Prakash Leasing Ltd v DCIT [ITA Nos 301,302 & 491 OF 2007] (Karnataka High Court)

Background:

The assessee was a non-banking financial company. The assessee received a sum of Rs. 11.84 crores as the lease rentals. The assessee had deducted a sum of Rs. 4.35 crores representing the lease equalization account from lease rentals of Rs. 11.84 crores. It contended that the lease equalization charges should not be added as income.

The assessing authority disallowed the said claim on the ground that the same was neither a liability, nor an allowance and nor an expenditure. He held that same was just a matching entry for the purpose of tallying the accounts with regard to the assets leased out. He was also of the opinion that the said claim was made for the first time during the year and also that the depreciation was provided in the books and the lease income was recognized.

Tax authority’s arguments

• Since the assessee is in receipt of the entire lease rentals shown in the profit and loss during the year, the same is taxable income. The income to the aforesaid extent has accrued to the assessee.
• Hence on both accrual as well as on receipt basis, the total lease rentals received is the real income.
• The assessee did not follow the system till last year. The claim is being made for the first time during this year which makes a deviation from the accounting method so far followed by the assessee.
• The assessee cannot change its method of accounting which was being followed for many years.

Assessee’s contentions:

• The total rentals received is of two components, namely the financing charge and the amount embedded in it in the form of capital sum.
• The financing charging is the real income on which the assessee is liable to pay tax. He is not liable to pay tax on the capital value which forms part of the total rental receipt.
• The said capital value which is called as lease equalisation charges is to be excluded from the total rental receipts as per the accounting standards which the assessee is bound to follow by virtue of the directions issued by the Reserve Bank of India in its Circular to a non-banking Institution

HELD:

• Paragraphs 11 and 12 of the Guidance Note of ICAI provide for four elements which arise for consideration for treatment of the amount received as lease rentals by the lessor in order to bring to tax. The four elements are:
  – Lease rentals;
  – Implicit rate of return [IRR];
  – Depreciation;
  – and lease equalization charge.
• Reliance is placed on the Delhi High Court ruling in the case of CIT v. Virtual Soft Systems Ltd [2012] 205 Taxman 257/18 taxmann.com 119
• Lease rental in monetary terms is a sum total of the financing charge and the amount embedded in it in the form of a capital sum.
• The said financing charge constitutes the real income, which is to be offered for tax, which is determined by applying the IRR to the net investment made in the asset
• 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. Lease equalization charges is a method of recalibrating the depreciation claimed by the assessee in a given accounting period.
• Insofar as the lease equalization charges are concerned, it is not provided in the notified accounting standards by the Department. The same is also not explained under the provisions of the Act. In the absence of any specific provision in the Act dealing on the subject, even if the Central Government has not notified in the Official Gazette the accounting standards, certainly the accounting standards prescribed by the Institute of Chartered Accountants has to be followed. Reliance is placed on the Apex Court ruling in the case of Challapalli Sugars Ltd. v. CIT [1975] 98 ITR 167