Ambika Cotton Mills Ltd. v. Joint Cit

These are appeals preferred by the assessee, a limited company, for the assessment years 1994-95 to 1997-98, though involving a common issue, namely, replacement of certain machinery out of the total plant, whether could constitute revenue expenditure.

2. For the assessment year 1994-95 the assessee had replaced carding machines. For the assessment year 1995-96 the assessee had replaced auto coner in place of old cone winding machine. The assessee replaced certain old cone winding machine by auto-coner machines in assessment years 1996-97 and 1997-98 as well. The assessee had stated before the authorities that it had one MMC carding machine, 1958 model that was purchased from G.K.D. Textiles, Coimbatore, in earlier years. Similarly, it had two other old machines. Two carding machines were first added or replaced in assessment year 1991-92 and three more carding machines were added subsequently. Two MCC carding machines replaced in assessment year 1994-95 for Rs. 22.45 lakhs was noted as five times the cost as it was in 1991-92. The Commissioner (Appeals) considered the decision of the Supreme Court in State of Punjab v. Surinder Kumar (1992) 194 ITR 434 (SC) and observed that a decision could be treated as a precedent only if it decides a question of law. This observation was so made because the assessee had placed reliance on the decision of the Tribunal and the decision of Kerala High Court in CIT v. Co-operative Sugars Ltd. (1998) 5 DTC 284 (Ker-HC) : (1999) 235 ITR 343 (Ker). The Commissioner (Appeals) was of the opinion that he had not come across any decision that held that after the setting up of the mill, all subsequent replacement of any plant or machinery would have to be treated as revenue expenditure. He considered the meaning of the term "current repairs" and referring to another decision of the Apex Court in Assam Bengal Cement Co. Ltd. v. CIT (1955) 27 ITR 34 (SC) observed : "In cases where the expenditure is made for the initial outlay or for extension of a business or a substantial replacement of the equipment, there is no doubt that it is a capital expenditure." The Commissioner (Appeals) noted that the machinery need not be a self-contained unit. He referred to section 32, the circulars issued by the Board, Budget Speech of the Finance Minister in regard to the philosophy in allowing depreciation. The Commissioner (Appeals) further made reference to the decision of the Tribunal in Nagammal Mills Ltd. in ITA No. 277A/Mad/of 1993 for assessment year 1990-91 and noted that the decision was rendered after the Bench had paid a visit to the textile mill. He noted that in that case spinning frames, cone winders, etc., that were replaced were found to be independent machines capable of independent functioning and that their replacement constituted capital expenditure. He accordingly rejected the claim of the appellant.

3. For the assessment year 1995-96 the Commissioner (Appeals) considered the replacement expenditure of Rs. 80,68,157 was covering new auto coner in place of an old cone winding machine and following his order for the assessment year 1994-95 rejected the claim of the assessee. He did likewise for the assessment year 1996-97 in regard to replacement of speed frame, carding machine and generator and following his earlier order rejected the claim. For the assessment year 1997-98 a sum of Rs. 1,77,48,225 was claimed as revenue expenditure covering replacement of old manual cone winders with auto-cone winding machines. The Commissioner (Appeals) noted that two auto-coners were imported from Murata Machinery Ltd. Japan, and noted that it was purchase of imported machinery. He noted that auto-coners are additional attachment to a spinning mill and the capacity of auto-coner is definitely larger when compared to manual cone winders. Auto-coners replaced few workers also.

4. On the above facts the learned counsel for the appellant Mr. V. Ramachandran made elaborate arguments. He provided a booklet insofar as auto-coners are concerned. He submitted that carding machines are used for carding of cotton after which the cotton is sent for further processing for making yarn. The assessee manufactures yarn and textiles also. The assessee buys cotton from cotton growers and using its various machines in the plant it manufactures yarn and finally converts them into textiles. The carding machine is first of the processes which is involved after which the cotton that is cleaned is sent for further process. He submitted that carding machine could work independent of any other machine. The assessee does not merely carry on the business of cleaning of cotton and in fact it does not carry on the business of cleaning cotton alone. Cleaning of cotton is done for further process by it. It is, therefore, necessary to appreciate, he submitted that carding machine is attached to the entire plant of textile mills and in order to improve the product the assessee had to replace its worn out carding machines as such. He submitted that a person carrying on only carding activity, if replaces the entire carding machine with a new and improved machine may have to be treated as having acquired an asset of enduring nature. However, if an assessee who replaces its worn out carding machine which is one set of machines belonging to a group of plant and machinery, their replacement including substantial replacement would result in revenue expenditure. He pleaded that the Kerala High Court decision in CIT v. Co-operative Sugar Ltd. (supra) is a direct authority on the proposition. He submitted that in that case the assessee had incurred Rs. 27.49 lakhs under the head machinery maintenance and this covered machineries like high velocity juice heater, sugar grader, centrifugal machinery, juice sulphiter, vacuum filter drum, pumps and meters. The Honble High Court was able to appreciate that sugar plant consisted of various machineries some of which was replaced by the assessee as mentioned above. The High Court noted that the sugarcane juice that is processed through each of the equipment might undergo some change, the end product of the sugar mill would be available only after the entire process was complete and that would be complete only after the completion of the processing through all the machinery on which the expenditure was incurred. It further observed that because each equipment changed the form of the sugarcane juice, that did not mean that sugar was produced by each equipment or machinery. The High Court further observed that the assessing officer ought not to have swayed by the extent of expenditure incurred on major components purchased for replacing the old ones. It further observed that though the expenditure was incurred on the principal component, yet each machinery was an independent unit. All the machinery put together completed the sugar plant. Though expenditure was incurred on substantial replacement, the fact remained that the sugar plant was there and the same plant existed even after replacement and, therefore, it was wrong to say that any new asset of enduring nature had come into existence. Therefore, the expenditure incurred on purchase of new machinery to ensure sound functioning of the sugar mill to replace the old ones was revenue expenditure. He submitted that auto-coner is an improved version of the old coner winding machines. Its capacity is more. Its sphere is more and the output that is generated of yarn is also uniform and of a better quality. He submitted that it is attached to the machines from where cotton is turned to make yarn and later on the yarn is used for making textile. He submitted that a coner has, no role other than preparing the cones which are used for textile manufacturing. The process involved by the coner is an intermediary process which and the items so brought out, namely, the cones are not finally sold by the assessee but used by it in further manufacture. He submitted that merely because the coners were imported, it cannot lead to a conclusion that its cost is capital expenditure. He submitted and insisted that the ratio laid down by the Kerala High Court in Co-operative Sugars Ltd. (supra) must be applied because as stated earlier, auto-coners prepare cones comprising of yarn which yarn is used in textile manufacture and yarn as such is not sold. Mr. V. Ramachandran, the learned counsel, insisted that the decision of the Supreme Court in CIT v. Mahalakshmi Textile Mills Ltd. (1967) 66 ITR 710 (SC) still holds good and should be applied to the facts of the case. He submitted that in that case there was clear appreciation by the Madras High Court, which was upheld by the Supreme Court, that replacement of a machine by an improved one would still remain a replacement and would have to be allowed as revenue expenditure.

5. The learned senior Departmental Representative, Mr. Gorakhnathan, submitted a paper book and to facilitate us had filed in the shape of written submissions comprising of 22 pages the various aspects of the issue. He had also placed in the paper book the decisions of the Supreme Court in Mahalakshmi Textiles Mills (supra) and the decision of the Tribunal in Nagammal Mills Ltd. (supra). The point that Mr. Gorakhnathan was making was that the Supreme Court in Mysore Minerals Ltd. v. CIT (1999) 11 DTC 387 (SC) : (1999) 239 ITR 775 (SC) had considered an earlier decision of the Supreme Court in P.K Badiani v. Commissioner Of Income Tax, Bombay . (1976) 105 ITR 642 (SC) for the appreciation of the concept of depreciation, that is it is being allowed as a deduction over the life of the asset with the view that it would need to be replaced when its value is lost. He accordingly contended that the concept of replacement is inbuilt into depreciation and, therefore, replacement would have to be treated as capital expenditure. He also referred to the Accounting Standards issued by the Institute of Chartered Accountants of India on the same subject. He made elaborate arguments with reference to his written submissions covering judicial pronouncements on replacement and modernisation. He covered various decisions and their impact. He submitted that Income Tax Act per se does not have any specific provision to allow expenditure on modernisation and replacement. His plea was modernisation and replacement constitute capital expenditure and what is allowable as revenue is only current repairs. He was of the view that Income Tax (Sixth Amendment) Rules, 1969, had placed each plant and machinery in independent category for purposes of allowance of depreciation and on that basis he was of the view that replacement of every machinery has to be treated as replacement of an independent unit. He further emphasised that a machinery does not cease to be a machinery merely because it is used in conjunction with one or more machines. He referred to judicial compulsion and felt that it should be in favour of revenue. This he observed with reference to the decision of the Tribunal in Nagammal Cotton Mills (supra), a copy of which has been filed along with the paper book for our facility. He accordingly made reference to the provisions of sections 2(14) and 2(11) of the Act and submitted that consequent to the term block of assets having been introduced in the Act, every replacement of worn out machinery has to be treated as capital in nature.

6. Rival contentions have been very carefully considered, and the detailed note submitted by the learned Departmental Representative and the case laws that have been relied by both the parties have also been very carefully considered and perused. Truly speaking, from the point of view of enunciation of law, we are of the view that the law has been delivered by the Kerala High Court in Co-operative Sugars Ltd. (supra), though in that case there was no reference to the decision of the Supreme Court in Mahalakshmi Textiles Mills Ltd. (supra), it has been able to appreciate the fact that when there is wear and tear out over the years by use and the old type replacement parts were not available in the market, or the machines as such became not economical for use, the same being replaced by improved version, the replacement of an existing machine which was part of the entire plant was revenue in nature. The Kerala High Court has been able to appreciate that sugar mill has various machineries and it carries on several processes before the end product, namely, sugar, is brought out. They have further appreciated the proposition that the intermediary product, namely, sugarcane, is not the end product of the assessee but an intermediary product which undergoes further processes and it is only the final product, namely, sugar, that is sold by it. The Kerala High Court had carried out extensive tests as laid down by the Supreme Court in Alembic Chemical Works Co. Ltd. v. CIT (1989) 177 ITR 377 (SC), for the proposition once for all payment and enduring benefit with reference to their treatment whether capital or revenue. The broad proposition as laid down by the Supreme Court in Mahalakshmi Textiles Mills Ltd. (supra) as well as Co-operative Sugars Ltd. (supra) is that replacement of any of the machines in the group of machines even if that machine is replaced in entirety, may not result in capital expenditure for the sole reason that the product that machine generates is not the end product that is sold by the assessee but used for further processing. To put in other words, if the machinery as replaced constitutes the entire machinery and plant of the assessee and it results in developing a product that is sold, then the proposition and its conclusion would have a different perspective because of replacement of the entire machinery as such. However, when the mill constitutes several machineries and each of those machineries are linked together for carrying on various processes in sequence, replacement of any one or more of the machines in the link of sequence would result only in replacement of part of the whole plant, and hence it is in the nature of revenue expenditure. The principle that is laid down by the Kerala High Court in Co-operative Sugars Ltd. (supra) and by the Supreme Court in Mahalakshmi Textiles Mills Ltd. (supra) is to the effect that the extent of expenditure incurred in replacement is not of material consideration, but what is material consideration is what is the machine itself that is replaced. If the machine is part of the plant, though it may be capable of carrying on independent activity, it might still be part of the whole plant. To give an example, a carding machine is capable of carrying on carding activity of cotton. There may be persons who may carry on the business of carding alone. Such persons who carry on the carding business alone, buy cotton, carry on the carding activity and then give the carded cotton to various mills for making use in textiles, etc., his end product is carded cotton only. Such persons when replaces old worn out carding machine by a new and improved carding machine, has to be stated, rather held, as acquired an asset of enduring nature. The test apparently is the end product and if the machine that is replaced gives the end product and is the only process that is involved, the expenditure incurred would definitely be a capital expenditure. However, the same conclusion would not apply to cotton mill which has got various machineries for carrying on various processes like carding, yarn making, etc. Combination of all of these machineries constitute one wholesome plant and machinery of the mill. Replacement of any of the machinery that carries on one of the processes by even a new and improved version, as was held in Mahalakshmi Textiles Mills Ltd. (supra). "Casablanca conversion system", would still constitute revenue expenditure. Replacement of a diesel engine in place of a petrol engine after carrying out certain modification was held to be revenue expenditure. No doubt, the petrol engine was capable of being sold separately and the diesel engine also. But so far as the user is concerned, he uses the vehicle, of which vehicle the engine is a part. The vehicle comprises of various parts, namely, engine, body, seats, wheels, suspension foundation for holding the body and so on. Insofar as the manufacturers of each of these items is concerned, it may be a different story. But so far as the buyer of the vehicle is concerned, what he buys is the vehicle and if he replaces any item, which is part of the vehicle, by another and improved item, the vehicle will still remain a vehicle. This is in fact the proposition brought out by the Supreme Court in Mahalakshmi Textiles Mills Ltd. (supra) and by the Kerala High Court in Co-operative Sugars Ltd. (supra). Carding machine, as stated above, has the initial process where cotton is cleaned before it is converted into yarn. It is not the end product as far as the assessee is concerned and, therefore, the replacement of carding machine by a new and improved carding machine would constitute revenue expenditure. The various decisions, including the decision that was relied upon by the Tribunal, have considered that in all textile mills the raw material is raw cotton. They have noted that raw cotton is fed into blow room for removal of impurities and is converted into cotton laps, which are sent to carding machine. From there the cotton slivers are fed into draw frames. It is then fed into siplex machine for converting into something that is called hank. It is then fed into ring frame and finally from the ring frame yarn is obtained. It was further noted that in some mills coner is also used finally for making yarn. With due respects to our colleagues, who had rendered that decision, judicial precedents require that decision of a High Court would have to be given its precedence over the decision of the Tribunal. Further, in the light of the detailed philosophy that has been brought out by the decision of the Kerala High Court and the Supreme Court (supra), we have formed the opinion that replacement of any part in any machinery, which is part of the whole plant, would constitute revenue expenditure and the basis of this conclusion is that the product manufactured by that machine is not intended for sale but is intended for further processing by the assessee itself.

7. Coners comes into last few processes in the manufacture of cotton that is in making yarn. The old cone winding machines are replaced by new and improved coners for bringing in better output, better yarn, etc. Such a conversion into improved method is only to facilitate a better business proposition and incidentally it may have some impact insofar as the enduring nature of the business. We are accordingly of the view that the coners that are replaced by improved coners, though they have been imported as a separate machine, being not capable of functioning independently, that is to say that the assessee does not use it for a job or contract work of anyone else but in its own production by connecting it to the earlier process, it is clearly in the nature of replacement and hence revenue expenditure. Accordingly, the common issue in regard to replacement of machinery by cotton mills would constitute revenue expenditure is decided in favour of the assessee and against the department.

8. One other common issue raised is with regard to claiming 100 per cent depreciation for overhead cleaners. The claim of the appellant is that overhead cleaners are used for dust collection and thus is able to control air pollution and accordingly are eligible for enhanced depreciation. The claim of the assessee that these are pollution control equipments, they have been installed in textile mills and hence have to be given 100 per cent depreciation as prescribed in the rules was supported by a certificate from the manufacturer only. The authorities below were of the opinion that certificate from the Pollution Control Board is necessary.

9. On this issue considering the insistence by the Central Government and the State Government to the industries for controlling various kinds of pollution that the industry generates, this issue requires reconsideration at the level of the assessing officer. The Ministry of Industries together with State Ministry of Industry have been issuing notifications or circulars as to what constitutes pollution control equipments. The assessee would do well to get those notifications and produce the same before the authorities to support its claim. We may observe here, if all that the machine does is to collect dust instead of being blown all over and in no way could be treated as pollution control equipment, the claim of the assessee would have to be rejected. The assessing officer, however, is directed to allow the assessee sufficient opportunity before coming to any conclusion.

10. The other common issue that has been raised is with reference to the inclusion of interest earned by the assessee while computing the deduction under sections 80HH and 80-I of the Act. The authorities below have limited the quantification of the deduction with reference to the income that is generated by the industrial activity and have treated interest income as in no way relatable to industrial activity. The assessees ground before us is that the interest has been earned with reference to the deposits and guarantees given to the Electricity Board for providing the assessee necessary power for running its factory. In this situation it gives an impression that the deposits and guarantees is perhaps the basis for providing electricity and power. If that be the case, then the deposits and guarantees given to Tamil Nadu Electricity Board have a direct connection to the industrial activity. All that the assessing officer has to do is to verify whether the deposits and guarantees are required by the Tamil Nadu Electricity Board based on which supply would be given to the assessee, in which event he would treat the interest as part of the industrial activity and allow the assessee deduction under sections 80HH and 80-IA of the Act.

11. There is one common issue applicable for assessment years 1995-96 and 1997-98, which is in respect of sales-tax treated as part of the turnover while computing the deduction under section 80HHC of the Act. The claim of the assessee on this issue is that the assessee happens to be an agent of the government and collects the tax from various customers and gives it over to the government by depositing the same in the treasury. The claim of the assessee is that on this element of sales-tax so collected there is no element of profit embedded to the assessee. He pleaded this sale price means the price that is charged by the assessee but it is the customers that gives the assessee some profit. The learned counsel Mr. V. Ramachandran relied on the Bombay High Court decision in CIT v. Sudarshan Chemicals Industries Ltd. (2001) 19 DTC 82 (Bom-HC) : (2000) 245 ITR 769 (Bom) for the above proposition and submitted that in that case it had been clearly held that excise duty and sales-tax are not includible in total turnover for the purpose of special deduction under section 80HHC of the Act. The senior Departmental Representative, Mr. Gorakhnathan, relied on the various decisions of the Supreme Court which had held that sales-tax is part of the sale price and would have to be included in the total turnover.

12. After considering the rival contentions on the above issue, we find that the issue is squarely covered by the decision of the Bombay High Court, (supra). In that case profits derived from exports, profits and gains of business as computed in the same proportion as export turnover bears to the total turnover, were all considered with reference to the deduction to be allowed under section 80HHC of the Act. Their Lordships of the Bombay High Court found considerable merit in the various contentions of the assessee. They observed that the intention of the legislature is that profit from exports should not be taxed. It was for this purpose that a formula was evolved of giving deduction with reference to export turnover and total turnover. They considered clause (b) of the Explanation to section 80HHC that defined export turnover to mean sale proceeds received in India by the assessee in foreign exchange. They further referred to the definition of "export turnover" to mean sale proceeds of any goods which are exported out of India but excluding freight or insurance. They referred to clause (ba) that defines total turnover which also excluded freight and insurance. Their Lordships held on a combined reading of clause (b) and clause (ba) that sale proceeds would not include those which have no nexus to the sale proceeds. Referring to clause (b) of the Explanation to section 80HHC, which specifically excluded excise duty and sales-tax from the concept of export turnover, their Lordships observed that when the numerator requires exclusion, the denominator too must also be excluded. Respectfully following the said decision we uphold the claim of the assessee and direct the assessing officer to exclude the sales-tax from the total turnover while working out the deduction under section 80HHC of the Act. This issue is accordingly decided in favour of the assessee.

13. In the result, the appeals of the assessee are allowed in part.