2025 (5) TMI 1180 - HC - Income Tax

Leasehold property maintenance expenses ruled as revenue expenditure under Section 32 despite simultaneous incurrence

The HC ruled in favor of the assessee regarding expenditure incurred on leasehold property. The court held that expenses for carpentry, electrical work, ... Nature of expenditure - expenditure incurred in respect of lease hold property - revenue expenditure or capital expenditure - HELD THAT:- We have no doubt that the incurrence of the expenses at serial numbers 1 to 9 are necessary in order to render the building functional for the purposes of the assessee’s business. Their recurring nature is also not in doubt insofar as Carpentry, electrical work, painting, false ceiling, repair and maintenance of the walls, pest control, installation of camera and execution of annual maintenance contracts, are works that are routinely carried out in business premises as and when required, to keep the premises in proper shape for the conduct of business. As far as Item No.10 is concerned, parties concur on the position that they are only miscellaneous expenses. The Tribunal has rejected the claim of the assessee opining that the ‘simultaneous incurrence’ of the expenditure would result in re-construction of the old building. The tribunal thus goes on to adopt the cumulative impact of the repair and maintenance work as the relevant parameter, which, in our view, would not be a proper approach. The question of re-construction does not arise and in fact, it is nobody’s case that the building has been re- constructed. The rental agreement clearly states that there would be no structural modification to the subject property. Hence, the finding of the Tribunal to the effect that the individual repair/maintenance works would amount to re-construction of the old building, are, in our view, perverse and not borne out of the materials available on regard. Though the Tribunal has not referred to Explanation (1) to Section 32(1)(ii) of the Act, the assessing officer has made reference to the Explanation and Mr. Narayanasamy has also drawn our attention to the same. In our considered view, Explanation does not, in any way, militate against the claim of the appellant and reliance upon the same by the Department does not advance its case in any way. The purport of the Explanation is laudable and enables even a lessee of a building to seek grant of depreciation, despite the premises being leasehold in nature. However, the attempt of the revenue is to interpret Explanation (1) such that, when an assessee is deemed to be the of the leasehold premises, all expenses incurred by that assessee be taken to be capital in nature. We do not agree with such an interpretation as it does not reflect the true purport of Explanation (1) and in fact, runs counter to its avowed intention. Further, there is nothing in the Explanation to lead one to such an interpretation. The Explanation is intended to enable a lessee in leasehold premises to claim depreciation on capital assets, despite his status as a lessee and not as owner. This would not stand in the way of the lessee claiming the expenditure as revenue, if the lessee is otherwise able to establish the nature of the expenditure incurred. Assessee appeal allowed. The core legal question considered by the Court was whether the expenditure incurred by the assessee in respect of leasehold property should be classified as revenue expenditure or capital expenditure for the purposes of income tax assessment.In addressing this question, the Court examined the nature of the expenses incurred on a leased property, specifically whether such expenses were merely for maintenance and upkeep (revenue expenditure) or amounted to substantial improvements or reconstruction (capital expenditure). The assessment year under consideration was 2008-09.The relevant legal framework centered primarily on the provisions of the Income Tax Act, 1961, particularly Section 32 which deals with depreciation, and Explanation (1) to Section 32(1)(ii), which provides guidance on capital expenditure incurred by a lessee on leasehold property. The Court also relied on precedents from various High Courts and the Supreme Court that elucidate principles distinguishing capital from revenue expenditure.The Court noted that the appellant had entered into a lease agreement for a property with a superstructure of 9,000 sq.ft., and had incurred expenses totaling approximately Rs. 1.17 crores on various works such as carpentry, electrical wiring, painting, false ceiling, pest control, and installation of security cameras. The lease agreement permitted only cosmetic modifications without structural changes, and the modifications were to remain with the property at the end of the lease.Initially, the Assessing Authority treated the expenditure as capital in nature, disallowing the full claim and permitting only depreciation. The Commissioner of Income Tax (Appeals) partially accepted the assessee's contention that many of the expenses were revenue in nature, disallowing only those related to reconstruction and substantial improvements. However, the Income Tax Appellate Tribunal reversed the CIT(A) order, holding that the cumulative effect of the alterations was to convert the old building into a new usable building, thus characterizing the expenditure as capital.The Court critically analyzed the Tribunal's approach of aggregating the expenses to treat them as capital expenditure. It held that the Tribunal's finding that the individual repair and maintenance works collectively amounted to reconstruction was perverse and not supported by the facts, particularly since the lease deed expressly prohibited structural modifications. The Court emphasized that the question of reconstruction did not arise, and the modifications were temporary and cosmetic in nature.Regarding Explanation (1) to Section 32(1)(ii), the Court clarified that this provision was intended to enable lessees of leasehold premises to claim depreciation on capital assets as if they were owners, but it did not mandate that all expenses incurred by a lessee be treated as capital expenditure. The Court rejected the Revenue's argument that Explanation (1) automatically rendered all such expenses capital in nature, stating that such an interpretation would defeat the provision's purpose and was not supported by its language.In support of its interpretation, the Court relied on the Full Bench decision of the Kerala High Court in Indus Motors Co. (P) Ltd., which held that whether expenditure on leasehold property is capital or revenue depends on the facts of each case and that Explanation (1) does not create a blanket rule treating all such expenses as capital. The Court noted that this view aligns with settled principles of statutory interpretation and the object and spirit of Explanation (1).The Court distinguished the present case from other cited decisions where the expenses were major, non-recurring, or involved structural changes or interior decoration that amounted to capital expenditure. In contrast, the expenses in the present case were recurring and related to maintenance and functional upkeep necessary for conducting business.Ultimately, the Court concluded that the expenditure incurred by the assessee on the leasehold property was revenue expenditure and not capital expenditure. The substantial question of law was answered in favor of the assessee and against the Revenue, allowing the appeals.Significant holdings include the following verbatim excerpt elucidating the Court's reasoning on Explanation (1):'The purport of the Explanation is laudable and enables even a lessee of a building to seek grant of depreciation, despite the premises being leasehold in nature. However, the attempt of the revenue is to interpret Explanation (1) such that, when an assessee is deemed to be the owner of the leasehold premises, all expenses incurred by that assessee be taken to be capital in nature. We do not agree with such an interpretation as it does not reflect the true purport of Explanation (1) and in fact, runs counter to its avowed intention.'Core principles established include:The classification of expenditure as capital or revenue depends on the nature and effect of the expenditure, not merely on the status of the property as leasehold.Explanation (1) to Section 32(1)(ii) facilitates depreciation claims by lessees but does not convert all expenses incurred by them into capital expenditure.Recurring, maintenance-related expenses that preserve the functionality of leased premises are revenue expenditure, even if incurred simultaneously on multiple items.The cumulative effect of repairs and maintenance should not be treated as reconstruction unless there is evidence of structural alteration or substantial improvement.On the final determinations:The Tribunal's approach of aggregating expenses to treat them as capital expenditure was rejected as perverse and unsupported by the lease terms and facts.The Assessing Authority's disallowance of the entire expenditure as capital was also set aside.The CIT(A)'s partial allowance of the claim was upheld in respect of the nature of the expenses.The appeals were allowed in favor of the assessee, confirming the expenditure as revenue expenditure.