- (1.) THE main issues that arise for our consideration in the above appeals under the following facts and circumstances of the case are: (i) Whether the replacement of machinery is to be treated as revenue expenditure, but not as a capital expenditure? and (ii) Whether the interest paid on the borrowed capital to the extent relatable to the sums advanced to the sister concern is allowable as deduction under Section 36 (1) (iii) of the Income-tax Act, 1961?
(2.) 1. The facts relating to the first issue, viz. , whether the expenditure incurred on replacement of machinery is capital expenditure or revenue expenditure, are stated as hereunder: The above appeals relate to the assessment years 2000-01, 2001-02 and 2002-03. The assessee claimed deferred revenue expenditure incurred for the replacement of parts of plant and machinery, which reflected in the books and the balance sheet. The expenditure was in the nature of routine maintenance of the machinery and therefore, the same was claimed as revenue expenditure under Section 31 of the Act in the year in which the expenses were incurred. These expenses were amortised over the estimated life of such expenditure in eight years in the books by debiting the Profit & Loss account and crediting deferred revenue expenditure account. 2. 2. According to the assessee, the expenditure incurred by him for the replacement of the machinery is a revenue expenditure under section 31 of the Act. But, the assessing officer rejected the contention of the assessee on the ground that the expenditure was in the nature of capital expenditure on acquisition of plant and machinery, as the assessee himself admits the life of the machinery installed as eight years, as entered in his books of accounts and therefore, the assessee cannot ask for a different treatment to the capital expenditure on the plant and machinery and claim full cost of machinery as a deduction in one year, i. e. , in the year in which the expenses were met. Holding so, the assessing officer disallowed the claim of deferred revenue expenditure and allowed depreciation at 25% on the cost of machinery installed. The Assessing Officer also observed that the disallowance was made not due to the fact that the assessee had capitalized the cost of machinery in its book but because of the fact that the nature of expenditure incurred and the cost of machinery itself is capital in nature. 2. 3. Aggrieved by the order of the assessing officer, the assessee preferred appeals before the Commissioner of Income-tax (Appeals) for the respective assessment years and the Commissioner allowed the appeals by holding the issue in favour of the assessee, which was also confirmed by the income-tax Appellate Tribunal, on appeals at the instance of the Revenue. Aggrieved by the same, the Revenue has filed the above appeals raising the following common substantial questions of law:- " (i ). Whether on the facts and in the circumstances of the case, the Income Tax Tribunal is right in law in holding that the replacement of machinery was to be treated as a revenue expenditure and not capital? (ii ). Whether on the facts and in the circumstances of the case, the Income Tax Tribunal is right in holding that the cost of acquisition of new machinery to replace the old one was a revenue expenditure only? The law on the point, viz. , whether the expenditure incurred on replacement of machinery is to be treated as revenue expenditure or capital expenditure, is well settled by the decision of this Court in commissioner OF INCOME-TAX v. JANAKIRAM MILLS LTD. , [2005] 275 ITR 403, whereunder it has been held that all plant and machinery put together amounts to a complete spinning mill which is capable of manufacturing yarn and hence, each replaced machine could not be considered as an independent one and no intermediate marketable product was produced. 3. 2. In view of the ratio laid down by this Court in the decision cited supra, we hold that the expenditure on replacement of machinery is revenue expenditure and therefore, the Tribunal was right in allowing the claim of the assessee. With regard to the second issue, viz. , Whether the interest paid on the borrowed capital to the extent relatable to the sums advanced to the sister concern is allowable as deduction under Section 36 (1) (iii) of the Act, during the respective assessment years, the brief facts are that the assessee claimed the interest on borrowed money as expenditure in the Profit & Loss Account, which was disallowed by the assessing officer on the ground that the assessee diverted the funds borrowed from the financial institutions and banks to its sister concerns and therefore, the interest paid on such funds borrowed for purchase of machinery on working capital finance, which was subsequently diverted to the sister concerns, is not entitled to be allowed as deduction under Section 36 (1) (iii) of the Act. Aggrieved by the order of assessment made by the assessing officer, the assessee preferred appeals before the Commissioner of Income-tax (Appeals), who rendered a finding that the amounts paid by the assessee to its sister concerns are not out of the funds borrowed from the financial institutions and banks, the interest paid on which is sought to be allowed, but out of the profits earned during the relevant assessment years, as it is not in dispute that the assessee had earned profits during the relevant assessment years and consequently, the commissioner, based on the facts, held that the advances were made by the assessee to the sister concerns out of the profits earned during the relevant assessment years and the borrowings of the assessee company were fully utilised for acquisition of fixed/capital assets and therefore, the assessee had not diverted the borrowed funds to the sister concerns during the relevant assessment years. 4. 2. On further appeals by the Revenue, the Tribunal by its common order dated 25. 8. 2006, concurred with the factual findings rendered by the Commissioner that the advances were given out of the profits earned by the assessee during the relevant assessment years and the borrowings were utilised for acquisition of fixed/capital assets as envisaged in the respective expansion projects and hence, there is no diversion of funds borrowed and as a result, the question of disallowing interest paid by the assessee on the funds borrowed on the ground that the assessee diverted the funds to its sister concerns, does not arise.
(3.) AGGRIEVED by the said order of the Tribunal, the revenue has raised the following common substantial questions of law:- " (i) Whether on the facts and circumstances of the case, the Income Tax Tribunal is right in law in holding that the interest on the capital borrowed for the funds diverted to the trust/ hospital was to be allowed in spite of Sec. 36 (1) (iii) of the Income Tax Act? (ii) Whether on the facts and in the circumstances of the case, the Income Tax Tribunal is right in not following the judgment of the madras High Court in the case of K. Somasundaram and Brothers Vs. CIT reported in 238 ITR 939 wherein it was held that the capital borrowed should not only invested in the business but the capital borrowed should continue to remain in the business? (iii) Whether on the facts and in the circumstances of the case, the Income Tax Tribunal is right in not following the judgment of the kerala High Court in the case of CIT Vs. V. I. Baby & Co. reported in 254 ITR page 248 wherein it was held that if the assessee with liquidity diverts funds interest-free and borrows, then such borrowings cannot be considered for business purposes, but for supplementing the case diverted without any benefit to it?" Mr. T. Ravikumar, learned standing counsel for the revenue, reiterated the submissions made before the authorities below placing reliance on the decision of this Court in K. SOMASUNDARAM AND BROTHERS vs. COMMISSIONER OF INCOME-TAX [ (1999) 238 I. T. R. 939] and on the decision of the kerala High Court in COMMISSIONER OF INCOME-TAX vs. V. I. BABY AND CO. [ (2002)254 I. T. R. 248].;