Substance over form in sale-and-lease transactions controls depreciation, lease income taxation, and section 234B interest.

Depreciation under section 32 required real ownership and business use, so depreciation on electric meters leased back under a sale-and-lease arrangement was disallowed because the transaction was treated in substance as financing rather than a genuine transfer of assets. Depreciation on office and residential premises was confined to the superstructure and not the land component, with the valuation report forming the proper basis for recomputation. Interest under section 234B was held leviable as mandatory and compensatory. In contrast, the capital recovery element embedded in lease rentals was not taxable as income; only the revenue or finance element was taxable.

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Issues: (i) whether depreciation was allowable on the electric meters purchased from Gujarat State Electricity Board and leased back to it; (ii) whether depreciation on office and residential premises was to be restricted by excluding the land component; (iii) whether interest under section 234B was leviable; and (iv) whether the capital component embedded in lease rent received from Gujarat State Electricity Board was taxable as income.

Issue (i): whether depreciation was allowable on the electric meters purchased from Gujarat State Electricity Board and leased back to it.

Analysis: Depreciation under section 32 requires ownership of the asset and its use for business. The transaction was examined on its real substance against the Sale of Goods Act, 1930 and the surrounding contractual terms. The goods were not specifically ascertained, there was no effective transfer of identifiable goods, and the agreement showed that rentals were linked to financing of the cost rather than a genuine transfer of ownership and use in an operating lease. The arrangement was treated as a finance transaction and a colourable device, so the assessee could not establish true ownership for depreciation purposes.

Conclusion: Depreciation on the electric meters was rightly disallowed and the issue was decided against the assessee.

Issue (ii): whether depreciation on office and residential premises was to be restricted by excluding the land component.

Analysis: Depreciation is admissible only on the superstructure and not on land. The valuation adopted by the assessee was accepted as the proper basis for determining the cost attributable to the building component, and the Assessing Officer's own estimate of land and structure was not sustained in the presence of that valuation material.

Conclusion: Depreciation on the premises was to be allowed on the basis of the valuation report, with the land component excluded to that extent; the issue was decided in favour of the assessee in principle, but the Revenue's appeal was partly allowed for recomputation.

Issue (iii): whether interest under section 234B was leviable.

Analysis: Interest under section 234B is mandatory and compensatory. The assessee's reliance on cases dealing with unforeseen additional liability was held inapplicable because the present case involved a deliberate tax-avoidance arrangement and not an unforeseen enhancement of tax liability. The reassessment was also treated as a regular assessment for this purpose.

Conclusion: Interest under section 234B was leviable and the issue was decided against the assessee.

Issue (iv): whether the capital component embedded in lease rent received from Gujarat State Electricity Board was taxable as income.

Analysis: Once the underlying arrangement was characterised as financing rather than a genuine lease, the principal or capital recovery portion of the lease rentals could not be treated as income. Only the finance or interest element was taxable as revenue receipt.

Conclusion: The capital component was not taxable as income and the issue was decided in favour of the assessee.

Final Conclusion: The judgment sustained disallowance of depreciation on the electric meters and levy of interest under section 234B, while recognising that only the revenue element of lease receipts could be taxed and that depreciation on the premises had to be worked out on the correct superstructure value.

Ratio Decidendi: For depreciation under section 32, the assessee must prove real ownership and business use, and courts may look to the true substance of a transaction to disregard a sale-and-lease-back arrangement that is in substance financing rather than a genuine transfer of assets.

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