Expenditure on Construction and improvement on leased building-Revenue or capital. Enduring benefit cannot be a conclusive test and it cannot be mechanically applied-High Court
Prelude:
Section 29 of the Income tax Act, 1961 (the Act) provides that the profits and gains of business or profession shall be computed in accordance with the provisions contained in section 30 to 43D.
While section 30 provides for allowance of expenditure inter alia incurred on repairs of building occupied, Section 32(1) of the Act provides for allowance of depreciation on buildings owned by the assessee and used for the purpose of business or profession.
However, Explanation-1 to section 32(1) creates a fiction by providing that the capital expenditure incurred on a leasehold/rented building for the purposes of the business or profession including the construction of any structure, renovation or improvement thereto, for the purpose of deduction of depreciation u/s 32 under the Act, such structure or work shall be deemed to be a building owned by the assessee.
A controversy arose with respect to the treatment of expenditure (i.e. capital or revenue) incurred by the assessee on leasehold buildings both for refurbishment and construction of the same to carry on the business of the assessee.
ABCAUS Case Law Citation:
ABCAUS 2154 (2017) (12) HC
The Challenge/Grievance:
This income tax appeal was filed under Section 260-A of the Income Tax Act, 1961 (the Act) by the assessee against the order passed by the Income Tax Appellate Tribunal (Tribunal/ITAT) confirming the disallowance of expenses incurred for repairs, refurbishing and making improvements and also for construction made on the buildings taken on lease, treating them as capital expenditure.
Important Case Laws Cited/relied upon by the parties:
Joy Alukkas India (P) Ltd. v. Assistant Commissioner of Income Tax [(2016) 282 CTR (Ker) 551]
Arvind Mills Ltd. v. C.I.T. [(1992) 197 ITR 422 (SC)]
C.I.T. v. Madras Auto Service (P.) Ltd. [(1998) 233 ITR 468 (SC)]
C.I.T. v. TVS Lean Logistics Ltd. [(2007) 293 ITR 432 (Mad]
Assam Bengal Cement Co. Ltd. v. C.I.T., West Bengal [(1955) 27 ITR 34 (SC)]
The Substantial Questions of Law framed/pressed for determination:
The question of law framed broadly involved allowability of expenses;
(i) incurred for repairs, refurbishing and making improvements on the buildings taken on lease, treating them as revenue expenditure, and
(ii) incurred for construction of buildings in leased out lands as revenue expenditure?
Contentions made on behalf of the Respondent Assessees:
It was pointed out that any item which would revert back to the assessee and could be used by the assessees again at the end of the lease was treated as a capital and depreciation alone was claimed treating them as a capital expenditure. However, with respect to the other improvements made to the building, like painting and constructions made or alterations carried out, were treated as revenue expenditure since the assessee does not get any enduring benefit out of the same. They are also recurring expenditure since the assessee was a dealer in vehicles of Maruti Suzuki and authorized Service Centre, its business, to a great extent, depended upon the ambiance provided, which varies with time, consumers and very many factors which were not constant.
Observations made by the High Court:
The Hon’ble High Court observed that Explanation-1 to section 32(1) provides that capital expenditure incurred on a leasehold/rented building for the purposes of the business or profession including the construction of any structure, renovation or improvement thereto, for the purpose of deduction of depreciation u/s 32 under the Act, such structure or work shall be deemed to be a building owned by the assessee.
The Hon’ble High Court further observed that since the Full Bench had interpreted the said Explanation creates only a fiction insofar as permitting a lessee to claim the capital expenditure made in a building, leased out for its business; just as the owner of the building would claim it, if it were his business that was run in the building. The Full Bench rejected the notion that the introduction of the Explanation manifested the legislative intent to treat all expenditure incurred on a lease hold building as capital expenditure of the assessee. The Full Bench specifically found that the Explanation does not create a fiction insofar as any expenditure made in a leased out premises being treated as a capital expenditure.
The Hon’ble High Court opined that whether an expenditure is in the nature of a capital expenditure or a revenue expenditure is not to be decided by the legal fiction in the said Explanation. If the expenditure is in the nature of capital expenditure, then the lessee; despite, not being the owner of the building, can claim depreciation.
The Hon’ble High Court observed that the assessee had taken out leasehold buildings which were refurbished and improvements made for the purpose of carrying on the day-to-day business. It was noted that as observed by the Full Bench, the Supreme Court has held that the theory of enduring benefit or advantage may break depending upon the facts and circumstances of the case and thus enduring benefit irrespective of creating an asset could not alone be the criterion.
It was held that the stand and argument of the revenue that as long as there is income earning effort by whatever means or name you call it, whether it could be expansion or extension of the business, the same had to be considered as capital investment had to be looked into from the facts of the case.
Keeping in view that the Apex Court had held that what amounts to capital receipt in the hands of the payee need not be capital expenditure so far as the payer, the Full Bench held that payment of certain amounts would not be the deciding factor to arrive at a conclusion whether a particular expenditure is revenue or capital. enduring benefit cannot be a conclusive test and it cannot be mechanically applied without referring to facts of a particular case.
The Full Bench held that though income earning effort that is the expenditure spent on different items would be the basis to ascertain whether it is a capital or revenue expenditure, unless and until it ultimately leads to acquisition of an asset or a right of permanent character irrespective of the possession of the same for a long period, it would not amount to capital expenditure.
The Full bench specifically held that in the process of renovation and repairs of the premises taken on lease, expenditure may be on different items like flooring, panelling of walls, electrical wiring and fittings, air conditioning, setting up of cupboards, showcases etc. Though electrical fittings could be removed and taken, so also cupboards, showcases, electrical wiring, painting and flooring cannot be taken away by the assessee. Hence, at the end of the day, it has to be an asset in the hands of the assessee which could be called as capital asset. The fact that assessee with creation of a new ambience would earn more profits in the premises cannot be the criterion to decide the issue. Ultimately, the items on which expenditure was made must be able to come back to the assessee at the end of the day”.
The Hon’ble High Court opined that Explanation-1 to Section 32(1) of the Act does not intend to lay down that whenever expenditure has been incurred by the assessee in a leased out building, then such expenditure has to be mandatorily treated as capital expenditure. The explanation only meant that in the event of any capital expenditure incurred by the assessee, who is only a lessee, the provisions of Section 32(1) shall be applicable as if the leased out premises is owned by the assessee. The explanation was interpreted as one enabling even a lessee to claim depreciation if capital expenditure is made on a building or in a property, which is leased out from the real owner. It is not to say that the Explanation deemed any expenditure made by the lessee on a leasehold building or on a leasehold property as capital expenditure.
The Hon’ble High Court observed that the Hon’ble Supreme Court in another case found that the lease rent was very minimal and investments were to be deemed as setting off the actual lease rent payable over a period of time. It was in such circumstances that the expenditure made on making constructions in leased out lands were held to be revenue expenditure and not capital expenditure. The Hon’ble High Courtg opined that the explanation brought in later to the aforesaid decision would not detract from the above position. If the expenditure could be treated as revenue expenditure, necessarily the lessee, the assessee, would be entitled to show the same as revenue expenditure in its books of accounts. Merely because the property was leased out and constructions carried out, having no enduring benefit to the assessee; would not be the test for finding a revenue expenditure. The test of enduring benefit has been held by the Hon’ble Supreme Court to be not applicable in all cases.
The Hon’ble High Court observed that the Explanation-1, enables any expenditure, which if made by the owner of the property to be capital expenditure in the hands of the owner, to be treated as capital expenditure in the hands of the lessee; if it is the lessee who expended the amounts. The Explanation, in other words enables such consideration of the expenditure made by the lessee on another’s property to be capital expenditure. In such circumstances, what would be relevant is the nature and scope of the agreements entered into.
The Hon’ble High Court opined that lease rent would have to be verified with the total plinth area constructed in the property and the period for which the lease is permitted. The going market rent for buildings, in the specified locations, would also have to be looked into by the Assessing Officer to arrive at a proper determination of whether the expenditure is a capital expenditure or revenue expenditure. If the Assessing Officer finds that the investments made in the property spread over the period of lease, together with the lease rent payable as per the agreement, would constitute the ostensible lease rent for the building, then investment made for constructing superstructures, has to be deemed to be revenue expenditure, otherwise it should be treated as capital expenditure and in the latter event allowable as depreciation under the Explanation I to Section 31(1).
The Hon’ble High Court however noted that the lease deeds were not registered whereas under Section 17 of the Registration Act, 1908, any lease from year to year or beyond one year to be compulsorily registrable, failing which it shall not be received in evidence as per Section 49. It has also to be duly stamped under the Stamp Act of the State.
The Hon’ble High Court noted that the Assessing Officer was one holding a public office, before whom the evidence was produced for supporting the claim of the assessee. The Hon’ble High Court opined that the person in charge of a public office is obliged to impound the documents and send it to the District Registrar for proper stamping under Section 33 of the Stamp Act, if it is not duly stamped. The assessee cannot also rely on the documents unless they are properly stamped and registered. Sub Clause (b) of Section 33(2) empowers the High Court to delegate the function of examining and impounding any instrument under the provision to such Officer as the Court appoints.
Accordingly, the Hon’ble High Court directed the Deputy Commissioner to impound the documents produced and refer it to the District Registrar for proper stamping and the assessee would also be obliged to register the same. The assessee shall produce the lease deeds of period one year or above before the concerned Sub-Registrars, who shall calculate the duty payable under Article 33 of the Stamp Act and levy penalty of Rs.10,000/- each. If the assessee pays up the amounts then the procedure as prescribed in Section 37(1) shall be complied with. The Sub-Registrar shall also register the document de-hors Sections 23 and 25 of the Registration Act, but levying registration fees as applicable and an amount of Rs.5,000/- each as penalty.
Decision/ Conclusion/Held:
The expenditure incurred on repairs, refurbishing and making improvements made on leased out buildings allowed as a revenue expenditure by answering the first question in favour of the assessee and against the Revenue.
It was further directed by the Hon’ble High Court that the assessee after getting the agreements registered shall produce them before the A.O, who shall finalise the assessment in the light of the principles laid down, determining whether the expenditure made by the assessee can be treated as a capital expenditure or revenue expenditure.
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