Kalpesh Classes

Re-construction of lease hold property - Revenue

In the SUPREME COURT OF INDIA, Madras Auto Service (P.) Ltd. The assessee-company had obtained premises on lease for a period of 39 years. Under the terms and conditions of the lease, the lessee (the assessee-company) had demolished the existing construction and constructed a new building thereon to suit the purposes of their business as per the plan approved by the lessors, and used to pay rents lower than the rents prevailing in vicinity.

The lease deed provided that the new construction shall, right from the commencement of the work, be the property of the lessors; and upon completion of the work of construction the lessee will have only the right to be a tenant for a period of 39 years under the existing lease subject to the payment of rent and observation of other terms and conditions of the lease. The lessee shall not be entitled under any circumstances for any compensation whatsoever on account of its putting up the new const- ruction in the place of the old. The assessee claimed that the expenditure spent on construction was revenue expenditure. The Assessing Officer rejected its claim and treated the said expenditure as capital expenditure. The Tribunal held that the expenditure of the amounts for the construction of a new building was in the nature of business expenditure for proper carrying on of the business of the assessee and treated these amounts as revenue expenditure and allowed a deduction in that regard to the assessee. The High Court upheld the Tribunal’s order. On appeal to Supreme Court HELD The assessee had spent the amounts in question in order to construct a new building after demolishing the old building. The new building, however, from the inception was to belong to the lessor and not to the assessee. The assessee, however, had the benefit of the existing lease in respect of the new building at the agreed rent for a period of 39 years. The Tribunal had found, as a fact, that the rent as stipulated in the lease was extremely low. It had said that the area of the building was somewhere about 7000 sq. ft. The rental rate for the area in which the building was situated was much higher and would be not less than Rs. 12,000 as against which the maximum rent the assessee would be paying was only Rs. 2,000. This confessional rent was on account of the fact that the new building was constructed by the assessee at its own cost.

In order to decide whether this expenditure is revenue expenditure or capital expenditure, one has to look at the expenditure from a commercial point of view. What advantage did the assessee get by constructing a building which belonged to somebody else and spending money for such construction. The assessee got a long lease of a newly constructed building suitable to its own business at a very concessional rent. The expenditure, therefore, was made in order to secure a long lease of new and more suitable business premises at a lower rent. In other words, the assessee made substantial savings in monthly rent for a period of 39 years by expending these amounts. The saving in expenditure was a saving in revenue expenditure in the form of rent. Whatever substitutes for revenue expenditure should normally be considered as revenue expenditure. Moreover, the assessee did not get any capital asset by spending the said amounts. The assessee, therefore, could not have claimed any depreciation. Looking to the nature of the advantage which the assessee obtained in a commercial sense, the expenditure appeared to be revenue expenditure. The building was never belonged to the assessee. Right from the inception, the building was under the​​ ownership of the lessor. Therefore, by spending this money, the assessee did not acquire any capital asset. The only advantage which the assessee derived by spending the money was that it got the lease of a new building at a low rent. From the business point of view, therefore, the assessee got the benefit of reduced rent. The High Court had, therefore, rightly considered this as obtaining a business advantage. The expenditure was, therefore, to be treated as revenue expenditure.​​ 

Since the asset created by spending the amounts did not belong to the assessee but the assessee got the business advantage of using modern premises at a low rent, thus, saving considerable revenue expenditure for the next 39 years, both the Tribunal as well as the High Court had rightly come to the conclusion that the expenditure should be looked upon as revenue expenditure.

Capital Expense on lease hold property is deemed building – Depreciation is allowable.

Explanation 1 to section 32 provide that 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 (depreciation) shall apply as if the said structure or work is a building owned by the assessee.

IN THE ITAT CHENNAI, ABT Ltd. Section 32 , read with section 37(1), Assessee-company took a premises on lease for running service station for cars manufactured by 'M' Ltd. - It made certain changes/addition in existing structure such as construction of washing ramps, oil change and wheel alignment pit, etc., to suit norms of 'M' Ltd. - Assessee's claim for deduction in respect of said expenditure under section 37(1) was rightly disallowed. Such capital expense would fall within the scope of building.