1. This is an appeal by the assessee against the Order dt. 19.3.2004 of CIT(A)-V, New Delhi relating to the A.Y. 2001-2002.
2. The facts and circumstances giving raise to the present appeal are as follows. The assessee is a company. It is in the business of operation of air craft for carriage of passengers. It possesses the necessary certificate granted by the Director General of Civil Aviation under the Air Crafts Act, 1934 to operate the air craft. The permission so granted specifically mentions that the assessee shall comply with the provisions of the Air Craft Act, 1934, Air craft Rules, 1937 and orders, directions, requirements issued under the aforesaid Act and rules from time to time. The assessee purchased a Second hand Cessna citation air craft in September, 1997.
3. The assessee filed a return of income for the A.Y. 2001-2002 declaring a loss of Rs. 49,21,329/=. In arriving at this loss the assessee had made deduction of Rs. 39,67,99/= as provision for overhauling and hot section inspection charges for the engine of the air craft. According to the recommendations of the manufacturers of the air craft the assessee was required to carry out overhauling and hot section inspection of the air craft. if the air craft completes flying of 3500 hours and 750 hours respectively. At the time when the assessee purchased the air craft it had already completed 2700 hours and 5 minutes of flying time.
4. The Air Crafts Act, 1934 was enacted with a view to make better provision for the control of manufacture, possession, use, operation, sale, import and export of the air craft. Section 5 of the said Act empowers making of rules for regulating the purpose for which the Act was enacted. Pursuant to such rule making power, the Air Crafts Rules, 1937 were framed. Rule 50 Part IV of the said Rules provides for provisions with regard to Air worthiness. An Air Worthiness certificate has to be obtained from the Director General. Rule 52 provides that an operator of air craft should follow the repair schemes issued by the manufacturer of an air craft. Rule 53 provides as follows.
Rule 53. Use of materials, processes, parts and periodical overhaul of aircraft.
(1) Every air craft required under these rules to be provided with a certificate of airworthiness and items of equipment on such aircraft shall periodically be inspected, overhauled and certified on completion of the prescribed flight time or calendar time or on the basis of any other stipulated condition in accordance with the approved maintenance schedules or approved maintenance system. Such inspection and certification shall be effected by appropriately licensed engineers or authorised persons, as may be specified by the Director General.
(2) A certificate to be issued in pursuance of Sub-rule (1) shall not be issued unless the materials, processes, parts, method comply with such designs, drawings, specifications or instructions as may be issued by the manufacturers or as may be specified or approved by the Director General The method and workmanship shall be in accordance with standard aeronautical practice or as may be approved by the Director General.
5. The question before the AO was as to whether the provision made by the assessee for overhauling and hot section inspection of the engine of the air craft can be allowed as a deduction. According to the assessee overhauling and hot section inspection of the engine of the air craft was mandatory after specific number of flying hours. The assessee therefore estimated its liability in respect of TBO (time between overhauls) and HIS (Hot section inspection) after completion of the requisite flying hours and divided the said liability by the number of hours after completion of which TBO and HIS is mandatory and multiplied the resultant figure by the number of hours the air craft flew during the P.Y. The assessee gave the following chart of estimated expenses that it had provided for the various A.Ys.---------------------------------------------------------------------------------A.Y. No. of flying Amount of Aggregate hours overhauling amount till end undertaken by and HOT of each A.Y. the aircraft inspection---------------------------------------------------------------------------------1998-99 71 Hrs 15 Min.
Nil Nil---------------------------------------------------------------------------------1999-2000 171 Hrs 45 Nil Nil Min.---------------------------------------------------------------------------------2000-2001 332 Hrs 50 5158918 5158918 Min.---------------------------------------------------------------------------------2001-2002 256 Hrs 20 3967988 9126906 Min.---------------------------------------------------------------------------------2002-2003 308 Hrs 05 4775282 13902188 Min.--------------------------------------------------------------------------------- The assessee further brought to the notice of the AO that the engine of the Air craft was actually sent for TBO and HIS to Singapore in November, 2000 and a sum of Rs. 1,54,30,379/= was incurred in carrying out the TBO and HIS. This was paid on 11.6.2001 in the P.Y. ended 31.3.2002. The assessee further explained before the A.O. that the provision made up to 31.3.2001 viz., Rs. 91,26,906/= was reduced by the assessee from the aggregate expenses incurred in A.Y. 2002-2003 and only the net expenses were claimed by the assessee in A.Y. 2002-2003.
This is made clear in the Notes to the Balance Sheet as on 31.3.2002 which reads as follows.
During the year, the company has incurred Rs. 1,77,75,637/= towards repair of damaged engine of the Aircraft and its transportation expenses to Singapore. This includes overhauling expenses of Rs. 91,26,917/= which has been adjusted against the provisions made for Hot Section Inspection charges and overhauling of Aircraft Engine upto 31^st March, 2001 and out of the remaining expenses of Rs. 86,48,720/= the company has received a claim of Rs. 83,85,910/= from The Oriental Insurance Co. Ltd. and the balance of expenses of Rs. 2,62,810/= has been charged as Aircraft maintenance expense in these accounts.
6. The AO however rejected the claim of the assessee for deduction of the aforesaid expenses for which provision had been made in the A.Y.2001-2002. According to the A.O. the liability in respect of the aforesaid expenses would arise only on completion of the stipulated number of flying hours. According to him no provision can be made in respect of such expenses when certainty as to the air craft flying stipulated number of hours is subjective due to various reasons which may even be beyond the control of the assessee. He thereafter referred to several case laws in which expenses which are contingent in nature had been held as not deductible while computing income. The AO also made a reference to the fact that in A.Y. 1998-99 and 1999-2000 when the air craft flew for some hours the assessee did not make any provision for expenses and therefore the claim made in this A.Y. is not genuine and was an after thought. The AO also held that TBO and HIS brings new life of enduring nature to the engine of the air craft and therefore those expenses would in any case be capital expenses.
7. On appeal by the assessee the CIT(A) upheld the order of the AO. The main reason assigned by the CIT(A) for confirming the order of the AO was that the liability in question was contingent liability. The relevant observations of the CIT(A) is as follows.
From the above discussion, it may be noted that overhauling and hot inspection is to be carried out in future after the Air craft is flown for specific number of hours. The air craft mayfly the stipulated number of hours in a year or two or may take several years to complete the flying hours. On the facts and in the circumstances of the case, the overhauling and hot inspection expenditure will accrue only when the overhauling and hot inspection is carried but These future expenses cannot be termed as accrued expenses. On the facts and circumstances of the case, therefore, the claim of the appellant for future expenses are held to be inadmissible. The AO has correctly disallowed the same. These additions are, therefore, confirmed.
8. Aggrieved by the order of the CIT(A) the assessee has preferred the present appeal before the Tribunal. The issue for consideration in this appeal is as to whether the assessee is entitled to claim a sum of Rs. 39,67,998/= being provision for overhauling and hot section inspection of air craft.
9. We have heard the submissions of the ld. counsel for the assessee who highlighted with reference to provisions of the Air Craft Act as to how the liability of the assessee is a certainty. He also brought to our notice the fact that the estimate of liability made by the assessee was reasonable. In this regard it was also highlighted by him that in A.Y. 2002-2003 when the actual expenses were incurred, it turned out that the provision made by the assessee was not excessive. Reliance was placed by the ld. counsel for the assessee on the decision of the Hon'ble Supreme Court in the case of Calcutta Company Ltd., 37 ITR (1) (SC), Metal box Co. of India Ltd. v. Workmen 73 ITR 53 (S.C.), Bharat Earth Movers v. CIT 245 ITR 428 (S.C.). The proposition laid down in the aforesaid decisions are to the effect that if business liability has definitely arisen in the P.Y. the deduction should be allowed although the liability may have to be quantified and discharged at a future date. The ld. counsel further placed reliance on the observations of the Hon'ble Bombay High Court in the case of Taparia Tools Ltd. v. JCIT 260 ITR 102 (Bombay) wherein the Hon'ble Bombay High Court has highlighted that under the mercantile system of accounting revenues of a particular Accounting period have to be matched with the corresponding expenses relatable to the very same accounting year irrespective of the fact whether there is an actual cash out flow in respect of that expenditure or not. On the question whether the expenditure in question was capital expenditure or revenue expenditure, the ld. counsel for the assessee submitted that the expenditure in question was purely for maintenance of the air craft and by no stretch of imagination can it be said that the assessee incurred capital expenditure. He highlighted that this expenditure was necessary for preserving or maintaining an already existing asset and that no new asset comes into existence and that the assessee does not get a new or different advantage. Reliance was placed by the ld. counsel for the assessee on the decision of the Hon'ble Bombay High Court in the case of New Shorrock Spinning and Manufacturing Company Ltd. v. CIT 30 ITR 338 (Bombay) and the decision of the Hon'ble Supreme Court in the case of Empire Jute Co. Ltd. v. CIT 121 ITR 1 (S.C.).
10. The ld. D.R. on the other hand submitted that the liability in question was a contingent liability and it was not certain as to when the assessee would complete the required number of flying hours which calls for overhauling of the engine. In the circumstances it was submitted by him that the liability in question was a contingent liability. He also relied on the decisions referred to by the CIT(A) in his order in support of his conclusion that the expenditure in question was a capital expenditure.
11. We have considered the rival submissions. The assessee follows the mercantile system of accounting. It is only the actual liability which accrues or arises during the previous year that can be considered as an expenditure deductible for income tax purposes. A liability which is dependent on fulfillment of a condition cannot be allowed as a deduction unless the dependent condition is fulfilled during the previous year. According to the revenue authorities, the liability was contingent. Till such time the contingency occurs there is no liability in law and therefore the claim for deduction on account of estimated liability cannot be allowed. The Hon'ble Supreme Court in the case of Bharat Earth Movers v. CIT (supra) had an occasion to consider the claim for deduction on account of a contingent liability. The following principles were laid down by the Hon'ble Supreme Court.
If a business liability has definitely arisen in accounting year, the deduction should be allowed although the liability may have to be quantified and discharged at a future date. What should be certain is the incurring of the liability. It should also be capable of being estimated with reasonable certainty though the actual quantification may not be possible if these requirements are satisfied the liability is not as contingent one. The liability is in present though it will be discharged at a future date. It does not make any difference if the future date on which the liability shall have to be discharged is not certain.
Keeping in mind the principles laid down by the Hon'ble Supreme Court, we shall now examine the facts of the present case.
12. In the present case it is clear from the provisions of the Air Craft Act and the Air Craft Rules that the assessee had to mandatorily carry out TBO and HIS after the air craft flies the required number of hours. In fact it was mandatory for the assessee to incur these expenses. The incurring of the liability by the assessee is a certainty. When the assessee purchased the air craft in September, 1997 the engine of the air craft already run 2700 hours and 58 minutes. As on November, 2000 the assessee had completed flying of 3500 hours of engine. In fact the air craft was sent for repair in November, 2000.
The repairs were effected and payments were made in the P.Y. relevant to A.Y, 2002-2003. On facts therefore the liability has crystallised during the P.Y. Even otherwise we are of the view that the liability in the case of the assessee was a certainty and the estimate of the same on a reasonable basis was possible. As the facts turned out in the subsequent years the estimate made by the assessee was a correct estimate of its liability. Even the matching concept of accountancy advocates accounting for such expenses. The liability of the assessee is in presenti though it had to be discharged at a future date. Even if the date on which the liability is to be discharged is not certain that will not have any bearing as laid down by Hon'ble Supreme Court in the case of Bharat Earth Movers (supra). We are therefore of the view that the liability in question was not a contingent liability and the assessee is entitled to claim deduction on the basis of the provision made for such liability.
13. The next aspect that needs to be decided is as to whether the expenditure in question was a capital expenditure or a revenue expenditure. The tests laid down in the judicial decisions referred to by the ld. counsel by the assessee in this regard are as follows. Where the expenditure is only incurred for preserving or maintaining an already existing asset which does not bring a new asset into existence or does not give the assessee a new or different advantage, then the same must be regarded as a revenue expenditure. As we have already noticed the expenditure in question was in respect of an air craft engine for its overhauling and hot air inspection. These are necessary for preserving and maintaining the air craft. Such expenses does not bring a new asset into existence or does not give the assessee a new or different advantage. The expenditure cannot therefore be said to be a capital expenditure. The ld. CIT(A) in his order has not discussed this aspect at all and has merely held that those cases are entirely different and does not help the assessee's case. We are therefore of the view that the expenditure in question cannot be said to be a capital expenditure. We therefore hold that the assessee is entitled to claim the expenditure in question as of revenue expenditure and the disallowance made by the AO is directed to be deleted. The appeal of the assessee is allowed.