Only when the entire machine is replaced is a capital expense incurred; not for individual parts

Fact and issue of the case

The appeal has been preferred by the Revenue and the Assessee against appellate order dated 20.02.2017 in appeal no. 248/16-17 for the assessment year 2012-13 passed by Commissioner of Income Tax (Appeals)-33, New Delhi (hereinafter referred to as the ‘First Appellate Authority’ or in short ‘Ld. F.A.A.’) in appeal against order dated 27.03.2015 u/s 143(3) of the Income Tax Act, 1961 passed by DCIT, Circle 18(2) ( herein after referred to as ‘Ld. Assessing officer or in short Ld. AO’).

The facts in brief are that Assessee company was engaged in the business of manufacturing of Industrial Nitrocellulose, having plant at Gujrat. During the course of scrutiny assessment proceedings, Ld AO had made following additions.

In regard to 1st addition, Assessee company has made investment amounting to Rs. 9,96,82,500/- in the form of equity shares. Ld AO enquired as to why disallowance of expenses u/s 14A may not be made. In response to query raised, the assessee company had furnished the reply stating therein that the company has made investment out of interest free funds in the form of share capital, Reserve and surplus, Deferred Tax Liability and accumulated depreciation of Rs. 14542 lacs against investment in shares of Rs. 996 lacs. The assessee further relied upon the decision of the Hon’ble High Court of Delhi in the case of CIT vs. Oriental Engineers Pvt. Ltd. However AO had made disallowance u/s 14A by applying rule 8D ;

In regard to 2nd addition, during the course of assessment proceedings, the assessee company was asked to show cause as to why loss on foreign exchange fluctuation on ECB may not be added to taxable income on the similar lines as in earlier assessment years. In response to query raised, the assessee company has furnished the reply stating therein that with regard to the Forex Exchange Loss on ECB Rs. 1,03,34,504/-, there was no change in the facts of the case compared with the earlier years and the Ld. CIT(A) has deleted the said addition in the AY 2009-10. However, relying Sutlej Cotton Mills V CTR (SC) 155(1979) the Ld AO observed that as the term loan was taken for fixed assets later on converted into USD the loss is not admissible u/s 37(1) of the Act.

In regard to 3rd addition, during the course of assessment proceedings, it was observed from the P&L account that the assessee had made huge expenses under the head repair and maintenance & replacement amounting to Rs. 3,08,45,539/- as compared to last year’s expenses at Rs. 53,64,765/-. The assessee was asked to justify the huge expenses incurred under the head of the repair & maintenance and replacement. In response to query raised, the assessee has furnished the reply stating therein that during the year under consideration, there is an increase in the said expenses on account of fire at the factory at Valsad (Gujrat). Accordingly, the assessee was asked to furnish copy of the documents regarding claim lodged before insurance company and to also provide the details in respect of insurance claim lodged. In response to this, the assessee has submitted a copy of claim lodged before the Insurance Company. On perusal of the said claim, Ld AO noticed that the assessee has lodged a claim on account of building and machinery, which were destroyed or damaged amounting to Rs. 86,42,865/-after reducing the value of salvage of Rs. 2,15,00/-. Further, it was observed from the fixed asset chart/ depreciation chart that the assessee had not reduced the destroyed/ damaged by fire amounting to Rs. 86,42,865/- from the block of building and machinery and claimed depreciation on the said destroyed plan & machinery. Ld AO observed that as per the provisions of section 32(l)(iii) of the Act, the value of the money payable by the Insurance company is to be reduced from the written down value. Thus, as the assessee had not reduced the written down value of the asset in respect of claim lodged before the insurance company. It was held that the assessee has claimed excess depreciation of Rs. 8,64,264/- on account of building and machinery destroyed by fire amounting to Rs. 86,42,865/- and the same was added back to the assessee’s total income.

In regard to 4th addition, Ld AO as observed from the P&L account that the assessee had made huge expenses under the head repair and maintenance & replacement amounting to Rs. 3,08,45,539/- as compared to last year’s expenses at Rs. 53,64,765/-. The assessee was asked to justify the huge expenses incurred under the head of the repair & maintenance and replacement. Assessee furnished a chart in a excel format. Ld AO observed that the assessee has claimed the expenses for repair and maintenance under the head mechanical and the Digester amounting to Rs 1,77,66,854/- and Rs 85,57,096/- which were destroyed in fire. As Ld AO found them not verifiable in nature of revenue expenditure an amount to extent 20%, i.e Rs 52,64,790 was considered to be capital in nature and added back to the total income.

The Ld CIT(A) had partly allowed the appeal so Revenue has come in appeal raising following grounds :-

Whether on facts and in circumstances of the case, the Ld. CIT(A) is legally justified in deleting disallowance of ‘foreign exchange fluctuation loss of Rs 1,03,34,504/- on External Commercial Borrowing (ECB) which was illegally diverted for other than prescribed purpose without considering Explanation 1 to section 37(1) of the Income Tax Act, 1961 (the Act)?

Whether on facts and in circumstances of the case, the Ld. CIT(A) is legally justified in deleting disallowance of ‘foreign exchange fluctuation loss of Rs 1,03,34,504/- on External Commercial Borrowing (ECB) even when the assessee had not discharged its primary onus u/s 37(1) of the Act?

Whether on facts and in circumstances of the case, the Ld. CIT(A) is legally justified in setting aside the issues pertaining to disallowance out of depreciation on account of destroyed/damaged assets and disallowance out of repair and maintenance expenditure being capital in nature without recording a clear cut finding on the issue and by ignoring provisions of clause (a) of subsection (1) of section 251 of the Act?

Whether on facts and in circumstances of the case, the Ld. CIT(A) is legally justified in setting aside the issues pertaining to disallowance out of depreciation on account of destroyed/damaged assets and disallowance out of repair and maintenance expenditure being capital in nature by ignoring clear cut finding of the Assessing Officer (the AO) and solely on the basis of various presumptions/assumptions which were not supported by any credible evidence?

That the appellant craves leave to add, amend, alter or forgo any ground/(s) of appeal either before or at the time of hearing of the appeal.”

The Assessee had come in appeal raising following grounds :-

That the learned CIT (A) has erred in law and facts by confirming the disallowance of Rs.4,98,412/- under section 14A of the Act and therefore, the Assessing officer should be directed to delete the said disallowance in full while computing total income.

That the learned CIT (A) has erred in law and facts, by directing the learned AO, for computing and allowing the depreciation on the asset destroyed and therefore, the Assessing officer should be directed to allow the depreciation claimed in full, while computing total income.

That the learned CIT (A) has erred in law and facts by directing the learned AO, to consider the amount of replacement expenses as capital expenditure and therefore, the Assessing officer should be directed to allow the same as revenue expense, while computing total income.

Your appellant craves a leave to add, alter or amend any grounds at the time of hearing.”

Arguments were heard and record perused. The grounds raised are common and accordingly determined as below.

Ground no 1 and 2 of Revenue’s Appeal. As for the disallowance of foreign exchange fluctuation loss of Rs. 1,03,34,504/- it can be observed that Ld. CIT(A) has followed the Hon’ble Delhi High Court’s order dated 03.08.2018 in regard to assessee’s own case where considering the ECB loan as an old one the treatment of the foreign exchange fluctuation as revenue income or loss was sustained and Ld. DR was unable to cite any change of facts or law. There is no force in the ground raised by Revenue.

Observation of the court

There appears to be no error in the findings of Ld. CIT(A) while referring the matter back to ld. AO to consider the expenses into repair and maintenance expenses or replacement expenses. As a distinction has to be made if the replacement is of a baby part only, then the same cannot be considered to be a capital expenditure. It is only when a baby part alone cannot be repaired and the whole of machine is required to be replaced, the expenditure of replacement will be of capital nature. Thus, in regard to these grounds there is no substance in the contentions on behalf of the revenue or the assessee. The grounds are disallowed.

As a sequel to determination of aforesaid grounds, as raised by the assessee and the revenue, the appeal of assessee succeeds partly with regard to ground no. 1 and 2 and of Revenue is dismissed.

Order pronounced in the open court on 30th June, 2023.