2014 (12) TMI 885 - AT - Income Tax

Various expenses incurred prior to setting up of Plant and machinery - Held that- The expenditure incurred by the assessee on account of salary wages power charges repair maintenance professional fees etc. are prior to the date of setting up of plant and machinery so acquired by the assessee - though the expenditure has been incurred on account of salary wages power charges repair maintenance professional fees etc. but the same is with respect to a new plant and machinery acquired by the assessee and before the same is put to use the expenses was incurred for bringing a new asset into existence as decided in Dalmia Jain and Co. Ltd. Vs. CIT 1971 (7) TMI 2 - SUPREME Court it is the real nature and quality of the payment and not quantum or manner of the payment which would prove decisive - If the object of making payment is to acquire a capital asset the payment would partake character of the capital payment even though it is not made in lumpsum but by installment - even in case of expansion of existing business the expenditure incurred for acquiring the additional plant and machinery will be in the nature of capital expenditure - If the outlay is made for the extension of business it will be treated in the capital filed and not revenue. Expenses made under the head trial run expenses during construction period Capital expenses or not - Whether on the date of trial run the plant and machinery acquired by the assessee was set up or not Held that - If the expenditure even on trial run is considered as prior to the setting up of plant and machinery then it cannot be allowed as revenue expenditure but has to be capitalized and being part of cost of the newly acquired capital asset - The plant and machinery is set up when it is established and in ready to start function - the plant must be put into such shape and stage that it can start functioning for the purpose of business of the assessee - the trial run is one stage prior to discharge the functions for which it has been acquired - until and unless a successful trial run is completed the newly acquired machinery cannot be said to have put in such a shape that it can start functioning as business asset and therefore it cannot be said that the plant and machinery has been set up - Prior to the installation of the machinery and bring to the shape to be ready to discharge the function the activities carried out are merely operations for setting up of the plant - the plant and machinery could be treated as set up only as a culmination of all these operations which are necessary for establishing the plant and machinery and bring in the shape as it is ready to discharge function - the expense which have been incurred by the assessee prior to setting up the plant and machinery are capital in nature and cannot be allowed. Term loan interest to be treated as revenue expenditure or not Held that - As per proviso to Section 36(1)(iii) interest on term loan is to be allowed only from the date when asset is first put to use - Prior to it such expenditure cannot be allowed as Revenue expenditure as decided in ESSAR STEEL INDIA LTD Versus ADDL COMMISSIONER OF INCOME TAX & ASSTT COMMISSIONER OF INCOME TAX 2013 (11) TMI 278 - ITAT MUMBAI which is - expenditure was claimed as Revenue but the same was not allowed Decided against assessee.

Summary

Issues Involved:
1. Disallowance of revenue expenses of Rs. 54,80,00,000 included in Capital Work in Progress (CWIP).
2. Disallowance of revenue expenses of Rs. 23,71,00,000 included in CWIP during the trial run period of Cold Rolling Mill.

Issue-wise Detailed Analysis:

1. Disallowance of Revenue Expenses of Rs. 54,80,00,000 Included in Capital Work in Progress (CWIP):

The assessee claimed Rs. 54,80,00,000 as revenue expenditure incurred during the construction period, arguing that it was for the expansion of the existing steel plant and pellet plant. The Assessing Officer (AO) disallowed this claim, treating the expenses as capital expenditure necessary for setting up a new unit to manufacture Cold Rolled Steel. The AO noted that the new unit required acquiring profit-making assets like buildings, plants, and machinery, thus classifying the expenses as capital in nature. This view was supported by the Hon. Bombay High Court in the case of CIT vs. J.K. Chemicals Ltd. (207 ITR 985).

The CIT(A) upheld the AO's decision, emphasizing that the expenditure was for a substantial extension of business, which should be treated as capital expenditure. The CIT(A) also pointed out that the accounting treatment of these expenses as CWIP indicated their capital nature.

The Tribunal, referencing its decision in the assessee's own case for the assessment year 2007-08, noted that neither the AO nor the CIT(A) had examined whether the expenses were for increasing the capacity of the existing plant or for an entirely new line of business. The Tribunal remanded the matter back to the AO for a detailed examination of this aspect, emphasizing that the nature and purpose of the expenditure must be clearly established to determine whether it is capital or revenue.

2. Disallowance of Revenue Expenses of Rs. 23,71,00,000 Included in CWIP During Trial Run Period of Cold Rolling Mill:

The assessee also claimed Rs. 23,71,00,000 as revenue expenditure incurred during the trial run period of the Cold Rolling Mill. The AO disallowed this claim, treating it as capital expenditure because it was incurred before the plant and machinery were set up and ready to function. The AO relied on the decision of the Hon. Bombay High Court in CIT vs. J.K. Chemicals Ltd., which held that expenses incurred for setting up a new unit are capital in nature.

The Tribunal reiterated that the nature of the expenditure must be examined to determine whether it was for maintaining the existing business or creating a new asset. The Tribunal noted that until the plant and machinery are set up and ready to function, any expenditure incurred is capital in nature. The trial run is a stage prior to the plant being ready to function, and therefore, expenses incurred during this period should be capitalized.

The Tribunal also referenced the Hon. Supreme Court's decision in Dalmia Jain and Co. Ltd. Vs. CIT, which established that expenses incurred for creating, curing, or completing the title to a capital asset are capital expenditures. The Tribunal concluded that since the expenditure was incurred prior to the plant being set up, it was capital in nature and could not be allowed as revenue expenditure.

Additional Points:

The assessee also claimed term loan interest of Rs. 25.09 crores as revenue expenditure. The Tribunal noted that as per the proviso to Section 36(1)(iii), interest on term loans is allowable only from the date when the asset is first put to use. Since the asset was not yet put to use, the interest could not be allowed as revenue expenditure.

Conclusion:

The appeal of the assessee was dismissed. The Tribunal upheld the decisions of the AO and CIT(A), concluding that the expenditures in question were capital in nature and not allowable as revenue expenses. The Tribunal emphasized the necessity of examining the purpose and nature of the expenditure to determine its classification as capital or revenue.