Andhra Pradesh H.C : Whether time to create resrve be allowed to an assessee who neither claimed investment allowance in the return, nor created any investment allowance reserve

High Court Of Andhra Pradesh

CIT Vs. Sarvaraya Textiles Ltd.

Assessment Year : 1984-85

Section : 31,32A

V.V.S. Rao And Ramesh Ranganathan, JJ.

R.C. No. 85 Of 1994

October 29, 2010

JUDGMENT

Ramesh Ranganathan, J. – Both the revenue and the assessee have sought a reference to this Court under section 256(1) of the Income-tax Act, 1961. The question referred for our opinion, at the instance of the revenue, is :

“Whether on the facts and circumstances of the case, i.e., assessee not having claimed investment allowance in the return, nor having created any investment allowance reserve, the Income-tax Appellate Tribunal was justified in directing that the assessee should be allowed an opportunity to create such a reserve within the meaning of Explanation to section 32A(4)?”

The question referred to us for our opinion at the instance of the assessee is :

“Whether on the facts and circumstances of the case, the Tribunal was right in holding that the expenditure of Rs. 36,36,386 was a capital expenditure and not in the nature of current repair, as claimed by the assessee?”

Question referred at the instance of the assessee:-

2. It would be convenient to first deal with the question referred for our opinion at the instance of the assessee.

3. The assessee, a private limited company, filed its return of income for the assessment year 1984-85 on 30-7-1984 claiming to have suffered a loss of Rs. 6,03,870. On scrutiny of the accounts, the Income-tax Officer noted that an expenditure of Rs. 32,32,109 in the Kakinada unit, and Rs. 7,03,131 in the Vizianagaram unit, was incurred towards machinery which was independent by itself and, for which, erection charges had also been incurred. The assessee contended that, while in the Vizianagaram unit the speed frames and ring frames were new and were therefore shown as additions to machinery, in the Kakinada unit these were replacements for the old existing machinery, and were therefore treated as current repairs. The Income-tax Officer observed that there were different processes in the assessee’s mill, and for each process there was a different unit of machinery; the speed frames formed one such unit, and could not be termed as a subordinate part of a bigger machine; the entire unit was replaced in the course of modernization; and likewise the cost of Rs. 4,04,777, which related to tendem breaker cards and was debited to machinery repairs account of the Vizianagaram unit, was also capital expenditure. While completing the assessment, the Income-tax Officer treated Rs. 36,37,086 which the assessee claimed was in the nature of repairs and maintenance of plant and machinery, as capital expenditure and allowed depreciation thereupon. Aggrieved thereby, the assessee carried the matter in appeal. The Commissioner of Income-tax (Appeals), Visakhapatnam, (CIT(A)), in his order in ITA No. 12/K.I/87-88 dated 1-8-1987, endorsed the Income-tax Officer’s views in treating Rs. 36,37,086 as capital expenditure. The assessee carried the matter in further appeal to the Income-tax Appellate Tribunal in ITTA. No. 2219/Hyd./1987. The Tribunal, by its order dated 23-11-1993, held that the expenditure of Rs. 36,37,086, incurred by the assessee, was incurred as a consequence of modernization and, when a part of the machinery had been capitalized, there was no justification in claiming a part of it as repairs merely because the assessee had some machines of a similar nature earlier, and the new additions were to be in replacement thereof. The Tribunal held that the existing machines, or parts thereof, had become useless and were badly worn out; and the authorities were justified in not allowing the expenditure as revenue expenditure and treating it as capital in nature.

4. In CIT v. Sri Mangayarkarasi Mills (P.) Ltd. [2009] 315 ITR 1141 , the Supreme Court observed :

“… The first issue that needs to be resolved is whether each machine in a textile mill is an independent item or merely a part of a complete spinning mill, which only together are capable of manufacture, and there is no intermediate marketable product produced. In our view, this issue has been satisfactorily answered by the recent decision of this Court in CIT v. Saravana Spinning Mills (P.) Ltd. In that case this Court has held unambiguously that “each machine in a segment of a textile mill has an independent role to play in the mill and the output of each division is different from the other.” Dealing with a ring frame in a textile mill, this Court has held that it is an “independent and separate” machine. Further, it is accepted that each machine in a textile mill is part of the integrated process of manufacture of yarn and is integrally connected to the other machines in the mill for production of the final product. However, this interconnection does not take away the independent identity and distinct function of each machine. Thus, each machine in a textile mill should be treated independently as such and not as a mere part of an entire composite machinery of the spinning mill. As stated above, it can at best be considered part of an integrated manufacture process employed in a textile mill.”

5. The factual position, as recorded in the orders aforementioned, is that there are different processes in a textile mill, and for each of the process there is a different unit of machinery; speed frames form one such unit; this is not a subordinate part of a bigger machine; the assessee had purchased new speed frames and ring frames and tendem breaker cards; the entire unit was replaced/substantially replaced in the course of modernization; the speed frames and tendem breaker cards were separate machines; the expenditure incurred for its procurement did not amount to repairs of existing machinery; and the assessee, while treating the speed frames purchased for the Vijayanagaram unit as addition to machinery, had taken a different stand and had claimed the speed frames, purchased for the Kakinada unit, as repairs.

6. In order to determine whether or not a particular expenditure amounts to ‘current repairs’, the test is “whether the expenditure is incurred to ‘preserve and maintain’ an already existing asset and not to bring a new asset into existence or to obtain a new advantage. For ‘current repairs’ determination, whether expenditure is revenue or capital is not the proper test.” The entire textile mill machinery cannot be regarded as a single asset, replacement of parts of which can be considered to be for the mere purpose of ‘preserving or maintaining’ this asset. All machines put together constitute the production process and each separate machine is an independent entity. Replacement of an old machine with a new one would constitute the bringing into existence of a new asset in the place of the old one, and not repair of the old and existing machine. A new asset in a textile mill gives the purchaser an enduring benefit of better and more efficient production over a period of time. A new asset, or a new/different advantage, would not amount to ‘current repairs’. Two exceptions, in which replacement could amount to current repairs, are (1) where old parts are not available in the market CIT v. Mahalakshmi Textile Mills Ltd. AIR 1968 SC 101, or (2) where old parts have worked for 50-60 years. Neither of the two exceptions apply to the facts of the present case. “Repair” implies existence of a part of the machine which has malfunctioned, which does not arise in the case of replacement. Replacement expenditure cannot be said to be “current repairs” (Sri Mangayarkarasi Mills (P.) Ltd.’s case (supra); CIT v. Saravana Spg. Mills (P.) Ltd. [2007] 293 ITR 201 (SC)2 and Ballimal Naval Kishore v. CIT AIR 1997 SC 851.

7. The finding of fact recorded by the assessing authority, as upheld both by the CIT(A) and the Tribunal, is that the speed frames, ring frames, and tendem breaker cards were all replacement of machinery, and did not amount to repairs. Applying the test as aforementioned, it is evident that the expenditure incurred is to bring a new asset into existence with a view to obtain a new advantage, and not an expenditure incurred to preserve and maintain an already existing asset.

8. Sri C. Kodandaram, Learned Senior Counsel appearing on behalf of the petitioner, would submit that, in the absence of adequate information, the matter should be remanded to the CIT (Appeals). He would rely on CIT v. Ramaraju Surgical Cotton Mills [2007] 294 ITR 3283 wherein the Supreme Court held that, in the absence of requisite details regarding the production capacity remaining constant even after replacement of the machinery, the matter needed to be remitted to the CIT(A) who was directed to dispose of the matter in accordance with law. Unlike in Ramaraju Surgical Cotton Mills case (supra), there is adequate material on record in the present case to show that the expenditure incurred in purchasing speed frames, ring frames and tendem breaker cards is to bring a new asset into existence with a view to obtain a new advantage, and not an expenditure incurred to preserve and maintain an already existing asset. We see no reason, therefore, to remand the matter back to the CIT (Appeals).

9. This question must, therefore, be answered in the affirmative, against the assessee and in favour of the revenue.

Question referred at the instance of the revenue:

10. The assessing authority, while rejecting the assessee’s claim that the speed frames, ring frames and tendem breaker cards were parts of existing machinery, treated the expenditure incurred for their procurement as capital expenditure, and allowed depreciation allowance thereupon. Before the CIT(A), the assessee contended that, if these machines were treated as additions to machinery, they were then entitled to claim investment allowance thereupon at 25 per cent; and they should have been given an opportunity to create the necessary Investment Allowance Reserve under section 32A(4) of the Income-tax Act. The CIT(A) rejected the assessee’s contention holding that, under the circumstances in which the addition was made and considering the nature of the addition, there was no need to give any such opportunity to the assessee; and such questions would arise only in the circumstances narrated in the explanation to section 32A(4) of the Act. On further appeal, the Tribunal held that, as per the returns filed by the assessee, there was loss; it was converted into positive income by the order of assessment; on the basis of the accounts, the assessee could not have created any reserve; they could create it only on the basis of the assessed income at a higher figure; and, in these circumstances, the assessee should have been allowed an opportunity within the meaning of the explanation to section 32A(4) of the Act.

11. Section 32A relates to Investment Allowance and the deduction specified in section 32A(1) is available to an assessee if, in terms of section 32A(4)(ii), an amount equal to seventy five per cent of the investment allowance to be actually allowed is debited to the profit and loss account of any previous year in respect of which the deduction is to be allowed under sub-section (2), or in any earlier previous year (being a previous year not earlier than the year in which the machinery or plant was installed or was first put to use), and credited to a reserve account to be called the “Investment Allowance Reserve Account”. Under the explanation thereunder, where the amount debited to the profit and loss account, and credited to the Investment Allowance Reserve Account, is not less than the amount required to be so credited on the basis of the amount of deduction in respect of investment allowance claimed in the return made by the assessee under section 139, but a higher deduction in respect of the investment allowance is admissible on the basis of the total income as proposed to be computed by the Assessing Officer under section 143, the Assessing Officer shall, by notice in writing in this behalf, allow the assessee an opportunity to credit within the time specified in the notice, or within such further time as the Assessing Officer may allow, a further amount to the Investment Allowance Reserve account out of the profits and gains of the previous year in which such notice is served on the assessee, or of the immediately preceding previous year if the accounts for that year have not been made up; and, if the assessee credits any further amount to such account within the time specified, the amount so credited shall be deemed to have been credited to the Investment Allowance Reserve Account of the previous year in which the deduction is admissible, and such amounts shall not be taken into account in determining the adequacy of the reserve required to be created by the assessee in respect of the previous year in which such further credit is made.

12. Admittedly, in the case on hand, the assessee has not credited 75 per cent. of the Investment Allowance claimed, to the Investment Allowance Reserve account. The explanation to section 32A(4) is applicable only where a certain sum is debited to the profit and loss account and credited to the Reserve Account, but a higher deduction in respect of Investment Allowance is admissible on the basis of the total income computed by the Assessing Officer. In such a case, and if the accounts for the relevant previous year are not made up, the Assessing Officer is required to give the assessee an opportunity to credit a further amount to the Investment Allowance Reserve account. In the present case, the assessee has neither debited the Investment Allowance claimed to their profit and loss account, nor have they created, much less credited any sum to, the Investment Allowance Reserve account.

13. Sri C. Kodandaram, Learned Senior Counsel, would submit that the assessee had filed a loss return and it is only because of the addition of the amount, debited earlier towards repairs of machinery, treating it as addition to machinery, that the assessee had an income liable to tax which, in turn, entitled them to claim the benefit of investment allowance and, in such circumstances, the assessee could neither have debited the profit and loss account earlier with the Investment Allowance claimed by them, nor have credited 75 per cent thereof to the Investment Allowance Reserve account.

14. In this context, it is useful to refer to section 33 of the Act which relates to development rebate. Under section 33(1)(a), in respect of a new machinery or plant, which is owned by the assessee and is wholly used for the purposes of the business carried on by him, there shall, in accordance with and subject to the provisions of sections 33 and 34, be allowed a deduction, in respect of the previous year in which the machinery or plant was installed, or when the machinery or plant was first put to use, a sum by way of development rebate as specified in clause (b) section 34(1) of the Act, (prior to its omission by the Taxation Laws Amendment Act, 1986 with effect from 1-4-1988), provided that the deduction, referred to in section 33, shall be allowed only if the particulars prescribed for the purposes of clauses (i ) and (ii) of section 32(1) have been furnished by the assessee in respect of the machinery or plant section 34(3)(a) stipulated that the deduction, referred to in section 33, shall not be allowed unless an amount equal to seventy five per cent of the development rebate to be actually allowed is debited to the profit and loss account of the relevant previous year and credited to a reserve account to be utilized by the assessee during a period of eight years next following for the purposes of the business of the undertaking. By the Finance Act, 1990 the words “relevant previous year” in section 34(3)(a) were substituted by the words “any previous year in respect of which the deduction is to be allowed under sub-section (2) of that section or any earlier previous year (being a previous year not earlier than the year in which the machinery or plant was installed or was first put to use)”, with retrospective effect from 1-4-1962.

15. The Explanation to section 34(3)(a), prior to its omission by the Finance Act, 1990 with retrospective effect from 1-4-1962, read thus :

“For the removal of doubts, it is hereby declared that the deduction referred to in section 33 shall not be denied by reason only that the amount debited to the profit and loss account of the relevant previous year, and credited to the reserve account aforesaid, exceeds the amount of the profit of such previous year (as arrived at without making the debit aforesaid) in accordance with the profit and loss account.”

16. It is evident, from a reading of the above referred provisions, that the benefit of development rebate, available under section 33 of the Act, is similar to the benefit of investment allowance available under section 32A of the Act. In Shri Shubhlaxmi Mills Ltd v. Addl. CIT [1989] 2 SCC 465, the Supreme Court held that what is contemplated by section 34(3)(a) of the Act is the creation of a Reserve Fund in the relevant previous year irrespective of the result of the profit and loss account disclosed by the books of the assessee; book entries would suffice for creating such a Reserve Fund; the debit entries, and the entries relating to the Reserve Fund, have to be made before the Profit and Loss account is finally drawn up; that is a condition for securing the benefit of development rebate; and, if that condition is not satisfied, the deduction on account of development rebate cannot be claimed at all.

17. An assessee, carrying on business, would maintain its books of account and effect entries therein on a daily basis. A profit and loss account is, ordinarily, prepared only at the end of the accounting period. It is only after a profit and loss account is prepared can it be ascertained whether the assessee has suffered a loss or has made profits in the said accounting period. The book entries, both with regard to the debit of Investment Allowance and credit of the Investment Allowance Reserve account, would precede the determination of whether the assessee has incurred a loss or has made profit in the accounting period in question. The explanation to section 32A(4) would apply where the amount of Investment Allowance debited to the profit and loss account, and credited to the Investment Allowance Reserve account, is found insufficient on additions made to the assessee’s income by an order of assessment, and not where no amount has either been debited to the profit and loss account or credited to the Investment Allowance Reserve account. In as much as, in the case on hand, the necessary book entries for debiting the investment allowance to the Profit and Loss Account, and crediting 75 per cent thereof to the Investment Allowance Reserve account have not been made, neither is the assessee entitled to claim the benefit of Investment Allowance nor was the Tribunal justified in directing that the assessee should be given an opportunity, within the meaning of the explanation to section 32(A)(4), to create such an Investment Allowance Reserve account.

18. Sri C. Kodandaram, Learned Senior Counsel, would submit that, pursuant to the amendment made by the Finance Act, 1990 and as clarified by the CBDT in its Circular No. 572 dated 3-8-1990, the basis of the judgment in Shri Shubhlaxmi Mills Ltd. case (supra) has been removed, and the said judgment can no longer be relied upon, more so as the matter has been referred to a Larger Bench for reconsideration of the law laid down therein.

19. In Shri Shubhlaxmi Mills Ltd’s, case (supra) the Supreme Court had also held that, in order to claim deduction on account of development rebate under section 33(1), it was obligatory that the debit entries in the Profit and Loss account and the credit entries in the Reserve account should be made in the relevant previous year in which the machinery or plant is installed or first put to use; the development rebate, contemplated by section 33(1), cannot be allowed as a deduction unless a Reserve account has been created in the previous year in which the installation or first use occurs; and any doubt in so reading the provisions, because of a want or insufficiency of profit in such previous year, had been removed by the explanation to clause (a) of sub-section (3) of section 34 of the Act.

20. In its Circular No. 572 dated 3-8-1990, the CBDT observed that though the decision of the Supreme Court, in Shri Shubhlaxmi Mills Ltd’s case (supra) had been pronounced only with regard to the provisions relating to Development Rebate, the underlying principle would apply equally to the grant of Investment Allowance; accordingly, sections 32A and 34 had been amended to secure that the condition of creation of a reserve even in a year of loss or of insufficiency of profit, as laid down by the Supreme Court, will not be mandatory in respect of both Development Rebate and Investment Allowance; it was now provided that, in considering whether the condition regarding creation of a Reserve is fulfilled or not, the Reserve(s) created in the year in which the deduction is to be allowed, and in any earlier year, will be taken into account; the earlier year should not be a year earlier than the year in which the plant or machinery is installed or first put to use; these amendments would take effect retrospectively from 1st April, 1962 in relation to Development Rebate, and 1st April, 1976 in relation to Investment Allowance; and would, accordingly, apply from the assessment years 1962-63 and 1976-77 respectively, and in the subsequent years.

21. In CIT v. Century Enka Ltd. [1992] 196 ITR 447 ; the Calcutta High Court noted that, in Bharatiya Vehicles & Engg. Co. Ltd. v. Union of India SLP Civil Nos. 11925 and 11926 of 1989 (1990) 181 ITR (St.) 7-8 (SC), the assessee had filed a special leave petition against the order of rectification contending that (i) it would be futile to proceed by way of appeal and reference since the authorities and the High Court would feel bound by Shri Shubhlaxmi Mills; (ii) the words “75 per cent of the Investment Allowance actually allowed” in section 32A(4) (ii) meant that the Reserve had to be created in the year when the investment allowance was to be allowed, and not in any other year where, due to loss, the Investment Allowance was not allowed; (iii) to this extent the decision, in Shri Shubhlaxmi Mills Ltd.’s case (supra) needed reconsideration; and the Supreme Court, by its order dated March 19, 1990, had granted special leave, and had directed the resultant appeal to be listed before a Larger Bench of three judges. Thereafter the Calcutta High Court held :

“…As a result of the amendment made in section 32A(4) (ii ) by the Act, 1990, with retrospective effect from April 1, 1976, and the omission of section 32A(9) by that Act, also with effect from that date, the effect of the Supreme Court decision in Shri Shubhlaxmi Mills Ltd. [1989] 177 ITR 193 , has statutorily been superseded. The net effect of such amendments is that the condition of creation of investment allowance reserve even in a year of loss on the analogy of the principle laid down by the Supreme Court in Shri Shubhlaxmi Mills Ltd. [1989] 177 ITR 193, will not be mandatory retrospectively for and from the assessment year 1976-77. As a result of such amendments, such reserve can be created in any previous year in respect of which the deduction is to be allowed under section 32A(3) or any earlier previous year not being a previous year earlier than the year in which the ship or aircraft was acquired or the machinery or plant was installed or the ship, aircraft, machinery or plant was first put to use…” [Emphasis supplied]

22. It is only to the extent that the Supreme Court, in Shri Shubhlaxmi Mills Ltd.’s case (supra), held that debit of the Profit and Loss Account, and the credit to the Reserve account, should only be made in the year in which the machinery or plant was installed or first put to use, has the amendment, by Finance Act, 1990 now provided for such deduction to be claimed even in a subsequent previous year. We are not concerned in the present case with any subsequent previous year, but with the previous year in which the machinery was purchased. As such, the judgment in Shiri Shubhlaxmi Mills Ltd.’s case (supra) would still squarely apply to the facts of the present case.

23. The Judgments of the High Courts, in CIT v. Prasad Film Laboratories (P.) Ltd. [1997] 225 ITR 348 (AP)4 ; CIT v. Beco Engg. Co. [1998] 232 ITR 102 , (Punj. & Har.); CIT v. Raza Buland Sugar Co. Ltd. [1993] 202 ITR 191 (All.)5 ; CIT v. Seshasayee Paper Boards Ltd. [2006] 283 ITR 200 (Mad.)6 ; and Velan Textiles (P.) Ltd. v. Deputy CIT [2009] 312 ITR 56 7 (Kar.) relied upon by the Learned Senior Counsel, relate to a claim of Investment Allowance/Development Rebate, and creating the necessary Reserve, in a previous year subsequent to the previous year in which the machinery or plant was installed or first put to use. It is in such circumstances that it was held that, with the omission/amendment of sections 34 and 32A by the Finance Act, 1990 with retrospective effect from 1-4-1962/1-4-1976, it was not necessary to create a Development Rebate Reserve Fund/Investment Allowance Reserve, in the year of loss as laid down in Shri Shubhlaxmi Mills Ltd.’s case (supra), and the assessee could create a Reserve in any of the years subsequent to the year of installation of plant and machinery; the assessee need not create a Reserve in the year of installation; and, if there was insufficient profit, it could create it in a subsequent year of actual deduction.

24. The order of the Supreme Court in Bharatiya Vehicles & Engg. Co. Ltd.’s case (supra), doubting the correctness of the law laid down in Shri Shubhlaxmi Mills Ltd.’s case (supra) and referring the matter to a Larger Bench, is an order of reference. An order of reference is neither a judgment of the Supreme Court within the meaning of Article 141 of the Constitution of India nor an opinion of that Court under Article 143 of the Constitution of India. Inspite of the language in which the opinion is couched it has no binding authority or force on any Court of law. (S. Kannan v. State Bank of India [1990] 2 LLJ 487 (Mad.)). The order of reference, in Bharatiya Vehicles and Engg. Co. Ltd.’s case (supra) does not overrule the earlier judgment of the Supreme Court in Shri Shubhlaxmi Mills Ltd.’s case (supra). Since the judgment of the Supreme Court, in Shri Shubhlaxmi Mills Ltd.’s case (supra), remains a binding precedent, till it is overruled by a Larger Bench of the Supreme Court, failure on the part of the assessee to debit the Investment Allowance claimed to the P&L account, and to credit 75 per cent thereof to the Investment Allowance Reserve account, would disentitle them from claiming the benefit of Investment Allowance, or to be subsequently granted an opportunity to create such a Reserve, within the meaning of the explanation to section 32(A)(4) of the Income-tax Act, in the year in which the said machines were purchased.

25. This question must, accordingly, be answered in the negative, against the assessee, and in favour of the revenue.

26. Both the questions referred for our opinion are answered against the assessee, and in favour of the Revenue. The referred case is disposed of accordingly.

[Citation : 332 ITR 553]

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