By TIOL News Service

MUMBAI, FEB 17, 2012: THE issue before the High Court is - Whether when assessee pays certain sum to a developer of a property which the assessee was occupying as tenant, for repair and reconstruction, such an expenditure is to be construed as capital in nature. No, it is revenue expenditure, rules the High Court.

Facts of the case

Assessee is a tenant in a building which was declared by the Municipal Corporation to be unsafe for occupation and an eviction notice was served. A suit was instituted on the Original Side of the Court in a partition dispute between the owners of the property and court receiver was appointed in 1978 and the assessee continued to pay rent to the receiver. In March 1999 Consent Terms were arrived and a developer came to be impleaded as a party. Under the Consent Terms the developer agreed to repair and reconstruct the building at his costs and agreed to handover certain area in the newly constructed and renovated building to the co-owners. Court Receiver was to execute a conveyance or a long term lease of the property in favour of the cooperative society of the owners and/or tenants of the building. Under the agreement with developer the tenancy of the assessee was confirmed and the assessee assumed an obligation to contribute a sum of Rs.1.50 Crores for the work of repair and restoration of the structure. As per the agreement the rent would not increase.

AO held that the assessee secured rights for an area of 5,000 sq. ft. on payment of Rs. 1.50 crores and became a member of the society or company and held that the assessee had deemed ownership of the premises. AO held that the amount paid was capital in nature and disallowed the same. CIT (A) allowed the appeal of the assessee following the decision of Supreme Court in the case of Commissioner of Income Tax v. Madras Auto Service (P) Limited that the assessee had not acquired any capital asset and the expenditure was allowable as revenue in nature. ITAT also confirmed the order of the CIT (A).

Revenue contended that the assessee had obtained a benefit of an enduring nature upon the reconstruction of the building and entitled to possession of premises of an equivalent area on a tenancy basis, the assessee was and continued to be a statutory tenant and the payment was made to secure an asset of enduring nature. The assessee entitled to become a member of the society.

Assessee contended that ownership of the structure did not transfer to the assessee and the assessee continued to be the tenant of the premises. By making contribution to cost of renovation it obtained a commercial revenue advantage of a right to continue in premises on the equivalent area at the same rent.

After hearing both the parties, the High Court held that,

++ in the case of Madras Auto the assessee had incurred the entire cost of construction of a new building but obtained no title to the new construction. The benefit which the assessee obtained was a long lease of thirty nine years on low rent. The Supreme Court held that the asset which was created belonged to someone else. The assessee was held to have obtained an enduring business advantage for the purpose of conducting the business profitably and more successfully, thus saving a considerable amount of revenue expenditure over the term of the lease. In the case of the assessee, the assessee was and continues to be a tenant. The character of the occupation of the assessee has not been altered. The assessee by contributing an amount of Rs.1.50 Crores to the reconstruction of the building has obtained an enduring advantage but nonetheless of a commercial nature of securing an equivalent area on the same rent in the new structure. The ownership of the new structure has not been transferred to the assessee nor has the assessee acquired any capital asset. Thus, the principal laid down by the Hon’ble Supreme Court in the case of Madras Auto is clearly applicable;

++ the judgement of the Supreme Court is relating to the AY prior to insertion of Explanation I to Section 32. As per the explanation I 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 the clause shall apply as if the said structure or work is a building owned by the assessee. In order that Explanation I is attracted, it is necessary that any capital expenditure is incurred by the assessee. Unless the expenditure is of a capital nature, there would be no occasion to apply the deeming fiction that is carved out by Explanation I. In the present case, the assessee had not incurred any expenditure of a capital nature. The expenditure did not result in the acquisition of a capital asset by the assessee. The assessee continued as before to be a tenant in respect of the premises. By contributing an amount of Rs.1.50 Crores towards the reconstruction or as the case may be renovation of the existing structure, the assessee obtained a commercial advantage of securing tenancy of an equivalent area of premises on the same rent as before. Since there was no acquisition of a capital asset and the occupation of the assessee continued in the character of a tenancy, the expenditure could not be regarded as being of a capital nature.

(See 2012-TIOL-124-HC-MUM-IT in 'Income Tax')