By TIOL News Service

NEW DELHI, FEB 21, 2018: THE issue is - Whether if the assessee debits lease equalisation charges in its P&L Account, such an act is in harmony with the statutory requirements of Sec 211(2) of the Companies Act. YES is the verdict.

Facts of the case

The assessee-company is a leading real estate developer in India. Its commercial activity centered on leasing assets and the assessee derived income from the same. In its lease agreements, the ownership of the assets remained with the assessee, and the assets were shown in the balance sheet as 'Fixed Assets'. On this account, the assessee claimed depreciation. However, while preparing profit and loss account, it did not credit the full amount of lease charges, and some amounts were set apart to be carried over to the lease equalization reserve. Only the balance amount was credited to the profit and loss account. Thereupon, in the relevant AY the assessee credited an amount as lease charges. Such amount was the net of the lease equalization reserve. Thus, the total amount carried over to the lease equalization reserve, was added to the total income of the assessee.

However, on assessment, the assessee requested the AO to exclude lease equalization charges so offered for taxation. The AO held that the Act did not distinguish between a finance lease and operating lease, since the legal ownership of the underlying asset was unchanged. Therefore, the lease charges received by the owner would be taxed as a whole and no artificial provision could bifurcate such amounts. The AO further held that lease equalization charges did fall within any allowable deduction or expense, being similar to depreciation and that the assessee incurred no liability of any nature. Hence the AO added back the lease equalization charges to the assessee's income. The assessee's appeal was rejected by the CIT(A). However, the Tribunal relied on previous decisions on the issue and gave relief to the assessee. Hence the Revenue's appeal.

On hearing the matter, the High Court held that,

++ the consistent view adopted in the various authorities - Virtual Soft Systems onwards, is that in monetary terms, lease rentals are the sum total of financing charges and the amount included in it towards the capital sum. While offering for tax income derived from lease, a taxpayer has to separate the amount received towards capital, from the financing charge. The financing charge is determined by applying a separate formula to the net investment made in the asset. Depreciation too needs to be provisioned on the capital value fixed in the lease rental. Next is the lease equalization charge;

++ 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...” Therefore, the Revenue’s contention that the amount is unknown to the Act - as held in the decision, is a misappreciation of what constitutes a lease equalization charge. Therefore, as long as the method of accounting follows some established principles, one of which, includes offering only Revenue income for tax, there is no fault in the assessee debiting lease equalization charges in the AYs in issue, in its profit and loss account. It represents a true and fair view of the accounts, which is a statutory requirement under Section 211(2) of the Companies Act. For these reasons, the first question is answered in favour of the assessee and against the Revenue.

(See 2018-TIOL-320-HC-DEL-IT)