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Income Tax Appellate Tribunal, “F” BENCH, MUMBAI
This appeal by the Revenue is arising out of the order of Commissioner of Income Tax (Appeals)-20, Mumbai [in short CIT(A)], in appeal No. CIT(A)-20/DCIT 12(3)(2)/IT-79/2015-16 dated 27.05.2016. The Assessment was framed by the Asst. Commissioner of Income Tax, Circle 12(3)(2), Mumbai (in short ‘ACIT’) for the A.Y. 2012-13 vide order dated 11.03.2015 under section 143(3) of the Income Tax Act, 1961 (hereinafter ‘the Act’).
The only issue in this appeal of Revenue is against the order of CIT(A) deleting the disallowance of depreciation on the leased assets despite the fact that the assessee entered into financial lease. For this Revenue has raised ground No. 1 : -
“1. Whether, on the facts and in the circumstances of the case, the ld. CIT(A) has rightly allowed the depreciation on the leased assets despite the fact that the assessee had entered into financial lease.”
At the outset, the learned Counsel for the assessee explained that the assessee is in the business of providing equipments on leased to various parties and accordingly claimed deprecation at the leased assets on the ground that the assessee has entered into operating lease and was owner of the assets. According to the AO, the assessee entered into financial lease transactions and disallowed the claim of depreciation on the ground that the assessee is not the owner of the asset as he has merely entered into financial lease. The CIT(A) held that the assessee was the owner of the assets and lease is operating lease. Hence, he allowed the claim of deprecation by observing in para 6.2 as under: -
“6.2 It is noted that in the present case the assessee is a company engaged in business of providing various types of equipments on lease basis. The scope of this line ci business of the assessee is that the company is the owner of equipment and no lessee has ever claimed that he is the dc-facto or de-jure owner of the asset given on lease and therefore, no lessee has claimed depreciation in his income tax assessment in respect of assets given on lease by assessee. The commencement and termination of leases is specified and the lease period has also been specified. rite assets have been identified and both the lessor and lessee are clear as to which particular equipment belongs to assessee. The Master Lease agreements between the assessee company and the lessees provide for return of equipment on the expiry of the lease. the agreements provide that lessee has no right to transfer or assign or mortgage the asset (given on lease by assessee) in Favour of any other party. The rental structure has been laid down in the respective agreements. The agreements provide that the right to inspection of the assets rests with the assessee. However, the A.O in its order has noted that the assessee was not entitled to the claim of depreciation for the reason that the assessee did not acquire the absolute ownership of the asset and the transaction is a Finance transaction only and the assessee has used a colorable device to evade taxation by claiming huge depreciation of Rs. 8,49,85,543/- accordingly the depreciation claim of the assessee was disallowed and added to the total income of the year. It is noted that the Ld. A.O. has not brought any material on record to establish that the assessee was not the owner of the assets which were given on lease. It is not a case where the assessee has not made the payment to acquire the assets. It is noted that the transactions for purchase and lease of assets are properly accounted for in the books of accounts which are duly audited by the auditors. It is also noted that the assessee company has claimed the depreciation in the books in accordance with Explanation 4A to section 43(1) of the I.T. Act. Having regard to the (acts of the case, it is noted that lease transactions of the assessee are similar in nature and are squarely covered by the ratio of in case of ICOS Ltd. vs CIT (supra) by the Hon’ble Supreme Court and the decision in the case of IDSI Bank vs DCIT (supra). In view of this discussion and the ratio in the cases of ICDS Ltd. and IDBI Bank Ltd. as discussed above the disallowance of depreciation of Rs. 5,49,85,543/- made by the Ld. A.O. cannot be sustained in appeal. The A.O. is directed to delete the disallowance made and allow the claim of depreciation of the assessee. Accordingly, these grounds of appeal are allowed.”
4. Now before us, the learned Counsel for the assessee stated that the similar issue is arisen in other years also and litigation pending before CIT(A) in respect of subsequent assessment years. Hence, he stated that he has clear cut instructions from the assessee that in order to avoid prolonged litigations, the assessee concedes to the departmental appeal and accept the order of the AO by disallowing the depreciation but he made only one submission that while offering lease for tax, the assessee has offered the entire lease as income. The AO has taxed the lease in entirety. It was claimed that once the assessee’s lease is treated as finance lease in that eventuality what can be brought to tax under finance lease is only the interest component of the lease rental. For this the learned Counsel for the assessee relied on the decision of Hon’ble Supreme Court in the case of CIT vs. Virtual Soft Systems Ltd. & others in Civil Appeal No. 4358 of 2018 order dated 24.04.2018, wherein Hon’ble Supreme Court has given categorically finding that in case interest earned would be revenue receipt chargeable to tax vide Para 12,13 and 14 as under:-
“12) At the first look, it appears that the method of accounting provided in the Guidance Note of 1995, on the one hand, adjusts the inflated cost of interest of the assets in the balance sheet. Secondly, it captures “real income” by separating the element of capital recovery (essentially representing repayment of principal amount by the lessee, the principal amount being the net investment in the lease), and the finance income, which is the revenue receipt of the lessor as remuneration/reward for the lessor’s investment. As per the Guidance Note, the annual lease charge represents recovery of the net investment/fair value of the asset lease term. The finance income reflects a constant periodic rate of return on the net investment of the lessor outstanding in respect of the finance lease. While the finance income represents a revenue receipt to be included in income for the purpose of taxation, the capital recovery element (annual lease charge) is not classifiable as income, as it is not, in essence, a revenue receipt chargeable to income tax.
13) The method of accounting followed, as derived from the ICAI’s Guidance Note, is a valid method of capturing real income based on the substance of finance lease transaction. The rule of substance over form is a fundamental principle of accounting, and is in fact, incorporated in the ICAI’s Accounting Standards on Disclosure of Accounting Policies being accounting standards which is a kind of guidelines for accounting periods starting from 01.04.1991. It is a cardinal principle of law that the difference between capital recovery and interest or finance income is essential for accounting for such a transaction with reference to its substance. If the same was not carried out, the Respondent would be assessed for income tax not merely on revenue receipts but also on non-revenue items which is completely contrary to the principles of the IT Act and to its Scheme and spirit.
14) The bifurcation of the lease rental is, by no stretch of imagination, an artificial calculation and, therefore, lease equalization is an essential step in the accounting process to ensure that real income from the transaction in the form of revenue receipts only is captured for the purposes of income tax. Moreover, we do not find any express bar in the IT Act which bars the bifurcation of the lease rental. This bifurcation is analogous to the manner in which a bank would treat an EMI payment made by the debtor on a loan advanced by the bank. The repayment of principal would be a balance sheet item and not a revenue item. Only the interest earned would be a revenue receipt chargeable to income tax. Hence, we do not find any force in the contentions of the Revenue that whole revenue from lease shall be subjected to tax under the IT Act.”
When these facts were confronted to the learned Sr. Departmental Representative he fairly agreed in case depreciation is disallowed.
We have heard the rival contentions and gone through the facts and circumstances of the case. we find that this issue has been deliberated by the Hon’ble Supreme Court in the case of Virtual Soft Systems Ltd. (supra) and in term of the decision of the Hon’ble Supreme Court we direct the AO to reduce the amount of lease rentals and bring to tax only the interest component after disallowing the deprecation claimed by the assessee in the computation of income. The AO will recompute the income in view of the above direction.
In the result, the appeal Revenue is allowed in term of the above direction.
Order pronounced in the open court on 11-05-2018. AadoSa kI GaaoYaNaa Kulao mao idnaMk 11.05.2018 kao kI ga[- .