2023 (5) TMI 1237 - AT - Income Tax

Court upholds CIT(A)'s decision on depreciation claim in finance lease, directs AO to verify.

The Court upheld the CIT(A)'s decision to delete the addition made by the AO regarding the excess claim of depreciation. The CIT(A) determined that ... Excess claim of Depreciation - appellant had claimed depreciation on assets under “Finance Lease” - Scope of AS-19 issued by the ICAI - determination of ownership of asset - CIT-A deleted the addition - HELD THAT:- We find that the Ld. CIT(A) has duly taken the note that after issuance of AS-19 issued by the ICAI, the CBDT vide Circular No. 2/2001 dated 9 February 2011 has clarified that capitalization of assets acquired under the finance lease by the lessees in their books of account will not have any bearing on the allowance of depreciation on those assets u/s 32 of the Income Tax Act and also states that the ownership of the asset is determined by the terms of contract between the lessor and the lessee. As per the above circular the owner is entitled to depreciation, whether he is lessee or lessor, depending upon the terms of the contract. CIT(A) taken the note of case of ICDS Ltd. [2013 (1) TMI 344 - SUPREME COURT] wherein as reaffirmed the position that in a leasing transaction it is the lessor and not the lessee, who is entitled to claim depreciation on the leased assets. Hence, the order of the Ld. CIT(A) is in accordance with law - Decided against revenue. ISSUES PRESENTED AND CONSIDERED 1. Whether depreciation claimed by the taxpayer on assets shown in books as capitalized pursuant to finance lease can be disallowed on the ground that audit annexure (Form 3CD) does not record the same amounts. 2. Whether assets under a finance lease are entitled to depreciation in the hands of the lessee or the lessor and the effect of accounting standard AS-19 and CBDT Circular on entitlement to depreciation under Section 32. 3. Whether the Assessing Officer was bound to verify the terms of the finance lease agreement before disallowing depreciation claimed on leased assets and whether direction to verify the agreement is appropriate relief. ISSUE-WISE DETAILED ANALYSIS - Issue 1: Disallowance based on discrepancy between return/computation and audit annexure (Form 3CD) Legal framework: Assessment under Section 143(3)/147 and computation of taxable income requires reconciliation between return and audit records; Form 3CD and its annexures are material for verifying claims such as depreciation. Precedent treatment: The tribunal considered statutory guidance and authoritative pronouncements on accounting treatment of finance leases (see Issue 2) rather than treating a mismatch in audit annexure as conclusive proof of disallowance. Interpretation and reasoning: The Court observed that a numerical discrepancy between depreciation claimed in the return and figures in the audit appendix/3CD alone does not automatically justify disallowance where substantive legal entitlement to depreciation exists. The Assessing Officer's computational approach - reducing allowable depreciation solely because the particular amount claimed by the assessee was not shown identically in appendix B - was not accepted as dispositive without verifying contractual and substantive entitlement to depreciation. Ratio vs. Obiter: Ratio - an assessment disallowing depreciation cannot rest solely on a clerical or documentary mismatch in the audit annexure; substantive legal entitlement must be examined. Obiter - procedural weight to particular audit entries without contract verification is inadequate. Conclusion: The AO's blanket disallowance on the basis of absence of a corresponding figure in the audit appendix was unsustainable; the claim required adjudication on substance (ownership/lease terms) rather than solely on the Form 3CD entry. ISSUE-WISE DETAILED ANALYSIS - Issue 2: Entitlement to depreciation in finance lease transactions (lessee v. lessor) and effect of AS-19 / CBDT Circular Legal framework: Section 32 (allowance of depreciation) is determined by ownership for tax purposes as fixed by contract/accepted accounting principles; AS-19 (Leases) and CBDT Circular No.2/2001 clarify treatment where finance lease capitalization occurs in lessee's books. Precedent treatment (followed/distinguished/overruled): The Court relied on the CBDT circular interpreting AS-19 and cited the Supreme Court decision (reversing a High Court) that in leasing transactions depreciation is ordinarily allowable to the lessor and not the lessee, subject to the contractual allocation of ownership/rights. Interpretation and reasoning: The Court accepted that AS-19 and CBDT Circular establish that capitalization in the lessee's books per se does not determine entitlement to depreciation under Section 32; instead, ownership for tax purposes depends on lease contract terms. The Supreme Court's pronouncement was read as reaffirming that generally the lessor is entitled to depreciation in leasing arrangements unless the contract or transaction shows otherwise. Thus, depreciation claimed by a lessee on finance-leased assets is permissible only if the lease terms convey ownership or entitlement consistent with Section 32. Ratio vs. Obiter: Ratio - entitlement to depreciation in finance lease cases is to be determined by reference to contractual terms and governing accounting guidance (AS-19/CBDT Circular) and not merely by book capitalization; Supreme Court authority confirming lessor's general entitlement is binding and formed the basis of the decision. Obiter - general statements about accounting practice where not determinative of contract terms. Conclusion: The appellate authority correctly applied AS-19/CBDT Circular and Supreme Court authority to hold that depreciation on finance-leased assets could not be disallowed merely because of bookkeeping entries; entitlement depends on lease terms and, absent a contractually conclusive allocation to the lessor, the lessee's claim cannot be summarily rejected. ISSUE-WISE DETAILED ANALYSIS - Issue 3: Requirement and scope of verifying the finance lease agreement Legal framework: Assessment actions under Sections 143(3)/147 must be founded on verification of material facts and documents; where entitlement to tax deductions depends on contractual allocation (ownership/right to use), the AO must examine the relevant contracts. Precedent treatment: The CIT(A) directed verification of the finance lease agreement as a condition for allowing depreciation; the Tribunal upheld that direction as consistent with the legal requirement to determine entitlement by reference to contract. Interpretation and reasoning: The Court held that the CIT(A)'s direction to verify the finance lease agreement was appropriate because AS-19/CBDT Circular and judicial precedent require an inquiry into contract terms to determine which party is entitled to depreciation. The AO's summary arithmetic disallowance failed to engage with that substantive inquiry. Therefore, a directive to verify the lease agreement and allow depreciation if the agreement supports the assessee's claim was warranted. Ratio vs. Obiter: Ratio - where entitlement to depreciation turns on contractual ownership or rights, the AO is obliged to verify the lease agreement before making a disallowance; directions for verification are proper remedial steps. Obiter - specific methods of verification and evidential thresholds not exhaustively prescribed. Conclusion: The CIT(A)'s instruction that the AO verify the finance lease agreement and allow relief accordingly was legally correct; the Tribunal found no error in that approach and dismissed the revenue's appeal. OVERALL CONCLUSION The Court concluded that the appellate authority's order was in accordance with law: depreciation on finance-leased assets cannot be disallowed solely because audit annexure figures do not match the taxpayer's computation; entitlement must be determined by reference to AS-19, the CBDT Circular, and contract terms, and the Assessing Officer must verify the finance lease agreement before finalizing any disallowance. The Revenue's appeal was dismissed.