Vardhman Developers Ltd vs. ITO (ITAT Mumbai)
Expenditure towards repair and renovation of leased premises is capital in nature. Method for allocation of common expenses to different WIP projects of a builder explained
(i) Expenditure towards false ceiling, fixing tiles/flooring, replacing glasses, wooden partitions, replacement of electrical wiring, earthing, replacement of G.I. pipes, plumbing and sanitation lines, plaster and painting of walls of leased premises cannot be regarded as ‘current repairs’. ‘Repairs’, though a term of wider scope, yet cannot extend beyond that of the term itself. A repair, by definition, is toward the maintenance and preservation of an ‘existing’ asset. Surely, the advantage or asset, in terms of its functional utility and capacity for the business, needs to be maintained, so that expenditure for retaining the same is essentially revenue expenditure, which, again, by definition, does not lead to or result in an enhancement or improvement. The premises in the instant case was admittedly not in use for a long time and, thus, in a dysfunctional, if not dilapidated, state prior to it being acquired by the assessee. The expenditure stands thus incurred on refurbishment and renovation of an old premises, in an inoperable state, so as to make it fit for use. It is therefore wrong to classify or describe it as ‘repairs’. The expenditure was incurred to render it in a functional state and, therefore, is clearly in the capital field. Could, one may ask by way of a test, the answer be any different if the same was acquired on own account? The ingredients and prerequisites of a capital expenditure would remain the same, and not undergo any change depending on the object matter of the expenditure, i.e., whether an owned or leased premises, and which itself is the premise of Explanation 1 to section 32(1)(ii), invoked by the Revenue (Ballimal Naval Kishore v. CIT [1997] 224 ITR 414 (SC) & New Shorrock Spinning & Mfg. Co. Ltd. v. CIT [1956] 30 ITR 338 (Bom) referred). On the termination or expiry of the lease or rent arrangement, leading to the vacation of the premises, the assessee would continue to be entitled to claim deduction on the written down value (WDV) of the relevant block of assets, subject to the adjustment in respect of ‘moneys payable’, if any, as explained by the tribunal in Metro Exporters Pvt. Ltd. (in ITA No. 7315/Mum/2012 dated 30.09.2014, as modified by its’ further order dated 30.01.2015). Reliance by the assessee on the decision in the case of CIT vs. Hi Line Pens (P.) Ltd. [2008] 306 ITR 182 (Del) is misplaced.
(ii) The assessee being a builder and developer, Accounting Standard 7 (AS-7), issued by the ICAI, titled, ‘Construction Contracts’, would not apply, so that the prescription of AS-9 and AS-2, based on general principles that govern any business, would apply for the revenue recognition and inventory valuation respectively. Only costs incurred toward a particular project, or otherwise related to construction activity, would stand to be allocated and, thus, capitalized as a part of the project cost. ‘Capitalized’ here is not to be construed in the regular, classical sense of the relevant expenditure being not of revenue nature, but only in the sense of it being accumulated under a particular head of account (i.e., WIP), for being set off, under the matching principle, at the time the corresponding revenue is recognized. Indirect costs could therefore include only production/project overheads, and not general office and administrative expenses. The assessee has not specified the duties allotted to different employees or the functional responsibility of the directors. Identification of individual sites, besides work in relation to site preparation, clearances, project supervision or overseeing project execution, etc., would understandably form part of the director’s duties. Further, we do not observe any employee costs in the expenses allocated to the various projects. Managerial and supervisory costs are necessary inputs to project execution. We, accordingly, consider 50% of the personnel costs, claimed at Rs.40.22 lacs, i.e., including director’s remuneration, as liable for inclusion in the project cost, to be allocated on some systematic or rational basis which would capture project execution, which is a composite activity commencing with site identification to the construction in a deliverable state. No such proportion could be applied to rent, rates and taxes which constitutes the second major component of the impugned expenditure. The same would need to be examined with reference to the purpose for which each item comprising the same is incurred, to be decided accordingly. If not for any specific project, no part of the said cost could be capitalized. Rent for office premises, however, if forming part thereof, would stand to be allocated on the basis of the balance expenditure. Again, as no particulars in respect of these expenses stand specified; the account head describing only the nature of the expense and not its purpose or the activity in relation to which it is incurred, we consider 20% of such expenditure to be allocable to WIP toward project overhead cost, again on the same parameter as applied to the personnel costs.
(iii) Expenditure on architect & engineering fees, tender & survey expenses and other miscellaneous expenses incurred for a project that was not awarded to it cannot be allocated to any of the projects, work in respect of which is under execution as at the year-end. Similarly, advertisement, sponsorship and brand-building expenses are only in the nature of selling costs, i.e., of the construction business, and which would not therefore stand to be capitalized, in-as-much as the same could only be in respect of a direct cost which adds value to or otherwise adds to its cost of production to the assessee. As regards the argument of there being no corresponding income, or it being not relatable to any revenue stream, the same is to our mind of little consequence. As long as the assessee is carrying a particular business during the year, income there-from has to be computed u/s.28 of the Act, allowing it all permissible deductions, i.e., in accordance with the provisions of sections 30 to 43D (refer section 29). Whether the method of accounting followed by the assessee, i.e., the project completion method, is a correct method in accordance with the law, i.e., given that it follows mercantile method of accounting, is another matter altogether, which has not been impugned by the Revenue in any manner.
Expenditure towards repair and renovation of leased premises is capital in nature. Method for allocation of common expenses to different WIP projects of a builder explained
(i) Expenditure towards false ceiling, fixing tiles/flooring, replacing glasses, wooden partitions, replacement of electrical wiring, earthing, replacement of G.I. pipes, plumbing and sanitation lines, plaster and painting of walls of leased premises cannot be regarded as ‘current repairs’. ‘Repairs’, though a term of wider scope, yet cannot extend beyond that of the term itself. A repair, by definition, is toward the maintenance and preservation of an ‘existing’ asset. Surely, the advantage or asset, in terms of its functional utility and capacity for the business, needs to be maintained, so that expenditure for retaining the same is essentially revenue expenditure, which, again, by definition, does not lead to or result in an enhancement or improvement. The premises in the instant case was admittedly not in use for a long time and, thus, in a dysfunctional, if not dilapidated, state prior to it being acquired by the assessee. The expenditure stands thus incurred on refurbishment and renovation of an old premises, in an inoperable state, so as to make it fit for use. It is therefore wrong to classify or describe it as ‘repairs’. The expenditure was incurred to render it in a functional state and, therefore, is clearly in the capital field. Could, one may ask by way of a test, the answer be any different if the same was acquired on own account? The ingredients and prerequisites of a capital expenditure would remain the same, and not undergo any change depending on the object matter of the expenditure, i.e., whether an owned or leased premises, and which itself is the premise of Explanation 1 to section 32(1)(ii), invoked by the Revenue (Ballimal Naval Kishore v. CIT [1997] 224 ITR 414 (SC) & New Shorrock Spinning & Mfg. Co. Ltd. v. CIT [1956] 30 ITR 338 (Bom) referred). On the termination or expiry of the lease or rent arrangement, leading to the vacation of the premises, the assessee would continue to be entitled to claim deduction on the written down value (WDV) of the relevant block of assets, subject to the adjustment in respect of ‘moneys payable’, if any, as explained by the tribunal in Metro Exporters Pvt. Ltd. (in ITA No. 7315/Mum/2012 dated 30.09.2014, as modified by its’ further order dated 30.01.2015). Reliance by the assessee on the decision in the case of CIT vs. Hi Line Pens (P.) Ltd. [2008] 306 ITR 182 (Del) is misplaced.
(ii) The assessee being a builder and developer, Accounting Standard 7 (AS-7), issued by the ICAI, titled, ‘Construction Contracts’, would not apply, so that the prescription of AS-9 and AS-2, based on general principles that govern any business, would apply for the revenue recognition and inventory valuation respectively. Only costs incurred toward a particular project, or otherwise related to construction activity, would stand to be allocated and, thus, capitalized as a part of the project cost. ‘Capitalized’ here is not to be construed in the regular, classical sense of the relevant expenditure being not of revenue nature, but only in the sense of it being accumulated under a particular head of account (i.e., WIP), for being set off, under the matching principle, at the time the corresponding revenue is recognized. Indirect costs could therefore include only production/project overheads, and not general office and administrative expenses. The assessee has not specified the duties allotted to different employees or the functional responsibility of the directors. Identification of individual sites, besides work in relation to site preparation, clearances, project supervision or overseeing project execution, etc., would understandably form part of the director’s duties. Further, we do not observe any employee costs in the expenses allocated to the various projects. Managerial and supervisory costs are necessary inputs to project execution. We, accordingly, consider 50% of the personnel costs, claimed at Rs.40.22 lacs, i.e., including director’s remuneration, as liable for inclusion in the project cost, to be allocated on some systematic or rational basis which would capture project execution, which is a composite activity commencing with site identification to the construction in a deliverable state. No such proportion could be applied to rent, rates and taxes which constitutes the second major component of the impugned expenditure. The same would need to be examined with reference to the purpose for which each item comprising the same is incurred, to be decided accordingly. If not for any specific project, no part of the said cost could be capitalized. Rent for office premises, however, if forming part thereof, would stand to be allocated on the basis of the balance expenditure. Again, as no particulars in respect of these expenses stand specified; the account head describing only the nature of the expense and not its purpose or the activity in relation to which it is incurred, we consider 20% of such expenditure to be allocable to WIP toward project overhead cost, again on the same parameter as applied to the personnel costs.
(iii) Expenditure on architect & engineering fees, tender & survey expenses and other miscellaneous expenses incurred for a project that was not awarded to it cannot be allocated to any of the projects, work in respect of which is under execution as at the year-end. Similarly, advertisement, sponsorship and brand-building expenses are only in the nature of selling costs, i.e., of the construction business, and which would not therefore stand to be capitalized, in-as-much as the same could only be in respect of a direct cost which adds value to or otherwise adds to its cost of production to the assessee. As regards the argument of there being no corresponding income, or it being not relatable to any revenue stream, the same is to our mind of little consequence. As long as the assessee is carrying a particular business during the year, income there-from has to be computed u/s.28 of the Act, allowing it all permissible deductions, i.e., in accordance with the provisions of sections 30 to 43D (refer section 29). Whether the method of accounting followed by the assessee, i.e., the project completion method, is a correct method in accordance with the law, i.e., given that it follows mercantile method of accounting, is another matter altogether, which has not been impugned by the Revenue in any manner.
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