If you know what you're doing, altering pieces can lead to absolutely fantastic results.
I guess I prefer aesthetic modifications over functional ones, though. Changing the look of a mask, or certain armour parts (for example to make them look semi-destroyed, corroded or similar) changes the general atmosphere of a MoC, and can really help you get your point across or make the character more believeable; it's an art from in itself.
Modifying parts so that you can achieve a certain build more easily, though... IMO it's a bit like cheating, because as others said, it's part of the challenge of building with Lego. Also, it's far more impressive to see what people can do with the "limited" options given by the building components (although IMO particularly Technic-pieces are surprisingly versatile...)
Then again, in the end it's always up to the MoCists how far they want to go and what they want to achieve with it. I'm just not sure whether it would be fair to enter heavily-modified MoCs in contests.
[...] But models with alterations and models without alterations cannot be judged according to the same terms. They demand entirely different types of creative thought and experience, and furthermore some methods of part alteration are not as accessible to everyone. Prohibiting non-official parts evens the playing field for contest entrants as much as possible without dictating specific parts builders are allowed to use.
I could imagine that adding an extra category for modified MoCs might work, though; the only problem with that is that I don't know what their quantity would be like - a special category for, say, 2 MoCs wouldn't make that much sense...