Commissioner of Income-tax Vs. Tamil Nadu Heat Treatment and Fetting Services (P.) Ltd. (No. 1) - Court Judgment

Janarthanam, J.

1. The assesses, a private company, going by the name, Tamil Nadu Heat Treatment and Fetting Services (P.) Ltd., Madras, is engaged in the business of receiving raw or untreated crankshafts, forg-ings and castings from its clients and subjecting them to heat treatment to toughen them up for marketing purposes.

2. For the assessment years 1984-85, 1985-86 and 1986-87, the assessee claimed investment allowance, on the ground that it was engaged in manufacturing activity.

3. For the assessment years 1985-86 and 1986-87, the assessee claimed deduction (?) of Central subsidy received by it from the actual cost of assets for the purpose of depreciation and investment allowance.

4. With regard to the assessment year 1984-85, the Assessing Officer rejected the claim of the assessee for investment allowance on the ground that the assessee had not commenced production during the previous year 1983-84, relevant to the assessment year 1984-85.

5. For the two subsequent assessment years, the Assessing Officer rejected the claim of the assessee on the ground that the assessee was not carrying on any manufacturing activity. The Assessing Officer brought to tax a sum of Rs. 18,467, as 'income from other sources' and rejected the claim of 'business loss' returned by the assessee. The Assessing Officer also negatived the claim of the assessee with respect to the deduction of Central subsidy.

6. Aggrieved by the order of assessment, the assessee preferred an appeal before the Commissioner of Income-tax (Appeals), Madras- 34 (for short the 'CIT(A)') who held that the process of heat treatment, pressing of crankshafts, etc., was a manufacturing activity and, hence, investment allowance claimed by the assessee on the basis that it was carrying on manufacturing activity was sustainable.

7. The Commissioner of Income-tax (Appeals) relied upon the report sent by the assessee to the State Industries Promotion Corporation of Tamil Nadu Limited (for short 'SIPCOT'), the minutes of the assessee's board meeting and a letter from BOFCO Engineering Services to the effect that the production had started with effect from December 1, 1983. The Commissioner of Income-tax (Appeals), therefore, held that the income of Rs. 18,467 should be assessed under the head 'Business' and the loss claimed has to be accepted as 'business loss'.

8. The Commissioner of Income-tax (Appeals), thus, allowed the appeal of the assessee.

9. Aggrieved by the orders passed by the Commissioner of Income-tax (Appeals), the Revenue preferred an appeal before the Income-tax Appellate Tribunal, Madras Bench (D), Madras (for short the 'Tribunal').

10. With regard to the claim of investment allowance, the Tribunal upheld the order of the Commissioner of Income-tax (Appeals), holding that the activity carried on by the assessee was a 'manufacturing activity'. The Tribunal held that because of the heat treatment, there is an increase in wear and tear resistance and the tensile strength is augmented. Though there is no change in physical appearance, a qualitative change is brought about by the assessee and, hence, the output is a new product fit for use in automobile industries. The Tribunal, in this view, held that the assessee was engaged in 'manufacturing activity'.

11. With regard to the claim of deduction of Central subsidy, the Tribunal, following the decision of Srinivas Industries v. CIT : [1991]188ITR22(Mad) , held that the Central subsidy has not to be deducted from the cost of assets for the purpose of depreciation and investment allowance. The Tribunal placing reliance upon the materials relied on by the Commissioner of Income-tax (Appeals), held that the assessee has commenced production with effect from December 1, 1983, in the previous year 1984-85. The Tribunal, in this view, dismissed the appeal preferred by the Revenue.

12. Aggrieved by the order of the Tribunal, the Department filed a reference application under Section 256(1) of the Income- tax Act, 1961 (Act No. 43 of 1961-- for short 'the Act'), requiring the Tribunal to state a case to this court and refer the following questions of law, for its opinion.

'(1) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal is right in law and had valid materials to hold that the assessee's business commenced from December 1, 1983 ?

(2) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal had valid materials to hold and is right in law in holding that the assessee is engaged in the manufacturing activity ?

(3) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal is right in law in holding that the assessee is entitled for investment allowance for plant and machinery employed in the business ?'

13. The Income-tax Appellate Tribunal, by its order in R. A. Nos. 802, 803 and 804 (Mad.) of 1991, dated August 28, 1991, rejected the reference applications on the ground that the three questions sought to be referred to this court were not referable questions of law and the question as to the date of commencement of commercial production is a question of fact.

14. Aggrieved by the order, as above, the Revenue, at the instance of the Commissioner of Income-tax, Tamil Nadu-IV, Madras, prayed for issuance of a direction to the Tribunal to state a case and refer the questions of law, as stated above, to this court for its opinion, resorting to the present actions-Tax Cases Petitions Nos. 592 to 594 of 1997.

15. When these actions, listed for hearing today (February 24, 1987), were taken up, Mrs. Chitra Venkataraman, the learned counsel representing Mr. C.V. Rajan, the learned junior standing counsel for income-tax cases representing the Revenue and Mr. P.P.S. Janarthana Raja, the learned counsel appearing for the assessee, submitted that instead of calling for a statement of the case from the Tribunal and directing it to refer the questions as above, for the opinion of this court, it would be better, in the fitness of things and interests of one and all concerned, to straightaway answer those questions, as if those questions were referred to this court for its opinion, inasmuch as the factual matrix was sufficient and adequate enough, besides the same not being disputed.

16. So far as question No. 1 is concerned, the Commissioner of Income-tax (Appeals) went into the facts and circumstances of the case and found that the assessee had indeed started commercial production during the relevant previous year. In this regard, he relied upon the following factors :

(1) A copy of the report sent by the assessee to SIPCOT intimating the latter that the machinery had been erected in commercial production from December 1, 1983. This report was stated to have been submitted in connection with the disbursement of subsidy, etc.

(2) A certified true extract of the proceedings of the meeting of the board of directors held on December 23, 1983. In the said minutes, the chairman had informed the board that the plant and machinery had been duly erected and commercial production commenced with effect from December 1, 1983.

(3) A letter from BOFCO Engineering Services to the effect that production had started with effect from December 1, 1983.

17. The Tribunal had taken into consideration the factors that fell within the purview of the Commissioner of Income-tax (Appeals) for recording a finding that the assessee had indeed started commercial production during the relevant previous year. The Tribunal said that the Commissioner of Income-tax (Appeals) cannot be faulted on this issue and, consequently, the Tribunal recorded a finding that there is no justification for interfering with the finding of fact, as arrived at by the Commissioner of Income-tax (Appeals).

18. This apart, the Tribunal on the side of consideration of the reference application under Section 256(1) of the Income-tax Act, also said that the question as to the date of commencement of the commercial production is only a question of fact and, therefore, such a question cannot at all be referred to this court for opinion. We concur with the opinion so recorded by the Tribunal, on question No. 1 and the same is answered accordingly.

19. The issue involved for consideration under questions Nos. 2 and 3 is as to whether the activities of the assessee can ever be construed to be in the nature of manufacturing activities entitling it for investment allowance for the plant and machinery employed in the business for the assessment years 1984-85, 1985-86 and 1986-87 ?

20. It is an undisputed fact that the assessee had been engaged in the business of receiving raw or untreated crankshafts, forgings and castings from its clients and subjecting them to heat treatment to toughen them up and sell the same in the market for being used as automobile parts. The raw and untreated crankshafts, as such, cannot at all be used as spare parts in automobiles. Such raw or untreated crankshafts received from the clients of the assessee had been subjected to heat treatment with a view to increase wear and tear resistance and augmentation of tensile strength. In this process, of course, there is no change in physical appearance, though there is a qualitative change suitable for a different purpose. The moot question that arises for consideration, in such a situation, is as to whether the heat treatment given to raw or untreated crankshafts can ever be construed as a 'manufacturing activity' so as to enable the assessee to claim investment allowance for the relevant assessment years under Section 32A of the Income-tax Act.

21. Learned counsel appearing for the assessee drew our attention to various literatures and treatises from books of foreign and Indian authors relatable to the qualitative change being brought about by heat treatment practices.

(i) In Forging Hand Book by Thomas G. Byrer, editor, S.L. Semiatin, associate editor and Donald C. Vollmer, associate editor, brought out by Forging Industry Association American Society for Metals under the heading 'Heat Treated To Final Physical Properties', the learned contributing authors Robert Morelli, Consultant, Pittsburgh, Pennsylvania and Dr. S.L. Semiatin, Principal Research Scientist, Battelle's Columbus Laboratories, Columbus, Ohio said (at pages 228-229), thus :

'Normalising or normalising and tempering may produce the required minimum hardness and by a direct correlation give the minimum ultimate tensile strength. However, for most steels, a hardening (austenitize) and quenching (in oil or water, depending on section size and hardenability) cycle is employed, followed by tempering to produce the propet hardness, strength, ductility, and impact properties. For steels to be heat treated above the 150--ksi strength level, it is general practice to normalise prior to austenitizing to produce a uniform grain size and to minimize internal residual stresses. In some instances, it is common practice to use the heat for forging as the austenitizing cycle and to quench at the forge unit. The forging is then tempered to complete the heat treatment cycle. Although there are obvious limitations to this procedure, definite economies are possible when the procedure is applicable (usually symmetrical shapes of carbon steels).

SPECIAL HEAT TREATMENT provides control of dimensional distortion, relief of residual stresses before or after machining operations, avoidance of quench cracking, prevention of thermal shock, surface (case) hardening, and stabilization of microstructure in certain high alloy steels. Although most of the cycles discussed above can apply, very specific cycles may be required. Such treatments usually apply to complex forging configurations with adjacent differences in section thickness, or to very high hardenability steels and alloys. When stability of critically dimensioned finished parts permits only light machining of the forging after final heat treatment to final properties, special treatments are available including marquenching (martempering) stress relieving, and multiple tempering.'

Many applications, such as crankshafts, cam-shafts, gears, forged rolls, rings, certain bearings, and other machinery components, require increased surface hardness for heat resistance. The important surfaces usually are hardened after machining by flame or induction hardening, carburizing, carbonitriding or nitriding. These processes are listed in the approximate order of increasing cost and decreasing maximum temperature. The latter consideration is important in that dimensional saturation usually decreases with decreasing temperature. This is particularly true of nitriding, which is usually performed below the tempering temperature for the steel used in the forging.

Most of these special treatments are performed by the forging customer or on their behalf. Although most forge plants have in house heat treating equipment to improve machinability or to develop required minimum mechanical properties, outside facilities for certain special treatments exist. These treatments are discussed in subsequent sections. Heating for cold shearing of forging stock is of special interest to all forgers and can properly be regarded as a special heating operation.

(ii) Learned author Mr. S.K. Hajra Choudhury in his book 'Materials Science and Processes in SI Units' (Indian Book Distributing Co., Calcutta 9), 1987 edition, under the heading 'Heat Treatment' (at page 274) said thus :

'Heat treatment of metals may be defined as an operation or a combination of operations involving the heating and cooling of metals or alloys in the solid state to produce certain desired properties. As a result, heat treatment plays a vital part in the manufacturing process of machine parts and tools. Only by heat treatment it is possible to alter the structure and consequently, the mechanical properties of metals required for normal operation of modern machinery and tools. As well, many shaping, forming and joining processes involve heating and cooling the metal and, thus, 'accidental' heat treatment may result. All heat treatment processes may be considered to consist of three main parts ;

(1) The heating of the metal to the pre-determined temperature ;

(2) The soaking of the metal at that temperature until the structure becomes uniform throughout the section ;

(3) The cooling of the metal at some pre-determined rate to cause the formation of desirable structures within the metal for the desired properties.'

(iii) In the book, I Movikov's 'Theory of Heat Treatment of Metals', translated from the Russian language by Mr. V. Afanasyev, published in 1978 by Mir Publishers, Moscow, the learned author (at page 9) states thus: 'Heat treatment is a process that is used most extensively in modern technology to change the properties of metals and alloys. At metallurgical and machine-building works, it is one of the principal links in the manufacturing process, for making semi-products and machine elements. Heat treatment is used as an intermediate procedure for improving some engineering properties (forgeability, machinability, etc.) or as a final operation to impart to metals and alloys the desired combination of mechanical, physical and chemical properties which can ensure the specified operational characteristics of products. As a general rule, major structures and machines have more heat treated elements.

The theory of heat treatment is a part of physical metallurgy. One of the main problems with which physical metallurgy is concerned is how the, structure of metals and alloys is related with their properties of engineering importance. Heating or cooling of a metal can change its structure, which causes variations in the mechanical, physical and chemical properties and affects the behaviour of the metal in processing and operation.

The theory of heat treatment studies thermally induced alterations in the structure and properties of metals and alloys which do not disappear when the thermal factor stopped acting.

As regards the depth and diversity of structural changes, heat treatment is incomparably more effective than mechanical or other methods of metal treatment.'

(iv) In the book 'Elements of Mechanical Engineering by Mr. K.P. Roy and Mr. S.K. Hajra Choudhury, third edition (Asia Publishing House), under the heading 'Heat treatment', the learned authors (at page 226) said thus :

'Heat treatment of metals may be defined as an operation or combination of different operations involving the heating and cooling of metals or alloy in the solid state to produce certain desired qualities. Heat treatment may, therefore, serve one or more of the following purposes :

(1) Improve mechanical properties such as tensile strength, hardness, ductility, shock-resistance, etc.

(2) Improve machinability.

(3) Increase resistance to heat and corrosion.

(4) Relieve stresses developed due to hot and cold working.

(5) Modify electrical and magnetic properties.

(6) Change in grain size.

18.2 Heat treatment processes The principal methods of heat treatment are :

(1) Normalizing (5) Carburising

(2) Annealing , (6) Cyaniding

(3) Hardening (7) Nitriding

(4) Tempering (8) Flame hardening.'

In each of the first four methods, the improvements that take place are mainly due to the development of certain micro-constituents, while in each of the four others improvements are due to the absorption of carbon or nitrogen or carbon and nitrogen both. Flame hardening is an exception to the above remarks.

Carburising, cyaniding, nitriding and flame hardening are known as case-hardening process used to produce a hard surface on the case or skin of the metal.'

(v) In the book 'Practical Heat Treating' by Howard E. Boyer (American Society for Metals, Metals Park, OH 44073) (1984 edition), in Chapter 1, under the heading 'What is Heat Treatment, Classification and Commercial Importance' (at page 1), the learned author said thus :

'The generally accepted definition for heat treating metals and metal alloys is 'heating and cooling a solid metal or alloy in a way so as to obtain specific conditions and/or properties'. Heating for the sole purpose of hot working (as in forging operations) is excluded from this definition. Likewise, the types of heat treatment that are sometimes used for products such as glass or plastics are also excluded from coverage by this definition.

COMMERCIAL IMPORTANCE

It would be difficult to imagine what life would be like if the properties of metals could not be altered in a variety of ways through the use of heat treatment. Without the benefits derived from heat treating, the auto industry, airplane/aerospace industries, and countless everyday hardware items would be non-existent. Indeed, a sharp-edge steel razor blade would not be available.

Almost all metals and alloys respond to some form of heat treatment in the broadest sense of the definition. The response of various metals and alloys, however, is by no means equal. Almost any pure metal or alloy can be softened (annealed) by means of a suitable heating and cooling cycle ; however, the number of alloys that can be strengthened or hardened by heat treatment is far more restricted.

Practically all steels respond to one or more type of heat treatment. This is the major reason why steels account for over 80 per cent, of total metal production.'

22. We may now refer to certain decisions emerging from the superior courts of jurisdiction--the apex court and the High Courts, relied on by learned counsel appearing for the assessee, as relatable to the question as to whether an article is or is not a manufacture or whether a process or operation is not manufacturing ?

(i) In Arthur E. Newell v. CIT , the observations of their Lordships of the Authority for Advance Rulings, relevant for the present purpose, read as under (pages 785-786) :

'The expression 'manufacture' involves the concept of changes effected to a basic raw material resulting in the emergence of, or transformation into, a new commercial commodity. Judicial decisions on the meaning of the expression 'manufacture', starting with the leading case of Union of India v. Delhi Cloth and General Mills Co. Ltd. : 1973ECR56(SC) and South Bihar Sugar Mills Ltd, v. Union of India : 1973ECR9(SC) , are legion and it is unnecessary to refer to them in detail. Broadly speaking, the essence of manufacture lies in the change or modification of some material into an acceptable form to satisfy some want, desire, fancy or taste in man. As the Corpus Juris Secundum (volume 56, at pages 685 and 686) puts it :

'In determining whether an article is or is not a manufacture, or whether a process or operation is not manufacturing, one of the important factors is the extent of the change that has been effected in the original material. While every change in an article is the result of treatment, labour and manipulation, every change is not manufacture. Something more is necessary and the application of labour must be carried out to such an extent that the article suffers a species of transformation and a new and different article emerges.'

Whether an article is converted into a different article depends on several criteria and one of the essential tests is whether in a commercial sense, the original article has ceased to exist and a new article has taken its place. It is, however, not necessary that the original article or material should have lost its identity completely ; all that is important is whether, what has emerged as a result of the operations is a different commercial commodity, having its own name, identity, character or end use. This determination is essentially one of fact and has to be arrived at on a consideration of all relevant factors such as, the quality and nature of the original article, the extent and magnitude of the operations carried out on, or in relation to it, and the commercial identity, character and use of the article produced.'

(ii) In CIT v. N. C. Budharaja and Co. : [1993]204ITR412(SC) , the observations of their Lordships of the Supreme Court, occurring at page 423 are relevant and the same reads as under :

'The words 'manufacture' and 'production' have received extensive judicial attention both under this Act as well as the Central Excises Act and the various sales tax laws. The word 'production' has a wider connotation than the word 'manufacture'. While every manufacture can be characterised as production, every production need not amount to manufacture. The meaning of the expression 'manufacture' was considered by this court in Dy. CST v. Pio Food Packers [1980] 46 STC 63, among other decisions. In the said decision, the test evolved for determining whether manufacture can be said to have taken place is, whether the commodity which is subjected to the process of manufacture can no longer be regarded as the original commodity but is recognised in the trade as a new and distinct commodity. Pathak, J., as he then was, stated the test in the following words (at page 65) :

'Commonly, manufacture is the end result of one or more processes through which the original commodity is made to pass. The nature and extent of processing may vary from one case to another, and indeed there may be several stages of processing and perhaps a different kind of processing at each stage. With each process suffered, the original commodity experiences a change. But it is only when the change, or a series of changes, take the commodity to the point where commercially it can no longer be regarded as the original commodity but instead is recognised as a new and distinct article that a manufacture can be said to take place.' '

(iii) What their Lordships of a Division Bench of the Delhi High Court said, as respects the expression 'processing of goods' used in Section 2(6)(d) of the Finance Act, 1968, in the case of Addl CIT v. Kalsi Tyre (P.) Ltd. : [1981]131ITR636(Delhi) , reads as under (headnote) :

'The expression 'processing of goods' used in Section 2(6)(d) of the Finance Act, 1968, refers to a wide category of activities. The expression means the subjection of the goods to some special process of treatment. It may be for the purpose of manufacture, for the purpose of development, for preparation for the market or for conversion into marketable form such as livestock by slaughtering, grain by milling, cotton by spinning, milk by pasteurizing and fruits and vegetables by sorting and repacking.' (iv) In CIT v. Industrial Ancillaries (P.) Ltd. : [1993]200ITR514(Delhi) , the assessee purchased moulds from the manufacturer and sold them after reshaping and polishing them. Their Lordships of a Division Bench of the Delhi High Court, placing reliance on Addl CIT v. Kalsi Tyre (P.) Ltd. : [1981]131ITR636(Delhi) , held that the assessee was engaged in 'processing of goods' and was an 'industrial company', as defined in Section 2(7)(c) of the Finance Act (No. 2) Act, 1977, and was liable to tax only at the lower rate of 55 per cent.

23. In the backdrop and setting of the principles, as enunciated by the Supreme Court and various High Courts as relatable to the activity of 'manufacture' or 'processing of goods' and in the light of the various literature and books of foreign authors, relatable to the qualitative change, having been brought about by well-termed process, as referred to above, we may now proceed to consider and decide the moot question as to whether the activities carried on by the assessee, namely, receiving untreated crankshafts and forgings and castings from its clients and subjecting them to heat treatment to toughen them up for being used as automobile spare parts can ever be construed as activities relatable to manufacture and, consequently, enable it to claim investment allowance under Section 32A of the Income-tax Act.

24. We have to take note of the fact that the process of heat treatment to crankshaft, etc., were absolutely essential for rendering it marketable. Automobile parts, as crankshafts, need to be subjected to heat treatment to increase the wear and tear resistance to remove the inordinate stress and increase tensile strength. The raw untreated crank shafts and the like can never be used in an automobile industry. Thus, in the crank shafts subjected to the process of heat treatment, etc., a qualitative change is effected, to be fit for use in automobiles, although there is no physical change in them. In such state of affairs, it cannot at all be stated that the crank shafts, subjected to heat treatment, etc., cannot at all change the status of new products of different quality for a different quality for a different purpose altogether. In this view of the matter, we are of the view that the activities of the assessee in relation to raw or untreated crank shafts being subjected to heat treatment, etc., is definitely a 'manufacturing activity' entitling it to claim 'investment allowance' under Section 32A of the Income-tax Act, We answer questions Nos. 2 and 3 accordingly.

25. In fine, we hold that the assessee is engaged in manufacturing activities in relation to crankshafts being subjected to heat treatment, etc., for the assessment years 1984-85, 1985-86 and 1986-87 and, consequently, entitled to 'investment allowance' under Section 32A of the Income-tax Act, 1961.

26. These tax case petitions are, thus, disposed of. There shall, however, be no order as to costs, in the circumstances of the case.