Finance lease rentals treated as revenue expenditure where ownership stays with lessor and use-rights alone pass to lessee.

Where a finance lease leaves title with the lessor and gives the lessee only a right to use the asset, the lease rentals are treated as revenue expenditure under section 37(1) and not as capital outlay merely because the arrangement is labelled a finance lease. The accounting treatment under AS 19 does not control tax deductibility, and the CBDT circular confirms that accounting classification is not determinative under the Income-tax Act. On those contractual terms, the principal component of rentals for leased computers and networking equipment was allowable, and the disallowance was deleted.

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Issues: Whether the principal component of finance lease rentals paid for use of leased computers and networking equipment was allowable as revenue expenditure under section 37(1) of the Income-tax Act, 1961.

Analysis: The lease arrangement showed that title remained with the lessor, the lessee had only use rights, the equipment had to be returned on expiry, and default enabled repossession by the lessor. The accounting treatment under AS 19 did not determine the tax treatment. The CBDT circular clarified that accounting classification of finance lease transactions does not govern allowance under the Act. Applying the ratio that ownership for tax purposes depends on the contractual terms and that lease rent paid for use of an asset is not capital outlay, the lease payment could not be treated as acquisition cost merely because it was called a finance lease.

Conclusion: The lease rental was held allowable as revenue expenditure under section 37(1), and the disallowance was deleted in favour of the assessee.

Ratio Decidendi: In a finance lease, where the contractual terms show that ownership remains with the lessor and the lessee only acquires use of the asset, the lease rentals are deductible as revenue expenditure under the Income-tax Act and are not to be treated as capital expenditure merely because of the accounting treatment.

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