Whether when assessee enters into financial lease agreement to virtually use entire productive life span of an asset, it can capitalise lease payments made towards principal sum paid for taking asset on lease - if not, whether depreciation can be claimed - NO, rules ITAT

Income tax -  THE issues before the Tribunal are - Whether when assessee enters into a financial lease agreement to virtually use entire productive life span of an asset, and lease charges calculated to cover full cost with interest, it amounts to disguised purchase of asset - Whether assessee can capitalise lease payments made towards principal sum paid for taking vehicles on lease - Whether assessee is entitled to make alternate claim for depreciation - Whether assessee's contribution to building fund of Federation of Indian Mining Industries is revenue expenditure - Whether any commercial expediency is involved in such a donation. And the verdict partially goes against the assessee.

Facts of the case

A) The assessee, belonging to an international mining group of companies, is engaged in providing services for the development of the mining sector in India. The assessee filed its return of income, which was selected for scrutiny. The assessee had taken certain vehicles on financial lease for its use, which were registered in its name. The insurance policy was also in the name of the assessee. The assessee had entered into a lease agreement with M/s LeasePlan India (LPIN) for a lease period of 48 months, under which it had made the principal payment under the financial lease besides making payments on account of interest. In its books of account, the assessee had capitalized these assets acquired in the financial lease agreement, as required under Accounting Standard 19 on leases. In accordance with the CBDT circular, the assessee had not claimed depreciation under section 32. Though the depreciation on capitalized leased vehicles was debited to its profit and loss account, it was added back in the computation of income. The assessee had claimed deduction on the principal amount paid to LPIN under the lease agreement

The AO rejected the assessee’s explanation that as per the CBDT circular, accounting standard 19 had no implication on the allowance of depreciation on assets acquired under the finance lease agreement and the lease charges incurred during the year were allowed as deduction. The AO held that the vehicles had been taken under a finance lease arrangement and not under operational lease. Considering the lease period, the assessee had got enduring benefit of the vehicles for the period of the lease. Thus the principal payment towards financial lease had been incurred for the creation of a capital asset, of enduring benefit to the assessee company. Also, considering the accounting standard and the CBDT circular, the AO concluded that the circular did not help the assessee, who was not entitled to depreciation on base payments. Only the lessor was entitled to claim depreciation. Thus, the principal payments towards financial lease being for acquisition of assets, were capital in nature and, therefore, could not be allowed as revenue expenditure. The AO, while treating the principal payment as a capital expense, allowed the payment of interest as revenue expenses. Depreciation was also not allowed under section 32 on cost of assets taken on lease.

In appeal, the CIT(A) confirmed the AO’s order holding that all the terms and conditions of the lease agreement showed that the assessee had entered into a financial lease and not an operational lease and thus only interest payment could be allowed as an expense and not the repayment of principal. In view of the CBDT Circular, depreciation was also disallowed.

B) The assessee had made a contribution to the building fund of the all-India Federation of Indian Mining Industries (FIMI), a non-profit corporate body, established by individual mine operators and associations to promote the interests of the mining community, which was engaged in liaisoning with various government bodies and providing support to mining industries. The assessee had claimed this amount as a deduction as it was a member of the Federation and rendering services to mining industries whereby this expenditure was claimed as being wholly and exclusively incurred for the purpose of business. The AO however concluded that the assessee had failed to establish that the expenditure was incurred wholly and exclusively for the purpose of business, whereby it was disallowed.

In appeal, the CIT(A) confirmed the AO’s order concluding that the payment made to the Federation could not be said to be for the purpose of business and revenue in nature. The expense was in the nature of donation and capital in nature and could not be said to have been incurred wholly and exclusively for the purpose of business under section 37(1). Thus the CIT(A) treated the amount in the nature of donation and capital in nature.

In appeal before the Tribunal, the assessee claimed that it was entitled to deduction of the principal amount under the lease finance arrangement or alternatively, depreciation on the original amount of the assets taken on financial lease. Regarding the contribution to the building fund of the mining industries federation, the assessee submitted that the activities of federation were closely linked with the welfare of mining industry, whereby the expenditure was admissible as revenue.

Regarding the contribution to the Federation, the Revenue submitted that the amount conferred enduring benefit to the assessee, spread over a number of years and thus, could not be allowed as revenue expenditure.

Having heard the parties, the Tribunal held that,

++ considering the terms and conditions of the lease agreement, it was clear that the assessee had entered into a financing lease arrangement where the lessee could use the asset for substantially the whole of its useful life and the lease payments were calculated to cover the full cost together with interest charges. It was thus a disguised way of purchasing the asset with the help of a loan. An operating lease was any other type of lease where the asset was not wholly amortised during the non-cancellable period, if any, of the lease and where the lessor did not rely for his profit on the rentals in the non-cancellable period. The distinction had been explained in various decisions;

++ the jurisdictional High Court had concluded that, financial lease was a transaction current in the commercial world, the primary purpose whereof was financing of the purchase by the financier. Following these decisions and, on analyzing the various terms and conditions of the lease agreement, the assessee was not entitled to deduction of payment of principal amount under the financing arrangement. Accordingly, there was no need to interfere with the findings of the CIT(A) in upholding the disallowance of claim for deduction towards payment of principal amount;

++ regarding the alternative contention for depreciation, there were specific covenants in the agreement, under which the assessee was neither entitled to claim any right, title or interest in the vehicle other than that of a lessee nor contest LPIN’s sole and exclusive ownership thereof. The assessee could also not claim any relief by way of any deduction, allowance or grant available to LPIN as the owner of the vehicle. Thus, in the light of the terms and conditions stipulated in Article 10 of the agreement, the alternative claim of the assessee was not accepted. These grounds of the assessee’s appeal were dismissed;

++ regarding the contribution made by the assessee to the building fund, the apex court had held in a decision that the correct test was that of commercial expediency. The Madras High Court had held that the contribution made by the company to the Chamber of Commerce, whose activities were closely linked with the welfare of corporate entities, who were members therein, and whose interest was taken care of by the Chamber, irrespective of whether the expense incurred was compulsory or otherwise, satisfied the commercial expediency test. The apex court in another decision had also held that the fact that the scheme was not for any temporary or particular duration made little difference to the nature of the expenditure. The Kerala High Court had also held that the contribution made by the assessee at the suggestion of the State Minister concerned, for sharing of cost incurred for cement lining of an irrigation canal serving sugarcane cultivators, was allowable as revenue expenditure under section 37(1), as it went to the advantage of the assessee in the form of better supply of sugarcane;

++ in the present case, the federation had over 44 years of experience in mining technology solutions for the mineral industry and represented the entire non-fuel mining and mineral processing activities of the nation. Following the various decisions, the contribution towards the building fund of the Federation, of which the assessee was a member, had been incurred with a view to obtaining a commercial advantage and was allowable as revenue expenditure. This ground of the assessee was allowed.