By TIOL News Service

BANGALORE, AUG 05, 2014: THE issues before the Bench are - Whether when there is no substantial change in the language of the substituted provision of law, it can be said that the assessee would be denied deduction merely because the provision has changed; whether in order to claim depreciation u/s 32, it is relevant how the said machinery was acquired & whether in case acquisition of machinery was contrary to the terms of the contract between the parties, depreciation claim can be denied to the assessee. And the verdict favours the assessee.

Facts of the case

The assessee company was engaged in the business of manufacture and trading of pharmaceutical products and its machines. It had entered into a contract with M/s. Nicholas Piramal and the products manufactured were ophthalmic which required a particular type of machinery to manufacture the moulds. M/s. Nicholas Piramal had the particular type of machinery to manufacture the moulds and as per the manufacturing agreement, the assessee also could purchase the second machinery which could be installed in the premises of M/s. Nicholas Piramal and used for the manufacture of the said moulds. Accordingly, M/s. Nicholas Piramal had one machine and the assessee purchased another machine and installed the same in the premises of M/s. Nicholas Piramal and the same was used for manufacturing the moulds. During the FYs 1997-98 and 1998-99, the assessee claimed depreciation on the second machine purchased by it. The AO disallowed the depreciation claimed by the assessee on the ground that the assessee company had purchased the second hand machine and that it had not undertaken any manufacturing activity.

On appeal, the CIT(A) confirmed the disallowance. On further appeal, Tribunal held that for allowing the claim of depreciation on any machinery, Sec.32 provides that the machinery should be owned wholly or partly by the assessee and used for the purpose of business or profession of the assessee. There was no dispute that the assessee owned the machinery but the only dispute was, whether it was used for the purpose of assessee’s business or profession. Tribunal held that when the manufacturing was done as per the specifications of the assessee and the goods were also recognized as manufactured by the assessee, since they were sold in the brand name of assessee, though M/s. Nicholas Piramal manufactured the said goods, it was the assessee who was manufacturing the goods. Therefore it cannot be said that the machinery was not used for the business or profession of the assessee. Therefore it was held that assessee satisfied the condition of using the machinery for the purpose of his business. Accordingly assessee was entitled to depreciation on this machinery.

A) It was contended by the revenue that Section 40(a)(i) was substituted by Finance Act, 2004, which came into effect from 01.04.2005. Therefore, the said provision had no application for the AYs prior to 01.04.2005 and therefore it was submitted that the impugned orders passed granting the benefit in terms of the substituted provision was erroneous and required to be interfered with.

B) The Revenue's counsel further contended that the Tribunal was in error in granting depreciation to machinery which was in use by the assessee in manufacturing of its products and therefore the requirement of Sec.32 was not complied with and therefore it was contended the impugned order requires to be set aside. It was further contended that, firstly the question of assessee providing machinery would arise only in the event of M/s. Nicholas Piramal not possessing the said machinery for manufacturing. In the instant case M/s. Nicholas Piramal did possess the machinery. In fact they had sold the machinery to the assessee and therefore the assessee was not entitled to the benefit as it runs counter to the terms of the contract. Secondly it was contended, inspite of sufficient opportunity given to the assessee, the assessee had not produced any material to show that the said machinery was used for the manufacture of their pharmaceutical products and therefore the finding recorded by the Tribunal that it was used for manufacturing activity was without any supporting evidence and therefore it was submitted, the said finding requires to be set aside.

C) It was contented by the Revenue that the demonstration equipment in respect of which the assessee had claimed deduction as revenue expenditure, was not proper. According to them, the said machinery was in the nature of capital asset and therefore what the assessee was entitled to, was only depreciation. The assessee was trading in medical equipment particularly relating to cataract operations. The said equipment which was to be traded is treated as stock in trade of the assessee and the said equipments were shown in the inventory. The expenditure incurred for the purpose of stock in trade was revenue in nature and the assessee was entitled to claim the expenditure in the year of its purchase.

Held that,

A) ++ a careful reading of the aforesaid provisions makes it clear there is no substantial difference in the language employed. The benefit which is now conferred on the assessee was available to him prior to the amendment also. In that view of the matter, we do not see any merit in the said contention and the said substantial question of law is answered in favour of the assessee and against the Revenue;

B) ++ in order to claim depreciation under Sec.32, the condition to be satisfied is, the assessee should own wholly or partly the machinery used for the purpose of business or profession. Therefore how the machinery is acquired, whether acquisition of machinery is contrary to the terms of the contract between the parties, is totally irrelevant. Once the assessee owns wholly or partly any machinery which is used for the purpose of the business or his profession, then Sec.32 is attracted and is entitled to depreciation. Therefore we do not see any merit in the first contention;

++ insofar as user of the machinery is concerned, the assessee has produced the contract between the parties. He has produced documents showing that he owns the machinery. There is evidence on record to show that the assessee is in the business of pharmaceutical products. The assessee has also furnished certain sale bills and eye drops and other pharmaceutical products made during the calendar year 1998-99. The machine in question is used for manufacture of plastic bottles of sizes 360 ml., 120 ml., etc. These bottles have been used by the assessee for selling the eye drops and other pharmaceutical eye care products in support of which he has enclosed the details. Unfortunately the Assessing Authority seems to think the assessee has to demonstrate before him in the Income Tax office how this machinery is used in manufacturing the products and the same is not produced. He has recorded a finding that the said machinery is not used in his business. In those circumstances, rightly, the Tribunal has set aside the said order on appreciation of the aforesaid material which was on record and has categorically recorded a finding of fact that the said machine was used in the business of the assessee and therefore he is entitled to depreciation as provided under Sec.32 of the Act. We do not see any error committed by the Tribunal in recording the said finding and therefore the said substantial question of law is answered in favour of the assessee and against the Revenue.

C) ++ the question is, if the assessee has not sold some other equipment and distributed them to doctors as demonstration equipment, whether the character of the said equipment changes from revenue expenditure to capital asset. The machinery given to doctors for demonstration purposes is also a part of promoting sale of the said machinery. It is only on such demonstration, the assessees goods are accepted in the market. The assessee has submitted that the life of the said equipment is 3 years and therefore in their accounts they have written off the value of the said equipment in a period of 3 years deducting 1/3rd for each year and they have claimed deduction on the ground that it is revenue expenditure. The Tribunal, on consideration of the aforesaid undisputed facts, has recorded a finding that it amounts to revenue expenditure and not capital asset and in our view the said finding is proper and legal and do not call for any interference. In that view of the matter, the said question of law is answered in favour of the assessee and against the Revenue. For the aforesaid reasons, these appeals are dismissed.

(See 2014-TIOL-1291-HC-KAR-IT)