Income Tax Act, 1961 – Deduction on account of lease equalization charges from lease rental income – Entitlement for – Held: The bifurcation of the lease rental is, by no stretch of imagination, an artificial calculation and, therefore, lease equalization is an essential step in the accounting process to ensure that real income from the transaction in the form of revenue receipts only is captured for the purposes of income tax – Moreover, there is no express bar in the IT Act which bars the bifurcation of the lease rental – This bifurcation is analogous to the manner in which a bank would treat an EMI payment made by the debtor on a loan advanced by the bank – The repayment of principal would be a balance sheet item and not a revenue item – Only the interest earned would be a revenue receipt chargeable to income tax – Hence, whole revenue from lease would not be subjected to tax under the IT Act – Respondent is entitled for bifurcation of lease rental as per the accounting standards prescribed by the ICAI – Chartered Accountants Act, 1949.
Chartered Accountants Act, 1949 – Guidance note issued by the Institute of Chartered Accountants of India (ICAI) – Reliability of – Held: ICAI is a recognized expert body vested with the authority to recommend accounting standards – The method of accounting followed, as derived from the ICAI’s Guidance Note, is a valid method of capturing real income based on the substance of finance lease transaction.
Companies Act, 1956 – s.211 – Accounting standards as prescribed by ICAI to prevail until the accounting standards are prescribed by the Central Government.
Disposing of the appeals, the Court
HELD: 1.1 The ICAI is an expert body, created by the Parliament under the Chartered Accountants Act, 1949. The ICAI’s publication on the subject indicates that the Guidance Note on Accounting for Leases was issued by it for the first time in 1988 which was later on revised in 1995. The Guidance Note reflects the best practices adopted by the accountants throughout the world. The ICAI is a recognized body vested with the authority to recommend accounting standards for ultimate prescription by the Central Government in consultation with the National Advisory Committee of Accounting Standards for the presentation of true and fair financial statements. [Para 8] [601-C-D]
1.2 Section 211 of the Companies Act, 1956 as it stood before the amendment dealt with “the Form and contents of balance-sheet and profit and loss account”. Sub clause (3C) of Section 211 was added vide 1999 amendment with retrospective effect. The purpose behind the amendment in Section 211 of the Companies Act, 1956 was to give clear sight that the accounting standards, as prescribed by the ICAI, shall prevail until the accounting standards are prescribed by the Central Government under this sub-section. The purpose behind the accounting standards was to arrive at a computation of real income after adjusting the permissible deprecation. It is not disputed that these accounting standards are made by the body of experts after extensive study and research. [Paras 9, 10] [601-E; 602-A-B]
2.1 The method of accounting provided in the Guidance Note of 1995, on the one hand, adjusts the inflated cost of interest of the assets in the balance sheet. Secondly, it captures “real income” by separating the element of capital recovery (essentially representing repayment of principal amount by the lessee, the principal amount being the net investment in the lease), and the finance income, which is the revenue receipt of the lessor as remuneration/reward for the lessor’s investment. As per the Guidance Note, the annual lease charge represents recovery of the net investment/fair value of the asset lease term. The finance income reflects a constant periodic rate of return on the net investment of the lessor outstanding in respect of the finance lease. While the finance income represents a revenue receipt to be included in income for the purpose of taxation, the capital recovery element (annual lease charge) is not classifiable as income, as it is not, in essence, a revenue receipt chargeable to income tax. [Para 12] [604-C-E]
2.2 The method of accounting followed, as derived from the ICAI’s Guidance Note, is a valid method of capturing real income based on the substance of finance lease transaction. The rule of substance over form is a fundamental principle of accounting, and is in fact, incorporated in the ICAI’s Accounting Standards on Disclosure of Accounting Policies being accounting standards which is a kind of guidelines for accounting periods starting from 01.04.1991. It is a cardinal principle of law that the difference between capital recovery and interest or finance income is essential for accounting for such a transaction with reference to its substance. If the same was not carried out, the Respondent would be assessed for income tax not merely on revenue receipts but also on non-revenue items which is completely contrary to the principles of the IT Act and to its Scheme and spirit. [Para 13] [604-F-H]
2.3 The bifurcation of the lease rental is, by no stretch of imagination, an artificial calculation and, therefore, lease equalization is an essential step in the accounting process to ensure that real income from the transaction in the form of revenue receipts only is captured for the purposes of income tax. Moreover, there is no express bar in the IT Act which bars the bifurcation of the lease rental. This bifurcation is analogous to the manner in which a bank would treat an EMI payment made by the debtor on a loan advanced by the bank. The repayment of principal would be a balance sheet item and not a revenue item. Only the interest earned would be a revenue receipt chargeable to income tax. Hence, there is no force in the contentions of the Revenue that whole revenue from lease shall be subjected to tax under the IT Act. [Para 14] [605-A-C]
Commissioner of Income Tax-VII, New Delhi v. Punjab Stainless Steel Industries (2014) 15 SCC 129 – relied on.
3. The main contention of the Revenue is that the Respondent cannot be allowed to claim deduction regarding lease equalization charges since as such there is no express provision regarding such deduction in the IT Act. The IT Act is silent on such deduction. For such calculation, the Respondent has to take course of Guidance Note prescribed by the ICAI if it is available. Only after applying such method which is prescribed in the Guidance Note, the Respondent can show fair and real income which is liable to tax under the IT Act. Therefore, it is wrong to say that the Respondent claimed deduction by virtue of Guidance Note rather it only applied the method of bifurcation as prescribed by the expert team of ICAI. Further, a conjoint reading of Section
145 of the IT Act read with Section 211 (un-amended) of the Companies Act make it clear that the Respondent is entitled to do such bifurcation and there is no illegality in such bifurcation as it is according to the principles of law. Moreover, the rule of interpretation says that when internal aid is not available then for the proper interpretation of the Statute, the court may take the help of external aid. If a term is not defined in a Statute then its meaning can be taken as is prevalent in ordinary or commercial parlance. [Paras 16, 17] [605-F-H; 606-A-C]
As published in the Supreme Court Reports, Supreme Court of India. Text from the Indian Supreme Court Judgments open data set (Dattam Labs), CC BY 4.0.
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