2012 (7) TMI 282 - HC - Income Tax

Dis allowance of lease rental paid to the Trust - enhanced lease rent for the period from January to March, 1992 was a capital expenditure and therefore not allowable as a deductible expenditure - AO invoked the provisions of Section 40A(2) - Held that - The limited right which the assessee acquired under the lease was the right to purchase khair wood trees from the Government in the State of Himachal Pradesh. Assessee company would have got a right only to purchase the raw material and not the source of raw material. Therefore, that part of the lease rent, which is attributable to the right to purchase Khair wood would be a revenue expenditure and not a capital expenditure - the normal lease rental in this case would be a revenue expenditure and not a capital expenditure, as the ownership of the property as well as the plant and machinery continued to vest in the trust and in any case the lease granted to the assessee company was neither a perpetual lease nor a lease for such a long term as would bring it at par with a perpetual lease. Enhancement of lease rent attributable to improvement and modernization of plant and machinery carried out by the Trust - enhancement of lease rental from Rs.1 lac p.m. to Rs.6,70,000/- p.m., to the extent it is attributable to the expenditure incurred by the trust in the year 1989-90 on modernization and improvement of the plant and machinery which the lessee had taken on lease, would be a revenue expenditure, since it would have the effect of enhancing the lease rent of the plant and machinery in the open market Enhancement in lease rent attributable to normal appreciation in line with the lease rentals prevailing in the market - if there was any appreciation in the market in the lease rentals of such properties, the enhancement in the lease rent of the property to the extent it is attributable to such normal appreciation in the lease rentals prevailing in the market, would be a revenue expenditure. Thus it would be for the AO to determine whether there was any such appreciation in lease rentals, and if so, to what extent. Payment of non-compete fees - Increase in lease rent relatable to elimination of competition from the Trust constitutes capital expenditure as the Trust had leased whole of its production unit which was a profit generating unit to the assessee and not only the building, but the plant and machinery was also leased to the assessee along with all benefits, etc - The Trust had also relinquished its rights to purchase khairwood from the Government in favour of the assessee. Therefore, the business being carried by Trust was practically taken over by the assessee-company for an indefinite period . Therefore, this was a case of takeover of the business, coupled with elimination of competition from the rival - constitutes capital expenditure,applicability of Section 40A(2). the trust is not an association of persons , the provisions of Section 40A(2) are not attracted to the transaction between the trust and the assessee company.

Issues Involved:
1. Whether the lease rent of Rs 6,75,000/- per month paid by the assessee to the Trust was a capital expenditure or revenue expenditure or partly capital and partly revenue expenditure.
2. Whether the payment made by the assessee to the Trust or part of it comes within the purview of Section 40A(2) of the Income Tax Act.
3. If issue No. 2 is decided in favour of the revenue, whether the payment made by the assessee to the Trust was excessive or unreasonable, having regard to the fair market value of the goods, services or facilities for which the payment was made or legitimate needs of the business of the assessee or the benefit derived by or accruing to it from those goods, services or facilities.

Detailed Analysis:

1. Nature of Lease Rent: Capital or Revenue Expenditure
The lease rent was enhanced from Rs 1,00,000/- to Rs 6,75,000/- per month for various reasons, including the Trust relinquishing its rights to purchase Khairwood in Himachal Pradesh, agreeing not to compete with the assessee within a 1000 km radius, and having incurred expenditure on modernization and improvement of the plant and machinery.

- Revenue Expenditure: The normal lease rental is considered a revenue expenditure since the ownership of the property and the plant and machinery continued to vest in the Trust. The enhancement attributable to the modernization and improvement of the plant and machinery in 1989-90 also constitutes revenue expenditure, as it enhances the lease rent in the open market.
- Capital Expenditure: The enhancement attributable to the Trust agreeing not to compete with the assessee within a 1000 km radius is considered capital expenditure, as it brings benefits of an enduring nature to the assessee company.

2. Applicability of Section 40A(2) of the Income Tax Act
Section 40A(2) aims to address tax evasion under the guise of permissible deductions by checking payments made to closely connected persons and entities.

- Association of Persons: The Trust is not a company, firm, or HUF; hence, the only question is whether it is an association of persons. The term "association of persons" implies an association where two or more persons join with a common purpose or for a common action. However, trustees or beneficiaries of a trust do not come together for a common purpose or action. Therefore, the Trust is not an association of persons within the meaning of Section 40A(2)(b) of the Income Tax Act.

3. Reasonableness of Payment
Since the Trust is not an "association of persons," the provisions of Section 40A(2) are not attracted to the transaction between the Trust and the assessee company. Hence, the reasonableness of the payment does not need to be examined under this section.

Conclusion:
1. Enhancement of lease rent attributable to the Trust relinquishing its right to purchase Khairwood is revenue expenditure.
2. Enhancement attributable to the improvement and modernization of plant and machinery is revenue expenditure.
3. Enhancement attributable to normal appreciation in lease rentals is revenue expenditure.
4. Enhancement attributable to the Trust agreeing not to compete with the assessee within a 1000 km radius is capital expenditure.
5. Section 40A(2) of the Income Tax Act is not applicable to the transaction between the Trust and the assessee company.

The Assessing Officer is directed to apportion the lease rental into various categories as indicated and pass a fresh order accordingly. The appeals are disposed of with no order as to costs.

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