Business expenses - Extensive renovation of leasehold premises
February, 09th 2007
ACIT vs Flour Daniel India (P) Ltd. Citation 2007 11 SOT 349
Summary AY 1997-98. The assessee had taken certain premises on lease for a period of nine years for business purposes. The expenses incurred on renovating and customising the premises had resulted in extreme renovation like putting up EPABX, electric works, fixing of carpet, card access system, etc. Since the expenditure was in the nature of extensive renovation and beautification, therefore, in view of Explanation I to s.32(1) of the Income Tax Act 1961, such expenses constituted capital expenditure, not revenue expenditure.
Explanation I to s.32(1) and s.37(1) of the Income Tax Act 1961
ACIT vs Flour Daniel India (P) Ltd.
IT Appeal No. 3251 (Delhi) of 2002 [Assessment Year 1997-98]
S.C. Tiwari, Accountant Member and N.K. Karhail, Judicial Member
15 September 2006
Sangeeta Gupta for the Appellant S.D. Kapila for the Respondent
N.K. Karhail, Judicial Member. - This appeal of the revenue is directed against the order dated 17-5-2002 passed by Ld. CIT(A)-XIV, New Delhi for the assessment year 1997-98.
2. The grounds of appeal read as under:
"(1) On the facts and circumstances of the case the Ld. CIT(A) has erred in deleting the disallowance of Rs. 1,70,51,609 made by the Assessing Officer by capitalizing the expenses claimed by the assessee under the head 'Repair and Maintenance'.
(2) On the facts and circumstances of the case while deciding the appeal the Ld. CIT(A) has erred in ignoring the fact that out of a total amount of Rs. 1,70,51,609, the assessee has incurred an amount of Rs. 37,57,007 on fixing of carpet which were imported from USA and definitely is in the nature of capital expenditure.
(3) On the facts and circumstances of the case, the Ld. CIT(A) has erred in law while not considering the Explanation 1 to section 32 of the Income-tax Act which clearly provides that for the purpose of section 32, even if the assessee is not the owner of the building then also for the purpose of any expenditure in the nature of capital expenditure in this building, he will be treated as the owner of the building."
3. Briefly stated facts are that during the year the assessee had occupied a lease premise in Corporate Park, DLF Qutab Enclave, Phase III, Gurgaon from where it was carrying on its business. The lease was for an initial period of three years tenure with a right to the lessee to renew the lease at sole discretion beyond the initial lease term of three years for two consecutive terms of three years each [clause 10(c) of the Lease Agreement]. The assessee had incurred certain expenses for customizing the leased premises for its use and an amount of Rs. 1,70,51,608 was debited to the Profit and Loss Account and considered as revenue in nature. According to the assessee all these expenses were in the nature of revenue as these expenses were incurred in the premises taken on lease for three years which were further extendable by another three years. The assessee submitted that incurring of such expenditure had not given rise to any fresh capital asset but was only to give a better look to its business premises to attract customers and cater to the taste of clientele. He also relied upon the decision of the jurisdictional High Court in the case of Modi Spg. and Wvg. Mills Co. Ltd. v. CIT  200 ITR 544 (Delhi), according to which, expenditure incurred by a tenant for renovation/alteration of rental building are in nature of revenue expenditure. The Assessing Officer reproduce the nature of these expenses as under:
Plant Design System Software
Fire detection and alarm system
Card access system
Air-conditioning, ducting etc.
Call billing software for EPABX
Fixing of carpet
4. The Assessing Officer observed that nature of above expenses itself would show that these were not merely expenses on current repair and in fact were in nature of fixtures and other fixed assets. He further mentioned that the facts involved in decision of Hon'ble Delhi High Court in case of Modi Spg. and Wvg. Mills Co. Ltd. (supra) on which the assessee had heavily relied were not comparable with the facts of the instant case. In the case of Modi Spinning, the quantum involved was only Rs. 34,606 which was incurred for repair and renovation of administrative block, whereas in instant case the expenses were as high as Rs. 1.7 crores and this fact could not be ignored. He further mentioned that as per Explanation 1 to section 32 where the business was carried out in a leased premises, and any expenditure was incurred by the assessee on the construction of any structure or doing of any work or renovation or extension or improvement to the building then for purpose of section 32, the said structure of work carried out shall be deemed to be building owned by the assessee. Thus, Assessing Officer observed that this would show that expenses on lease hold improvements were to be treated as capital expenditure, particularly when the amount spent was very heavy and not in nature of current repair. Expenditure as of high as Rs. 49.5 lakhs on civil and interior work could not be said to be merely a part of current repair. Similarly, an expense of Rs. 37.57 lacs incurred on a carpet which was imported from USA was in nature of capital expenditure forming part of fixtures. The other expenses for air-conditioning, fire detection system, electric works etc. and software were also in nature of capital expenditure. Thus, he held that all these expenses of Rs. 1,70,31,292 shall be treated as capital expenditure and depreciation for half of the year at the rate of 5% on civil work and cost of the carpet and at the rate of 12.5 at the rate of on remaining expenses (total depreciation Rs. 14,75,915) would be allowed. Even otherwise, if these expenses were to be treated as revenue expenditure in nature, same were to be allowed on deferment basis over the period of the lease, because benefit of these expenses was not confined to this year only and allowing deduction for these expenses in one year would distorted the profit of the year, reliance in this regard was placed on decision of Hon'ble Supreme Court in case of Madras Industrial Investment Corpn. Ltd. v. CIT  225 ITR 802.
5. On appeal, the Ld. CIT(A) had held thus :
"(14) I have gone through the order of ld. Assessing Officer, the contention of the ld. AR, the material documents made available to me and also the material documents/evidences required by the undersigned. On careful perusal of the same, I find that the appellant had shifted from the leased premises to new premises on August 2001, a little more than 4 years from the date of lease. The agreement provided that upon vacating the premises, the lessee would need to restore the premises to their original condition and this clearly establishes the fact that the benefit would not be of an enduring nature and should the premises have been vacated all the ducting, plumbing, electrical work, cabling etc. that had been installed would need to be pulled down. The appellant has submitted a list certified by the landlord containing the items left behind at the leased premises at the time of the vacating the same. I find that most of these items have been capitalized by the assessee. The appellant has also submitted that all expenses that were of a capital nature have been capitalized in the books and depreciation at rates specified in the Income-tax Act have been charged. It is only expenses that were not capital in nature that have been considered as allowable. A list of these additions during the assessment year 1997-98 have also been produced for verification.
(15) The appellant has submitted that 4 out of 8 floors in the building had been occupied by them, the floor area occupied was approximately 24,832 sq.ft. In view of the large area taken up by the appellant, the quantum of expenses during the year for repairs and renovation are completely justified.
(16) On a careful perusal of the entire facts and circumstances of the case as well as material documents obtained on record including the ratio of decisions cited by the ld. AR and the subsequent history of the case, I am of the opinion that the disallowance is not justified in the particular case. The view expressed by the ld. Assessing Officer 'if there expenses are to be treated as revenue expense, the same are to be allowed on deferment basis over the period of the lease, because benefit of these expenses is not confirmed to this year only and allowing deduction for these expenses in one year shall distort the profit of the year' is also not warranted as there is no such provision in the Income-tax Act allowing deferment of revenue expenditure and the expenses incurred pertain to the year under consideration. Consequently, the Assessing Officer is directed to allow the expense on this account. In fact the issue is clinched in favour of the appellant in view of Hon'ble Supreme Court decision in the case of Madras Auto Services Pvt. cited Sup."
6. Before us the ld. DR has submitted that assessee has acquired the premises in question for a period of 3 years and extendable for two consecutive terms of three years. Thus the assessee has entered into the premises with intention to stay for a longer period. This could be the reason for incurring such huge expenditure of 1.7 crores on the leased premises. The expenditure was incurred in relation to fixed assets i.e., leased building premises resulting into durable value advantage to the fixed assets and long-term advantage to the assessee. Thus he has supported the order passed by the Assessing Officer. On the other hand, ld. counsel for the assessee has submitted that the assessee had incurred certain expenditure on repair/renovation inclined it to use the premises for the purpose of carrying on its business. The premises required repairs/ renovation to develop and facilitate business the incurring of such expenditure had not given rise to any such fresh capital assets but was only to given better look to the business premises, and to attract customers, and to cater to the taste of cliental. The expenditure having been incurred to run its business efficiently and more profitably, the same was revenue in nature. He has further submitted that Explanation 1 to section 32(1) is not applicable as the Explanation talks of "any capital expenditure incurred by the assessee...". Thus the Explanation does not apply to all expenditure but only to such expenses which are of capital nature, which otherwise would not have been eligible for depreciation in absence of fictional "ownership" created by virtue of the Explanation. He has further submitted that the question whether an expenditure was capital or revenue had to be examined in relation to the "assessee" and not the owner of the leased property. In other words, an amount spent by the assessee in his capacity as a lessee would be a revenue expenditure to the assessee even if it results in creation of a capital asset for the lessor. The expenditure incurred on assets which become property of the lessor would be allowable as a revenue expenditure to the assessee, lessee, as the same would have been incurred to remove certain disadvantage in utilization of the property for the intended purposes.
7. He has further submitted that the major part of the expenditure was of such items that would be of little value if detach or removed from the leased premises. Ld. counsel for the assessee further argued that enduring benefit or long-term advantage in itself was not conclusive as to the nature of expenditure.
8. The learned counsel had referred to the decision of Hon'ble Delhi High Court in the case of Modi Spg. and Wvg. Mills Co. Ltd. (supra) and pointed out that in that case the Hon'ble High Court had held that an expenditure that could not be claimed as on current repairs under section 30, being on renovation of the premises, could be claimed as deduction under the provisions of section 37 of the Act. He has further referred to the case of Installment Supply (P.) Ltd v. CIT [ 1984] 149 ITR 52 (Delhi) wherein it had been held that the commercial advantage obtained by the assessee by redesigning the premises and providing better fittings, better material and marble flooring was not in the nature of capital expenditure. He has further referred to the decision in the case of BandA Plantations and Industries Ltd. v. CIT 242 ITR 22 (Gauhati) and pointed out that in that case the Hon'ble Gauhati High Court, following the judgment of Hon'ble Supreme Court in the case of CIT v. Madras Auto Services (P.) Ltd.  233 ITR 468 held that by way of expenditure on wall papers, partition wall, marble flooring etc. was not in the nature of capital expenditure.
9. The learned counsel placed reliance upon the judgment of Hon'ble Supreme Court in the case of Madras Auto Services (P.) Ltd. (supra). In that case the assessee had constructed new building after demolishing old building. The premises had been taken on rent by the assessee. By the expenditure the assessee got a long lease of a newly constructed building suitable to its own business at a very concessional rate. The Hon'ble Supreme Court held that whatever substituted the revenue expenditure should normally be considered as revenue expenditure and held that in that case the assessee had not got any capital asset by spending the amount. The learned counsel for the assessee also placed heavy reliance upon the judgment of Hon'ble Supreme Court in the case of Empire Jute Co. Ltd. v. CIT 124 ITR 1 and argued that it had been held by the Apex Court that every expenditure that results in long-term benefit or advantage, need not necessarily be capital expenditure and if by such expenditure the fixed capital left untouched and the expenditure merely resulted into facilitating the assessee's trading operations or enabling the management and conduct of the assessee's business to be carried on more efficiently or more profitably, the expenditure would be of revenue account. He had further relied upon the order passed by the Ld. CIT(A).
10. We have heard the parties, perused the record of the case as well as the case law referred to. There are two major aspects of the issue before us. First, the facts that the building premises upon which the expenditure in question has been incurred by the assessee were not ownership building premises of the assessee but taken on lease. Secondly, whether the expenditure incurred by the assessee can be categorized as revenue or capital expenditure. of these two issues we find the first issue to be no longer material in view of the following Explanation 1 inserted by the Taxation Laws (Amendment and Miscellaneous Provisions) Act, 1986, with effect from 1-4-1988 :
"Explanation 1.Where the business or profession of the assessee is carried on in a building not owned by him but in respect of which the assessee holds a lease or other right of occupancy and any capital expenditure is incurred by the assessee for the purposes of the business or profession on the construction of any structure or doing of any work in or in relation to, and by way of renovation or extension of, or improvement to, the building, then, the provisions of this clause shall apply as if the said structure or work is a building owned by the assessee."
11. Thus, in view of the Explanation 1 to section 32(1) to the Act, the premises are lease-hold premises is not of much significance. The judgment of Hon'ble Supreme Court in the case of Madras Auto Services (P.) Ltd. (supra) and of Hon'ble Delhi High Court in the case of Installment Supply (P.) Ltd. (supra) on which so much reliance has been placed by the learned counsel for the assessee are no longer applicable. Thus, for the purpose of determination of the nature of expenditure incurred by the assessee we have to assume as if the premises were owned by the assessee. Before us the learned counsel for the assessee has placed reliance on the judgment of Hon'ble Delhi High Court in the case of Modi Spg. and Wvg. Mills Co. Ltd. (supra). In that judgment the Hon'ble Delhi High Court have not accepted the contention of the assessee that the expenditure of Rs. 34,606 on repairs and renovations of the administrative block of the assessee's building was admissible as current repairs under section 30(a)(ii) of the Act. The Hon'ble Delhi High Court have held that the fact that the building required repairs which were long overdue made it apparent that the amount was not spent on current repairs. The Hon'ble High Court, however, observed as under :
"One of the ingredients of the amount being allowed as a deduction under section 30(a)(ii) is that the amount must be spent for purposes of carrying out current repairs. The facts as found by the Tribunal are that the administrative block had been built in 1948 and required repairs and improvement in the relevant assessment year in question. As the amount was spent for carrying out repairs which were long overdue, it is evident that the amount was not spent on current repairs. Section 30(a)(ii) is not concerned with the question as to whether the nature of the expenses towards current repairs is capital or revenue. As long as the repairs which are carried out fall under the category of current repairs, then, irrespective of the fact that the repairs have been carried out to a capital asset, and may otherwise have been regarded as a capital expenditure, the said provision specifically allows deduction. Current repairs must necessarily mean repairs which are required to be carried out from time to time as and when a defect arises. If there has been wear and tear on an item, like the floors in the present case, over a number of years and ultimately they are replaced, then such replacement cannot be regarded as current repairs. The replacement may amount to renovation or repairs which may or may . not be entitled to deduction under section 37 of the Act but such an expense has been rightly held by the Tribunal as not being allowable as deduction under the said head 'Current repairs'."
12. It would be seen that in the case of Modi Spg. and Wvg. Mills Co. Ltd. (supra) their Lordships were considering a case where the assessee had carried out repairs that were long overdue. There is no such aspect involved in the case of the assessee before us. Significantly in that judgment the Hon'ble jurisdictional High Court have observed that replacement of building parts on account of wear and tear over a number of years would amount to renovation or repairs which may or may not be entitled to deduction under section 37 of the Act. We find the case of the assessee before us still inferior inasmuch as expenditure is neither on current repairs nor on account of renovation and repairs being made to make good wear and tear over a large number of years.
13. During the course of hearing before us the learned counsel for the assessee placed considerable reliance on the judgment of Hon'ble Supreme Court in the case of Empire Jute Co. Ltd. v. CIT  124 ITR 1, especially upon the following observations of the Hon'ble Apex Court in that judgment:
"There may be cases where expenditure, even if incurred for obtaining advantage of enduring benefit, may, nonetheless, be on revenue account and the test of enduring benefit may break down. It is not every advantage of enduring nature acquired by an assessee that brings the case within the principle laid down in this test. What is material to consider is the nature of the advantage in a commercial sense and it is only where the advantage is in the capital field that the expenditure would be disallowable on an application of this test. If the advantage consists merely in facilitating the assessee's trading operations or enabling the management and conduct of the assessee's business to be carried on more efficiently or more profitably while leaving the fixed capital untouched, the expenditure would be on revenue account, even though the advantage may endure for an indefinite future. The test of enduring benefit is, therefore, not a certain or conclusive test and it cannot be applied blindly and mechanically without regard to the particular facts and circumstances of a given case."
14. It may mention that in the case of Empire Jute Co. Ltd. (supra), the Hon'ble Apex Court considered the question as to whether expenditure incurred by that assessee-company on purchase of loom hours from another signatory member constituted a revenue expenditure. The revenue contended that as loom hours acquired were in the nature of long-term advantage acquired, the expenditure should be treated as capital expenditure. It is important to remember that in that judgment the Hon'ble Apex Court were dealing with the expenditure on an intangible assets that did not constitute any part of the fixed capital assets of the assessee. In the extract quoted by us above their Lordships have made it very clear that the position in law would be otherwise in respect of expenditure in relation to fixed capital of the assessee. The learned counsel for the assessee has emphasized before us the later part of the observations as extracted above and he argued that if the expenditure was incurred for facilitating the assessee's trading operations or enabling the management and conduct of the assessee's business to be carried on more efficiently or more profitably, the expenditure would be on revenue account, even though the advantage may endure for an indefinite future. However, in the said case it is held that if the asset is not part of fixed capital asset, the test of enduring benefit may not be a conclusive test in relation thereto. In the present case, however, we are dealing with the building which is a fixed capital asset. Therefore, we are of the view that observation of Hon'ble Supreme Court in the case of Empire Jute Co. Ltd. (supra) do not apply where expenditure in question relates to a fixed capital asset. As per the said judgment what distinguishes a capital expenditure from revenue expenditure is the fact that former is related to fixed capital asset of the assessee and later leave the fixed capital asset untouched.
15. Thus we hold that in view of the Explanation 1 to section 32(1), the expenditure could not be claimed to be revenue expenditure for reason only that it is in relation to a property of which the assessee was a lessee and if the expenditure is incurred in respect of predominantly fixed capital assets, the expenditure cannot be claimed to be revenue expenditure for reason only that it facilitates the assessee's business. A business expenditure whether capital or revenue served the same purpose i.e., to facilitate the management and conduct of business to be carried on more efficiently or more profitably.
16. Therefore, we have to adjudge the case before us on the basis as to whether the expenditure claimed by the assessee can be allowed as current repairs under section 30 or as revenue expenditure under section 37(1) of the Act. This aspect has been considered at length by Hon'ble Supreme Court in their judgment in the case of Ballimal Naval Kishore v. CIT  224 ITR 414 (SC) in the following words :
"The expression used in section 10(2)(v) is 'current repairs' and not mere 'repairs'. The same expression occurs in section 30(a)(ii) and in section 31(i) of the Income-tax Act, 1961. The question is what is the meaning of the expression in the context of section 10(2). In New Shorrock Spinning and Manufacturing Co. Ltd. 's case  30 ITR 338 (Bom.), Chagla C.J., speaking for the Division Bench, observed that the expression 'current repairs' means expenditure on buildings, machinery, plant or furniture which is not for the purpose of renewal or restoration but which is only for the purpose of preserving or maintaining an already existing asset and which does not bring a new asset into existence or does not give to the assessee a new or different advantage. The learned Chief Justice observed that they are such repairs as are attended to as and when need arises and that the question when a building, machinery, etc., requires repairs and when the need arises must be decided not by any academic or theoretical test but by the test of commercial expediency. The learned Chief Justice observed:
The simple test that must be constantly borne in mind is that as a result of the expenditure which is claimed as an expenditure for repairs what is really being done is to preserve and maintain an already existing asset. The object of the expenditure is not to bring a new asset into existence, nor is its object the obtaining of a new or fresh advantage. This can be the only definition of 'repairs' because it is only by reason of this definition of repairs that the expenditure is a revenue expenditure.
If the amount spent was for the purpose of bringing into existence a new asset or obtaining a new advantage, then obviously such an expenditure would not be an expenditure of a revenue nature but it would be a capital expenditure, and it is clear that the deduction which the Legislature has permitted under section 10(2)(v) is a deduction where the expenditure is a revenue expenditure and not a capital expenditure.'
In taking the above view, the Bombay High Court dissented from the view taken by the Allahabad High Court in Ramkishan Sunderlal v. CIT  19 ITR 324, where it was held that the expression "current repairs" in section 10(2)(v) was restricted to petty repairs only which are carried out periodically. The learned Judge agreed with the view taken by the Patna High Court in CIT v. Darbhanga Sugar Co. Ltd  29 ITR 21 and by the Madras High Court in CIT v. Sri Rama Sugar Mills Ltd.  21 ITR 191.
In Liberty Cinema v. CIT  52 ITR 153 (Cal.), P.B. Mukharji, J., speaking for a Division Bench of the Calcutta High Court, held that an expenditure incurred with a view to bring into existence a new asset or an advantage of enduring nature cannot qualify for deduction under section 10(2)(v).
In our opinion the test involved by Chagla C.J., in New Shorrock Spinning and Manufacturing Co. Ltd.'s case  30 ITR 338 (Bom.) is the most appropriate one having regard to the context in which the said expression occurs. It has also been followed by a majority of the High Courts in India. We respectfully accept and adopt the test.
Applying the aforesaid test, if we look at the facts of this case, it will be evident that what the assessee did was not mere repairs but a total renovation of the theatre. New machinery, new furniture, new sanitary fittings and new electrical wiring were installed besides extensively repairing the structure of the building. By no stretch of imagination, can it be said that the said repairs qualify as 'current repairs' within the meaning of section 10(2)(v). It was a case of total renovation and has rightly been held by the High Court to be capital in nature. Indeed, the finding of the High Court is that as against the sum of Rs. 17,000 for which the assessee had purchased the factory in 1937, the expenditure incurred in the relevant accounting year was in the region of Rs. 1,20,000.
The appeal accordingly fails and is dismissed. No costs."
17. The expression "repairs" implies a necessity i.e., something, which is required to be done in order to bring the asset to its original functionality in proper order. Such repairs may or may not be urgent but are certainly called for to restore the asset to its full original functionality. Where the repair is immediately attended to, the same can be construed as current repairs and where it is allowed to be accumulated, such repairs would not be current repairs but at the same time allowable as an expenditure under section 37(1) provided that the fundamental condition of the provisions of section 37(1) "not being in the nature of capital expenditure is satisfied". In the case of Ballimal Naval Kishore (supra) the Hon'ble Supreme Court have held that where the expenditure gives the assessee new or fresh advantage, that cannot be allowed as a revenue expenditure. In the case of Modi Spg. and Wvg. Mills Co. Lid (supra) the Hon'ble Delhi High Court have also said the same thing that the replacement may amount to renovation or repairs which may or may not be entitled to deduction under section 37. Keeping these aspects in mind we now proceed to consider the nature whether the expenditure claimed by the assessee in the assessment year before us can be allowed as revenue expenditure. It is seen that the asses'see took on lease the office premises in Corporate Park, DLF Qutab Enclave, Phase II, Gurgaon from where it is carrying on its business. It is apparent that the expenditure was incurred on the building so that it may yield to the assessee afresh advantage not forthcoming from the leased out premises in its original condition. The major part of the expenditure is in relation to building premises. We are of the view that the expenditure being in the nature of extensive renovation and beautification, thus, the same had rightly been disallowed as capital expenditure by the learned Assessing Officer. However, the Assessing Officer is directed to work out the depreciation allowable to the assessee under Explanation 1 to section 32(1) of the Act after allowing a reasonable opportunity of being heard to the assessee. For this limited purpose the matter is restored to the file of Assessing Officer.
18. Hence we reverse the order passed by Ld. CIT(A) and restore the order passed by the Assessing Officer.
19. In the result, the appeal of the revenue is allowed subject to above observation.