2018 (10) TMI 1862 - AT - Income Tax

Addition u/s 40A - enhancement of lease rent given by the assessee company to the Trust - unusual increase in the rent was primarily for the purpose of reducing the tax incident on the profits earned by the assessee company and not for business purpose - Tribunal held that enhanced lease rent was in the nature of capital expenditure, and therefore, not allowable. Even the invoking of provision of Section 40A (2) was confirmed - HELD THAT - It is lease of a commercial property; therefore, the annual escalation would normally be more than the residential property. The assessee has given a comparison of property taken on lease with HPMC to show that comparatively assessee is paying more HPMC, and therefore, keeping in that benchmark the escalation of 10% to 11% is reasonable. Though, both the parties have been unable to give annual rate prevailing in the market, however, on the facts and circumstances of the case and looking to the fact that assessee is paying percentage- wise more rent to the government undertaking on a similar lease of commercial property, therefore, we hold that 10% of annual escalation would be reasonable from Assessment Year 1992-93 onwards. Enhancement which is attributed to improvement and modernization of plant and machinery carried out by Trust - 12% rate as taken by the Assessing Officer seems to be on a very lower side even though this could not be proper base. Since substantial investment was done by the Trust in various years, therefore, looking to quantum of investment made and escalation over the period of time the rate of 18% claimed by the assessee seems to be quite reasonable and accordingly, we direct the Assessing Officer to take rent attributable to improvement and modernization of plant and machinery, building, etc during the Assessment Yea₹ 1989-90 to 1995-96 @18%. Depreciation should be allowed on such a capital expenditure, because it is in the nature of intangible asset - We find substance in such a contention because part of the lease rent has been held to be on account of payment made to the Trust for not indulging in competition, i.e., it is in the form of non-compete fees and such a non-compete fee ostensibly falls in the category of commercial rights as defined in Section 32(1)(i), therefore, assessee is liable for depreciation from 1st April, 1998. In so far as the claim for entire non compete fee should be treated as revenue expenditure because of amendment brought w.e.f. 01.04.2003 in Section 28(va), we direct the Assessing Officer to examine this aspect and what is allowable as per the statute in respect of certain payment then the same needs to be allowed. Purchase of khair wood - Assessee has claimed that 15% of the average purchases can be taken for the purpose of compensation which Assessing Officer has held that it should be @ 10% of the average purchases - HELD THAT - AO has applied rate of 10% of the average purchases on right to purchase of khair wood surrendered in favour of the assessee by the Trust. The Assessing Officer has not given any reason as to why allowance @10% of the average purchases should be given. On the contrary, the assessee before us has demonstrated that in the case of the Trust the gross profit rate on similar product was more than 17%. The assessee has claimed rate of 15% of the average purchases as its compensation for the purpose of allocation of enhanced rent towards capital expenditure. Such a rate of 15% is inconsonance with the average GP rate in the case of the Trust, therefore, allowance of 15% is held to be quite reasonable. Accordingly, we direct the Assessing Officer to treat part of the lease rent fee for surrendering the right to purchase @15% of average purchases of khair wood. ORDER - i. Part of the enhanced lease rent paid for surrendering the rise to purchase the khair wood should be taken @15% of the average purchases price. ii. The normal escalation on fixed rent should be taken @10% of the lease charges per year. iii. The rent attributable to modernization and improvement plant and machinery should be taken @18%. iv. The Assessing Officer should allow depreciation w.e.f. 01.04.1998 on the portion of the rent which is held to be capital in nature in accordance with law and also examine the assessee s contention that whether the non compete fee can be allowed as an expenditure in terms of amendment in the statute w.e.f. 01.04.2003.

Summary

Issues Involved:
1. Classification of lease rent as capital or revenue expenditure.
2. Applicability of Section 40A(2) of the Income Tax Act.
3. Determination of whether the lease rent paid was excessive or unreasonable.

Detailed Analysis:

1. Classification of Lease Rent as Capital or Revenue Expenditure:
The primary issue was whether the lease rent paid by the assessee to the Trust was capital expenditure or revenue expenditure. The Tribunal examined the nature of the lease agreements and the reasons for the rent enhancements. The High Court had previously categorized the lease rent into four parts:
- Rent attributable to the Trust surrendering its right to purchase khair wood was deemed revenue expenditure.
- Rent attributable to the modernization and improvement of plant and machinery by the Trust was considered revenue expenditure.
- Rent attributable to normal appreciation in line with market rates was also considered revenue expenditure.
- Rent attributable to the Trust agreeing not to compete within a specific radius was deemed capital expenditure.

The Tribunal directed the Assessing Officer to apportion the lease rent accordingly and to treat the part related to non-compete agreements as capital expenditure.

2. Applicability of Section 40A(2) of the Income Tax Act:
The Tribunal examined whether the provisions of Section 40A(2), which disallow excessive or unreasonable payments to related parties, were applicable. The High Court had ruled that since the Trust was not an "association of persons," Section 40A(2) did not apply. Consequently, the Tribunal upheld this decision, confirming that Section 40A(2) was not attracted to the transactions between the Trust and the assessee.

3. Determination of Whether the Lease Rent Paid Was Excessive or Unreasonable:
The Tribunal reviewed the Assessing Officer’s methodology for determining whether the lease rent was excessive or unreasonable. The Assessing Officer had used a 10% rate for the right to purchase khair wood and a 5% annual escalation rate for lease rent, which the Tribunal found to be unsupported by evidence. The Tribunal directed the Assessing Officer to:
- Use a 15% rate for the right to purchase khair wood, based on the average gross profit rate of the Trust.
- Apply a 10% annual escalation rate for lease rent, considering the commercial property context and comparable lease agreements.
- Use an 18% rate for rent attributable to modernization and improvement of plant and machinery, based on substantial investments made by the Trust.

Additional Directions:
The Tribunal also addressed the issue of depreciation on the capital expenditure portion of the lease rent, specifically the non-compete fee. It directed the Assessing Officer to allow depreciation from 1st April 1998, as the non-compete fee constituted an intangible asset. Furthermore, the Tribunal instructed the Assessing Officer to examine whether the non-compete fee could be treated as revenue expenditure post-1st April 2003, following amendments to Section 28(va).

Conclusion:
The Tribunal's directions included:
- Treating 15% of the average purchase price as part of the enhanced lease rent for surrendering the right to purchase khair wood.
- Applying a 10% annual escalation rate for lease rent.
- Using an 18% rate for rent attributable to modernization and improvement of plant and machinery.
- Allowing depreciation on the capital expenditure portion of the lease rent from 1st April 1998 and examining the applicability of the non-compete fee as revenue expenditure post-1st April 2003.

All appeals were partly allowed for statistical purposes, with the Assessing Officer instructed to work out the net disallowable expenditure for the various assessment years based on these directions.