The Commissioner Of Income Tax Salem v. M/S.sambandham Spinning Mills Ltd., Kamarajar Nagar Colony, Salem

IN THE HIGH COURT OF JUDICATURE AT MADRASDATED: 18.04.2007 THE HON'BLE MR.JUSTICE P.D.DINAKARANANDTHE HON'BLE MR.JUSTICE P.P.S.JANARTHANA RAJA The Commissioner of Income TaxSalem...Appellant in T.Cs.373 & 375-377/07The Commissioner of Income TaxNungambakkam High Road,Chennai.34...Appellant in T.C.374/07Vs.M/s.Sambandham Spinning Mills Ltd.,Kamarajar Nagar Colony, Salem...Respondent in T.Cs.373 & 375-377/07M/s.Sambandham Siva Textiles Ltd.,Kamarajar Nagar Colony, Salem...Respondent inT.C.374/07 Appeals under Section 260A of the Income Tax Act, 1961against the order of the Income Tax Appellate Tribunal, Madras 'D'Bench dated 25.8.2006 in ITA Nos.2539/Mds/2005, 756/Mds/2005,758/Mds/2005, 1659/Mds/2004 and 2478/Mds/2005 for the assessmentyears 2002-03, 2001-02, 2001-02, 2000-01 and 2002-03 respectively.and against the order of the CIT (A) in ITA No.56-C/03-04 dated15.3.2004 and against the order of the CIT (A) in ITA No.86-C/04-05 dated 29.10.2004 and against the order of the CIT (A) in ITANo. 69/05-06 dated 10.8.2005 and against the Assessment order forthe Assessment year 2000 - 01 and against the Asst., order for theAsst., year 2001-02 and against the Asst., order for the Asst.,year 2002-03. ----- https://hcservices.ecourts.gov.in/hcservices/ J U D G M E N T (Delivered by P.D. DINAKARAN, J.) The main issues that arise for our consideration in the aboveappeals under the following facts and circumstances of the caseare: (i) Whether the replacement of machinery is to betreated as revenue expenditure, but not as a capitalexpenditure ? and (ii) Whether the interest paid on the borrowed capitalto the extent relatable to the sums advanced to thesister concern is allowable as deduction under Section36(1)(iii) of the Income-tax Act, 1961 ? 2.1. The facts relating to the first issue, viz., whether theexpenditure incurred on replacement of machinery is capitalexpenditure 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 revenueexpenditure incurred for the replacement of parts of plant andmachinery, which reflected in the books and the balance sheet.The expenditure was in the nature of routine maintenance of themachinery and therefore, the same was claimed as revenueexpenditure under Section 31 of the Act in the year in which theexpenses were incurred. These expenses were amortised over theestimated life of such expenditure in eight years in the books bydebiting the Profit & Loss Account and crediting deferred revenueexpenditure account. 2.2. According to the assessee, the expenditure incurred byhim for the replacement of the machinery is a revenue expenditureunder Section 31 of the Act. But, the assessing officer rejectedthe contention of the assessee on the ground that the expenditurewas in the nature of capital expenditure on acquisition of plantand machinery, as the assessee himself admits the life of themachinery installed as eight years, as entered in his books ofaccounts and therefore, the assessee cannot ask for a differenttreatment to the capital expenditure on the plant and machineryand claim full cost of machinery as a deduction in one year, i.e.,in the year in which the expenses were met. Holding so, theassessing officer disallowed the claim of deferred revenueexpenditure and allowed depreciation at 25% on the cost ofmachinery installed. The Assessing Officer also observed that thedisallowance was made not due to the fact that the assessee hadcapitalized the cost of machinery in its book but because of the fact that the nature of expenditure incurred and the cost ofmachinery itself is capital in nature. fact that the nature of expenditure incurred and the cost ofmachinery itself is capital in nature. 2.3. Aggrieved by the order of the assessing officer, theassessee preferred appeals before the Commissioner of Income-tax(Appeals) for the respective assessment years and the Commissionerallowed the appeals by holding the issue in favour of theassessee, which was also confirmed by the Income-tax AppellateTribunal, on appeals at the instance of the Revenue. Aggrieved bythe same, the Revenue has filed the above appeals raising thefollowing common substantial questions of law:- "(i). Whether on the facts and in the circumstances ofthe case, the Income Tax Tribunal is right in law inholding that the replacement of machinery was to betreated as a revenue expenditure and not capital ? (ii). Whether on the facts and in the circumstances ofthe case, the Income Tax Tribunal is right in holdingthat the cost of acquisition of new machinery to replacethe old one was a revenue expenditure only ? 3.1. The law on the point, viz., whether the expenditureincurred on replacement of machinery is to be treated as revenueexpenditure or capital expenditure, is well settled by thedecision of this Court in COMMISSIONER OF INCOME-TAX v. JANAKIRAMMILLS LTD., [2005] 275 ITR 403, whereunder it has been held thatall plant and machinery put together amounts to a completespinning mill which is capable of manufacturing yarn and hence,each replaced machine could not be considered as an independentone and no intermediate marketable product was produced. 3.2. In view of the ratio laid down by this Court in thedecision cited supra, we hold that the expenditure on replacementof machinery is revenue expenditure and therefore, the Tribunalwas right in allowing the claim of the assessee. 4.1. With regard to the second issue, viz., Whether theinterest paid on the borrowed capital to the extent relatable tothe sums advanced to the sister concern is allowable as deductionunder Section 36(1)(iii) of the Act, during the respectiveassessment years, the brief facts are that the assessee claimedthe interest on borrowed money as expenditure in the Profit & LossAccount, which was disallowed by the assessing officer on theground that the assessee diverted the funds borrowed from thefinancial institutions and banks to its sister concerns andtherefore, the interest paid on such funds borrowed for purchaseof machinery on working capital finance, which was subsequently https://hcservices.ecourts.gov.in/hcservices/ diverted to the sister concerns, is not entitled to be allowed asdeduction under Section 36(1)(iii) of the Act. Aggrieved by theorder of assessment made by the assessing officer, the assesseepreferred appeals before the Commissioner of Income-tax (Appeals),who rendered a finding that the amounts paid by the assessee toits sister concerns are not out of the funds borrowed from thefinancial institutions and banks, the interest paid on which issought to be allowed, but out of the profits earned during therelevant assessment years, as it is not in dispute that theassessee had earned profits during the relevant assessment yearsand consequently, the Commissioner, based on the facts, held thatthe advances were made by the assessee to the sister concerns outof the profits earned during the relevant assessment years and theborrowings of the assessee company were fully utilised foracquisition of fixed/capital assets and therefore, the assesseehad not diverted the borrowed funds to the sister concerns duringthe relevant assessment years. 4.2. On further appeals by the Revenue, the Tribunal by itscommon order dated 25.8.2006, concurred with the factual findingsrendered by the Commissioner that the advances were given out ofthe profits earned by the assessee during the relevant assessmentyears and the borrowings were utilised for acquisition offixed/capital assets as envisaged in the respective expansionprojects and hence, there is no diversion of funds borrowed and asa result, the question of disallowing interest paid by theassessee on the funds borrowed on the ground that the assesseediverted the funds to its sister concerns, does not arise. 5. Aggrieved by the said order of the Tribunal, the Revenuehas raised the following common substantial questions of law:- "(i) Whether on the facts and circumstances of thecase, the Income Tax Tribunal is right in law in holdingthat the interest on the capital borrowed for the fundsdiverted to the trust/ hospital was to be allowed inspite of Sec.36(1)(iii) of the Income Tax Act ? (ii) Whether on the facts and in the circumstances ofthe case, the Income Tax Tribunal is right in notfollowing the judgment of the Madras High Court in thecase of K.Somasundaram and Brothers Vs. CIT reported in238 ITR 939 wherein it was held that the capitalborrowed should not only invested in the business butthe capital borrowed should continue to remain in thebusiness ? (iii) Whether on the facts and in the circumstances ofthe case, the Income Tax Tribunal is right in not following the judgment of the Kerala High Court in thecase of CIT Vs. V.I.Baby & Co. reported in 254 ITR page248 wherein it was held that if the assessee withliquidity diverts funds interest-free and borrows, thensuch borrowings cannot be considered for businesspurposes, but for supplementing the case divertedwithout any benefit to it ?" 6. Mr.T.Ravikumar, learned standing counsel for the Revenue,reiterated the submissions made before the authorities belowplacing reliance on the decision of this Court in K.SOMASUNDARAMAND BROTHERS vs. COMMISSIONER OF INCOME-TAX [(1999) 238 I.T.R.939] and on the decision of the Kerala High Court in COMMISSIONEROF INCOME-TAX vs. V.I.BABY AND CO. [(2002) 254 I.T.R. 248]. 7. We have given our anxious consideration to the submissionsof the learned standing counsel for the Revenue and also perusedthe entire materials placed before us. 8. All the above three questions revolve on the issue as towhether the interest paid on the borrowed capital to the extentrelatable to the sums advanced to the sister concern is allowableas deduction under Section 36(1)(iii) of the Act. 6. Mr.T.Ravikumar, learned standing counsel for the Revenue,reiterated the submissions made before the authorities belowplacing reliance on the decision of this Court in K.SOMASUNDARAMAND BROTHERS vs. COMMISSIONER OF INCOME-TAX [(1999) 238 I.T.R.939] and on the decision of the Kerala High Court in COMMISSIONEROF INCOME-TAX vs. V.I.BABY AND CO. [(2002) 254 I.T.R. 248]. 7. We have given our anxious consideration to the submissionsof the learned standing counsel for the Revenue and also perusedthe entire materials placed before us. 8. All the above three questions revolve on the issue as towhether the interest paid on the borrowed capital to the extentrelatable to the sums advanced to the sister concern is allowableas deduction under Section 36(1)(iii) of the Act. 9.1. In K.SOMASUNDARAM AND BROTHERS vs. COMMISSIONER OFINCOME-TAX [(1999) 238 I.T.R. 939], cited supra, a Division Benchof this Court observed that it is not in dispute that the amountof interest paid in respect of capital borrowed for the purposesof the business or profession as referred to in Section 36(1)(iii)of the Act, implies that the capital amount so borrowed should notonly be invested in the business, but that the amount borrowedshould continue to remain in the business and so long as theamount borrowed is used in the business, the interest paid on suchborrowing is an expenditure which is required to be deducted inthe computation of income from the business. In the said case,the assessee-firm was engaged in the business of construction andit borrowed certain amounts for the purpose of its business andalso claimed deduction for the interest amounts paid on suchborrowings. The assessing officer found that the assessee hadbeen advancing monies to close relatives of the partners withoutcharging any interest. The assessee therein claimed that theamounts so lent had not been lent out of the borrowed funds, butonly at a time when the firm had sufficient funds at its disposal.According to the assessee therein, the advance was made when itreceived substantial contract receipts. But, the assessingofficer, holding that there was diversion of borrowed funds,disallowed the claim of interest paid to the extent relatable tothe amount diverted. On appeal, the Appellate Commissionerreduced the extent of disallowance, but upheld the finding of the assessing officer that there had been a diversion, which wasconfirmed by the Tribunal on further appeal. Under the saidfacts and circumstances of the case, this Court, on a reference,held as follows:-".. the amount lent, according to the assessee, came outof the contract earnings. The amount borrowed,according to the assessee, was invested in the executionof the contracts. It was clear, therefore, that theassessee had invested the borrowed funds in theexecution of the contracts, had recouped the money soinvested presumably with profits as well on executingthe contract. The amount realised on the execution thusincluded the amount which the assessee had borrowed andinvested. When the assessee decided to lend asubstantial part of those funds interest-free to therelatives of the partners, it was clearly not a businesspurpose. The assessee clearly diverted the funds whichhad been borrowed. After such diversion, the interestpaid on the capital borrowing to the extent of theamounts diverted could no longer be an item ofexpenditure which could be claimed for deduction as anitem of business expenditure." 9.2. Similarly, reliance was also placed on the decision ofthe Kerala High Court in COMMISSIONER OF INCOME-TAX vs. V.I.BABYAND CO. [(2002) 254 I.T.R. 248], wherein the assessee, a firmdealing in piecegoods, paid interest on borrowings from banks andsince the assessee had transferred amounts to the personalaccounts of its partners and also advanced amounts to therelatives of the partners and sister concerns without charginginterest, the assessing officer disallowed proportionate interestpayments in respect of the amounts so advanced by the assessee incomputing its profits. But, the appellate Tribunal held that thedisallowance was not proper because the partners and theirrelatives had utilised the amounts for business purposes, such asconstruction of a shop building. A Division Bench of the KeralaHigh Court, on a reference, reversed the decision of the appellateTribunal by holding that the disallowance of proportionateinterest was proper, since so long as the assessee was not thebeneficiary of the investments made by the partners and theirrelatives, the nature of the investments or the utilisation ofsuch advances had no relevance and that the cash balancesavailable for the advances to the partners, their relatives andthe sister concerns were also of no effect. It was further heldthat so long as the assessee was not the beneficiary of theinvestments made by their relatives and the sister concerns and solong as the advances made were interest-free, the AssessingOfficer was justified in disallowing interest in proportion to theadvances made. 10. But, in the instant case, both the Commissioner and theappellate Tribunal concurrently found, on the basis of thematerials available on record, that the amounts paid by theassessee to the sister concern, viz., SPMM Hospital/Trust are fromthe profits earned by the assessee during the relevant assessmentyears and not by diverting the funds borrowed from the financialinstitutions and banks. It is not in dispute that the assesseehad profits during the relevant years and hence, we find itdifficult to hold that the amounts paid by the assessee to thesister concern, be that be a trust or a hospital, are divertedfrom the funds borrowed from the financial institutions and banks,since both the Commissioner and the appellate Tribunal haverendered a specific finding that the assessee paid the amounts tothe sister concerns, whether trust or hospital, only out of theprofits earned during the relevant assessment years. Hence, therefusal to allow the interest paid by the assessee from and out ofthe funds borrowed from the financial institutions and banks wouldbe contrary to the spirit and substance of Section 36(1)(iii) ofthe Act. We are, therefore, convinced that the ratios laid downin K.SOMASUNDARAM AND BROTHERS vs. COMMISSIONER OF INCOME-TAX[(1999) 238 I.T.R. 939] and COMMISSIONER OF INCOME-TAX vs.V.I.BABY AND CO. [(2002) 254 I.T.R. 248], do not fit into thefacts and circumstances of the case on hand, as dealt with above. 11. On the other hand, the Apex Court in a recent decision inS.A.BUILDERS LTD. vs. COMMISSIONER OF INCOME-TAX (APPEALS),[(2007) 288 I.T.R. 1], had an occasion to consider the issue,viz., whether the interest on borrowed capital from the bank canbe disallowed merely on the ground that the assessee lent someamount to its sister concern without charging interest out oftheir bank account, in which there was sufficient credit balance.Even in the said case, the assessee therein had received paymentsfrom its clients and deposited the same in its accounts, out ofwhich advances were subsequently made to the sister concern. Inthe said decision, the Apex Court, agreeing with the view taken bythe Delhi High Court in COMMISSIONER OF INCOME-TAX v. DALMIACEMENT (B.) LTD. [(2002) 254 I.T.R. 377], held that once it isestablished that there was nexus between the expenditure and thepurpose of the business (which need not necessarily be thebusiness of the assessee itself), the Revenue cannot justifiablyclaim to put itself in the arm-chair of the businessman or in theposition of the board of directors and assume the role to decidehow much is reasonable expenditure having regard to thecircumstances of the case. It is further held that no businessmancan be compelled to maximize his profit and the income-taxauthorities must put themselves in the shoes of the assessee andsee how a prudent businessman would act and they must not look atthe matter from their own point but that of a prudent businessman. 12. In the instant case, the assessing officer refused toallow the interest paid by the assessee on the amounts borrowedfrom the financial institutions and banks on the ground that theassessee advanced certain amounts to SPMM hospital, run byS.Palaniandi Mudaliar Charitable Trust, out of the funds borrowedby the assessee. But, both the Commissioner and the appellateTribunal factually found that the assessee had made advances tothe hospital/trust not out of the amounts borrowed, but out of theprofits made during the relevant assessment years. 13. That apart, the case of the assessee was that theadvances were given primarily for the reason that the employees ofthe assessee company and their family members are being givenconcessional treatment at SPMM hospital and the said arrangementis a permanent one and all the employees of the assessee companyare benefited by the same. If that be so, it cannot be disputedthat the amounts advanced by the assessee are nothing but ameasure of commercial expediency. 14. In view of the ratio laid down by the Delhi High Court inCOMMISSIONER OF INCOME-TAX v. DALMIA CEMENT (B.) LTD. [(2002) 254I.T.R. 377], which is affirmed by the Apex Court in S.A.BUILDERSLTD. v. COMMISSIONER OF INCOME-TAX [(2007) 288 I.T.R. 1], referredsupra, the Revenue cannot justifiably claim to put itself in thearm-chair of the businessman or in the position of the board ofdirectors and assume the role to decide how much is reasonableexpenditure having regard to the circumstances of the case and theRevenue should not look at the matter from their own point of viewbut that of a prudent businessman, once it is established thatthere was nexus between the expenditure and the purpose ofbusiness. 15. In the instant case, there are sufficient materials toreach a conclusion that the amounts advanced to the sisterconcerns, viz., SPMM Hospital/Trust, are for the commercialexpediency and therefore, it may not be proper for the Revenue todeny the benefit conferred under Section 36(1)(iii) of the Actallowing deduction for the interest paid by the assessee on theborrowed amounts. In that view of the matter, finding no question of law muchless a substantial question of law that arises for consideration,the tax case appeals are dismissed. Consequently, connectedmiscellaneous petitions are also dismissed. sraSd/Asst.Registrar /true copy/Sub Asst.RegistrarTo 15. In the instant case, there are sufficient materials toreach a conclusion that the amounts advanced to the sisterconcerns, viz., SPMM Hospital/Trust, are for the commercialexpediency and therefore, it may not be proper for the Revenue todeny the benefit conferred under Section 36(1)(iii) of the Actallowing deduction for the interest paid by the assessee on theborrowed amounts. In that view of the matter, finding no question of law muchless a substantial question of law that arises for consideration,the tax case appeals are dismissed. Consequently, connectedmiscellaneous petitions are also dismissed. sraSd/Asst.Registrar /true copy/Sub Asst.RegistrarTo 1. The Asst Registrar,Income Tax Appellate Tribunal,Rajaji Bhavan, Besant Nagar,Chennai 90. 2. The Assistant Registrar,Income Tax Appellate TribunalBench "D", Chennai. 3. The Secretary, Central Board of Direct Taxes, New Delhi. 4. The Commissioner of Income Tax (Appeals), Coimbatore. 5. The Assistant Commissioner of Income-tax, Central Circle-I,Coimbatore. 6. The Deuty Commissioner of Income Tax,Company Circle, Salem 636 007. + 5 ccs to MR. N. Muralikumaran, Senior Standing Counsel for IT,SR Nos.25691 to 25695. SGL(CO)SR/18.6.2007 https://hcservices.ecourts.gov.in/hcservices/ https://hcservices.ecourts.gov.in/hcservices/