2012 (3) TMI 212 - AT - Income Tax

Sham finance lease treated as advance; lessor denied depreciation as transaction found tax-avoidance masquerading as lease

ITAT MUMBAI (AT) held against the assessee, denying depreciation to the lessor. Although the agreement bore hallmarks of a finance lease and Supreme Court ... Finance lease vs Operating lease - whether lessor is entitled to depreciation on assets leased by it in finance lease - assessee, a bank, purchased a boiler and gave it on lease to Indo-Gulf Fertilisers and claimed depreciation on it on the basis that it was the owner thereof - Revenue contended that it is not a case of operating lease and hence no granting of depreciation - Held that:- Finance lease is for a fixed period & non-cancellable. Lessee uses the asset for its entire economic life & all risks and rewards incidental to ownership are transferred to the lessee even though title may or may not be eventually transferred to him. There is a fixed obligation on the lessee for payment of lease money. On facts, the assessee’s lease agreement had all the characteristics of a finance lease. Further, RBI Circular No. FSCBC 18/24-01- 001/93-94 dated 14.02.1994 states that equipment leasing activity should be treated by banks “on par with loans and advances”. Therefore, in view of decision in case of Association of Leasing & Financial Services Companies v. Union of India & Ors [2010 (10) TMI 4 - SUPREME COURT], and Asea Brown Boveri Limited v. IFCI [2004 (10) TMI 325 - SUPREME COURT], lease agreement under consideration is that of finance lease and not operating lease. Only the lessee can be treated as owner of the asset in case of a finance lease and is entitled to claim depreciation as per law. No depreciation can be allowed to the lessor in case of a genuine finance lease. Reality Behind Present Lease Agreement – Held that:- A bare perusal of various clauses of the agreement clearly transpires that this lease agreement has been entered into with the sole purpose of enabling the assessee to artificially fulfill the twin requirements of ownership and user of the asset so as to claim depreciation, to which it was not otherwise entitled as per law and thereby reduce its income in a mala fide manner. The law permits tax planning and not tax avoidance. Therefore, it is held it was a case of mere advancing of loan by the assessee to Indo Gulf Fertilizers. There was, in fact, no genuine leasing of boiler, neither operating nor finance. In that view of the matter also no depreciation is admissible to the assessee-lessor – Decided against the assessee. Issues Involved:1. Whether the agreement in question could be called a 'financial lease agreement'.2. Whether the lessor is entitled to depreciation on assets leased by it in the event of the transaction being held as a financial lease.Issue-Wise Detailed Analysis:I. WHETHER PRESENT AGREEMENT IS OF OPERATING OR FINANCE LEASE1. Definition and Characteristics of Lease:- Section 105 of the Transfer of Property Act, 1882 defines lease as a transfer of a right to enjoy property for a certain period in consideration of a price paid or promised.- Fundamental characteristic: separation of 'use' from 'ownership'.- Types of leases include finance lease, operating lease, deferred lease, etc. The present case focuses on finance and operating leases.2. Finance Lease vs. Operating Lease:- Finance Lease: A lease where the present value of minimum lease payments exceeds or is equal to substantially the whole of the fair value of the leased asset.- Operating Lease: Defined as a lease other than a finance lease.3. Guidance Note and Accounting Standards:- Guidance Note on Accounting for Leases: Describes finance lease as securing the lessor's capital outlay plus a return on funds invested.- Accounting Standard (AS) 19: Defines finance lease as transferring substantially all risks and rewards of ownership to the lessee.4. Supreme Court Judgment in Asea Brown Boveri Limited:- The Supreme Court analyzed finance and operating leases, concluding that finance lease transfers all risks and rewards to the lessee, making the lessor only a financier.5. Application to Present Case:- The lease agreement between the assessee and Indo Gulf Fertilizers satisfies the conditions of a finance lease:- Non-cancellable lease period.- Lease rentals recover the cost of the asset plus interest.- Lessee bears all costs of insurance, repairs, and maintenance.- Lessee is the real owner of the asset.6. RBI Circular and Treatment of Equipment Leasing:- RBI Circular treats equipment leasing on par with loans and advances, recognizing only the interest component as income.7. Conclusion on Lease Nature:- The agreement is a finance lease, not an operating lease, based on the characteristics and conditions outlined.II. WHETHER DEPRECIATION ADMISSIBLE IN CASE OF GENUINE FINANCE LEASE1. Ownership and User Conditions:- Section 32 requires ownership and user of the asset for business purposes to claim depreciation.- In a finance lease, the lessee is the real owner, not the lessor.2. Supreme Court Judgments:- CIT v. Podar Cement (P) Ltd.: Ownership for income tax purposes includes possession and right to receive income.- Mysore Minerals Ltd. v. CIT: Ownership for depreciation includes possession and control over the property.3. Application to Present Case:- The lessee, Indo Gulf Fertilizers, is the real owner of the boiler, exercising control and bearing all risks and rewards.- The lessor, being only a nominal owner, cannot claim depreciation.4. Distinction from Sale and Lease Back Transactions:- Sale and lease back transactions are treated differently, allowing depreciation to the lessor based on specific provisions.5. Conclusion on Depreciation:- Depreciation is not allowable to the lessor in a finance lease. Only the lessee, as the real owner, can claim it.III. REALITY BEHIND PRESENT LEASE AGREEMENT1. Substance Over Form:- Courts must consider the reality of the transaction over its form.- The agreement's terms and surrounding circumstances indicate a loan transaction disguised as a lease.2. Facts Indicating Loan Transaction:- The lease agreement was executed after the purchase of the boiler units.- Initial short-term loan sanctioned to Indo Gulf Fertilizers was later converted into a lease.3. Conclusion on Genuineness:- The so-called lease agreement is a sham, intended to reduce tax liability by claiming depreciation.- The transaction is not a genuine lease but a loan.Final Conclusion:1. The agreement in question is not a financial lease agreement but a loan transaction.2. The lessor is not entitled to depreciation on the leased asset. The real owner, Indo Gulf Fertilizers, may claim depreciation if legally advised.Order:- The appeals are to be listed before the Division Bench for disposing of the grounds of depreciation on loan to Indo Gulf Fertilizers in conformity with this order and other grounds as per law.