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Income Tax Appellate Tribunal, DELHI BENCH “I-2”, NEW DELHI
Before: SHRI S.V. MEHROTRA & SHRI KULDIP SINGH
Per month charge on Straight Line basis 678,286
Month expired till March 31,2008 20
Total Cost till March 31,2008 13,565,714
Less: Amount Payable as per Lease 644,263 122,732 521,531 64,461 585,992 20 11,719,840 Agreement till March 31, 2008
Amount to be provided for rent equalization 1,845,875 reserve under Straight Line Method
7. Ld. counsel referred to the definition of ‘lease term’ as per para 3.6, which is reproduced hereunder :-
“3.6 The lease term is the non-cancellable period for which the lessee has agreed to take on lease the asset together with any further periods for which the lessee has the option to continue the lease of the asset, with or without further payment, which option at the inception of the lease it is reasonably certain that the lessee will exercise.”
With reference to the Lease Deed, ld. counsel pointed out that option to exercise continuation of lease was there and it was reasonably certain that lessee would exercise the option to renew the lease. He, therefore, submitted that rent equalization reserve had been created on the basis of 9 years lease term after taking into account the escalation of 15% renewal at each time. Ld. counsel relied on following decisions :-
(a) Apollo Tyres Ltd. vs. CIT, (2002) 122 taxmann.com 562 (SC); (b) CIT vs. ICICI Venture Funds Management Co. Ltd., (2015) 62 taxmann.com 128 (Karnataka); and, (c) GE Capital Transportation Financial Services Ltd. vs. ACIT (2008) 113 ITD 22 (Delhi).
9. Per contra, ld. DR submitted that the Lease Deed was for three years and, therefore, the rent equalization reserve could not be created on the basis of 9 years lease term, which could materialize subject to renewal of lease.
Ld. DR submitted that it is not a case of lease covered by AS 19 since there was no certainty of continuance of lease. He submitted that property considered in AS 19 is different. He pointed out that AS 19 is not applicable to lease of immovable property. Ld. DR further submitted that the decision of Hon’ble Karnataka High Court in the case of ICICI Venture Funds Management Co. Ltd. (supra) was with reference to financial lease and not operational lease, wherein, it was, inter-alia, observed that lease equalization charges was nothing but the difference between the statutory depreciation on rentals and the recovery of cost of capital, therefore, merely because the said amount entered into the Profit & Loss Account in effect, made no difference. He, therefore, submitted that this decision is not applicable to the facts of the present case particularly because asset involved therein was not immovable property. As regards the decision of GE Capital Transportation Financial Services Ltd. (supra), ld. DR pointed out that the same was also not with reference to immovable property but with reference to vehicles lease out to third parties under lease agreement. Ld. DR has filed written submissions which are reproduced hereunder :-
“Submissions
STRAIGHT-LINE ACCOUNTING OF LEASE RENTAL
Accounting Standard 19 (AS-19) deals with the subject of accounting for lease rental from the standpoint of both, the lessor and the lessee. However, it is submitted that the same is not applicable to lease of immoveable property.
AS-19 classifies leases mainly into two categories: Finance lease and Operating lease (OL). Different accounting treatments are prescribed in respect of rental from finance lease and OL. AS-19, in paragraph 23, states the following, in the context of operating lease from the standpoint of the lessee: "Lease payments under an operating lease should be recognised as an expense in the statement of profit and loss on a straight-line basis over the lease term, unless another systematic basis is more representative of the time pattern of the user's benefit." Paragraph 24 of AS-19 explains the previous paragraph and provides that lease rental will be accounted on a straight-line basis, unless another systematic basis is more representative of the time pattern of the user, even if the payments are not on that basis. (emphasis supplied) 1.6 Paragraphs 23 and 24 relate to payments of lease rental and view the matter from the standpoint of the lessee. The same view is taken in paragraph 40 of AS- 19 when the matter is viewed from the standpoint of the lessor, and the language used therein makes it clear that AS19 is not applicable to lease of immovable property whose use pattern has nothing to do with passage of time. AS-19, in substance, states that expenditure and income, both, resulting from payments and receipts under an OL, should be recognised on a straight-line basis, unless another systematic basis is more representative of the time pattern of the user's benefit. Paragraph 40 of AS-19 makes is clear that it supposes the time pattern to be such in which benefit derived from the use of the leased asset is diminished. It is submitted that AS-19 postulates a situation in operating leases in which the benefits derived from the use of the leased asset are diminished over the period of lease. This is made clear in paragraph 40 of AS-19. This paragraph deals with accounting of lease rental in an OL, from the standpoint of the lessor. "Lease income from operating leases should be recognised in the statement of profit and loss on a straight-line basis over the lease term, unless another systematic basis is more representative of the time pattern in which benefit derived from the use of the leased asset is diminished."(emphasis supplied) A harmonious reading of paragraph 23, 24 and 40 suggests that it does not visualise a situation of increasing rental over the period of lease, whether benefits from the use of the leased asset increasing or diminishing or remaining constant. Therefore, in a case involving increasing rental, which in no case can represent a time pattern in which benefit derived from the use of the leased asset is diminished, AS19 cannot be applicable. Once it is clear that paragraphs 23, its extension in paragraph 24 and paragraph 40, all postulate a possibility of a situation of diminishing benefits and decreasing returns derived from the use of the leased asset, and do not postulate a situation of increasing benefits, then it is inappropriate to apply these paragraphs to a situation of escalating returns as in the case of immoveable property. 3.11 Moreover, when rent of an immovable property is fixed, it accounts for a large part the value of the land. Rental of a building can be split into: rental attributable to the land component and rental attributable to the superstructure. If this is done, then AS-19 becomes inapplicable to the rent attributable to the land. (It is provided in AS-19 itself that it does not apply to lease agreements for use of lands). Sd/- (T.M. Shivakumar) Commissioner of Income Tax (DR) I(2)- Bench, ITAT, New Delhi.”
We have considered the rival submissions and have perused the record of the case. The scope of AS 19 does not extend, inter-alia, to lease agreements to use lands. Para 2 of scope reads as under :-
“2. This Standard applies to agreements that transfer the right to use assets even though substantial services by the lessor may be called for in connection with the operation or maintenance of such assets. On the other hand, this Standard does not apply to agreements that are contracts for services that do not transfer the right to use assets from one contracting party to the other.”
The classification of leases for the purposes of AS 19 are as under :-
“Classification of Leases 5. The classification of leases adopted in this Standard is based on the extent to which risks and rewards incident to ownership of a leased asset lie with the lessor or the lessee. Risks include the possibilities of losses from idle capacity or technological obsolescence and of variations in return due to changing economic conditions. Rewards may be represented by the expectation of profitable operation over the economic life of the asset and of gain from appreciation in value or realisation of residual value.
A lease is classified as a finance lease if it transfers substantially all the risks and rewards incident to ownership. Title may or may not eventually be transferred. A lease is classified as an operating lease if it does not transfer substantially all the risks and rewards incident to ownership.
Since the transaction between a lessor and a lessee is based on a lease agreement common to both parties, it is appropriate to use consistent definitions. The application of these definitions to the differing circumstances of the two parties may sometimes result in the same lease being classified differently by the lessor and the lessee.
8. Whether a lease is a finance lease or an operating lease depends on the substance of the transaction rather than its form. Examples of situations which would normally lead to a lease being classified as a finance lease are:
(a) the lease transfers ownership of the asset to the lessee by the end of the lease term; (b) the lessee has the option to purchase the asset at a price which is expected to be sufficiently lower than the fair value at the date the option becomes exercisable such that, at the inception of the lease, it is reasonably certain that the option will be exercised; (c) the lease term is for the major part of the economic life of the asset even if title is not transferred; (d) at the inception of the lease the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset; and (e) the leased asset is of a specialised nature such that only the lessee can use it without major modifications being made.
Indicators of situations which individually or in combination could also lead to a lease being classified as a finance lease are: (a) if the lessee can cancel the lease, the lessor’s losses associated with the cancellation are borne by the lessee; (b) gains or losses from the fluctuation in the fair value of the residual fall to the lessee (for example in the form of a rent rebate equalling most of the sales proceeds at the end of the lease); and (c) the lessee can continue the lease for a secondary period at a rent which is substantially lower than market rent.
10. Lease classification is made at the inception of the lease. If at any time the lessee and the lessor agree to change the provisions of the lease, other than by renewing the lease, in a manner that would have resulted in a different classification of the lease under the criteria in paragraphs 5 to 9 had the changed terms been in effect at the inception of the lease, the revised agreement is considered as a new agreement over its revised term. Changes in estimates (for example, changes in estimates of the economic life or of the residual value of the leased asset) or changes in circumstances (for example, default by the lessee), however, do not give rise to a new classification of a lease for accounting purposes.”
Now, if, we examine various definitions contained in paragraph 3, we find that the same deals primarily with defining of finance lease, operating lease, non-cancellable lease, lease term, fair value of asset, economic life, useful life, residual value, guaranteed residual value of lease assets. It clearly shows that the main object of the AS 19 is to deal with the leases concerning movable assets and it specifically excludes lease agreements to use lands. We find considerable force in the submissions of ld. CIT-DR that AS 19 is not applicable to lease of immovable property. Therefore, the Assessing Officer rightly added back the rent equalization reserve debited to Profit & Loss Account while computing the book profit for the purposes of section 115JB of the Act. Moreover, the assessee itself has added back this reserve for the purposes of computation of total income under the normal provisions of the Act. Therefore, in any view of the matter, the stand of the assessee is contradictory. Accordingly, this ground is dismissed.
In the result, the appeal of the assessee is dismissed. Order pronounced in the open court on this 24th day of January, 2017.