2007 (4) TMI 182 - HC - Income Tax

Held that expenditure on replacement of machinery was revenue expenditure advances to hospital not out of amounts borrowed but out of profits Moreover, employees were benefited by it & were nothing but a measure of commercial expediency interest on borrowed capital allowable

Summary

Issues Involved:
1. Whether the replacement of machinery is to be treated as revenue expenditure or capital expenditure.
2. Whether the interest paid on the borrowed capital to the extent relatable to the sums advanced to the sister concern is allowable as deduction under Section 36(1)(iii) of the Income-tax Act, 1961.

Detailed Analysis:

Issue 1: Replacement of Machinery - Revenue vs. Capital Expenditure

Facts:
The assessee claimed deferred revenue expenditure for the replacement of parts of plant and machinery, treating it as routine maintenance under Section 31 of the Income-tax Act. The assessing officer rejected this, treating it as capital expenditure, and allowed only depreciation at 25%.

Lower Authorities' Decisions:
The Commissioner of Income-tax (Appeals) and the Income-tax Appellate Tribunal both ruled in favor of the assessee, treating the expenditure as revenue expenditure.

Legal Precedent:
The court referenced the decision in COMMISSIONER OF INCOME-TAX v. JANAKIRAM MILLS LTD., [2005] 275 ITR 403, which held that replaced machinery parts should be treated as revenue expenditure since they do not produce an intermediate marketable product and are part of a complete manufacturing unit.

Court's Conclusion:
The court upheld the Tribunal's decision, confirming that the replacement of machinery is revenue expenditure.

Issue 2: Deduction of Interest on Borrowed Capital Advanced to Sister Concern

Facts:
The assessee claimed interest on borrowed money as an expenditure, which the assessing officer disallowed, arguing that the borrowed funds were diverted to sister concerns.

Lower Authorities' Decisions:
The Commissioner of Income-tax (Appeals) and the Tribunal found that the advances to the sister concerns were made from the profits earned during the relevant assessment years, not from borrowed funds.

Revenue's Arguments:
The Revenue cited cases like K.SOMASUNDARAM AND BROTHERS vs. COMMISSIONER OF INCOME-TAX [(1999) 238 I.T.R. 939] and COMMISSIONER OF INCOME-TAX vs. V.I.BABY AND CO. [(2002) 254 I.T.R. 248], arguing that interest on borrowed funds should not be allowed if the funds were diverted.

Court's Analysis:
The court distinguished the cited cases, noting that in the current case, the advances were made from profits, not borrowed funds. The court referenced the Supreme Court decision in S.A.BUILDERS LTD. vs. COMMISSIONER OF INCOME-TAX (APPEALS), [(2007) 288 I.T.R. 1], which held that the Revenue should not interfere with business decisions if there is a nexus between the expenditure and the business purpose.

Court's Conclusion:
The court concluded that the advances to the sister concern were for commercial expediency, benefiting the assessee's employees, and thus, the interest on borrowed funds was allowable as a deduction under Section 36(1)(iii).

Final Decision:
The tax case appeals were dismissed, and the court upheld the decisions of the lower authorities, confirming that the replacement of machinery is revenue expenditure and the interest on borrowed capital advanced to the sister concern is allowable as a deduction.