TaxTMI 
TaxTMI 
2006 (2) TMI 219
X X X X Extracts X X X X
X X X X Extracts X X X X
....ade by the Assessing Officer on account of lease equalization charges. The facts with regard to the lease equalization charges claimed as deduction by the assessee, which was disallowed by the revenue authorities are as follows. The assessee is a company which is engaged in the business of leasing and hire-purchase. In respect of the assets which it had granted on lease to the customers, the assessee reflected them as fixed assets in its balance sheet. In other words, the assessee was the owner of the assets which were given on lease. As owner of the assets, the assessee claimed depreciation on the assets. The lease charges received by the assessee was shown as a receipt in the Profit & Loss Account. The assessee had, however, deducted from the lease charges certain amounts carried over to lease equalization reserve and only the balance has been credited to the P&L account. In the notes to the accounts, the system of deducting lease equalization reserve from the lease charges received has been explained as follows: "Revenue recognition.-Lease Rentals are accounted for as per the terms of the lease agreements. However, in compliance with the Guidance note issued by the Institute ....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... of three years) Depreciation at the rate of 30 per cent 1st year at Rs. 100 = 30 2nd year at Rs. 70 = 21 3rd year at Rs. 49 = 15 --- Total depreciation Rs. 66 Cost of assets Rs. 100 Recovered by way of depreciation Lease Rs. 66 Equalization Rs. 34 4. The assessee has also given further illustration explaining basis On which the lease equalization charges are determined for th....
X X X X Extracts X X X X
X X X X Extracts X X X X
....sp; ------- (d) Lease rental (33+ 15) 48 Second year (a) Depreciation 21 (b) 1/3rd of capital cost 33 ------- (c) Lease equalization 12 12 ------- (d) Lease rental (33+ 15) 48 Third year (a) Depreciation 15 (b) 1/3rd of capital cost 34 &nbs....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... 4 years" The various accounting entries in the books of the lessor and the computation of income would be as per the table given below:- -------------------------------------------------------------- Year 1st IInd IIIrd IVth Total -------------------------------------------------------------- 1. Capital balance outstanding 1000 800 570 305.5 -------------------------------------------------------------- 2. Lease rent received 350 350 350 350 1400 -------------------------------------------------------------- 3. Finance charges 150 120 85.5 45.825 401.3 -------------------------------------------------------------- 4. Capital recovery component &nbs....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... based on the presumption that in the case of Finance Lease the entire lease charges received does not constitute the income and part of it is attributable to the recovery of a capital investment. Under this method the total of the accumulated depreciation and accumulated lease equalization charge at the end of the lease period is equal to the cost of the asset i. e., the asset is fully written off from the balance sheet at the expiry of lease period. Under the Income-tax Act, no distinction is drawn between the 'Operating Lease Transaction' and 'Finance Lease Transaction'. In case of lease transaction, the ownership of the asset remains with the lessor and, accordingly, depreciation is also claimed by lessor. Since the ownership of the assets remains with the lessor, the entire amount received by the lessor constitutes its income. For the purpose of income-tax, the method of computation of total income cannot be changed because of the change in method of accounting due to the new guidelines prescribed by the Institute of Chartered Accountants of India. In fact, it has already been clarified in Para 27 of revised guidance note on accounting for leases that specific treatments for d....
X X X X Extracts X X X X
X X X X Extracts X X X X
....imate of profits in the books. In fact, Lease Equalization Charge is nothing but a provision charged in the books to create a reserve for the replacement of asset. Depreciation is also a provision to create reserves out of the profits to replace the asset after the end of its useful life. However, under the income-tax the rate of depreciation are much higher and normally substantial value of the assets is written off during the lease period itself. The amount of lease equalization charge depends upon the depreciation. Higher is the depreciation, lower is the amount of Lease Equalization Charge. The very basis of calculation of Lease Equalization Charge is linked with the depreciation rates. As mentioned above, the Lease Equalization charge is nothing but a provision similar to depreciation allowance. Therefore, when the book profit, determined after providing Lease Equalization Charge, are further adjusted to give higher allowance of depreciation as per rates provided in Income-tax Rule. It leads to very distorted results, i.e., total computed in this manner does not at all comes anywhere near the real income of the assessee. The obvious reason is that the lease equalization charge....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... of the other person. It is against the general principle of determination of income of the Income-tax Act. The expenditure in the hands of one person should normally constitute the income in the hands of other person. In the case of a hire-purchase transaction, the situation is totally different. The ownership of the asset passes over to the hiree and the depreciation is also claimed by it. The total amount paid by the hiree to the hirer is split into two parts viz., Finance charges and the capital payments and both, the hiree and the hirer, account for such payment on similar basis, i.e., in books of hiree also similar basis, i.e., in books of hiree also full amount of payment made to the hirer is also debited to the profit and loss account but only the part of it is debited and balance is accounted as a capital payment. The method of accounting followed by the assessee, as per the guidance note of ICAI, cannot be adopted for the purpose of computation of total income under the Income-tax Act. It is now a well-established principle that determination of income is not affected by the accounting entries made by the assessee. Another way to look at it is that since it is provision s....
X X X X Extracts X X X X
X X X X Extracts X X X X
....nt year 1998-99 the profits of the assessee had been computed in accordance with the provision of section 115JA of the Act. In that year from the profits as per the P & L A/c the Assessing Officer had reduced the lease equalization charges thereby increasing the book profits as per section 115JA of the Act. In this year the question that would arise for consideration is as to whether the lease equalization charges can be said to be an amount set aside to provisions made for meeting liabilities, other than ascertained liabilities within the meaning of Explanation to section 115JA of. the Act. This was the basis on which the Assessing Officer and the CIT(A) added the lease equalization charges to the profits as per P & L account while arriving at the book profits in accordance with the provisions of the section 115JA of the Act. The issue for consideration in the other two years would be as to whether the revenue authorities were justified in making an addition equivalent to the amount of lease equalization charges which was claimed by the assessee as a deduction in computing its income. 7. We have heard the submissions of the ld. counsel for the assessee and the ld DR. Ld. counse....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... the RBI has the power to determine the policy and give directions to all or any of the Non-Banking Financial Companies relating to the income recognitions and accounting standards, making of proper provision for bad and doubtful debts, capital adequately based on risk-for assets and credit conversion factors for off balance sheet items and also relating to deployment of funds by a Non-Banking Financial Company or a closure of Non-Banking Financial Company or Non-Banking Financial Companies generally, as the case may be. The section also specifies that Non-Banking Financial Companies shall be bound to follow the policies so determined and the directions so issued. The section also makes it clear that such policies have to be in public interest, or to regulate the financial system of the country to its advantage, or to prevent the affairs of any Non-Banking Financial Company being conducted in a manner detrimental to the interest of the deposits or in a manner prejudicial to the interest of the Non-Banking Financial Company. Further, section 45Q of the RBI Act is an overriding clause. This section is contained in Chapter III-B of the RBI Act and it provides that the provisions of Ch....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... Chennai Bench of the ITAT in the case of Overseas Sanmar Financial Ltd. v. Jt. CIT [2003] 86 ITD 602 (Chennai) laying down a similar proposition. 9. The submission of the ld. counsel for the assessee was that since the prudential norms of RBI read with the accounting standards/guidelines by ICAI in the matter of accounting for lease in the books of account of on NBFC, permit a deduction on account of lease equalization charges, the claim of the assessee should be allowed. In this regard, it was submitted that the accounting standards of ICAI referred to above, in the light of the NBFCs prudential norms issued by RBI, makes it obligatory for NBFCs to follow the accounting standards issued by ICAI, will have the force of law if read with the provisions of RBI Act. Strong reliance was placed on the decision of Tribunal referred to above in this regard. 10. The ld. DR, however, strongly opposed the plea raised by the ld. counsel for the assessee. His submissions were as follows:- (a) The claim for deduction of lease equalization charges is an artificial created claim. (b) The true picture in the case of finance lease will emerge only when the lease agreement is over. In th....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ings that the income determined in accordance of such guidelines should be the basis for determining income chargeable to tax under the Income-tax Act also. It is, however, seen from the prudential norms issued by the RBI that the accounting standards prescribed by ICAI would apply to NBFC. A copy of the guidelines issued by ICAI in the matter of accounting for lease in the books of a lessor have been filed before us. In clause 27 of such guidelines it is stated as follows:- "Clause 27. Computation of Taxable Income.-It is clarified that the specific treatments for determining taxable income would have to be in accordance with the provisions of taxation laws; such treatments may differ from the recommendations contained in the Guidance Note." 12. It is thus clear that even the ICAI is of the view that these provisions are meant only for recognizing the net income in respect of a finance lease at constant periodic rate of return on the lessor's net investment outstanding in the lease and are not to be considered while determining taxable income in accordance with the provisions of the Income-tax Act, 1961. In view of the above, we are of the view that the claim made by the ass....