COMMISSIONER OF INCOME-TAX VS COOPERATIVE SUGARS LTD, 2000 PTD-KERALA-HIGH-COURT-INDIA 2204 (1998)

Income-tax-

----Capital or revenue expenditure ---Assessee engaged in manufacture and sale of sugar and molasses---Sugar plant consisting of several components like juice heater, juice sulphiter, vacuum filter drum, centrifugal machinery, sugar crystallizer sugar grader, etc.---Each machinery though had distinct function was integral part of sugar plant---All machinery put together complete sugar plant---Expenditure incurred on "machinery maintenance" resulting in substantial replacement of machinery---No new asset of enduring nature brought into existence---Expenditure on "machinery maintenance" is revenue expenditure.

The assessee-company which carried on the business of manufacture and sale of sugar and molasses incurred expenditure under the head "Machinery maintenance" amounting to Rs.27,49,029 on items of machinery like high velocity juice heater, sugar grader, centrifugal machinery, juice sulphiter, vacuum filter drum, pumps and meters. The assessee claimed the expenditure as revenue expenditure. The Assessing Officer rejected the claim of the assessee and held that the entire expenditure was capital in nature on the grounds that the sugar plant of the assessee consisted of several independent components, viz., juice heater, juice sulphiter, vacuum filter drum, centrifugal machinery, sugar crystalliser, sugar grader, etc., that each unit was a separate entity by itself which could perform the' assigned task of each stage of operation and processing, that none of such components was part of other machinery, that the assessee replaced the entire machinery, that it was not a case of replacement of accessories of such components, that the assessee received benefits of enduring nature from the replacement of each equipment independent in itself, that a new asset by purchasing each such machinery had come into existence and, that therefore, the expenditure incurred by the assessee on the acquisition and installation of such assets could not be said to be expenditure incurred on repairs or replacement of some of the accessories of such independent equipment. On appeal, the Commissioner (Appeals) upheld the order of the Assessing Officer. On further appeal, the Tribunal held that though each machinery had distinct function, it was an integral part of the sugar plant, that sugar manufacturing process was- a continuous process and unless the sugarcane juice as such or in a different form passed through all the requisite components, the sugar, which was the end-product of, the sugar mill, could not be, produced, that none of the machinery purchased by the assessee during the relevant year to replace the old ones could produce sugar by itself, that sugar could be produced only when all the machinery, which were integral parts of the entire sugar plant, functioned in harmony and, that, therefore, : the expenditure was incurred only on the maintenance of the sugar mill---a profit earning apparatus. On a. reference:

Held, affirming the decision of the Tribunal, that though sugarcane juice processed through each 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 by the assessee. Merely because each equipment changed the form of the sugarcane juice, that did not mean that sugar was produced by each equipment or machinery. The sugar mill was a gigantic plant. The Income tax Officer should not have been swayed by the extent of expenditure incurred on major components purchased for replacing the old ones. -For manufacture of sugar, all the machinery was necessary. Though the expenditure was incurred on the principal components of the sugar mill, 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.

Alembic Chemical Works Co. Ltd. v. CIT (1989) 177 ITR 377 (SC) rel.

B.P. Australia Ltd. v. Commission of Taxation of the Common wealth of Australia (1966) AC 224 (PC) ref.

P.K.R. Menon; Senior Advocate and N.R.K. Nair for the Commissioner.

B.S. Krishnan, Senior Advocate, P.R. Raman and K. Anand for the Assessee.

JUDGMENT

OM ERAKASH, C. J:---Pursuant to the direction under section, 256(2) of the. Income .Tax Act, 1961 (briefly, the Act); the Income-tax Appellate Tribunal: referred the following question relating tot he assessment year .1983-84 for the opinion of this Court:

"Whether, our the facts and circumstances of the case; the Tribunal WAS justified in holding that the expenditure incurred b the assessee under the head Machinery maintenance is revenue in nature arid is an allowable deduction,?

The assessee-company, engaged in the business of manufacture and sale of sugar and molasses, claimed the following expenditure as revenue expenditure under the head "Factory maintenance":

The Assessing Officer rejectedthe claim of, the assessee holding that the entire: expenditure was capital, in. nature In support ofhis view the Assessing Officer held that the sugar point of the assessee consisted of several independent components viz juice heater, Juice sulphiter, vacuum filter drum, centrifugal machinery sugar crystalliser, sugar grader, etc that each unit is a separate entity by itself which could, perform assigned, task, of each stage of operation and processing; that none of such components is part of other machinery; that the assessee replaced the entire machinery viz., juice .heater; sugar .grader centrifugal machinery juice sulphitervacuum filter drum, pumps, meters, etc.; that it is not a case of replacement of accessories of such components; that the assessee .received benefits of enduring nature from the replacement-of each equipment independent in. itself; that a new asset by purchasing each such machinery has come intoexistence :and, therefore, the expenditure incurred by the assessee on the acquisition and installation of such as sets cannot be said tobe expenditure incurred on repairs or replacement of some of the accessories of such independent -equipment. The Assessing Officer was of the view that if the expenditure were incurred on repair's or "replacement 'accessories of each of such equipment, then that would have been revenue expenditure 'But on the facts and in the circumstances of this case, each equipment acquired by the assessee during the year in question can, be said to be only an addition to the existing factory. He therefore treated the entire expenditure aggregating to Rs:27;49;029 as capital expenditure.

On appeal the Commissioner of Income-tax.(Appeal)upheld the Assessing Officer in this behalf.

The assessee carried the dispute further in appeal to the Income tax AppellateTribunal; before whom counsel for the assessee contended that there could not be a sugar plant without juice, heater; `sugar grader, juice sulphiter; vacuum filter drum, centrifugal machinery; `pumps meters, etc: and, therefore, all such equipments are integral parts of 'the entire sugar plant. This is how, it was contended before the Appellate Tribunal that the sugar mill is an integrated machinery comprising several components.- The submission 'proceeded on the footing- that without theequipment in question the sugar ; which' is the end-product of the assessee's sugar mill, could not be produced and therefore it cannot ` be `said that each' 'equipment', was independentby itself. It 'is not disputed' by" the Assessing Officer that all such equipments before the were replaced by new ones were in existence in the sugar millof the assessee:

On thesefacts acid submissions the Appellate Tribunal ,held that each machinery, though has distinct function is an integral part: of the sugar plant that-sugar manufacturing process is. a continuous process is a continuous process and unless the sugarcane juice as such or in a different form passes through all the requisite components, the sugar, which is the end product of the sugar mill cannot be produced; that none of the machinery purchased by the assessee during the relevant year to replace the old ones, can produce sugar by itself; that sugar can be produced only When-all tile machinery": 'which are integral parts' of the entire sugar plant, function in harmony and therefore, the expenditure' was incurred only on the: maintenance of the sugar :mill--a profit darning apparatus.

The Appellate- Tribunal' negative the approach, of the Assessing Officer arid the Commissioner, of Income-tax:: (Appeals); who were of the opinion that each machinery; on,: Which: expenditure-. Was incurred, was independent and new machinery, which placed the old ones, were simply additions to the old ones.

The question for consideration is as to how to approach to solve the ticklish question as-to what is the distinction between capital and revenue expenditure. In B.P. Australia Ltd. v. Commissioner of Taxation of the Common wealth of Australia (1966)'AC;224.(PC),-,Lord Pearce unable to lay down, a clear test to make a distinction between capital and revenue expenditure, said (page 264):

"The solution to the problem. is not to be found by any rigid test or description. It has to be derived from many aspects of the whole set of circumstances some of which may point in one direction, some in the other. One consideration may point so clearly that it dominates other and vaguer indications in the contrary direction. It is a common sense appreciation of all the guiding features which must provide the ultimate answer ...." (Emphasis supplied).

In Alembic Chemical Works Co. Ltd. v. CIT (1989) 177 ITR 377 (SC), the fact matrix, in brief, was that the appellant, a company engaged in the manufacture of antibiotics and pharmaceuticals, was granted a licence for the manufacture of penicillin to June, 1961. By the year 1963, it had already made an outlay of more than Rs.66 lakhs for setting up a plant for the production of penicillin. There was moderate yield in initial years. With a view to increasing the yield, the appellant entered into an agreement in. 1963 with meiji, a reputed Japanese enterprise engaged in the manufacture of antibiotics, where under Meiji, in consideration of a "once for all payment" of certain amount, agreed to supply to the appellant "the sub-cultures of Meiji's most suitable penicillin producing strains" in know-how, inter alia. The appellant was to keep the technical know-how confidential and secret For the assessment year 1964-65, the appellant claimed deduction of certain amount as revenue expenditure. The Appellate Tribunal rejected the claim of the appellant holding that the expenditure was capital in nature. The view of the Appellate Tribunal was also affirmed by the High Court.

Reversing the decision of the High Court, the Supreme Court exploding the myth that the expenditure incurred on know-how is of enduring nature, said (page 390):

"It would, in our opinion, be unrealistic to ignore the rapid advances in research in antibiotic medical microbiology and to attribute a degree of endurability and permanence to the technical know-how at any particular stage in this fast-changing area of medical science. The state of the art in some of these areas of high priority research is constantly updated so that the know-how cannot be said to be the element of the requisite degree of durability and none-ephermerality to share the requirements and qualifications of an enduring capital asset. The rapid strides in science and technology in the field should make us a little slow and circumspect in too readily pigeon-holing an outlay such as this as capital Reversing the decision of the High Court, the Supreme Court, on the fact situation, observed as under

"The business of the assessee from the commencement of its plant in 1961, it is undisputed, was the manufacture of penicillin. Even after the agreement, the - product manufactured continued to be penicillin ...there was no material for the Tribunal to hold that the area of improvisation was not a part of the existing business or that the entire gamut of the existing manufacturing operations for the commercial production of penicillin in the assessee's existing plant had become obsolete or inappropriate in relation to the exploitation of the new sub-cultures of the high yielding strains of penicillin supplied by Meiji and that the mere introduction of the new biosynthetic source required the erection and commissioning of a totally new and different type of plant and machinery ....the mere improvement in or updating of the fermentation process would not necessarily be inconsistent with the relevance and continuing utility of the existing infrastructure, machinery and plant of the assessee."

Having so found, the Supreme Court concluded

" that the financial outlay under the agreement was for the better conduct and improvement of the existing business and should, therefore, be held to be revenue expenditure:"

The question for consideration is when the expenditure incurred on know-how on the basis of "once for all" payments was held to be expenditure as revenue in nature by the Supreme Court, could it be said in the case at hand that the expenditure incurred on several machinery to make the sugar mill functionally sound, was capital in nature?

In Alembic Chemical Works Co. Ltd. (1989) 177 ITR 377, the Supreme Court observed as under (page 386).

"The idea of 'once for all' payment and 'enduring benefit' are not to be treated as something akin to statutory conditions; nor are the notions of 'capital' or 'revenue' a judicial fetish. What is capital expenditure and what is revenue are not eternal verities but must needs be flexible so as to respond to the changing economic realities of business...."

The Supreme Court again observed as follows

"In the infinite variety of situational diversities in which the concept of what is capital expenditure and what is revenue arises, it is well -nigh impossible to formulate any general rule, even in the generality of -cases, sufficiently accurate and reasonably comprehensive, to draw any clear line of demarcation .... . "

From the above reproduced observations, it is nothing but clear that the answer to the question whether a given expenditure is capital m nature on revenue in nature, will depend on the facts and circumstances of each case 'Both the Assessing Officer and the Commissioner of Income-tax (Appeals) took the view, in the instant case, that each equipment, on which the expenditure was incurred by the assessee, was independent in nature. On the facts and in the circumstances of the case, the view so taken by them is not at all correct. It may be true that - sugarcane juice processed through each equipment may undergo some change, but the end-product of the sugar mill would be available only after the entire processing is complete and that would be complete only after the completion of the processing through all the machinery on which the expenditure was incurred by the assessee. Simply because each equipment changes the form or shape of the sugarcane juice, that does not mean that sugar is produced by each equipment for machinery. This being so, there is a bask fallacy in the approach of the Assessing Officer and the appellate authority.

Before us, learned senior standing counsel argued that a considerable expenditure was incurred by the assessee on each machinery and some of the machinery were replaced after about 17 years of service and, therefore, the expenditure so incurred-was capital in nature, inasmuch as the machinery acquired, constituted on asset of an enduring benefit. The sugar mill is a gigantic plant. The Assessing Officer should not have been swayed by , the extent-of expenditure, incurred on major components purchased for replacing the old ones. The vital question is whether the sugar mill can work in the absence of machinery, expenditure incurred on which is- claimed by the assessee. This question has to be answered in the negative. For the manufacture of sugar, all the machinery claimed are necessary. No doubt, the expenditure was incurred on the principal components of the sugar mill, still, however, it would be wrong to hold each machinery as an independent unit. All machinery put together complete the sugar plant. We, therefore, entirely agree with the view taken by the Appellate Tribunal.

Learned senior, standing counsel submits that expenditure incurred on substantial replacement is capital in nature. Depending on the facts and circumstances of a given case, such propositions cannot be disputed. But, in the case in hand, it does not hold to be good. No doubt, expenditure was incurred on substantial replacement, but the fact remains that the sugar plant was there and the same plant existed even after replacement and, therefore, it is wrong to say that any new asset of enduring nature has come into existence. Whether or not a new asset has come into existence--this question has to be considered vis- -vis the integrated sugar plant and not vis-a-vis each integral part of it. When expenditure incurred on technical know-how on consideration of "once for all payments" was held to be the expenditure as revenue in nature in, the case of Alembic Chemical Works Co. Ltd. (1989) 177 ITR 377 (SC), we see no reason why expenditure incurred on purchasing of new machinery to ensure sound functioning of the sugar. mill to replace the old ones, should not be held as revenue expenditure.

We, therefore, answer the above referred question in the affirmative, that is, in favour of the assessee and against the Revenue.

M.B.A./4080/FC Reference answered.