Whether when assessee incurs certain expenditure on abandoned project, even if such expenses are pre-operational in nature, it is to be allowed as revenue expenditure - YES: HC

THE issues before the Bench are - Whether the expenses on lease-rent can be claimed as revenue expenditure when lease agreement has all the features of a hire-purchase agreement; Whether when there is a binding obligation on the hirer to utimately purchase the leased asset, it is a case of hire purchase; Whether there is any difference between the 'lease' and 'hire purchase' transactions and Whether when the assessee incurs certain expenditure on abandoned project, even if such expenses are pre-operational in nature, it is to be allowed as revenue expenditure. And the verdict goes against the Revenue.

Facts of the case

A) Assessee

had entered into a lease agreement which as per the Revenue's counsel was a camouflage and in fact it was a hire-purchase agreement. During assessment, AO had given cogent reason for holding the agreement to be hire-purchase agreement and, therefore, was justified in rejecting the claim of the assessee as an expenditure. It was also submitted that from the earlier agreement and subsequently entered agreement it was clear that there are material changes in the terms and conditions of the agreement and the assessee has been given right to purchase the Air Conditioner on payment of nominal price of Rs. 1/- only, therefore, the Tribunal had wrongly held the same as a lease agreement. It was also submitted that the petitioner claimed benefit because of the subsidy given to the school under the provisions of Section 40A(9).

On the other hand, assessee's counsel submitted that in fact both the questions are are questions of fact. It was submitted that as the Tribunal held that it was a lease agreement, thus there was no question of law remained in the case. There was also a condition in the agreement that the assessee had to maintain the AC during the period of lease and option was also given to the assessee to purchase the same at the end of the lease term. But as the assessee had not exercised the option and the sale transcation was not completed. Regarding education subsidy assessee relied upon the judgment of Mahindra & Mahindra Ltd. Vs. CIT, wherein it was held that when the assessee company had paid certain amount to a educational society which runs the school in which children of the employees of the company study, then in that situation the amount should be allowed as business expenditure because it was incurred predominantly for civil welfare. It was submitted that the said subsidy was paid in pursuance of the agreement entered into between the assessee company and the Labour Union, therefore, predominant purpose was for the welfare of the workmen.

B) Assessee had claimed that an expenditure incurred in contemplation of a project, which was not completed and thus abandoned, was abortive in nature. During assessment AO rejected the claim of the assessee on the ground that it was a capital expenditure. On further appeal, CIT(A) also upheld the AO's order, but the Tribunal had reversed the finding.

Having heard the parties, the High Court held that,

A) ++ as per Halsbury's Laws of England, the test is whether there is or there is not, a binding obligation on the part of the hirer, to buy. If the agreement does not amount to a binding obligation on the hirer to complete the transaction as a purchase but is merely an agreement to hire with an option on the part of the hirer to purchase, it is not an agreement to buy within the Factors Act, 1889, or the Sale of Goods Act, 1893 and a purchaser or pledgee from the hirer can in such case obtain no better title than the hirer had, except in the case of a sale in market overt. If there is reserved to the hirer power to return the goods, either during the hiring thereby determining the bailment, or after the conclusion of the hiring and before the payment of such further sum as is required to complete the purchase, the agreement to hire with an option to buy, and even if the hirer in such a case by parting with the goods puts it out of his power to return them, he does not thereby become bound to buy. But an agreement whereby a person agrees to hire goods by paying the owner of them by stating instalments a fixed sum, which is to be the purchase price of the goods, is, in the absence of a provision enabling that person to determine the hiring, an agreement to buy the goods with the provisions of the Factors Act, 1889, and the Sale of Goods Act, 1893;

++ in the case of Helby V. Mathews, it was held "that the hirer was under no legal obligation to buy, and that the hirer could either return the piano or exercise his option to purchase the piano. It was further observed that we could not concur in the view of the Court of Appeal that upon the true construction of the agreement Brewster had “agreed to buy”. It was held that there was no obligation on Brewster to buy it.” There is a lot of difference between the purchase, hire-purchase and lease agreement. In this case, we are of the considered opinion that the terms indicate that the provider of the machines was required to maintain the machines and, therefore, he was entitled to take the rent also as per the terms of the agreement, and the petitioner, in the any relevant year could not have exercised his right to purchase the AC, his right to purchase the AC could have been exercised after expiry of certain period of time. Therefore, in that situation, we are of the considered opinion that there was an agreement for lease only and the Tribunal was right in holding so;

++ we are of the considered opinion that the Tribunal has given cogent reason for allowing payment of subsidy amount to the school as revenue expenditure in view of the fact that the subsidy was liability of the assessee in view of the agreement entered into between the Employees' Union and the assessee which is in consonance with the welfare scheme of the Industrial Disputes Act, 1947. Same view has been taken by the Bombay High Court in Mahindra & Mahindra Ltd;

B) ++ in the case of Indo Rama Synthetics (I) Ltd. Vs. CIT, it has been held that if expenditure has been incurred for setting up a new unit which was subsequently abandoned, then the aforesaid expenditure will be treated as revenue in nature as no new industrial asset came in existence. Substantially this is also a question of fact where an expenditure incurred by the assessee was of the revenue in nature or it was a capital expenditure. It is not in dispute that the project could not be accomplished because of the reason that the place where it was to be undertaken had a poor quality of soil and all the construction already damaged. The other articles bought by the assessee also got damaged and, therefore, in that fact situation, the Tribunal was fully justified in holding that such expenditure which may be pre-operational expenditure for a project can be treated to be a revenue expenditure actually and not a capital expenditure.