2009 (7) TMI 17 - SC - Income Tax

Replacement of machinery Capital Expenditure Versus Revenue Expenditure - AO held that the expenditure are capital in Nature and depreciation can be claimed - CIT(A) ITAT and High Court held that the expenditure revenue in nature and allowed the deduction Held that it is clear on record that the assessee has sought to treat the said expenditure differently for the purposes of computing its profit and for the purpose of payment of income tax. The said expenditure has been treated as an addition to the existing assets in the former and as revenue expenditure in the latter. Though accounting practices may not be the best guide in determining the nature of expenditure in this case they are indicative of what the assessee itself thought of the expenditure it made on replacement of machinery and that the claim for deduction under the Act was made merely to diminish the tax burden and not under the belief that it was actually revenue expenditure Order of AO restored by holding that the expenditure is capital in nature.

Summary

Issues Involved:
1. Whether the expenditure on replacement of machinery amounts to 'revenue expenditure' deductible under section 37 of the Income Tax Act, 1961 or 'current repairs' deductible under section 31 of the Act.
2. Whether each machine in a textile mill is an independent item or part of a complete spinning mill.
3. The applicability of the High Court's decision in Janakiram Mills Ltd. case.
4. The relevance of accounting practices in determining the nature of expenditure.

Detailed Analysis:

1. Expenditure on Replacement of Machinery:
The primary issue is whether the expenditure incurred on replacing machinery is deductible as 'revenue expenditure' under section 37 or as 'current repairs' under section 31 of the Income Tax Act, 1961. The Supreme Court clarified that the entire textile mill machinery cannot be considered a single asset for the purpose of 'current repairs.' Replacement of old machinery with new machinery constitutes the creation of a new asset, thereby providing an enduring benefit to the assessee, which does not qualify as 'current repairs.'

The court referred to the decision in CIT v. Saravana Spinning Mills (P) Ltd., which held that each machine in a textile mill has an independent role and replacing one machine with another brings a new asset into existence. Thus, such expenditure cannot be allowed as a deduction under section 31 of the Act.

2. Independence of Each Machine in a Textile Mill:
The court examined whether each machine in a textile mill should be treated as an independent item or as part of an integrated process. It was concluded that each machine has a distinct function and independent identity, even though they are part of an integrated manufacturing process. This view aligns with the decision in CIT v. Saravana Spinning Mills (P) Ltd., where it was held that each machine in a textile mill is an independent entity and not merely a part of a composite machinery.

3. Applicability of Janakiram Mills Ltd. Case:
The High Court had relied on its decision in CIT v. Janakiram Mills Ltd., which was subsequently set aside by the Supreme Court in the Saravana Mills case. The Supreme Court clarified that the tests applicable to section 31 cannot be read into section 37, and thus, the High Court's decision in Janakiram Mills was not a valid precedent. The court emphasized that the expenditure in question does not qualify as 'current repairs' and is capital in nature, providing an enduring benefit to the assessee.

4. Relevance of Accounting Practices:
The court noted that the assessee treated the expenditure differently for profit computation and tax purposes. While accounting practices may not be the best guide, they indicate that the assessee itself considered the expenditure as capital in nature. The claim for deduction under the Act was made to reduce the tax burden, not because it was genuinely believed to be revenue expenditure.

Conclusion:
The Supreme Court set aside the High Court's judgment, restoring the Assessing Officer's decision to disallow the deduction claim. The expenditure on replacing machinery was deemed capital in nature, providing an enduring benefit, and not qualifying as 'current repairs' under section 31 or 'revenue expenditure' under section 37 of the Income Tax Act, 1961. The appeal was allowed with no order as to costs.