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Bangalore Tribunal grants deduction of full amount of lease rentals classified as “finance lease” in books of account
In the case of Texas Instruments (India) Pvt. Ltd[1] (Taxpayer), the issue under consideration before Bangalore Tribunal was the tax treatment of lease rentals paid on leased equipment and vehicles recognized as taxpayer’s assets under finance lease in the books of account and profits on foreclosure of such leases.
The Taxpayer is engaged in the business of software development for purpose of creating semiconductor devices. The Taxpayer (Lessee) entered into a lease agreement whereby it took certain equipment and vehicles on lease and paid lease rentals on the same. In its books of account, the Taxpayer treated the lease as “finance lease” and capitalized the leased assets as per AS-19 (issued under the Companies (Accounting) Standard Rules, 2006). AS-19 requires lessee to capitalize assets taken on finance lease, split lease rentals between cost of asset and interest, provide depreciation on the cost of asset, debit the interest to profit and loss account (P&L) and recognize profit/loss on foreclosure of the lease in its P&L.
However, for tax purposes, the Taxpayer disregarded the book treatment (including profit/loss on foreclosure of lease) and claimed a full deduction of lease rentals as revenue expenditure. For such tax treatment, the Taxpayer relied on Central Board of Direct Taxes (CBDT) Circular[2] pertaining to finance lease arrangements, which has clarified that AS-19 has no impact on tax treatment. The Taxpayer also relied on the ruling of the Supreme Court in the case of ICDS Ltd. vs. CIT [3] , which upheld depreciation claim in the hands of the legal owner of the assets (i.e., lessor).
The tax authority disallowed the claim of lease rentals as revenue expenditure on the grounds that the Taxpayer is the owner of the assets since it had acquired the assets under finance lease and had provided depreciation in its books. According to the tax authority, even if the lease rentals are claimed as revenue expenditure, the Taxpayer ought to have debited the same to its P&L. But the Taxpayer had not debited full amount of lease rentals to P&L and had also not deducted tax thereon under section 194I of the Income Tax Laws (ITL). The tax authority alleged that the Taxpayer and lessor colluded with each other with an intention to suppress the profits. The tax authority also contended that profit on foreclosure of leased assets is the income of the Taxpayer.
The first appellate authority upheld the tax authority’s action. Being aggrieved, the Taxpayer filed further appeal to the Bangalore Tribunal.
The Bangalore Tribunal ruled in favor of the Taxpayer and held that full amount of lease rentals is allowable as deduction while the profit on foreclosure of lease is not taxable. The Tribunal held it is clear from the main terms of the lease agreement that the Taxpayer is a lessee and lessor was the owner of the equipment. Hence, the conclusion reached by the tax authority and the first appellate authority of Taxpayer being owner of the leased asset by relying on certain clauses of the agreement and ignoring the main clause of the agreement is erroneous. The treatment in the books of account cannot affect the taxable income to be computed in accordance with the statutory provisions of the ITL. There was no basis for the tax authority to claim that the Taxpayer has adopted a colorable device with a view to gain tax advantage.
Furthermore, in Taxpayer’s own case[4] , the Karnataka High Court held that it cannot withhold lease financing of vehicles under provisions of sections 194I and 194C and there could be no disallowance under section 40(a)(ia) of the ITL. In respect of lease rentals paid for lease of equipment, the Taxpayer has duly deducted tax at source and thus there could be no disallowance under section 40(a)(ia) of the ITL. Hence, the deduction of lease rentals could not be denied on the grounds of withholding tax default.
Consistent with the position of the Taxpayer, being a lessee entitled to deduction of full amount of lease rentals, the profit on foreclosure of leased assets is purely notional entry in compliance with the requirements of AS-19 and no income can be said to have accrued to the Taxpayer by reason of such an accounting treatment.