2020 (2) TMI 921 - AT - Income Tax

Nature of expenditure - current repairs - Disallowance of expenditure towards cost of machinery - second round of litigation - HELD THAT - The expenditure incurred for acquiring or replacing any machinery to run a factory or mill should be treated as capital expenditure in view of the decision in the case of Sri Mangayarkarasi Mills P. Ltd. 2009 (7) TMI 17 - SUPREME COURT wherein salient findings are summarised as under Placing reliance on the decision of Supreme Court in the case of Saravana Spinning Mills P. Ltd. 2007 (8) TMI 16 - SUPREME COURT it held that each machine in a textile mill has an independent role to play in the mill and each machine is part of the integrated process of manufacture of yarn and is integrally connected to the other machines in the mill. However, this interconnection does not take away the independent identity and distinct function of each machine. Replacement of the machine can at best amount to a repair made to the process of manufacture of yarn. Each machine in a textile mill should be treated independently and not as a mere part of an entire composite machinery of the spinning mill. Replacement of an old machine with a new one would constitute the bringing into existence of a new asset in place of the old one and not repair of the old and existing machine. It therefore cannot amount to current repairs. Expenditure incurred by the assessee was capital in nature as it amounted to enduring advantage for the business in the form of efficient production over a period of time. Though accounting practices may not be the best guide in determining the nature of expenditure, they are indicative in nature. We sustain the addition confirmed by the ld. CIT(A) for the assessment year 2001-02. - Decided against assessee

Summary

Issues Involved:
1. Whether the expenditure on replacement of machinery in a textile mill should be treated as capital or revenue expenditure.
2. Whether the entire machinery in a textile mill should be considered as a single asset or each machine as an independent entity.
3. Applicability of the Supreme Court’s judgments in CIT v. Ramaraju Surgical Cotton Mills Ltd. and CIT v. Sri Mangayarkarasi Mills Ltd.
4. Whether the Tribunal's directions in the first round of litigation were properly followed.
5. Whether the appeal filed by the Revenue for the assessment year 2005-06 is maintainable considering the tax effect.

Detailed Analysis:

1. Treatment of Expenditure on Replacement of Machinery:
The primary issue was whether the expenditure on replacing machinery in the textile mill should be classified as capital or revenue expenditure. The assessee argued that the machinery should be treated as a single machine, and the replacement should be considered as current repairs under section 37 of the Income Tax Act, 1961. However, the Assessing Officer (AO) and the Commissioner of Income Tax (Appeals) [CIT(A)] treated the expenditure as capital in nature, allowing only eligible depreciation.

2. Single Asset vs. Independent Machines:
The Tribunal noted that the Supreme Court in CIT v. Sri Mangayarkarasi Mills Ltd. held that the entire textile mill machinery could not be regarded as a single asset. Each machine in the textile mill is an independent entity with its distinct function, even though they are part of an integrated process. Therefore, replacing an old machine with a new one constitutes the creation of a new asset, not merely a repair.

3. Applicability of Supreme Court Judgments:
The Tribunal had earlier remitted the matter to the AO to follow the Supreme Court’s judgment in CIT v. Ramaraju Surgical Cotton Mills Ltd., which required the issue to be decided uninfluenced by the Madras High Court’s decision. However, the AO and CIT(A) followed the Supreme Court’s later decision in CIT v. Sri Mangayarkarasi Mills Ltd., which clarified that replacement of machinery is capital expenditure.

4. Compliance with Tribunal's Directions:
The Tribunal found that the authorities below had complied with its directions by following the Supreme Court’s judgment in CIT v. Sri Mangayarkarasi Mills Ltd. The assessee’s argument that the authorities failed to follow the ITAT’s directions was ruled out since the judgment in CIT v. Ramaraju Surgical Cotton Mills Ltd. did not provide a conclusive decision but remanded the matter for fresh consideration.

5. Maintainability of Revenue's Appeal for AY 2005-06:
The appeal filed by the Revenue for the assessment year 2005-06 was dismissed as not maintainable because the tax effect was less than ?50,00,000, as per the CBDT Circular No. 17/2019. The Revenue authorities are precluded from filing appeals before the Tribunal if the tax effect is below the specified monetary limit.

Conclusion:
The Tribunal upheld the CIT(A)’s decision to treat the expenditure on replacement of machinery as capital expenditure for the assessment years 2001-02, 2002-03, and 2005-06. The appeal filed by the Revenue for the assessment year 2005-06 was dismissed due to the low tax effect. The Tribunal’s decision was based on the Supreme Court’s ruling in CIT v. Sri Mangayarkarasi Mills Ltd., which established that each machine in a textile mill is an independent entity, and replacing it constitutes capital expenditure.