In CIT vs Steel Complex Ltd (238 ITR 1054), the assessee-company, engaged in the manufacture of steel, claimed expenditure incurred on installation of a water treatment plant and a fume extraction plant as revenue deduction on the ground that the expenditure was capital in nature. The first appellate authority affirmed the order of the assessing officer.

On further appeal, the tribunal found that the assessee installed two plants which were for the purposes of improvement in the operation of existing systems with greater efficiency and profitability. Originally, the municipality was supplying water to the assessee for running the factory, but sinceit was later found that the municipality was not supplying sufficient quantity of water, the assessee dug wells.

However, the well water was found to be salty and, therefore, the assessee installed the water treatment plant for getting pure water with an intention to improve the functioning of the factory. This did not in any way enhance the production of steel. The fume extraction plant also did not lead to any increase in the volume of production and it was installed to ward off the health hazards and in compliance with statutory requirements. Therefore, the tribunal held that the expenditure incurred was revenue in nature.

On a reference, the Kerala high court first referred to the decision of the Supreme Court in Alembic Chemical Works Co Ltd vs CIT (177 ITR 377). The Supreme Court, while laying down certain principles to find out which expenditure is capital or revenue in nature, inter alia, observed: "What is capital expenditure and what is revenue are not eternal verities but must to need beflexible so as to respond to the changing economic realities of business. The expression `asset or advantage of an enduring nature' was evolved to emphasise the element of a sufficient degree of durability appropriate to the context.

"There is also no single definitive criterion which, by itself, is determinative as to whether a particular outlay is capital or revenue. The `once for all' payment test is also inconclusive. What is relevant is the purpose of the outlay and its intended object and effect, considered in a common sense way having regard to the business realities. In a given case, the test of `enduring benefit' might break down."

In Alembic Chemical Works Co Ltd's case, the appellant entered into an agreement with Meiji - a foreign concern - engaged in the manufacture of antibiotics. Under the agreement, Meiji agreed to supply to the appellant the "subcultures of Meiji's most suitable penicillin producing strains" in a pilot plant, the technical information, know-how and written description ofMeiji's process for fermentation of penicillin along with a flow-sheet of the process in the pilot plant, and the design and specifications of the main equipment in such pilot plant and to arrange for the training of the appellant's representatives in Meiji's plant in Japan at the appellant's expense. The question which arose was whether the payment made under the agreement was capital or revenue in nature. The Supreme Court observed as under:

"Even after the agreement, the product continued to be penicillin and the agreement with Meiji stipulated the supply of the `most suitable subcultures' evolved by Meiji for purposes of augmentation of the yield of penicillin... The mere improvement in or updating of the fermentation - process would not necessarily be inconsistent with the relevance and continuing utility of the exiting infrastructure, machinery and plant of the appellant...

"That the improvisation in the process and technology in some areas of the enterprise was supplemental to the existing businessand there was no material to hold that it amounted to a new or fresh venture... The financial outlay under the agreement was for the better conduct and improvement of the existing business and was revenue in nature and was allowable as a deduction in computing the business profits of the appellant."

Applying the aforesaid principles and observations made by the Supreme Court, the Kerala high court was in complete agreement with the view taken by the appellate tribunal that the expenditure incurred for the water treatment plant and fume extraction plant was revenue expenditure and, hence, allowable as a deduction.

In the second case of Saraswati Industrial Syndicate Ltd vs CIT (137 ITR 886), the assessee, engaged in the manufacture of sugar, incurred expenditure for making improvements to its vacuum filter as also for purchasing tools and implements, laboratory equipment and furniture and fixtures.

The Punjab and Haryana high court observed that there was a catena of precedents giving guidelines as towhat expenditure would fall within capital or revenue. One of the guidelines is that if the expenditure is incurred for obtaining an advantage of enduring benefit, it would be capital expenditure, but the test of enduring benefit is not a certain or conclusive test and it cannot be applied blindly and mechanically with regard to the particular facts and circumstances of a given case.

It is not every advantage of enduring nature acquired by an assessee that would bring his case within the said concept. What is material to consider is the nature of the advantage in a commercial sense and it is only where the advantage is in the capital field, that the expenditure would be disallowable on an application of this test.

The high court thereafter considered the question whether Section 37 was attracted. According to the court, there could be little doubt that the expenditure incurred was incidental to the business of the assessee. It was involved in renovating the buildings, reconditioning the machinery andclearing the debris from the land. All the work done was for the purpose of resuming the operation of the colliery. The expenditure was, therefore, laid out wholly and exclusively for the purposes of the business.

After discussing several decisions, the Punjab and Haryana high court held that a capital asset of the nature involved in the instant case, if repaired or improved upon as part of business exigency, would entitle the assessee to claim the expenditure incurred thereon as business expenditure. Even if he is not capable of squarely putting his case under any specific head to claim deduction, the residuary Section 37 would be available to him, subject to the fulfilment of other conditions.

The court held that it would be purely academic to consider whether the improvements made on the plant squarely fell within "repairs" as known to Section 31 or "depreciation" as known to Section 32 (1) (iii) or "expenditure on scientific research" as known to Section 35 of the Income-tax Act. Therefore, thequestion referred on the finding of the tribunal under specific heads was appropriately answered in the negative, ie, in favour of the assessee and against the revenue, by holding that the improvement to the vacuum filter constituted an allowable deduction under Section 37 of the Income-tax Act, 1961.

The court further held that no new asset was created but improvements were made to the already created asset. There was no addition or expansion made to the profit-making apparatus of the assessee. The expenditure was incurred for the purpose of making the vacuum filter work advantageously and, thus, the expenditure laid out was part of the profit earning.

The aforesaid decisions of courts very clearly establish that though expenditure may result in assets being acquired, if the object of acquiring those assets is to improve the operation of an existing system or to run the existing plant and machinery with greater efficiency and proficiency, the cost of those assets would be deductible. In other words, thetrend is now towards ascertaining the object of incurring an expenditure so as to determine whether it is on capital account or whether it could be written off as revenue expenditure.

The author is a Supreme Court advocate