Deduction allowed as per Guidance Note of ICAI for lease equalization charges as there was no express bar in Income Tax Act regarding bifurcation of lease rental-SC
A batch of appeals had been filed by the Income Tax Department (Revenue) against the judgment and order passed by the High Court of Delhi whereby the Division Bench of the High Court upheld the decision of the Income Tax Appellate Tribunal (the Tribunal/ITAT) in allowing deduction towards towards lease equalization charges.
ABCAUS Case Law Citation:
ABCAUS 2308 (2018) (04) SC
Important Case Laws Cited/relied upon by the parties:
Commissioner of Income Tax-VII, New Delhi vs. Punjab Stainless Steel Industries (2014) 15 SCC 129
Deduction allowed as per Guidance Note of ICAI
The respondent was a company registered under the provisions of the Companies Act, 1956. the respondent filed its return of income for the relevant Assessment Year declaring loss while claiming a deduction towards lease equalization charges.
The Assessing Officer (AO) disallowed the deduction claimed as the lease equalization charges and added the same to the income of the Respondent.
Being aggrieved with the said Assessment Order, the Respondent preferred an appeal before the Commissioner of Income Tax (Appeals). However, the CIT (Appeals), upheld the order of the Assessing Officer and dismissed the appeal.
On second appeal, the ITAT allowed it and sett aside the orders passed by CIT (Appeals) and the Assessing Officer.
Being aggrieved, the Revenue took the matter before the High Court. The High Court, dismissed the appeals at the preliminary stage while confirming the decision of the ITAT.
The question was whether the deduction on account of lease equalization charges from lease rental income can be allowed under the Income Tax Act, 1961 (the Act), on the basis of Guidance Note issued by the Institute of Chartered Accountants of India (ICAI)?
The Hon’ble Supreme Court observed that the ICAI is an expert body, created by the Parliament under the Chartered Accountants Act, 1949. The ICAI’s publication on the subject indicated 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.
It was noted that Section 211 of the Companies Act, 1956. Sub clause (3C) 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.
It was observed that as per the Guidance Note on Accounting for Leases, revised in 1995, the method of accounting followed 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. 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 Income Tax Act and to its Scheme and spirit.
The Hon’ble Supreme Court observed that 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 any 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. Accordingly, the Apex Court rejected the contentions of the Revenue that whole revenue from lease shall be subjected to tax under the IT Act.
The main contention of the Revenue was that the respondent company could not be allowed to claim deduction regarding lease equalization charges since as such there is no express provision regarding such deduction in the IT Act. However, the Hon’ble Supreme Court pointed out that the Respondent can be charged only on real income which can be calculated only after applying the prescribed method. The IT Act is silent on such deduction. For such calculation, it is obvious that the respondent had 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. The Hon’ble Court opined that it was 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.
It was also observed that 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 thus there was no illegality in such bifurcation as it was 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.
Hence, the Hon’ble Supreme Court rejected the contentions of the Revenue that the accounting standards prescribed by the Guidance Note cannot be used to bifurcate the lease rental to reach the real income for the purpose of tax under the IT Act.
The Hon’ble Supreme Court held that the respondent company was entitled for bifurcation of lease rental as per the accounting standards prescribed by the ICAI as there was no express bar in the IT Act regarding the application of such accounting standards.
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