Delhi Tribunal allows deduction to taxpayer for aircraft rentals being in the nature of operating lease; rejects revenue's re-characterization of lease rentals as finance lease

The Taxpayer (Celestial Aviation Trading 15 Ltd.), [ITA No.1478/DEL/2025 (A.Y.2022-23)] a resident of Ireland, entered into a lease agreement with Indigo, an Indian airline company, for the lease of aircraft for a period of 10 years, with an option to extend the lease term for a further period up to 4 years. The Taxpayer claimed that since lease rentals received by it are in respect of operating lease, the lease rents received are covered under Article 8 of India-Ireland Double Taxation Avoidance Agreement (DTAA), hence, not taxable in India. 

However, during assessment, the tax authority re-characterized the nature of lease agreement and held the lease to be finance lease as against the Taxpayer’s claim of operating lease. The tax authority held that lease rentals received by the Taxpayer are in the nature of interest taxable at the rate of 10% in accordance with Article 11 of India-Ireland DTAA. The Dispute Resolution Panel (DRP) also upheld the decision of the tax authority and held that the economic life of an aircraft is 8 years and since the aircraft lease period covers substantial economic life of the asset even though ownership is not eventually transferred, the lease would be in the nature of financial lease.

On appeal, the Delhi Income Tax Appellate Tribunal examined the lease agreement between the two parties concerning the use of aircraft. The Tribunal noted the key facts established from the lease agreement that the Taxpayer retained ownership of the aircraft throughout the lease period, with no provisions in the agreement for transferring ownership to Indigo at the end of the lease. The Aircraft Specific Lease Agreement (ASLA) explicitly required Indigo to return the aircraft to Taxpayer upon lease termination, and it also stipulated that the deposit would be refunded upon the aircraft's return. 

The tax authority argued that the Taxpayer had characterized the actual transaction of purchase of aircraft as a transaction of lease. On perusal of various agreements, the tax authority observed that Indigo (lessee) and Airbus had entered into the purchase agreement. Subsequently, Indigo with the consent of Airbus assigned rights to the assignee (Taxpayer) for purchase of aircraft. As per the agreed terms, the Taxpayer would make payment for aircraft and thereafter would lease aircraft to Indigo. This circuitous transaction was in the nature of financial lease, where the aircraft was purchased by Indigo and the purchase consideration was paid by the Taxpayer. The tax authority thus, argued for examining the transaction considering substance over form.

The Tribunal determined that the lease agreement between the Taxpayer and Indigo was an operating lease, affirming that the lease rentals received were not taxable in India. The arguments made by the Taxpayer highlighted that the lease was clearly an operating lease due to the retention of ownership by the lessor and the obligation of the lessee to return the aircraft. The Tribunal also referenced the Reserve Bank of India (RBI) Circular No. 24 dated 1 March 2002, which distinguishes between operating and financial leases, noting that financial leases require prior RBI approval, which was absent in the present case. It rejected the tax authority's argument that the duration of the lease indicated it was a financial lease, emphasizing that the terms and conditions of the agreement were more significant in determining the lease's nature. The Tribunal also dismissed the tax authority's claims regarding circuitous transactions, asserting that the lessor's ownership and the absence of ownership transfer to the lessee were decisive factors in the classification. Furthermore, the Tribunal relied on a Special Bench decision of Delhi Tribunal in the case of Inter Globe Aviation Ltd.^[1], which supported the argument that lease rentals paid by Indigo were in the nature of rent rather than interest. 

^[1] 2021 TIOL 1607, ITAT-Del-SB