Commissioner Of Income Tax vs Sea Lord Hotel (P) Ltd.

S. Saawarasubbam J. The above reference is at the instance of the revenue under section 256(1) of the Income Tax Act, (hereinafter referred to as 'the Act'). The following questions are referred for the consideration of this court:

"1. Whether, on the facts and in the circumstances of the case, the hotel building is a plant entitled to depreciation at 15 per cent ?

2. Whether, on the facts and in the circumstances of the case and also for the reasons stated in enclosure to the reference application, the Tribunal is right in law and fact.

(i) in holding that the expenditure is a capital expenditure as it was incurred in connection with or incidental to the acquisition of the capital asset ?

(ii) in upholding the claim of the assessee for deduction of depreciation in respect of the amount of Rs. 6,31,267 ?

With regard to question No. 1, it is covered by the decision of the Supreme Court in CIT v. Anand Theatres. etc. etc. (2000) 15 DTC 579 (SC) : (2000) 244 ITR 192 (SC). The Supreme Court has held that the building used for running a hotel or cinema business is not plant for the purpose of depreciation.

2. On the basis of the above decision, the question is answered in the negative and against the assessee.

3. Relevant facts for the purpose of deciding question No. 2 are as follows :

Assessee was running a hotel by name Sea Lord Hotel (P) Ltd. Assessee claimed allowance of depreciation of a sum of Rs. 6,31,257, which was paid by the assessee as compensation to the retrenched employees. The hotel was closed with effect from 28-7-1980 on account of labour problems, when it was in the hands of the previous owner. As per the agreement with the previous owner, the hotel was to be transferred to the assessee on 25-4-1981. In the agreement, there was a clause stating that all the workers were paid compensation under section 25FF of the Industrial Disputes Act, 1947. According to the terms of the agreement, the purchaser was to discharge the liabilities in respect of the sundry creditors and debtors. The agreement further stipulated that the purchaser would not be liable to meet any other liabilities pertaining to the business undertaking which has been incurred by the vendor.

4. After the hotel was purchased by the assessee, a settlement was arrived at between the managing partner of the assessee and the representatives of the workmen that an amount of Rs. 6,31,267 should be paid as compensation to the employees, who were retrenched by the earlier management. In the original assessment, the assessee had claimed depreciation on the above amount treating it as capital expenditure, but this claim had been disallowed. In the fresh assessment, the assessee claimed it as a revenue expenditure. This was disallowed on the ground that it was not a liability of the transferee. According to the assessee, it had to incur the liability in order to run the business and, therefore, the same should be allowed as revenue expenditure. Alternatively, it was contended that it should be allowed as a capital expenditure and depreciation on the same should be allowed. The assessing officer treated it as capital, but did not grant depreciation. The Commissioner (Appeals) held that it is a capital expenditure and disallowed the depreciation on the ground that the expenditure was not part of the purchase consideration and that the amount was not paid as per the terms of the agreement between the transferor and the transferee.

5. Tribunal took the view that the assessee was not under an obligation to pay retrenchment compensation to the workers of the previous owner of the business. It was of the view that the assessee could not have conducted the business unless the compensation was paid to the workers. Hence, it was of the view that the compensation can be viewed as a capital expenditure in connection with or incidental to the acquisition cost of the asset. It held that the expenditure was a capital expenditure and it was incurred in connection with or incidental to the acquisition of the capital assets and uphold on principle the claim of the assessee for deduction of depreciation in respect of the amount of Rs. 6,31,267. For the purpose of quantifying the depreciation, the amount is to be apportioned among the various assets brought into the books upon purchase in the ratio of the value at which they have been stated in the books of accounts.

6. Learned senior counsel appearing for the revenue submitted that the department does not dispute the findings of the Tribunal that the expenditure was a capital expenditure. But contended that this cannot be held to be incurred in connection with or incidental to the acquisition of the capital assets. Learned counsel contended that retrenchment compensation was not a liability of the purchaser and was not embedded in the assets transferred to the assessee. No tangible assets were brought into existence to enable the assessee to claim depreciation. This expenditure can only be considered as any other expenditure incurred by the assessee before the commencement of the business. Assessee has discharged the liability on behalf of the seller. Therefore, no asset has emerged on which depreciation can be allowed. It is also not going to increase the value of various assets purchased by the assessee. This does not form part of the purchase consideration.

7. Advocate Shri Roy Chacko for the assessee contended that as a matter of fact, the expenditure was a revenue expenditure. But the Tribunal accepted only the alternative contention of the assessee that it is a capital expenditure without considering the question whether it was revenue expenditure. Further, he contended that but for the expenditure being made by the assessee, it could not have made use of the building for the purpose for which it was purchased. Hence, he submitted that this should also be taken as expenditure involved in connection with the acquisition of assets.

8. It is now not disputed that the amount that was paid as retrenchment compensation by the assessee was a liability of the seller. It did not form part of purchase consideration of the hotel. The amount was spent not for the purpose of acquisition of the hotel building. Because, according to us, as soon as the sale consideration was paid, the assessee had acquired the assets. The amount of retrenchment compensation does not form part of the sale consideration. It cannot also be said that the expenditure of the above amount did result in the improvement of the capital assets in the sense that there was an increase in the value thereof. Assessee is not entitled to depreciation. In Sitalpur Sugar Works Ltd. v. CIT (1963) 49 ITR 160 (SC) the Supreme Court held that no depreciation could be claimed because no tangible asset was acquired by the expenditure and no improvement was made in any capital asset in the sense that there was an increase in the value thereof.

9. We are of the view that, the Tribunal was not correct in holding that capital expenditure was involved in the acquisition of assets. In order to entitle to deduction, there has to be improvement in the capital assets. According to us, there has been no improvement in the capital assets. At the most, it could be said that the expenses incurred for acquiring an advantage for the trade. Appellant cannot claim depreciation on the amount spent for acquiring an advantage. Learned counsel for the assessee then submitted that as a matter of fact, the assessee has an alternative case that it was the revenue expenditure, but it was not considered by the Tribunal. In this reference application, we are only concerned with the questions referred to us. The question now raised by the respondent does not form any facets of question of law referred. Hence, we cannot consider the contention raised by the respondent.

10. In the above view of the facts, we hold that even though the expenditure is found to be a capital expenditure, it was not incurred in connection with or incidental to the acquisition of the capital assets and that the Tribunal was not right in upholding the claim of the assessee for deduction of Rs. 6,31,267.

11. In the result, the first question is answered in the negative and against the assessee. Question No. 2 consists of two clauses. The questions raised in both the clauses are answered in the negative and against the assessee.