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Two interpretations of an Explanation
October, 06th 2007

If a building is taken on lease and expenditure incurred on renovation of the same, Explanation 1 will apply and such expenditure can be capitalised for claiming depreciation.

T. C. A. Ramanujam

When a company incurs expenditure either by way of construction or renovation to an existing building in leasehold premises, questions arise with regard to the deductibility of such expenditure in the computation of the companys assessable income. Can such expenditure be deducted as revenue in nature? Two views have been expressed by the Delhi and Madras High Courts.

The Bigjos case

In this case (Bigjos India Ltd vs CIT 293 ITR 170 Delhi), Bigjos ran a departmental store in New Delhi on leasehold premises. The company, a mere licensee of the showroom, incurred expenditure towards renovation and shifting of the lift. Such expenditure was claimed by the company as revenue in nature. The idea in incurring such expenditure was to ensure maximum utilisation of existing floor area.

The Revenue argued that the incurring of huge expenditure, running to Rs 7 lakh in this case, resulted in long-term benefit and was neither repair nor maintenance expenditure. The Delhi High Court found that the licensee company was not authorised to make structural changes without the prior consent of the licensor. The expenditure, the court held, was capital in nature.

TVS Lean Logistics case

In this case (CIT vs TVS Lean Logistics Ltd 293 ITR 432 Madras), the company constructed a building on leasehold land. No building was taken on lease. The Revenue argued that the entire cost of construction should be disallowed as capital expenditure. The assessment years involved were 2000-02 and 2002-03. Reliance was placed by Revenue on Explanation 1 to Section 32(1) of the Income-Tax Act, 1961.

It was pleaded that the building did not belong to the company. It was constructed on leasehold land. Where any capital expenditure was incurred on such structure, depreciation will be allowed under Section 32 of the Act. It has to be disallowed as capital expenditure, according to the Revenue.

The Madras High Court ruled in favour of the company. The company did not acquire the land, which is a capital asset. It has put up the construction on the leased land. Explanation 1 can be invoked only where construction of any structure is made in a building taken on lease but not in the case where a building is constructed for the purpose of business of the company in a land taken on lease by the company. The Revenues appeal was dismissed by the Madras High Court. This appears to be a novel construction of Explanation 1.

If the building is taken on lease and expenditure is incurred on renovation of the same, Explanation 1 will apply and such expenditure can be capitalised for claiming depreciation. On the other hand, if the building is constructed on land taken on lease, no capital asset is acquired because it will ultimately revert to the lessor. The lessee is not the owner of the building, though he incurred expenditure on construction of the same.

On this issue, an important ruling is that of the Supreme Court in the Madras Auto Service P Ltd (233 ITR 468 SC) case. Here, the lessee incurred expenditure on new construction after demolishing the old building. The new building was to belong to the lessor and not to the lessee. The lessee had the benefit of lease for 39 years. The lease rent was also low.

The concessional rent was on account of the construction of the new building. The Supreme Court held that the expenditure on the building should be allowed as revenue in nature. The company could not have claimed depreciation. This apex court ruling was given in relation to a period prior to the insertion of the Explanation to Section 32.

The Madras High Court had taken a similar view in CIT vs Ayesha Hospitals (P) Ltd (292 ITR 266). Explanation 1 to Section 32 was considered an exceptional one, which permits depreciation in cases where the assessee does not own a building. It does not concern revenue expenditure such as painting, relaying of damaged floors or partitions, and so on. Here also, the Madras High Court referred to the Supreme Court decision in the Madras Auto Service case.

The point to note is that the Supreme Court has had no occasion to interpret Explanation 1. The ruling in the Madras Auto case is being interpreted in different ways by the Delhi and the Madras High Courts. A final word from the Supreme Court is awaited.

T. C. A. Ramanujam
(The author is a former Chief Commissioner of Income-Tax.)

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