CIT LARGE TAX PAYERS UNIT vs. INDIAN RAILWAY FINANCE CORP LTD

& * IN THE HIGH COURT OF DELHI AT NEW DELHI 1 Date ofdecision: 31^^ October, 2013 + ITA1189/2011 CIT LARGE TAX PAYERS UNIT ..... Appellant Through Mr. N.P. Sahni, Sr. Standing Counsel. versus INDIAN RAILWAY FINANCE CORP LTD Respondent Through Mr. S. Kirshnan, Advocate. CORAM: HON'BLE MR. JUSTICE SANJIV KHANNA HON'BLE MR. JUSTICE SANJEEV SACHDEVA SANJIV KHANNA, J. (ORAL) This appeal by the revenue pertains to assessment year 2001-02. Revenue has raised four questions in this appeal and for the sake of convenience these issues are being discussed separately:- Issue No.l Whether the lease equalisation charges can be disallowed/deleted from the profit and loss account for the purposes of computing book profits under Section 115 JB ofthe Income Tax Act, 1961? 2. The said issue need not be examined in detail as it is covered against the Revenue vide decision in the case of CIT vs. Virtual Soft SystemsLimited, (2012 ) 341 ITR 593 (Delhi). ITA 1189/2011 Page 1 of 14 2013:DHC:7829-DB

Issue No.2 Whether the lease equahsation charges can be reduced/taken into consideration while calculating profits under the profits and loss account provision of the income Tax Act? 3. This question is also covered by the decision of Delhi High Court in Virtual Soft Systems Limited (supra). In the said decision, nature and character of lease equalization charges in case of financial leases was examined and it was observed that lease equalization charges or funds have to be set off or included on the expenditure side in the profit and loss account to compute and calculated the profits. Principle of matching i.e. matching of income with the actual expenditure which is incurred by the assessee to earn the said income applies. In the decision of Delhi High Court in Virtual Soft Systems Limited (supra) from paragraph 9 onwards reference was made to Section 145 ofthe Act and the accountancy standards prescribed by the Institute of Chartered Accountants of India. The accountancy standards prescribed underwent amendment/change from assessment year 1996- 97 in respect of financial leases. Nature and character of lease equalization charges/funds was examined in paragraph 11 onwardL In paragraph 7.4 of the said judgment, reference was made to the decision of the tribunal in the present case i.e. the impugned decision ;and referring to these decisions, findings of the tribunal in the present case was quoted. ITA 1189/2011 Page 2 of 14 2013:DHC:7829-DB

followed by the assessee qua lease rentals without basing it on the grounds provided in Section 145 of the IT Act. The fact that the assessee justified its method of accounting, by taking recourse to the Guidance Note issued by the ICAI in that behalf, was disregarded, on what we would tenn as, a disjointed reading of the provisions of the said Guidance Note. Both the assessing officer as well as the CIT(A) have adverted to paragraph 2 of the Guidance Note to come to, what we consider an eiToneous conclusion in as much as they have held that in determining as to whether deduction on account of lease equalization charges ought to be allowed or not, what has to be borne in mind is ultimately the provisions of the IT Act. In our view, such an observation in paragraph 2 of the Guidance Note is really saying the obvious. Therefore, even if this Guidance Note was silent on this aspect the provisions of the I.T. Act would undoubtedly still apply. Thus, as to what is the impact of provision of para 2 of the Guidance Note will be considered by us as we progress further with our judgment." 9. In the present case also, we notice that the Assessing Officer has not based the addition on the finding that there was incorrectness or incompleteness in the account or the accounting standard employed by the assessee were contrary to the accounting standard notified by the Government under Section 145(2) ofthe Act. 10. In Virtual Soft Systems Ltd. (surpa), it has been further observed as under "14.3 Lease rental in monetary terms is a sum total of: the financing charge and the amount embedded in it in the form of the capital sum. What the assessee needs to do, while offering for tax income derived from lease is, to separate the financing charge from the amount recovered towards capital, that is, the capital recovery amount. The financing change is determined by applying the IRR to the net investment made in the asset. The assessee also needs to provide for depreciation, on the capital value embedded in the lease rental. The fourth element which is the lease equalization charge is the result of the adjustment, which the assessee has to make whenever, ITA 1189/2011 Page 5 of 14 2013:DHC:7829-DB

the amount put aside towards capital recovery is not equivalent to the depreciation claimed by the assessee. The assessee, may claim depreciation based on the provisions of the IT Act or, may even adopt the method of depreciation provided under the Companies Act. hi the event, the depreciation claimed is less than the capital recovery, the difference is debited in the profit and loss • account in the form of lease equalization charge, and similarly if, for any reason the depreciation claimed is more than capital recovery then, the difference is credited, once again, in the form of lease equalization charge to the profit and loss account. Therefore, the assessee in effect debits or credits its profit and loss account with a lease equalization charge depending on whether or not the depreciation claimed is, less or more than the capital recovery. The capital recovery can be known, as is evident, on deduction of financing charges from the lease rentals. In sum and substance, lease equalization charges is a method of re-calibrating the depreciation claimed by the assessee in a given accounting period. The method employed by the assessee, therefore, over the full term of the lease period would result in the lease equalization amount being reduced to a naught, as the debit and credits in the profit and loss account would square off with each other. Hence, the contention of the revenue that it is a claim in the form of a deduction which cannot be allowed, as there is no provision under the I.T. Act is, in our view, a complete misappreciation of what constitutes a lease equalization charge. In our opinion, as long as the method employed for accounting of income meets with the rudimentary principles of accountancy, one of which, includes offering only revenue income for tax, we cannot find fault with the assessee debiting lease equalization charges in the AYs in issue, in its profit and loss account. This represents true and fair view of the accounts; a statutory requirement under Section 211(2) of the Companies Act. As explained by us above, the rationale is that over the entirety of the lease period the said debit would work itself out." 11. The reasoning in the aforesaid paragraph can be best understood, if we refer to the following table by way of an example. INDIAN RAILWAY FINANCE CORPORATION LTD. - SAMPLE FINANCE LEASE CHART Lease Value of Rs. 1,00,000 Lease Rent: Primary = !5% for 15 years IRR = 12.6159% Secondary= 1% for 15 years Statutory Depreciation = Rs.4750/- p.a. Year | Lease | Capital | Finance | Recovery | Statutory | Lease | Net Profit | Dep.As | Taxable ITA 1189/2011 Page 6 of 14 2013:DHC:7829-DB

Rent Reed. Cost Outstan ding Charge at IRR of cost of capital Depre ciation Equali sation Dr./(Cr.) per l.T. Income 1. 15000 100,000 12,616 2,384 4,750 (2,366) 12,616 25,000 1 (7,634) 2 15000 97,616 12,315 2,685 4,750 (2,065) 12,315 18,750 ' (1,685) 3 15000 94,931 11,976 3,024 4,750 (1,726) 11,976 14,063 • 2,664 4 15000 91,907 11,595 3,405 4,750 (1,345) 11,595 10,547 5,798 5 15000 88.052 11,165 3,835 4,750 (915) 11,165 7,910 8,005 6 15000 84,668 10,682 4,318 4,750 (432) 10,682 5,933 9,499 7 15000 80,349 10,137 4,863 4,750 113 10,137 4,449 10,437 8 15000 75,486 9,523 5,477 4,750 727 9,523 3,337 10,936 9 15000 70,009 8,832 6,168 4,750 1,418 8,832 2,503 11,079 10 15000 63,842 8,054 6,946 4,750 2,196 8,054 1,877 10,927 11 15000 56,896 7,178 7,822 4,750 3,072 7,178 1,408 10,520 12 15000 49,074 6,191 8,809 4,750 4,59 6,191 1,056 9,885 13 15000 40,265 5,080 9,920 4,750 5,170 5,080 792 9,038 14 15000 30,345 3,828 11,172 4,750 6,422 3,828 594 7,984 15 15000 19,173 2,149 12,581 4,750 7.831 2,419 445 6,723 16 1000 6,592 832 168 4,750 (4,582) 832 334 5,248 17 1000 6,423 810 190 4,750 (4,560) 810 251 5,310 18 1000 6,234 786 214 4,750 (4,536) 786 188 5.349 19 1000 6,020 760 240 4,750 (4,510) 760 141 5,369 20 1000 5,780 729 271 4,750 (4,479) 729 106 5,373 21 1000 5,509 695 305 4,750 (4,445) 695 79 5,366 22 1000 5,204 657 343 250 93 657 59 847 23 1000 4,861 613 387 387 613 45 569 24 1000 4,474 564 436 436 564 33 531 25 1000 4,038 509 491 491 509 25 484 26 1000 3,548 448 552 . 552 448 19 429 27 1000 2,995 378 622 622 378 14 ! 364 28 • 1000 2,373 299 701 702 299 11 1 289 29 1000 1,672 211 789 789 211 8 ' 203 30 1000 883 117 883 883 117 • 24 : 93 240000 1,40,000 1,00,000 1,00,000 (0) 1,40,000 1,00,000 1,40,000 12. The net effect of the aforesaid table shows that the purchase value of the asset which is made subject matter of lease is not taken to 1 the profit and loss account and treated or debited as expenditure.; The purchase value or the recovery of capital cost gets distributed/divided over the term of the lease. The acronym IRR stands for Internal Rate of Return, on which there is no dispute. The lease rentals as stated above include recovery of the capital cost. The chart indicates depreciation which an assessee was entitled to claim under the Companies Act. Lease equalization charge represents the difference between the recovery of cost of capital and the depreciation as claimed ITA 1189/2011 Page 7 of 14 2013:DHC:7829-DB

under the Companies Act. The difference between the two may be negative or positive and is not constant over the period of the lease. Thus, the net revenue or tax effect is NIL in the entire term. This is clear from the net profit as declared under Column 'G'. The computation is logical, fair and true reflection of the income earned and reduces abnormalities. The above table indicates that lease equalisation chargeresults in debit or credit entry in the profit and loss account and it helps the income getting staggered or matched during the entire period of lease. 13. It may be appropriate to also refer to the Reserve Bank ofIndia's Prudential Norms on Income Recognition, Asset Classification and Provisioning-Pertaining to Advances dated 1^' September, 2001 to Commercial Banks. Under the head Income Recognition in paragraph 3.2.3 it has been observed:- "3.2.3 Leased Assets i) The net lease rentals (finance charge) on the leased asset accrued and credited to income account before the asset became non-performing, and remaining unrealised, should be reversed or provided for in the current accounting period. ii) The term 'net lease rentals' would mean the amount of finance charge taken to the credit ofProfit & Loss Account and would be worked out as gross lease rentals adjusted by amount of statutory depreciation and lease equalisation account. iii) As per the 'Guidance Note on Accounting for Leases' issued by the Council of the Institute of Chartered Accountants of India (ICAI), a separate Lease Equlisation Account should be opened by the. ITA 1189/2011 Page 8 of 14 2013:DHC:7829-DB

banks with a corresponding debit or credit to Lease Adjustment Account, as the case may be. Further, Lease Equalisation Account should be transfeiTed eveiy year to the Profit & Loss Account and disclosed separately as a deduction from/addition to gross value of lease rentals shown under the head 'Gross Income." 14. A perusal of the balance sheet and profit and loss account for the assessment year 2000-01 reflects the said position. In the said year, the assessee had received lease rentals of Rs. 2700.48 crores, from which lease equalization account of Rs.142.03 crores was reduced. The paid up capital of the respondent company held by the President of India and his nominees was Rs.232 crores. The addition of the fixed assets in the said year was Rs. 2273 crores which is reflective as the addition to the quantum of rolling stock. If the purchase price of the rolling stock stands subjected to revenue deduction, would have its own consequences and lead to abnormal financial results and absurdities. The balance sheet records that the total rolling stock aggregate was Rs. 19771.35 crores. The depreciation claimed (which may include certain fixed assets also which were not subject matter of finance leases) was Rs.5352.57 crores. Clearly, therefore, the purchase value of the leased assets did not find reflection or deduction in the profit and loss account. Legal ratio of Virtual Soft Systems Ltd. (supra) is that as long as the assessee does not indulge in any manipulation of the figures and the capital cost, IRR etc. are corrputed in accordance with the accountancy standards and no error can be found, ITA 1189/2011 Page 9 of 14 2013:DHC:7829-DB

lease equalisation charge should not be disallowed. 15. In view of the aforesaid position, the second issue has to be I decided against the appellant and in favour ofthe respondent-assessee. Issue No.3 Whether the bond issue expenses were capital or revenue in nature? 16. The respondent-assessee had incurred expenditure of Rs. 10,09,92,445/- towards bond issue expenses of different series during the year in question. Tribunal referred to their earlier order in the case ofthe respondent-assessee for the assessment years 1997-98 to 2000-01 and held that the expenses incurred were revenue expenditure. Reliance was placed upon decision of the Delhi High Court in the case of CIT Vs. Thirani Chemicals Ltd. [2007] 290 ITR 196 wherein it has 1 been held that issue of debentures on rights basis to the existing I shareholders was revenue expenditure and it was not mandatory to amortise the said amount under Section 35D of the Act in view of the Circular No.52 dated 19"^ March, 1971 issued by the Central Board of Direct Taxes. 17. While dealing with a similar issue in Commissioner ofIncome Tax Vs. Havells India Ltd. (2012) 208 TAXMAN 114 it has been held as under:- "26. It is well settled that expenditure incurred in 1 I ] ITA 1189/2011 Page 10 of 14 2013:DHC:7829-DB

connection with the issue of debentures or obtaining loan is revenue expenditure. Reference in this connection may be made to the leading judgment of the Supreme court in India Cements Ltd. v. CIT, (1966) 60 ITR 52. The question before us however, is whether it is a debenture issue or an issue of share capital ITA involving the strengthening of the capital base of the company. Though it prima facie appears that there are sufficient facts to indicate that what was contemplated was an issue of shares to the Mauritius Company under the Investor Agreement which would result in strengthening of the assessee"s capital base, having regard to the judgments cited on behalf of the assessee, in which it has been held that despite indications to the effect that the debentures are to be converted in the near future into equity shares, the expenditure incurred should be allowed as revenue expenditure on the basis of the factual position obtaining at the time of the debenture issue, we are not inclined to take a different view. The following cases have been cited on behalf of the assessee in support of the view that even in such a situation the expenditure is allowable as revenue expenditure:- (i) CIT V. East India Hotels Ltd., (2001) 252 ITR 860 (Cal.) (ii) CIT V. ITC Hotels Ltd., (2011) 334 ITR 109 (Kar.) (iii) CIT V. South India Corporation (Agencies) Ltd., (2007) 290 ITR 217 (Mad.) (iv) CIT V. First Leasing Co. of India Ltd., (2008) 304 ITR 67 (Mad.) 27. In addition to the above judgments, we also have the judgment of the Rajasthan High Court (supra) against which the Special Leave Petition filed by the Revenue was dismissed. Having regard to the predominant view taken in the above judgments, in which the judgment of the Supreme Court in India Cement (supra) has been noticed, we are inclined to uphold the view taken by the Tribunal that the expenditure is revenue in nature." 18. The respondent-assessee was/is a Government of India undertaking and was engaged in the business of leasing and financing to Indian Railways. It procured funds from various sources and acquired rolling stock which was leased to Indian Railways. The expenditure which was incurred on bondswas for ensuring finance and j ITA 1189/2011 Page 11 of 14 2013:DHC:7829-DB

availability of funds for carrying out the business of finance and leasing. To procure and get funds in the form of bonds etc. some expenditure had to be incurred. These funds, when procured, were used for the business activities to earn income. It is not a case wherein the respondent-assessee was yet to setup or commence their business. The business, it is accepted, had commenced much earlier and not during the year in question. Issue No.4 Whether the assessee is entitled to depreciation on office premises at NBCC place, Lodi Road, New Delhi? 19. The contention of the Revenue raised is that the respondent- assessee was not the owner of the building or in possession in part performance under Section 53A of the Transfer of Property Act. Learned senior standing counsel has referred to the observations and the contentions raised by the Revenue in paragraphs 17 and 18 of the impugned order, wherein reference is made to agreements dated ll'^ April, 2002 and 21®' November, 2002. In the agreement dated November, 2002, it stated that NBCC had handed over vacant possession to the respondent-assessee. The respondent-assessee, on the other hand, had relied upon letter dated 29^^ March, 2000 received from NBCC wherein it was clearly mentioned that commercial space measuring 625 square meters was allotted to the respondent-assessee ITA 1189/2011 Page 12 of 14 2013:DHC:7829-DB

vide lettef dated 28"" April, 1998 and commercial space measuring 285 i square meters was initially purchased by MMTC but was sold l]y them 1 i to the respondent-assessee. After noticing the conflicting positions, the tribunal in paragraph 20.1 has referred to their decision dated 28'*^ August, 2009 for assessment year 2002-03. They have quoted the possession letter dated 29^*^ March, 2000 and reached a conclusion that possession was "in fact" or actually was handed over to the assessee before the end of financial year ending 3r''' March, 2000. The respondent-assessee, therefore, became entitled to benefit under Section 53A of Transfer of Property Act and accordingly decision of the Supreme Court in Mysore Minerals Vs. CIT [2009] 239 ITR 775 (SC) was applicable. 20. The aforesaid findings are findings of fact. The tribunal has I ^ taken into account and relied upon the possession letter dated 28* April, 1998 in which NBCC had accepted that the possession of the space measuring 625 square meters and 285 square meters was handed over to the respondent assessee on 23'^'' September, 2000. NBCC was/is a Government of India undertaking and it is difficult to accept the contention of the Revenue that they would have fudged or manipulated the date of possession. The factual finding is not perverse. ITA 1189/2011 Page 13 of 14 2013:DHC:7829-DB