The courts are divided over deductibility of the premium. It is up to finmin to signal certainty
Land constitutes a significant portion of the overall cost incurred for setting up a manufacturing enterprise. One of the most common forms of acquiring land for setting up a manufacturing facility is to enter into a long-term lease arrangement with the lessor, generally a government authority. However, there is no clarity regarding the tax treatment of the initial lump-sum amount (commonly referred to as the premium) paid for acquiring land on long-term lease (i.e. acquiring leasehold rights) under the provisions of the Income-Tax Act, 1961.
If India aspires to achieve the targeted growth of over 25% in value-added manufacturing in 2034 as envisioned by PwC in its report Future of India—Winning Leap, there is a need for bringing clarity favourable to business with regard to the tax treatment of the initial amount paid for acquiring land on a long-term lease basis. This would also help the Make-in-India programme launched by prime minister Narendra Modi to prop up India on the global manufacturing map.
Based on the available judicial precedents, there seems to be three interpretations with regard to the above issue. First, the initial lump-sum amount is revenue expenditure and is deductible while computing the income. Second, this initial lump-sum amount is a capital expenditure and is disallowed while computing the income. Third, in case the initial lump-sum amount qualifies as capital expenditure, it needs to be decided whether it falls within the ambit of ‘any other business or commercial rights’ so as to be eligible for tax depreciation?
Judicial precedents have held that the premium amount paid for acquiring land on a long-term lease can be claimed as revenue expenditure. One of the most significant judgments was delivered by the Karnataka High Court, wherein it was held that the agreement created a lease in favour of the assessee and no other legal rights to the land as such were granted to the lessee. The Court said that the use of the term ‘premium’ in the agreement did not render payment anything more than rent paid in advance instead of paying that sum in the future periodically. It means that the lessee was entitled to deduction of the premium paid as business expenditure.
On the contrary, the Delhi High Court treated the premium paid at the time of allotment of land for a period of 90 years as capital in nature. The action of the Court was based on the following reasons: (1) The lessee, despite paying a substantial amount initially, had to pay 2.5% of the said amount as annual rent, which was subject to increase periodically. (2) The registration and stamp duty charges were borne by the lessee. (3) The restrictions imposed on the lessee were consistent with the nature of interest created, i.e. lease hold rights. (4) The tenure of the lease was quite substantial. (5) Exclusive possession was handed over to the lessee at the time of creation of the lease.
Another dimension to the above tax controversy is whether the initial lump-sum amount paid for acquiring tenancy rights (i.e. leasehold rights) would be eligible for depreciation under the provisions of the Income-tax Act? The Mumbai Tax Tribunal, in one of the important judgments, has held that the tenancy rights could not be considered as intangible assets. The tribunal observed that (1) the intangible assets eligible for tax depreciation includes such assets with which the business is directly carried on, i.e. which directly facilitate the profit earning activity. (2) The tenancy rights have no significance whatsoever either with the right to manufacture or actual manufacture of the products or their sale carrying a brand name or logo, etc. (3) A businessman can carry on manufacturing at any place but the business cannot be carried on without a licence, or without specific know-how, copyright, or trademark, etc.
It is evident from the above judicial precedents that the judiciary seems to be divided on the issue of deductibility of the initial lump-sum amount paid for acquiring land on long-term lease. Against this backdrop, it would have been a welcome step if the finance minister had provided much needed clarity on the same. This would have send out strong signals of a non-adversarial and investment-friendly tax regime, which is the focus area of this government.
By Kamal Abrol & Amit Singhal
Abrol is partner and Singhal is senior manager, (Tax & Regulatory) PwC India