In a recent textile mills case, the apex court ruled that the criterion for tax deductibility was not whether the expenditure was revenue or capital in nature, but whether the expenditure was for current repairs.
T. C. A. Ramanujam
The judiciary can be unpredictable at times. A company plans its tax affairs, presuming the law to be what the High Courts have laid down. But, unexpectedly, the applecart is upset, often leading to intervention by the Supreme Court. This is what has happened in respect of textile mills, which have been riding a wave of tax prosperity in the light of court rulings that expenditure on replacement of worn-out machines should be allowed as revenue expenditure and that no new asset is created in the process of replacement.
For instance, the Madras High Court, in CIT vs Janakiram Mills Ltd (275 ITR 403), had ruled that the concepts of current repairs, modernisation and expenditure laid out wholly and exclusively for business should all be interpreted in changing modern contexts e allowed either as current repairs or revenue expenditure in computing business income of the textile mill. .
It was an exhaustive judgment based on, among other things, the report of the South India Textile Research Association (SITRA).
Mill as plant
The Revenue took up the matter in appeal before the Supreme Court. The company argued that the whole textile mill should be considered a plant and ring frames were only one of the 25 machines which constituted one single process and, therefore, replacement of the frames had to be treated only as a replacement of old parts which had become derelict and not as replacement of a machine.
The assessing officer (AO) had held that by the replacement, the textile mill had obtained an enduring benefit and the expenditure incurred was capital in nature, not falling as current repairs under Section 31(i) of the Income-Tax Act, 1961.
On appeal, the three appellate authorities, namely, the CIT (Appeals), the Appellate Tribunal and the High Court, held that the process of converting fibre to yarn was one continuous interlinked process and that the ring frames could not work independently and could work only as a part of the spinning unit with the result that the expenditure was deductible under Section 31(i).
Reversing the Madras High Court decision, the Supreme Court (in 293 ITR 201) ruled that the manufacturing process in the textile mill was not one continuous integrated process. In cases involving the applicability of Section 31(i) of the Act, the test was not whether the expenditure was revenue or capital in nature, but whether the expenditure was current repairs.
The basic test was to find whether the expenditure was incurred to preserve and maintain an already existing asset. It should not bring a new asset into existence. There should be no enduring advantage. Deduction was admissible only for current repairs. The question whether the expenditure was revenue or capital in nature was not quite relevant. Even if the expenditure is revenue in nature, it may not fall in the connation of current repairs.
The AO was right in holding that each machine, including the ring frame, was independent and separate, capable of specific functions. Expenditure incurred for replacement of machine would not come within the meaning of current repairs. All repairs do not attract Section 31(i) even though the expenditure is revenue in nature.
The ring frame by itself constituted an independent machine with an independent function. It was replaced by a new ring frame giving enduring advantage to the textile mill. Replacement of three ring frames constituted substitution of an old asset by a new and, therefore, the expenditure incurred did not constitute current repairs.
All the authorities the CIT (Appeals), the Tribunal and the High Court had proceeded on the footing that since the expenditure was revenue, it constituted current repairs. This, said the Supreme Court, is an erroneous view. The court explained the concept of current repairs and decided the matter in favour of the Revenue.
At the same time, the court left the door open for future cases, pointing out that even if a case does not fall under Section 31(i), it is open to the assessee company to make out a case for relief under Section 37 and claim the expenditure as incurred wholly and exclusively for business.
(The author is a former Chief Commissioner of Income-Tax.)