CPT V24P7-Art1 (Content).pmd - Taxmann

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Direct Tax Laws 678 DECISIONS Bifurcation of Lease Rental into Capital and Revenue Receipt An analysis of Prakash Leasing Ltd. v. Deputy Commissioner of Income-tax [2012] 23 taxmann.com 3 (Kar.) (i) Lease rentals relating to finance lease consist of two components, i.e., capital receipt and financing charges. (ii) Only financing charges represent real income and are accordingly chargeable to tax. (iii) The amount received towards capital recovery constitutes the capital receipt and is adjusted against cost of the asset. (iv) The lease equalization charge is the result of such an adjustment, which the assessee makes whenever the amount put aside towards capital recovery is not equivalent to the depreciation claimed by the assessee. (v) While determining accrual of liability or income, the Accounting Standards prescribed by the ICAI would have to be followed and applied if they are not inconsistent with any provision of law. FACTS 12345678901234567890123456 12345678901234567890123456 12345678901234567890123456 1234567890123456789012345678901 1234567890123456789012345678901 1234567890123456789012345678901 The assessee was a non-banking financial company. For the assessment year 1998-99 the assessee had claimed a deduction of ` 4,35,89,486. under the head 'lease equalization account.' Under the profit and loss account for the said year the assessee had reduced the aforesaid amount representing the lease equalization account from the lease rental of ` 11,84,21,434 on the basis of Accounting Standard (AS) 19 issued by the ICAI. The Assessing Officer disallowed the said claim on the ground that the same was neither a liability nor an allowance nor an expenditure. He further observed that : (i) it was just a matching entry for the purpose of tallying the accounts with regard to the assets leased out, (ii) this claim was made for the first time during the year, (iii) depreciation was provided in the books, (iv) lease income was recognized. This order was confirmed by ld. CIT(A) and the Tribunal on the ground that it was an appropriation of profit and, therefore, could not be allowed as a deduction. The Hon'ble High Court admitted and allowed the appeal of the assessee by holding as above. COMMENTS August 1 to 15, 2012 u TAXMANN’S CORPORATE PROFESSIONALS TODAY u Vol. 24 u 58 1234567890123456789012345 1234567890123456789012345 1234567890123456789012345 This judgment recognizes the importance of Accounting Standards (AS in short) issued by ICAI. The scheme of the Companies Act, 1956, also indicates that Accounting Standards are mandatory. They have to be followed by the auditors. They have to be followed by the companies, as they provide discipline, harmonization of concepts and of accounting principles. The prudential norms issued by the Reserve Bank of India also hold that Accounting Standards prescribed by the Institute of Chartered Accountants of India would apply to non-banking financial companies. Even section 211(3C) of the Companies Act specifies that till such time when the Central Government prescribes the Accounting Standards, the Accounting Standards issued by the ICAI shall be deemed to be the Accounting Standards.
As per section 145 of the IT Act business income is required to be computed in accordance with the cash or mercantile system of accounting. Sub-section (2) thereof authorizes the Central Government to notify in the Official Gazette from time-to-time Accounting Standards to be followed by any class of assessees or in respect of any class of income. Sub-section (3A) requires that the profit and loss account and balancesheet should be prepared according to Accounting Standards. Sub-section (3C) defines “Accounting Standards”. A combined effect of these provisions of the Act and the Companies Act, 1956 is that the assessees, which are companies showing income under the head “Business or profession”, have to follow the Accounting Standards prescribed. The Government of India has notified Accounting Standards in exercise of its powers under section 145(2) of the Act. (RE: CIT v. Dinesh Kumar Goel [2011] 197 Taxman 375 (Delhi)). The Accounting Standards are intended to be in conformity with the law, but if conflict arises due to subsequent amendment, in law, then the provision of law will prevail. But if there is no conflict, AS is to be followed and applied for recognizing revenue and liabilities. Prior to issue of Accounting Standards by ICAI guidance notes on accounting of leases were issued for the first time in 1988 which were revised in 1995. About the importance of guidance notes issued by the ICAI, Hon'ble Delhi High Court in CIT v. Virtual Soft Systems Ltd. [2012] 205 Taxman 257/18 taxmann.com 119 observed that “the guidance notes reflect the best practices adopted by accountants the world over” and further, that “as long as there was a disclosure of the change in the accounting policy in the accounts which had a backing of a professional body such as ICAI, it could not be discarded by the A.O.” In this context, it would be appropriate to refer to para 11 of “Guidance Notes on Accounting for Leases as revised in 1995”. It says in respect of lessors as follows: “It is appropriate that against the lease rental, a matching lease annual charge is made to the profit and loss account. This annual lease charge should represent recovery of the net investment/fair value of the leased asset over the lease term. The said charge should be calculated by deducting the finance income for the period (as per para 12 below) from the lease rental for that period. This annual lease charge would comprise: (i) minimum statutory depreciation, (e.g., as per the Companies Act, 1956) and (ii) lease equalization charge, where the annual lease charge is more than the minimum statutory depreciation. However, where annual lease charge is less than minimum statutory depreciation, a lease equalization credit would arise. In this regard the following accounting entries/disclosures should be made:— (a) A separate Lease Equalization Account should be opened with a corresponding debit or credit to Lease Adjustment Account, as the case may be. (b) Lease Equalization Account should be transferred every year to the Profit and Loss Account and disclosed separately as a deduction from/addition to gross value of lease rentals shown under the head “Gross Income”. (c) Statutory depreciation should be shown separately in the profit and loss account. Accumulated statutory depreciation should be deducted from the original cost of the leased asset in the balance sheet of the lessor to arrive at the net book value. (d) Balance standing in Lease Adjustment Account should be adjusted in the net book value of the leased assets. The amount of adjustment in respect of each class of fixed assets may be shown either in the main balance sheet or in the Fixed Assets Schedule as a separate column in the section related to leased assets. August 1 to 15, 2012 u TAXMANN’S CORPORATE PROFESSIONALS TODAY u Vol. 24 u 59 679
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August 1 to 15, 2012 u TAXMANN’S
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