Calcutta H.C : Whether, on the facts and in the circumstances of the case, the Tribunal was right in directing the ITO to allow the assessee’s claim for deduction of Rs. 29,372 being the expenditure incurred for replacing machinery of United Vegetable Mfrs. Ltd. ?

Section 37(1)

Asst. Year 1972-73

Counsel Appeared

S.K. Mukharjee, for the Revenue : R.N. Bajoria, for the Assessee

AJIT K. SENGUPTA, J. :

The only question of law which has been referred to this Court under s. 256(1) of the IT Act, 1961 (“the Act”), for the asst. yr. 1972-73, at the instance of the CIT is as follows :

“Whether, on the facts and in the circumstances of the case, the Tribunal was right in directing the ITO to allow the assessee’s claim for deduction of Rs. 29,372 being the expenditure incurred for replacing machinery of United Vegetable Mfrs. Ltd. ?”

It is necessary to state briefly the relevant facts which have given rise to this dispute. The assessee took a lease of the factory of United Vegetable Mfrs. Ltd. for 15 years under a lease deed dt. June 29, 1961. The lessor-company reserved the right to terminate the lease after the expiry of five years or before for the purpose of its own use by giving three months’ notice to the assessee. The said lease was to commence from November 1, 1961, as per the lease deed dt. June 29, 1961, but by a supplementary agreement dt. December 27, 1961, the date of commencement was made operative from March 1, 1961. The lease rent was settled at Rs. 1,50,000 annually and it was provided that during the continuance of the lease and in the course of running the factory, if any machinery or a part of it be broken or becomes out of order, the lessee shall repair or replace the same at its own cost. During the course of the lease period, the assessee was required to carry out certain repairs/replacement in the plant and machinery of the United Vegetable, Mfrs. Ltd. which were situated in the aforesaid property. United Vegetable Mfrs. Ltd., through its solicitors, T. Banerjee & Co., gave notice on November 25, 1967, to the assessee for termination of the lease after expiry of six years and asked the assessee to vacate the lease-hold property within the specified period failing which the assessee was threatened to be penalised by way of payment of damages at the rate of Rs. 3,500 per day or mesne profit or other costs that would be incurred by the lessor to take legal action for recovery of possession of the leasehold property. The assessee disputed the right of the lessors to terminate the lease and sent the annual rent by cheques which were refused by the lessor. The dispute was ultimately settled by arbitration as a result of which the assessee had to pay a total sum of Rs. 6,05,127 which represented outstanding rent of Rs. 5,03,127 and interest and other claims of Rs. 1,00,000. Furthermore, the assessee had to surrender its machinery worth Rs. 29,372 for replacement of machinery belonging to the lessor which was said to have been damaged in the course of running of the assessee’s business.

In its return of income as well as at the time of assessment proceedings, the assessee claimed the aforesaid two items, viz., Rs. 1,00,000 and Rs. 29,372, as deductible expenditure in computing its total income. But the ITO as well as the AAC disallowed the assessee’s claim for deduction of these two amounts on the ground that the payment of Rs. 1 lakh was made by the assessee as damage for breach of its agreement and that the expenditure of Rs. 29,372 was capital in nature.

Being aggrieved by the order of the AAC, the assessee came up in appeal before the Tribunal. The Tribunal, after considering the rival submissions of the parties, accepted the assessees claim for deduction of the aforesaid two items. We are, however, concerned in this reference with the expenditure of Rs. 29,372. The question is whether the expenditure in question is capital or revenue.

Mr. Bajoria has submitted with reference to several decisions that the lessee has discharged its obligation under the lease and that no asset or advantage of enduring benefit has been acquired and as such this expenditure is on revenue account. This Court, in the case of CIT vs. Kalinga Otto (P) Ltd. (1981) 25 CTR (Cal) 1:(1983) 139 ITR 710 (Cal), was considering a case where the assessee-company carried on the business of execution of contracts. It entered into an agreement with HSL whereby it undertook the expansion of the coke oven plant as well as construction of houses, etc. Under the terms of the agreement, HSL was under an obligation to make available suitable unfurnished quarters to the assessee for its staff, while the assessee had to furnish them according to its requirements and on the completion of the contract it was required to hand over the furniture and fittings as well as electrical installations to HSL without claiming any payment therefor. On the question whether the amount spent by the assessee on furniture and fixtures for its staff quarters was deductible, this Court held that the business of the assessee was the working of the contract. In carrying on that business, the assessee was under an obligation to furnish the staff quarters, The benefit derived there from would not enure to the assessee beyond the performance or apart from the performance of the contract in question. The expenditure incurred on furniture and fixtures was, therefore, of a revenue nature and deductible as such. As rightly held by this Court, an asset or advantage may endure for the duration of the business of the assessee or for the duration of a contract. The question whether the advantage was of an enduring or transient nature has to be decided in considering the nature of the asset or advantage in the context of the trade in question. We are also of the view that on the facts and circumstances of the case and having regard to the conditions imposed under the deed of lease, the replacement of an asset belonging to the lessor cannot be treated as a capital expenditure. If the assessee in that case had to furnish the quarters and surrender the furniture and fixtures on the principle on completion of the contract and it can be held that it was a revenue expenditure in the context of the contract, in our view, in the context and stating all the facts of this case, such expenditure shall be treated as a revenue expenditure.

Mr. Bajoria has relied on a decision of the Punjab and Haryana High Court in the case of Allied Metal Products vs. CIT (1981) 25 CTR (P & H) 371:(1982) 137 ITR 689 (P & H). In that case, it was held that in view of the statutory provisions governing leases under the Transfer of Property Act, 1882, the lessee was bound to keep, and on the termination of lease to restore, the property in as good a condition as it was at the time when it was put in possession of the property. The assessee, vide cl. (iv) of the agreement of lease, had bound itself to keep the building in good condition. This good condition was to be seen with relevance to the purpose for which the lessee took the building on lease. Whitewashing was not the only step to keep the building in a good condition, some other steps were also necessary, according to the condition of the building, for its upkeep and maintenance in that condition. The building had to be kept in the worthy condition in which the business, for which it was taken, could be run. The lease commenced on September 1, 1968, but the repairs were not started immediately but after more than six months. Materials like cement, etc., were procured in April 1969. The roofs of the building were leaky. In that situation, for keeping the building in good condition during the term of the lease, which was for five years, extensive repairs were necessary. The leaks had to be stopped satisfactorily. If that was not possible, then the roofs had to be replaced. The repairs, in the peculiar circumstances of the case, could not be treated as a construction but had to be taken as a case of extensive repairs and to carry out any repairs to keep the building by the lessee in a good condition, no specific agreement was required at the time of the inception of the lease. Therefore, the amount of Rs. 22,301 expended by the assessee on the repairs of the leased premises was an allowable deduction under s. 30(a)(i) of the Act and the remainder out of the extensive repairs conducted in the interest of the assessee’s business for which it had taken the premises on lease was an expenditure of a revenue nature. The assessee was not the owner of the premises but was only a lessee for a period of five years. Even if the repairs to the roof were taken as an accretion of an enduring nature, the assessee did not acquire any interest of a permanent nature in it.

The roof was leaky and the landlord, on account of the meagreness or insufficiency of the rent, was not in favour of investing a sizeable amount of nearly Rs. 23,000 on the repairs.

9. He has also relied on a decision of the Allahabad High Court in the case of Girdhari Dass & Sons vs. CIT 1975 CTR (All) 156:(1976) 105 ITR 339 (All). In that case, the assessee was carrying on business in a rented building with the consent of the landlord. It was held that the expenditure incurred by the assessee on renovating, furnishing or remodelling of the business premises can be allowed as deduction under s. 37 of the Act, if the expenditure is not of a capital nature. It was held that when an owner incurs expenditure on addition or alteration in a building which enhances its value, the expenditure can be of a capital nature. But if a tenant incurs an expenditure on a rented building for its renovation or alteration, he does not acquire any capital asset, because the building does not belong to him. Ordinarily, such an expenditure will be of a revenue nature. To hold otherwise would amount to denying him the benefit of deduction of the expenditure at all because he will not be entitled to any depreciation allowance. Clearly, the assessee had not acquired an asset by incurring the expenditure on the rented shop.

10. In the light of the principles laid down in those decisions, we have to examine the facts of this case. The lessor was allowed to use and work in the factory including the plant and machinery during the subsistence of the lease. The lessee had the obligation to deliver vacant possession of the factory and the plant and machinery thereat in proper repair and running condition at the end of the lease. The lessor is the owner of the plant and machinery. The assessee is the lessee of the machinery and plant used by it for the purpose of its business. Clause 5(vii) of the lease agreement provides as follows : “If, during the continuance of the lease and in the course of running of the said factory, any machinery or any part thereof be broken or becomes out of order, the lessee shall repair or replace it with articles of similar nature and equal value at its own cost and expense.”

11. The assessee in this case replaced the machinery damaged in the course of the running of the factory. The terms and conditions as contained in cl. 5(vii) imposed an obligation upon the assessee to replace the machinery of the lessor if the machinery goes out of order in the course of running by the assessee. The lessee was bound to maintain the same and deliver it in good condition. The assessee surrendered the machinery valued at Rs. 29,372 for replacing the damaged machinery belonging to the lessor and it claimed the value of such machinery as a deductible expenditure in computing its total income. Any replacement made of plant and machinery would be to the advantage of the lessor and not to the advantage of the lessee. The lessee has only the right to use the said machinery. Even otherwise, replacement of the machinery cannot be treated as an improvement of the factory as such and the expenditure in such replacement cannot be treated as on capital account. It is with the object of keeping the factory in operation that the assessee had to replace the machinery in terms of the lease. In our view, where the lessee of the factory with plant and machinery has, in the performance of his obligation to maintain the machinery and plant and deliver it up in good condition, to replace the damaged machinery, he is entitled to deduction of the value of the surrendered machinery for replacement of the machinery belonging to the lessor, damaged in the course of running of the factory by the assessee in the course of its business. It is a case where the cost is a legitimate charge against the income as the damaged machinery has been restored to its original condition, and there is no improvement as such.

12. For the reasons aforesaid, we answer this question in the affirmative and in favour of the assessee.

There will be no order as to costs.

YUSUF, J.

I agree.

[Citation : 175 ITR 557]