Need Tally
for Clients?

Contact Us! Here

  Tally Auditor

License (Renewal)
  Tally Gold

License Renewal

  Tally Silver

License Renewal
  Tally Silver

New Licence
  Tally Gold

New Licence
 
Open DEMAT Account with in 24 Hrs and start investing now!
« From the Courts »
Open DEMAT Account in 24 hrs
 Inordinate delay in income tax appeal hearings
 Income Tax leviable on Tuition Fee in the Year of Rendering of Services: ITAT
 Supreme Court invoked its power under Article 142 of Constitution to validate notices issued under section 148 as notices issued under section 148A. However the same shall be subject to amended provisions of section 149.
 ITAT refuses to stay tax demand on former owner of Raw Pressery brand
 Bombay HC sets aside rejection of refund claims by GST authorities
 [Income Tax Act] Faceless Assessment Scheme does not take away right to personal hearing: Delhi High Court
 Rajasthan High Court directs GST Authority to Unblock Input Tax Credit availed in Electronic Credit Ledger
 Sebi-taxman fight over service tax dues reaches Supreme Court
 Delhi High Court Seeks Status Report from Centre for Appointments of Chairperson & Members in Adjudicating Authority Under PMLA
 Delhi High Court allows Income Tax Exemption to Charitable Society running Printing Press and uses Profit so generated for Charitable Purposes
 ITAT accepts Lease Income as Business Income as Business Investments were mostly in nature of Properties

Commissioner Of Income Tax, Delhi Vs. M/s. Mgf India Ltd.
February, 26th 2018
*      IN THE HIGH COURT OF DELHI AT NEW DELHI
                                            Reserved on: 09.11.2017
                                          Pronounced on: 21.02.2018

+      ITA 378/2004
       COMMISSIONER OF INCOME TAX, DELHI .... Appellant
                  Through: Sh. Rahul Chaudhary, Advocate.

                             versus
       M/S. MGF INDIA LTD.                            .... Respondent
                 Through: Sh. Satyen Sethi, Sh. Arta Trana Panda and Ms.
                 Gargi Sethee, Advocates.

+      ITA 76/2007
       COMMISSIONER OF INCOME TAX, DELHI .... Appellant
                  Through: Sh. Rahul Chaudhary, Advocate.

                             versus
       M/S. MOTOR AND GENERAL FINANCE LTD. .... Respondent
                Through: Sh. Satyen Sethi, Sh. Arta Trana Panda and Ms.
                Gargi Sethee, Advocates.

       CORAM:
       HON'BLE MR. JUSTICE S. RAVINDRA BHAT
       HON'BLE MR. JUSTICE SANJEEV SACHDEVA
MR. JUSTICE S. RAVINDRA BHAT
%
1.     The Revenue's appeal under Section 260A of the Income Tax Act
("the Act") had urged several questions of law. On 12.01.2016, this Court
framed the following questions:
(i)    whether the lease equalization charges can be deducted while
computing book profit; and




ITA 378/2004 & ITA 76/2007                                      Page 1 of 10
(ii)   whether the provisions for non-performing assets are liable to be
adjusted while computing book profit under Section 115JA of the Act.
2.     The assessee's commercial activity centers on leasing assets and the
resultant income from it. In terms of lease agreements it enters into,
ownership of the assets continues to vest with the assessee and the assets are
shown in the balance sheet under the head "Fixed Assets". On this account,
it claims depreciation. However, while preparing profit and loss account, it
does not credit the full amount of lease charges; some amounts are set apart
to be carried over to the lease equalization reserve; only the balance amount
is credited to the profit and loss account. In the relevant year (AY 1998-99)
the assessee credited ` 15,38,13,310/- as lease charges. The footnotes below
the schedule reflect that this amount is the net of the lease equalization
reserve. The total amount carried over to the lease equalization reserve is `
6,24,96,982/-. This was added in its total income while computing its return;
however, in the course of assessment proceedings, the assessee, by its letter
of 23.03.2001 contended that as it was lease equalization charge, the sum
(offered for taxation) should be withdrawn and that this position was based
on legal opinion. The Assessing Officer (AO) considered the assessee's
submissions and after analyzing the materials reasoned that the Act does not
distinguish between a finance lease and operating lease, because the legal
ownership of the underlying asset continues unchanged. Therefore, the
charges (towards lease) received by the owner should be taxed as a whole
and no artificial provision can bifurcate such amounts. It was further held
that lease equalization could not fall within any allowable deduction or
expense as it was a provision similar to depreciation and that the assessee
incurred no liability of any nature. The AO added back the amount. The



ITA 378/2004 & ITA 76/2007                                          Page 2 of 10
assessee's appeal was rejected by the CIT(A). In the body of its reasoning,
the CIT's observations and findings were accepted by the Income Tax
Appellate Tribunal (ITAT); however, it proceeded to note that similar claims
had been allowed in the past; relief was accordingly granted on this ground.
3.     This Court had, in Commissioner of Income Tax v Virtual Soft Systems
2012 (341) ITR explained the concept of lease equalization fund as follows:-
       "14.3 Lease rental in monetary terms is a sum total of: the
       financing charge and the amount embedded in it in the form of
       the capital sum. What the assessee needs to do, while offering
       for tax income derived from lease is, to separate the financing
       charge from the amount recovered towards capital, that is, the
       capital recovery amount. The financing charge is determined by
       applying the IRR to the net investment made in the asset. The
       assessee also needs to provide for depreciation, on the capital
       value embedded in the lease rental. The fourth element which is
       the lease equalization charge is the result of the adjustment,
       which the assessee has to make whenever, the amount put aside
       towards capital recovery is not equivalent to the depreciation
       claimed by the assessee. The assessee, may claim depreciation
       based on the provisions of the IT Act or, may even adopt the
       method of depreciation provided under the Companies Act. In
       the event, the depreciation claimed is less than the capital
       recovery, the difference is debited in the profit and loss account
       in the form of lease equalization charge, and similarly if, for
       any reason the depreciation claimed is more than capital
       recovery then, the difference is credited, once again, in the form
       of lease equalization charge to the profit and loss account.
       Therefore, the assessee in effect debits or credits its profit and
       loss account with a lease equalization charge depending on
       whether or not the depreciation claimed is, less or more than
       the capital recovery. 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









ITA 378/2004 & ITA 76/2007                                            Page 3 of 10
       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. Hence, the contention of the
       revenue that it is a claim in the form of a deduction which
       cannot be allowed, as there is no provision under the I.T. Act is,
       in our view, a complete misappreciation of what constitutes a
       lease equalization charge. In our opinion, as long as the
       method employed for accounting of income meets with the
       rudimentary principles of accountancy, one of which, includes
       offering only revenue income for tax, we cannot find fault with
       the assessee debiting lease equalization charges in the AYs in
       issue, in its profit and loss account. This represents true and
       fair view of the accounts; a statutory requirement under Section
       211 (2) of the Companies Act. As explained by us above, the
       rationale is that over the entirety of the lease period the said
       debit would work itself out."

This reasoning finds acceptance also in the Karnataka High Court's
judgment in Commissioner of Income tax v. Weizmann Finance [2013] 357
ITR 74 (Karn), where it was held as follows:
        "9. In the instant case, the assessee is in the business of long
       term finance. In order to carry on the said business, a debtor,
       who needs the assistance, has to make an application in
       writing. To consider the said application before granting loan,
       the assessee collects processing charges. After the debtor is
       found to be eligible to grant loan, agreements are entered into
       and thereafter loan is advanced. The amount has to be repaid
       with interest within 7 years period for repayment of the loan.
       The agreement also contains the stipulation that the amounts
       are not paid periodically as agreed to, the debtor has to pay
       penal interest. If the debtor chooses to repay the amount and
       fore close before the agreed period, then not only he has to pay
       the loan amount plus interest, he has also to pay additional
       interest, as he is not entitled to the benefit in respect of lower
       rate of interest, which was spread over the period of 7 years.




ITA 378/2004 & ITA 76/2007                                            Page 4 of 10
       All these amounts, which are paid by the debtor to the assessee,
       have a direct nexus with the business, which he is carrying on.
       All these incomes are derived from the business, which he is
       carrying on. It is also on record except this long term finance
       business, the assessee is not carrying on any other business
       much less any short term finance business. Therefore, all these
       categories of incomes which the assessee is receiving as a
       direct nexus with the long term finance and therefore section
       36(1)(viii) of the Act is attracted. Therefore, we do not see any
       merit in these appeals. Accordingly, the first substantial
       question of law is answered in favour of assessee and against
       the Revenue."

4.     The Revenue argues through its counsel, Mr. Rahul Chaudhary, that
the AO and the CIT(A) justifiably rejected the assessee's argument. The
assessee could not rely only on the Guidance Note issued by the ICAI with
respect to accounting for leases, in deciding what was the income. Whether a
particular deduction ought to be allowed or disallowed, has to be in
accordance with provisions of the Act. The Revenue argued that the debit
made to the profit and loss account by the assessee in the assessing year
concerned, towards lease equalization charge, was rightly disallowed by the
AO as there was no provision in the Act supporting such deduction.
Furthermore, there was no determination by the AO, whether the lease
transactions were finance or operating leases.
5.     Mr. Chaudhary urged that the claim for deduction of lease
equalization charges is an artificially created one and that the true picture in
the case of finance lease will emerge only when the lease agreement is over.
The assessee's arguments and claims do not show how it would deal with a
situation in a case where the lease is suspended without the full term having
been completed. It was also submitted that on expiry of the lease period



ITA 378/2004 & ITA 76/2007                                            Page 5 of 10
alone the lease assets are transferred and it cannot be said that till such only
would it be necessary to have a lease equalization reserve. In this connection,
the Revenue submitted that in the event of sale by the assessee on expiry of
the lease period, the assessee was entitled to reduce from the blocks and
assets the value realized on sale of the assets, and this will ensure the proper
deduction that the assessee has to get in accordance with the provisions of
the Act.
6.     It was next submitted that the reserve created by the assessee is only to
cover a loss, which may or may not occur in future and therefore, has to be
considered only as a contingent liability. According to counsel such
contingent liability cannot be allowed as a deduction. It was submitted that
these aspects were not considered in Virtual Soft Systems (supra) and
Weizmann (supra). Learned counsel relied on Manipal Finance Corporation
Ltd v. Assistant Commissioner of Income Tax 2014 49 Taxmann.com 353
(Karnataka).
7.     Mr. Satyen Sethi, learned counsel for the assessee argued that this
Court's judgment in Virtual Software (supra) has been accepted by most
High Courts, i.e. Gujarat High Court, Karnataka High Court etc. Reliance
was placed on Prakash Leasing Ltd. v. Commissioner of Income Tax (2012)
208 Taxman 464 (Karn); Commissioner of Income Tax v. Indian Railway
Finance Corp. Ltd (2014) 362 ITR 548; Commissioner of Income Tax v.
ICICI Ventures Funds Management Co. Ltd 2015 234 Taxman 569 (Karn);
Commissioner of Income Tax v. Pact Securities and Financial Services Ltd
(2015) 374 ITR 681 (AP & T) and Commissioner of Income Tax v. Sun
Pharmaceutical Industries Ltd. 2016 (240) Taxman 686 (Guj). Counsel
submitted that the amount is nothing but the difference between the statutory



ITA 378/2004 & ITA 76/2007                                            Page 6 of 10
depreciation on rentals and the recovery of cost of capital. Therefore, merely
because it entered in the P&L account, did not make any difference. At any
rate, it could not be treated as a reserve. Therefore, ITAT was justified in
directing deletion of the said amount.
8.     This Court is of the opinion that the consistent view adopted in the
various authorities - Virtual Soft Systems (supra) 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: it is described in Virtual Soft Systems (supra)
as "the result of the adjustment, which the assessee has to make whenever,
the amount put aside towards capital recovery is not equivalent to the
depreciation claimed by the assessee. The assessee, may claim depreciation
based on the provisions of the IT Act or, may even adopt the method of
depreciation provided under the Companies Act. In the event, the
depreciation claimed is less than the capital recovery, the difference is
debited in the profit and loss account in the form of lease equalization
charge, and similarly if, for any reason the depreciation claimed is more
than capital recovery then, the difference is credited, once again, in the form
of lease equalization charge to the profit and loss account. Therefore, the
assessee in effect debits or credits its profit and loss account with a lease
equalization charge depending on whether or not the depreciation claimed
is, less or more than the capital recovery."








ITA 378/2004 & ITA 76/2007                                           Page 7 of 10
9.     The Court also held that 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, we cannot find fault with 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.
10.     The second issue is whether the value of NPAs is to be adjusted while
determining book profits under Section 115 JA of the Act. The assessee here
argues that lease equalization is not a provision for diminution in asset value
and is a mere adjustment entry. It was argued that in this case, since lease
equalization was to the tune of ` 6,24, 96,982/- and debited to the profit and
loss account, and since the lease charges shown in the P&L Account were
the net amount of lease equalization charges, the gross block of fixed assets
was simultaneously reduced by an amount of ` 9,08,03,993/- which was the




ITA 378/2004 & ITA 76/2007                                            Page 8 of 10
accumulated lease adjustment. Therefore, no adjustment was made which
could be treated as being adjustment towards diminution in the value of
assets. The assessee relies on Commissioner of Income Tax v. Indian
Railway Finance Corporation Ltd. 2014 (362) ITR 548.
11.       Commissioner of Income Tax v. HCL Comnet Systems and Services
Ltd. 2008 (305) ITR 409 (SC) is an authority on the point that provision for
diminution of an asset is not provisioning for a liability. This logic was
followed in the case of TVS Finance and Services Ltd., Jayalakshmi Estates
v. The Joint Commissioner of Income Tax Special Range - XI (2009) 318
ITR 435(Mad) by the Madras High Court. The Gujarat High Court in
Principal Commissioner of Income Tax-2 v. Sun Pharmaceutical Industries
Ltd. [2016] 240 TAXMAN 686 (Guj) followed this view (also applying
Virtual Soft Systems) in the following terms:
       "the lease equalization charge is a method of recalibrating 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 debits
       and credits in the profit and loss account would square off with
       each other. Under the circumstances, the same is neither in the
       form of a reserve nor a deduction. The above view finds support
       in the decision of the Madras High Court in the case of TVS
       Finance and Services Ltd. {supra) wherein the court has held
       that lease equalization charge is not in the nature of a reserve,
       inasmuch as, the amount of lease equalization charge over a
       period of lease is equal to the difference between the quantum
       of principal recovered and the residual value."

The view expressed by the Gujarat and Madras High Courts have also held
that the lease equalization charges are not to be treated as adjustments




ITA 378/2004 & ITA 76/2007                                           Page 9 of 10
needing to be added back while computing book profits, under Section
115JA on account of Explanation 1. This Court is in agreement with that
view. Accordingly the second question too is answered in favour of the
assessee.
12. For the above reasons, the Revenue's appeal has to fail; it is dismissed.




                                                     S. RAVINDRA BHAT
                                                               (JUDGE)



                                                   SANJEEV SACHDEVA
                                                             (JUDGE)
FEBRUARY 21, 2018




ITA 378/2004 & ITA 76/2007                                         Page 10 of 10

Home | About Us | Terms and Conditions | Contact Us
Copyright 2024 CAinINDIA All Right Reserved.
Designed and Developed by Ritz Consulting