2017 (12) TMI 1168 - HC - Income Tax

Nature of expenditure - expenses incurred for repairs, refurbishing and making improvements on the buildings taken on lease - revenue v/s capital expenditure - Held that - Decision of the Division Bench in Joy Alukkas 2014 (6) TMI 80 - KERALA HIGH COURT binds us inexorably with respect to the question raised on expenses incurred for refurbishing and making improvements of a leasehold building. The questions of law raised by the Division Bench admitting the instant appeals as also the reference order indicates that the additions made were on two counts (i) the expenditure incurred on refurbishment, repairs and improvements and (ii) the superstructures constructed on leased out immovable property. The revenue expenditure made on leased out buildings has to be allowed as a revenue expenditure and not as a capital expenditure. We answer the first question in favour of the assessee and against the Department. Disallowance of expenses incurred for construction of buildings in leased out lands as capital expenditure - Lands taken on lease and constructions made thereon - Held that - 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 ₹ 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 ₹ 5,000/- each as penalty. The assessee then shall produce the registered documents before the respondent A.O, who shall finalise the assessment on the principles herein above stated, determining whether the expenditure made by the assessee can be treated as a capital expenditure or revenue expenditure. If the assessee does not comply with the above directions then the respondent shall impound the documents and send it for stamping under the provisions of Section 33 of the Stamp Act to the respective District Registrars who shall pass orders at their discretion under powers conferred by Section 39 of the Stamp Act, in which event the determination of penalty will be left to the District Registrar. The assessment will also then be without looking into the documents, since the Registration Act does not provide for registration beyond eight months from the execution.

Summary

Issues Involved:
1. Classification of expenses on leasehold buildings as revenue or capital expenditure.
2. Classification of expenses on construction of buildings on leased lands as revenue or capital expenditure.
3. Disallowance of expenses incurred on showrooms/service stations that were written off.
4. Disallowance of provision for free service expenses.

Detailed Analysis:

Issue 1: Classification of Expenses on Leasehold Buildings
The primary issue was whether expenses incurred for repairs, refurbishing, and improvements on buildings taken on lease should be treated as revenue or capital expenditure. The court referred to the precedent set in Joy Alukkas India (P) Ltd. v. Assistant Commissioner of Income Tax, where such expenses were treated as revenue expenditure. The Full Bench reaffirmed this view, interpreting Explanation 1 to Section 32(1) of the Income Tax Act, 1961, to mean that the legal fiction created allows a lessee to claim capital expenditure as if they were the owner. The court concluded that the revenue expenditure made on leased out buildings should be allowed as revenue expenditure and not as capital expenditure, thus answering this question in favor of the assessee.

Issue 2: Classification of Expenses on Construction of Buildings on Leased Lands
The court examined whether expenses incurred on constructing buildings on leased lands should be treated as revenue or capital expenditure. The assessee cited the Supreme Court's decision in C.I.T. v. Madras Auto Service (P.) Ltd., which allowed such expenses as revenue expenditure. The court noted that the Explanation to Section 32(1) does not mandate treating all such expenses as capital expenditure but allows for depreciation claims if they are capital in nature. The court emphasized the need to examine the lease agreements to determine if the expenses should be treated as revenue or capital. The court directed the Assessing Officer to verify the agreements and determine the nature of the expenses, considering factors such as lease duration, market rent, and the total investment made.

Issue 3: Disallowance of Expenses on Showrooms/Service Stations Written Off
For the assessment year 2009-10, the court addressed whether expenses incurred on showrooms/service stations, which were written off due to non-commencement of business, should be treated as capital loss or revenue loss. The court disagreed with the Tribunal's view that it was a capital loss, stating that if the business had commenced, the expenses would have been treated as revenue expenditure. The court concluded that merely because the business did not commence, the expenses should not be treated as capital loss, thus answering this issue in favor of the assessee.

Issue 4: Disallowance of Provision for Free Service Expenses
For the assessment year 2010-11, the court examined the disallowance of a provision for free service expenses amounting to ?36,00,000. The Tribunal had found that the expenditure claimed by the assessee was only a provision and had not accrued during the year, making it ineligible for deduction under Section 37 of the Act. The court agreed with the Tribunal's factual determination and declined to answer this question, confirming the Tribunal's order.

Conclusion:
The court answered the first issue in favor of the assessee, allowing the expenses on refurbishing and improvements of leasehold buildings to be treated as revenue expenditure. For the second issue, the court directed the Assessing Officer to examine the lease agreements to determine the nature of the expenses. The third issue was also answered in favor of the assessee, treating the written-off expenses as revenue loss. The fourth issue was confirmed in favor of the revenue, as the court agreed with the Tribunal's factual finding. The court ordered the Assessing Officer to make necessary rectifications in accordance with the law declared by the court.