Regularization fees for violation in construction form part of Construction & Depreciation allowable

ITAT CHENNAI, (THIRD MEMBER)

Dr. K. Senthilnathan

v.

Assistant Commissioner of Income-tax, Circle XIV, Chennai

IT Appeal NOS. 493 TO 495 (MDS.) of 2010

[Assessment years 2004-05 to 2006-07]

FEBRUARY 15, 2012

ORDER

Dr. O.K. Narayanan, Vice-President (As a Third Member) – There are three appeals. These appeals relate to the assessment years 2004-05, 2005-06 and 2006-07. The appeals are filed by Dr. K. Senthilnathan, the assessee. They are directed against the orders of the Commissioner of Income-tax (Appeals)-XII at Chennai, all dated 28-1-2010.

2. The assessee had constructed a hospital building. It was later found out that the assessee had violated certain regulations of Chennai Metropolitan Development Authority (CMDA) in constructing the said hospital building. Meanwhile, the Government of Tamil Nadu issued an Ordinance to add a new section 113A into the Tamil Nadu Town and Country Planning Act, 1971, whereby the State Government may regularize deviations made in constructing buildings. In the light of that Ordinance and the newly brought in section, the assessee opted for regularization of the violation. The violation alleged in the hands of the assessee in constructing the hospital building was thus regularized on payment of Rs. 18,41,787/- to CMDA as regularization fee. This amount was paid by the assessee in the previous year 2003-04, relevant to the assessment year 2004-05.

3. The return filed by the assessee for the assessment year 2004-05 was initially processed under section 143(1). Later on, the assessment was completed on a regular basis. Thereafter, in the course of assessment proceedings for the assessment year 2005-06, it was noticed that the regularization fee paid by the assessee has been capitalized and added to the cost of the hospital building and the assessee has claimed depreciation on that enhanced building cost. The Assessing Officer found that the Ordinance issued by the Government of Tamil Nadu was struck down by the Hon’ble Madras High Court as unconstitutional and, therefore, the sanctity of the regularization has been vitiated and in such circumstances the nature of regularization fee became penal. As the payment made by the assessee as regularization fee was in the nature of a penalty, the same cannot be allowed to be added to the cost of the building. So much so, the assessing authority held that the assessee was not entitled for depreciation on that additional amount capitalized by the assessee. Therefore, the assessing authority reopened the assessment for the assessment year 2004-05 and disallowed the differential amount of depreciation. Consequently, he disallowed the differential depreciation for the assessment years 2005-06 and 2006-07 as well. In first appeals, the above orders were confirmed by the Commissioner of Income-tax (Appeals).

4. The assessee came in second appeals before the Tribunal. The learned Judicial Member, who authored the order, found that the assessee is relying on the judgment of the Hon’ble Madras High Court in the case of CIT v. N.M. Parthasarathy, 212 ITR 105 as well as the judgment of the Hon’ble Delhi High Court rendered in the case of CIT v. Loke Nath & Co. (Construction), 147 ITR 624, in the light of which the assessee contended that even if the payment was construed as penalty, it was still allowable as an expenditure. The learned Judicial Member further observed that the Revenue is relying on the judgment of the Hon’ble Karnataka High Court rendered in the case of CIT v. Mamta Enterprises, 266 ITR 356, wherein the Court has characterized such payment as in the nature of penalty.

5. In the light of the above arguments, the Hon’ble Judicial Member held that he was in a quandary to decide the issue as such, and as a remedial measure, restored the issue to the file of the Assessing Officer for reconsideration. As the contentious issue has been remitted back to the assessing authority, he left open the question of reopening of the assessment for the assessment year 2004-05 with a permission to the assessee to agitate the issue, if so desired.

6. The learned Accountant Member could not agree with the order passed by the learned Judicial Member. The learned Accountant Member held that the actual cost of an asset has to be ascertained in terms of section 43(1) of the Income-tax Act, 1961. The said section nowhere requires exclusion of such part of the cost of an asset, which is penalty in nature. He observed that the genuineness of the expenditure is not in doubt and expenditure was in fact incurred and, therefore, it formed part of the cost of construction of the hospital building, which is used by the assessee for carrying on his business.

7. The learned Accountant Member thereafter referred to the judgment of the Hon’ble Karnataka High Court in the case of CIT v. Mamta Enterprises, 266 ITR 356. He found that the Court was examining the deductibility of a penalty paid by the assessee under section 37. The learned Accountant Member observed that in the present case the assessee was not claiming the regularization fee paid by him as a deduction under section 37. He is claiming only depreciation under section 32 as part of the cost of construction of the building. The judgment of the Hon’ble Karnataka high Court was delivered in the context of section 37 and not in the context of section 32. Therefore, he held that the said judgment of the Hon’ble Karnataka High Court is not applicable to the present case.

8. The learned Accountant Member accepted the contention of the assessee and held that the assessee is eligible for depreciation on the amount of regularization fee, as permissible under section 32. He allowed the appeals of the assessee on merit. As the issue has been decided on merit in favour of the assessee, the learned Accountant Member did not proceed further to decide the validity of the reopening of the assessment for the assessment year 2004-05, as according to him, the issue has become just academic.

9. In short, the learned Judicial Member remanded the issue back to the assessing authority, whereas the learned Accountant Member allowed the appeals filed by the assessee.

10. In view of the difference of opinion as stated above between the Members of the Tribunal, the matter was to be referred to a Third Member. Accordingly, the learned Judicial Member framed the point of difference as under and referred the same to the Hon’ble President of the Tribunal under section 255(4) of the Act:-

“Whether the assessee is eligible for claiming depreciation on a sum of Rs. 18,41,787/- paid to CMDA under the provisions of Section 133A of the Tamil Nadu Town and Country Planning Act, 1971 (as amended vide amending Acts 31 of 2000, 17 of 2001 and 7 of 2002) which was declared ultra vires and struck down by the Hon’ble Jurisdictional High Court, in the given facts and circumstances of the case or not?”

11. The learned Accountant Member framed different points as under and referred to the Hon’ble President of the Tribunal:-

“1.  Whether the payment of Rs. 18,41,787/- made to CMDA under the provisions of Section 133A of the Tamil Nadu Town and Country Planning Act, 1971 (as amended vide amending Acts 31 of 2000, 17 of 2001 and 7 of 2002), which was not refundable to the assessee forms part of the cost of hospital building to the assessee or not under section 43(1) of the Act?

 2.  Whether, the assessee was entitled to depreciation under section 32 of the Act in respect of the entire cost of hospital building including the payment made to CMDA, which was used by it for its business purpose or not?”

12. The Hon’ble President nominated me as the Third Member to resolve the issue in the light of the two sets of points of difference referred by the Hon’ble Members. It is how the issue has been placed before me.

13. I heard Shri R. Mugunthan, the learned chartered accountant appearing for the assessee and Shri K.E.B. Rengarajan, the learned standing counsel appearing for the Revenue.

14. There is no dispute on the facts of the case. The assessee had violated certain provisions of CMDA Regulations while constructing his hospital building. Later on, the Government gave an opportunity to such defaulters to regularize the violations by paying regularization fees. An Ordinance was issued by the Government of Tamil Nadu to operate the scheme. Later on, the Hon’ble Madras High Court quashed the Ordinance holding it as unconstitutional. At the same time, the Hon’ble High Court did not order the repayment of the regularization fees to the defaulters like the assessee. On the other hand, the Hon’ble High Court directed that the regularization fees collected should be kept aside in a separate fund and to be used to alleviate the sufferings of the affected citizens. It means that the assessee was not going to get back the regularization fee paid by him at any rate. Therefore, irrespective of the validity of the Ordinance proclaimed by the Government of Tamil Nadu, as far as the assessee is concerned, the amount paid by him as regularization fee is paid for once and all and the same will not be refunded to the assessee. Therefore, as a matter of fact, the said amount of regularization fee paid by the assessee forms part of the cost of construction of the hospital building.

15. Now, the question is whether such regularization fee paid by the assessee could be added to the cost of construction of the building for the purpose of claiming depreciation under section 32. The Revenue has relied on the judgment of the Hon’ble Karnataka High Court rendered in the case of CIT v. Mamta Enterprises, 266 ITR 356. The said decision is not applicable to the present case in hand. The Hon’ble Karnataka High Court was in fact examining the deductibility of penalty expenses under section 37 of the Income-tax Act, 1961. In the present case, the assessee has not made any such claim of deduction under section 37. Therefore, that decision does not apply to the case.

16. The case of the assessee is that as the amount paid by the assessee as regularization fee formed part of the cost of construction of the building, the same should be considered for granting depreciation allowance under section 32. Section 43(1) of the Income-tax Act, 1961 provides for computing cost of acquisition of assets. The regularization fee paid by the assessee has a direct nexus to the construction of the hospital building. The regularization fee was paid only for the purpose of regularizing the violations committed in the course of constructing the building. Therefore, the only account to which the payment for regularization fee could be booked is the construction account of the hospital building. Therefore, it is needless to say that the regularization fee paid by the assessee formed part of the construction cost of the hospital building. Once that particular payment formed part of the construction cost of the hospital building, the assessee is entitled for depreciation allowance on the entire cost of construction of the hospital building. The amount of regularization fee paid by the assessee cannot be excluded in computing the eligible depreciation allowance. Therefore, in the light of the facts of the case as well as in the light of the provisions of law stated in section 43(1), read with section 32, the assessee is entitled for depreciation.

17. Now the question is whether the regularization fee paid by the assessee partakes the character of a penalty and if so, whether the same can be booked at all anywhere in the business accounts of the assessee. It is to be seen that there was no penalty on the person of the assessee. There were certain violations as far as the building rules were concerned. As a matter of public policy, the State Government decided to regularize such buildings and exonerate the defaulters from the consequences of the violation of the regulation, on paying Regularization Fee. Such a step taken by the State Government has been held to be unconstitutional by the Hon’ble Jurisdictional High Court. But even then, the Hon’ble High Court has not directed to repay the amount to the defaulters. Therefore, the payment made by the assessee has become final. That payment has been made directly in connection with the construction of the hospital building, which is an asset used by the assessee in carrying on his business or profession. As far as the assessee is concerned, it was not an unlawful payment. It cannot be held that the payment could not be booked anywhere in the business accounts of the assessee. The assessee has rightly booked the payment under the cost of construction of the hospital building.

18. In the facts and circumstances of the case, I agree with the order of the learned Accountant Member that the assessee is entitled to claim depreciation on that amount of regularization fee paid by him, which has been capitalized to form part of cost of construction of the hospital building. I also agree with the learned Accountant Member that the question of reopening of the assessment for the assessment year 2004-05 has become just academic.

19. Accordingly, the appeals are to be allowed.

20. Now these files will be placed before the Regular Division Bench for passing orders to finally dispose of the case on a majority view.