Madras H.C : In the case of “Finance Lease” transaction the entire lease rental should be offered as income contrary to the Accounting Standard-19 dealing with accounting of leases issued by the Institute of Chartered Accountants of India

High Court Of Madras

Simpson And General Finance Co. Ltd. vs. DCIT, Co. Circle -I(2)

Section 28(I), 32

Mrs. Chitra Venkataraman And T.S. Sivagnanam, JJ.

Tax Case (Appeal) Nos. 124 To 130 Of 2014

M.P. No. 1 Of 2014 (6m.Ps.)

March 21, 2014


Mrs. Chitra Venkataraman, J. – The assessee seeks a decision of this Court on the following questions of law:

‘1. Whether on the facts and circumstances of the case the Tribunal was right in law in holding that in the case of “Finance Lease” transaction the entire lease rental should be offered as income contrary to the Accounting Standard-19 dealing with accounting of leases issued by the Institute of Chartered Accountants of India?

2. Whether on the facts and circumstances of the case the Tribunal was justified in not directing the assessing officer to consider that in the case of financial lease only the interest income accrued to assessee should be taxed and not the entire lease rental as assessed by him and consequentially withdraw the claim of depreciation on leased assets?’

2. The assessment order herein arises out of the common order of the Income Tax Appellate Tribunal relating to the assessment years 2002-03; 2003-04; 2004-05; 2005-06; 2006-07; 2007-08 and 2008-09.

3. The assessee is stated to be in the business of bill discounting, hire purchase and leasing, mutual funds and insurance agency. In the returns filed for the respective assessment years, the assessee offered interest portion alone in the leasing transaction as its income. It is stated that as per the amended Accounting Standard 19 dated 01.04.2001, only the income portion of the lease rental shall be offered as income and the lessor cannot claim depreciation. Accordingly, the assessee treated the lease transaction as financial lease transaction. However, in the returns filed, the assessee claimed depreciation on the leased assets stated to be based on the CBDT Circular dated 9th February 2001, wherein it was stated that even in financial leases, the lessor could claim depreciation. The Assessing Officer, however, viewed that offering the interest portion of the lease rent alone for income tax purposes but at the same time claiming depreciation on the leased assets, the assessee had attempted on a double benefit. When this was put to the assessee, the assessee explained through a written submission that upto financial year 2001-02, the cost of the asset was capitalised in the books of accounts under the head fixed assets and necessary depreciation was provided thereon. However after the introduction of Accounting Standard 19, the Company had accordingly followed the standard as mandatory under Section 211(3C) of the Companies Act,1956 and the lease was treated as current asset and not the fixed asset, hence, no depreciation was charged in the books of accounts for the financial year 2001-02. While agreeing with the assessee, that as per Accounting Standard 19 in the case of financial lease, the asset was treated as receivable amount equal to net investment in the lease, for income tax purpose in respect of lease rent also, the entire lease rent was taxed as income of the lessor. The Officer reasoned out that the computation of taxable income has to be done after taking into account the various additions and deductions in accordance with Accounting Standard 19. He further pointed out that total lease rent received and the depreciation claimed clearly tantamounted to double deduction to the assessee and the method of accounting followed by the assessee in respect of lease transaction was not giving a true and correct picture of the income of the assessee. The Assessing Officer thus ultimately came to the conclusion on scrutiny of the accounts, that the entire least rent was taxable as income of the lessor and the lessor was entitled to depreciation on the equipments.

4. The assessee went on appeal before the Commissioner of Income Tax (Appeals) questioning the assessment. Giving up its case on depreciation, the assessee contended that the treatment of the transaction in the books of accounts as per Accounting Standard 19 would outweigh the contract entered into with the lessee. The Commissioner pointed out that in the assessee’s case, it was the owner of the asset and it claimed depreciation as owner and thus rentals were received normally in 36 instalments. The Commissioner of Income Tax (Appeals) pointed out that the Assessing Authority after analysing the sample copies of the lease agreement came to the conclusion and that the said order of assessment did not call for any interference and held that the entire lease rent received by the assessee is taxable at its hands. Consequently, the appeal was dismissed.

5. Aggrieved by this, the assessee went on appeal before the Income Tax Appellate Tribunal. The Tribunal pointed out that once the depreciation was claimed by the assessee on the leased assets, it was imperative that the whole of the lease rental was liable to be shown as income. Whatever be the Accounting Standard followed by the assessee, it was not open to the assessee to contend that lease rentals were not to be considered as income; but at the same time, claimed depreciation on the leased assets. Thus, the Tribunal held that the treatment given by the Assessing Officer confirmed by the Commissioner of Income Tax (Appeals) could not be faulted. Thus, the Tribunal confirmed the order of assessment. Aggrieved by this, the present appeals have been filed.

6. Learned counsel appearing for the assessee submitted that the assessee company was engaged in providing finance by way of hire purchase lease. The transactions entered into by them were pure financial lease. Prior to 01.04.2001, there was no Accounting Standard for leasing transaction. Thus operating lease and finance transaction were treated at par. Further after Accounting Standard 19 introduction, the distinction has to be seen and thus rightly it offered only the interest income treating the lease as financial lease. Considering the requirement following Accounting Standard 19 in the case of financial lease and the terms of the lease agreement entered into between the parties, there could be no two opinion that the transactions were pure and simple a financial lease, which is in accordance with Accounting Standard 19. The lease entered into after 01.04.2001 is shown in the balance sheet under Investments/Current Assets Loans and Advances/Net Investment on leases. Whereas the lease entered into prior to 01.04.2001 are shown as fixed assets or leased assets.

7. Learned counsel pointed out that the Tribunal ignored the fact that the transaction were nothing but financial lease transaction and it had categorised the same in its accounts too. In the circumstances, the Income Tax Appellate Tribunal committed a serious error in ignoring the requirement under Accounting Standard 19 being complied with by the assessee. He placed reliance on the decision of the Delhi High Court in CIT v. Instalment Supply Ltd. [2012] 207 Taxman 19/20 779 and prayed for setting aside the order of the Tribunal. In support of his contention, learned counsel also placed before us the copy of the lease agreement etc.

8. A reading of the sample lease agreement placed before this Court with the Madras Advertising Co. Pvt. Ltd., dated 28.08.2008 show that in respect of lease of a car, the terms of lease was stated to be three years, with monthly rentals and total rentals payable. The terms of the lease agreement further point out that the lessor takes on lease the goods described in the Schedule on terms and conditions set forth in the Schedule. Clause 2 of the agreement relates to Delivery of Equipment. Clause 3 on rent payments and Clause 4 on ownership, which reads as under:

“The Equipment shall at all times remain the sole and exclusive property of the Lessor and the Lessee shall have no right, title or interest therein except as Lessee”.

The agreement further states that during the currency of the lease, the lessee shall insure the subject of lease and protect it from any risk. Clause 10 of the agreement states that without the prior written consent of the lessor, the lessee shall not make any alterations, additions or improvements to the equipment and all additions, replacements, attachments and improvements of whatever kind or nature made to the equipment shall be deemed to be parts of the property of the lessor and shall be subject to all the terms and conditions of the agreement. Clause 13 speaks about the surrender of the lease equipment upon the expiration of earlier termination of the lease agreement. It also gives the option for renewal on year to year basis on mutually agreed terms and conditions. Clause 15 deals with payment by lessor and Clause 20 is to the effect of the expiration of the lease, which stipulates that on expiration of the lease term, if the lessee fails to deliver the equipment to the lessor in accordance with any direction given by the Lessor, the lessee shall be deemed to be the monthly tenant of the equipment and upon the same terms expressed in the agreement and the tenancy should be terminated by the lessor immediately upon default committed by the lessee by serving seven (7) days notice. Clause 19 speaks about the default clause and the termination by default under Clause 24. Clause 33 speaks about the Assignment rights stating that no title or right in the property shall be passed to the lessee except the lease rights expressly granted to the lessee. It also stipulates that plates or other marking shall be fixed indicating that the lessor is the owner thereof and that the lessee would not remove the same. Upon termination of the lease period, the lessee shall immediately return the said property to Lessor in as good condition and received less normal wear, tear and depreciation. Clause 34 speaks about the Modification to rental payments during lease tenor. One of the Clauses under this head reads as follows:

“…. Without prejudice to the above, it is hereby agreed that at the option of the LESSOR the Lease Agreement will be reviewed if there is any material changes in the provisions of the Income Tax Act regarding leasing transaction. This review will also include, apart from changes in the rentals, cancelling of the Lease Agreement and replacing it with Hire Purchase transaction on mutually agreed terms.

It is further agreed that if the LESSOR is refused allowances or their claims are disallowed by the Income Tax Authorities on account of the failure on the part of the LESSEE to furnish any particulars/declaration required for this purpose, the LESSEE shall reimburse the LESSOR tax, interest, penalty or any outgo accruing or arising to the LESSOR on this account.”

9. On a reading of the terms of the agreement, we find that the agreement is a lease agreement sample and that there is nothing in the agreement to speak about mere financing for the purchase of an equipment as it had been contended by the assessee.

10. Learned counsel for the assessee however, submitted that the equipment leased out is one which the lessee had purchased. Consequently, the agreement has to be seen only as a finance agreement. We do not find any justification to accept this as a ground for holding the agreement as a finance lease agreement. If in effect the agreement is finance agreement, the question of returning the leased item back to the assessee will not arise at all. Further, the question of again affixing the name of the assessee on the property also does not arise. The fact that the equipment is delivered by the supplier to the location of the assessee thus by itself, will not make the agreement, the Finance Agreement and the terms thus seen are matters of arrangement between the parties, which in effect clearly points out that it is only a simple lease agreement and not a finance agreement. As has been contended by the Revenue, even in the calculation of the lease rental, the monthly repayment of the rent and the number of months of the lease rent payment is also clearly stated in the agreement.

11. In the circumstances, we do not think any justifiable ground to accept the case of the assessee that based on Accounting Standard 19 only that the agreement in question was entered into by the assessee and it has to be treated as the finance agreement.

12. As far as the reliance placed on the decision of the Delhi High Court [cited supra] is concerned, we do not find that the assessee could draw any strength from the said decision. The Delhi High Court discussed about the distinction between the “finance agreement” and the “operational lease” with reference to the decisions of the Apex Court and ultimately remitted the case for fresh consideration. As had been pointed out in the decision reported in Sundaram Finance Ltd. v. State of Kerala AIR 1966 SC 1178 the true effect of a transaction has to be seen from the terms of the agreement. The Supreme Court pointed out as follows:

“….When a person desiring to purchase goods and not having sufficient money on hand borrows the amount needed from a third person and pays it over to the vendor, the transaction between the customer and the lender will unquestionably be a loan transaction. The real character of the transaction would not be altered if the lender himself is the owner of the goods and the owner accepts the promise of the purchaser to pay the price or the balance remaining due against delivery of goods. But a hire-purchase agreement is a more complex transaction. The owner under the hire-purchase agreement enters into a transaction of hiring out goods on the terms and conditions set out in the agreement, and the option to purchase exercisable by the customer on payment of all the instalments of hire arises when the instalments are paid and not before. In such a hire-purchase agreement there is no agreement to buy goods; the hirer being under no legal obligation to buy has an option either to return the goods or to become its owner by payment in full of the stipulated hire and the price for exercising the option. This class of hire-purchase agreements must be distinguished from transactions in which the customer is the owner of the goods and with a view to finance his purchase he enters into an arrangement which is in the form of a hire-purchase agreement with the financier, but in substance evidences a loan transaction, subject to a hiring agreement under which the lender is given the license to seize the goods.”

13. As far as the present case is concerned, the question herein has to be seen from the terms of the agreement entered into between the assessee, which was placed before the Assessing Officer as well as before other Appellate Authorities, a copy of which is also placed before us and we have also gone through it. In the light of the details contained in the agreement has been narrated by us in the preceding paragraphs and considering the import of the agreement, we have no hesitation in rejecting the assessee’s contention that the transaction is only a finance lease.

14. In the result, the Tax Case (Appeals) are dismissed. No costs. Consequently, the connected miscellaneous petitions are closed.

[Citation : 365 ITR 328]