Court Upholds Revenue Expenditure for Hotel Renovations

Case Name:** COMMISSIONER OF INCOME TAX VS MAC CHARLES (INDIA) LTD. **Key Takeaways:** 1. Expenditures incurred for repairs, replacement of old parts, and refurbishing of an existing hotel building are considered revenue expenditure, not capital expenditure, as long as they do not create a new asset or add extra capacity. 2. The test is whether the expenditure was incurred to "preserve and maintain" an existing asset, rather than to bring a new asset into existence or obtain a new advantage. 3. Increased revenue from the renovations does not automatically make the expenditures capital in nature - the key is whether a new asset was created. **Issue:** Whether the expenditures incurred by the hotel company for interior decoration, refurnishing, and replacement of old parts should be treated as revenue expenditure or capital expenditure for tax purposes. **Facts:** The assessee, a public limited company operating a hotel, incurred expenditures of Rs. 4.45 crores towards repairs, maintenance, and refurbishment of the hotel building. The tax authorities disallowed this expenditure, classifying it as capital expenditure. The assessee appealed this decision, arguing that the expenditures should be treated as revenue expenditure. **Arguments:** - The tax authorities argued that the expenditures constituted capital expenditure as they resulted in the creation of a new asset and provided enduring benefits to the assessee. - The assessee contended that the expenditures were merely for repairs, replacement of old parts, and refurbishing to maintain the existing hotel building, and did not create any new asset or extra capacity. **Key Legal Precedents:** 1. Ballimal Naval Kishore v. CIT (1997) 224 ITR 414 (SC): Expenditure for total renovation of an asset, including installing new machinery, furniture, fittings, etc. is capital expenditure, not revenue expenditure. 2. CIT v. Saravana Spinning Mills (P) Ltd. (2007) 293 ITR 201 (SC): Replacement of a specific machine in a textile mill is capital expenditure, not revenue expenditure. **Judgment:** The court ruled in favor of the assessee, holding that the expenditures incurred were in the nature of revenue expenditure and not capital expenditure. The key reasons were: 1. The assessee did not create any extra room capacity or floor space, but only refurbished and replaced existing facilities. 2. The expenditures were incurred to preserve and maintain the existing hotel building and its rooms, not to bring a new asset into existence. 3. The fact that the hotel's revenue increased after the renovations does not automatically make the expenditures capital in nature. **FAQs:** Q: Why did the court rule that the hotel's renovation expenses were revenue expenditure and not capital expenditure? A: The court found that the expenditures were incurred to preserve and maintain the existing hotel building and its rooms, rather than to create a new asset or add extra capacity. As long as the renovations did not result in a new asset coming into existence, the expenses were considered revenue in nature. Q: How did the court apply the legal precedents cited in the case? A: The court distinguished this case from the Ballimal Naval Kishore and Saravana Spinning Mills cases, where the expenditures involved total renovation or replacement of specific machines, creating new assets. In this case, the renovations were focused on maintaining and upgrading the existing hotel building, without adding new capacity. Q: What is the key test the court used to determine if an expenditure is revenue or capital in nature? A: The court stated that the basic test is whether the expenditure was incurred to "preserve and maintain" an already existing asset, or if it was to bring a new asset into existence or obtain a new advantage. If the former, then the expenditure is considered revenue in nature. Q: How did the increase in the hotel's revenue after the renovations impact the court's decision? A: The court held that the mere increase in revenue does not automatically make the expenditures capital in nature. The key question is whether a new asset was created, not whether the renovations led to higher profits.

1. The Revenue has preferred this appeal against the order dated 30.04.2009 passed by the Income Tax Appellate Tribunal, Bangalore Bench ‘B’ (hereinafter referred to as ‘the Tribunal’ for short) in ITA No.587/(BNG)/08. The Tribunal partly allowed the appeal and held that the expenses incurred by the assessee are to be allowed under the provisions of Section 37 of the Income Tax Act, 1961 (hereinafter referred to as ‘the Act’ for short), and setting aside the orders passed by the authorities below.

2. The assessee is a Public Limited Company carrying on the business of hotel. The Assessing Authority disallowed a sum of Rs.4,45,10,181/- towards expenditure incurred under repairs and Maintenance of the hotel building. The appeal by the assessee was dismissed. Aggrieved by the said order, the assessee preferred an appeal to the Commissioner of Income Tax (Appeals)-III, Bangalore (hereinafter referred to as ‘the First Appellate Authority’ for short). The First Appellate Authority dismissed the said appeal. Aggrieved by the said order, the assessee preferred an appeal to the Tribunal. The Tribunal held that the details of expenditure incurred for the repairs/renovation/ refurbishing of building, plant and machinery along with interior decoration expenses which in no way suggest that an item of enduring benefit has come into being requiring necessary maintenance of records for the life of the asset so installed requiring determination of scrap value, if any, at the end of their term. The target was therefore only the customers who are used to certain basic amenities when booking a room in a star rated international chain of hotels. Ambience and luxury are related terms which cannot be assigned a life or duration for a business house to capitalize for a term to claim depreciation. In such business reputation is at stake especially when it booms only when a repeat customer patronises it and records satisfaction for a third visit which only results meeting the variable costs and not the fixed costs. Therefore, the assessee cannot be suggested to capitalize the same when the intention was to purely come up to a standard required of it for being part of an International Chain. Therefore, the Tribunal held the said expenditure as revenue in nature and allowable as deduction under Section 37(1) of the Act. Aggrieved by the said order, the Revenue is in appeal before this court.

3. The appeal was admitted to consider the following substantial questions of law:

1. Whether the Tribunal was correct in holding that the expenditure incurred by the assessee towards interior decoration and refurnishing should be treated as a revenue expenditure when the assessee gained a enduring advantage and the same constitute capital expenditure?

2. Whether the Tribunal was correct in not taking into consideration that after incurred of expenditure towards interior decoration and refurnishing the total receipts of the assessee from room rents, restaurants, banquets and other services were increased from Rs.21.64 Crores to Rs.28.29 Crores and hence expenditure is capital in nature?

4. Learned counsel for the Revenue assailing the impugned order contended that the expenditure incurred on replacement of several items as mentioned in the impugned order would not constitute the nature of repair or current repair. It is incurred not for preserving or maintaining an already existing asset. The improvement so carried out has resulted in a new asset coming to existence and benefit therefrom is enduring in nature and therefore, the said expenditure has to be treated as capital expenditure. In support of his contention, he relied upon a judgment of Apex Court in the case of BALLIMAL NAVAL KISHORE AND ANOTHER v/s COMMISSIONER OF INCOME TAX reported in (1997) 224 ITR 414 (SC) and another judgment in the case of the COMMISSIONER OF INCOME TAX, ETC ETC. v/s SARAVANA SPINNING MILLS (P) LTD. reported in (2007) 293 ITR 201 (SC).

5. In BALLIMAL case, what the assessee did was not only mere repair, but total renovation of the asset by installing new machinery, new furniture, new sanitary fittings and new electrical wiring besides extensively repairing the structure of building. In that context it was held that by no stretch of imagination, can it be said that the said repairs qualify as “current repairs”. It was a case of total renovation and therefore, the High Court has rightly treated the said expenditure as capital in nature.

6. In SARAVANA SPINNING MILLS case, in the balance sheet of the assessee the expenditure was shown to have been incurred for purchase of a new asset. In that context, it was held that each machine in a segment has an independent role to play in the mill and the output of each division is different from the other. “Repair” implies the existence of a part of the machine which has malfunction. The textile plant consists of about 25 machines. One of such machines is the ring frame and thus machinery is replaced by a new machine. Therefore, it was held that the expenditure incurred for replacement of the new machine would not come within the meaning of the words “current repairs”

7. There cannot be any quarrel with the said proposition. In the aforementioned case, the Apex Court has prescribed the test. It is stated that the basic test to find out as to what would constitute current repairs is that the expenditure must have been incurred to “preserve and maintain” an already existing asset, and the object of the expenditure must not be to bring a new asset into existence or to obtain a new advantage.

8. Keeping the above principle in mind, when we look into the facts of this case, it is categorically stated in the assessment order, that the assessee-Company though not created any extra room capacity or any extra floor space but, the volume of expenditure incurred when considered to proportion of the total cost of the buildings, it will have to be treated only as a capital expenditure giving enduring benefit to the assessee. Further, the assessee though not created any extra space but by replacing the flooring, the false roofing, furniture, carpets, the refurbishing of the rooms in tune with the international standards of ‘Meridian SA’, the assessee-Company definitely derived an enduring benefit by an upward revision of the existing Tariffs for the hotel rooms and the upward revision of the charges for various other services rendered and attracting more number of international customers. The increase in the occupancy rate is evident from the total receipts admitted during the previous year from room rents, restaurants, banquets and other services which were Rs.28.29 crores as against Rs.21.64 crores in the earlier year. If that income is derived from reserving banquets and other services, that cannot be taken into consideration.

9. Merely because the income of the hotel has increased, it does not necessarily follow it is because of the refurnishing or repair work done to the hotel rooms. That may be one of the factor. The real test is whether all those acts constitute replacing the existing asset. The existing asset is the hotel building and its rooms. When no extra flooring space or extra room capacity is added on account of such repairs, it cannot be said that a new asset has come into existence. All these repairs are done to preserve and maintain an already existing asset. In the course of such repairs, if they have upgraded the facilities to international standards, then that would not constitute a new asset. Therefore, the Tribunal was justified in holding that the expenditure incurred towards repairs and replacement of old parts would be in the nature of revenue expenditure and not capital expenditure.

10. In that view of the matter, we do not see any merit in this appeal. The substantial questions of law are answered in favour of the assessee and against the Revenue. The appeal is dismissed.

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JUDGE

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JUDGE