2025 (4) TMI 1428 - AT - Income Tax

Classification of expenditure incurred - replacement of Hydraulic system with electrical control panel of the main machine - Revenue or capital expenditure - HELD THAT - Assessee fairly accepted that the machine consists of 3 parts out of which 2/3rd parts have been replaced. We note from the order of the ld. CIT(Appeals) that he has noted that SMG Feintool Germany Fine Blanking 630 Ton Press is second hand machine and imported alongwith its hydraulic system. Since this second hand machine is imported it cannot be denied that assessee was not knowing the fact that after the purchase of old machinery to put the main machinery to working condition Hydraulic system with electrical control panel are required to be replaced. After replacing Hydraulic system with electrical control panel to maintain the working capacity of the machine the assessee has incurred expenditure. Therefore it cannot be said that it is a revenue expenditure which gives enduring benefit to the assessee. As relying on 2023 (8) TMI 373 - ITAT DELHI we uphold that the expenditure incurred by the assessee is a capital expenditure and the assessee is eligible for depreciation as per law. Decided against assessee.

Summary

The core legal questions considered in this appeal revolve around the classification of expenditure incurred on machinery repairs and replacements, specifically:

1. Whether the expenditure of Rs. 31,75,000 incurred on replacement of parts of machinery qualifies as revenue expenditure (current repairs) or capital expenditure.

2. If the expenditure is revenue in nature, whether it should be allowed as a deductible expense under section 37 of the Income Tax Act.

3. The applicability of judicial precedents distinguishing capital and revenue expenditure in the context of replacement of machinery components.

Regarding the classification of expenditure as capital or revenue, the relevant legal framework includes the principles laid down under the Income Tax Act and judicial precedents interpreting the distinction between capital and revenue expenditure. The Act allows deduction of revenue expenditure incurred wholly and exclusively for the purpose of business, while capital expenditure is generally not deductible but eligible for depreciation.

The Court examined the facts that the appellant had acquired a second-hand specialized machine (SMG Feintool Germany Fine Blanking 630 Ton Press) which had three main parts. Over time, two of these parts, including the hydraulic system, were replaced with an electrical control panel. The appellant contended that this replacement constituted routine repairs and maintenance, thus qualifying as revenue expenditure deductible under section 37. The Revenue contended that since the replacement involved substantial parts of the machine and enhanced its capacity, the expenditure was capital in nature.

The Court noted the appellant's admission that two-thirds of the machine's parts were replaced, and that the machine was second-hand at the time of purchase, with the hydraulic system imported along with it. The appellant was aware that replacement of parts would be necessary to keep the machine operational. The replacement was aimed at restoring the machine to working condition and increasing its capacity, thereby providing enduring benefit.

In interpreting the law, the Court relied on a coordinate Bench decision which clarified that replacement of a "baby part" (minor component) is revenue expenditure, but replacement of substantial parts or the whole machine is capital expenditure. The Court observed that the present case falls within the latter category, given the extent of replacement and the resulting enduring benefit.

The Court applied these principles to the facts, concluding that the expenditure incurred on replacing the hydraulic system with an electrical control panel was capital expenditure. It rejected the appellant's argument that the expenditure was merely repairs and maintenance. The Court held that the expenditure enhanced the machine's capacity and provided enduring benefit, thus qualifying as capital expenditure eligible for depreciation.

Competing arguments were treated by acknowledging the appellant's reliance on judgments supporting revenue classification but distinguishing them on facts. The Revenue's reliance on the coordinate Bench ruling was accepted as directly applicable and authoritative in distinguishing the nature of expenditure based on the extent of replacement and benefit derived.

The Court directed the Assessing Officer to compute depreciation accordingly and dismissed the appeal.

Significant holdings include the following verbatim excerpt from the coordinate Bench judgment relied upon:

"As a distinction has to be made if the replacement is of a baby part only, then the same cannot be considered to be a capital expenditure. It is only when a baby part alone cannot be repaired and the whole of machine is required to be replaced, the expenditure of replacement will be of capital nature."

The core principle established is that replacement of substantial parts of machinery that confer enduring benefit and enhance capacity is capital expenditure, whereas replacement of minor components is revenue expenditure.

Final determinations on the issues are:

- The expenditure of Rs. 31,75,000 incurred on replacement of the hydraulic system with an electrical control panel is capital expenditure.

- Such expenditure is not deductible as revenue expenditure under section 37 but is eligible for depreciation.

- The Assessing Officer shall allow depreciation on the replaced machinery parts as per the law.