahalakshmi Mills (supra) have remained intact
and the present Ruling is distinguished from those cases
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Increase in production capacity as a
prerequisite criteria for treating expenditure outlay as capital in nature,
remains intact and the present Ruling does not touch upon the same.
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It is evident from the judgment of Saravana
Mills case that every revenue expenditure relating to repairs/replacements
may not fit into the framework of current repairs u/s 31(i) of the Act.
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In Ramaraju Surgical’s case nothing has been
decided and the matter was remanded to Commissioner for fresh examination in
an uninfluenced manner considering respective claims of both the Revenue and
the Assessee the context of sec. 37 of the Act.
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It is to be noted that Janakiram Mills case
(supra) of Madras High Court has been reversed by the Apex Court and is no
more a good law.
3.5 In the advent of these RuIings and the above analysis of the
judgments, it is to be appreciated that a genuine revenue expenditure is not
hit by the Apex Court Rulings. It is only the scope of ‘current repairs’ u/s
31(i) has been clarified. It is to be further appreciated that the plethora of
case law decided in the context of repairs/replacements of machinery with
respect to deductibility u/s 37 has been unaffected.
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Conclusion
An assessee is legally entitled to appraise the Revenue of the true import of
Saravana Mill’s case, if an ad hoc approach of rejecting every repair /
replacement expenditure as deductible expenditure is adopted by the Revenue.
In the same breath every assessee is expected to understand the scope of the
current repairs u/s 31(i) of the Act, in the advent of these Rulings. The
unending controversy of capital and revenue expenditure attained a new
dimension under the recent judicial trends.
[Source
: Souvenir published at the time of National Tax Conference held at
Hyderabad. Page 98]
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