2005 (7) TMI 571 - AT - Income Tax

Summary

Issues Involved:
1. Disallowance of depreciation on plant and machinery leased out as an operating lease.
2. Disallowance of depreciation on leased assets when the main business is leasing of assets.
3. Disallowance of 50% depreciation on machinery purchased in the assessment year 2000-01.

Issue-wise Detailed Analysis:

1. Disallowance of Depreciation on Plant and Machinery Leased Out as Operating Lease:
The primary issue is the disallowance of depreciation on plant and machinery claimed to have been leased out by the assessee. The assessee claimed 100% depreciation on assets leased to M/s. Asian Electronics Ltd. (AEL), which were automatic load monitoring systems. The Assessing Officer (AO) disallowed the depreciation, viewing the sale and lease back (SLB) transaction between the assessee and AEL as not genuine, citing the Supreme Court decision in McDowell & Co. Ltd. v. CTO [1985] and the ITAT, Mumbai Special Bench decision in Mid East Portfolio Management Ltd. (MEPML) v. Dy. CIT [2003]. The AO believed the SLB transaction was a financial arrangement to avoid tax, as AEL had significant losses, and the transaction reduced the assessee's taxable income.

2. Disallowance of Depreciation on Leased Assets When Main Business is Leasing of Assets:
The CIT(A) examined the issue and noted discrepancies in the sale price and excisable value of the assets, concluding that the assets were not purchased at the prevailing market price. The CIT(A) also observed that the assets were sub-leased by AEL to the Transmission Corporation (TC) of the A.P. State Electricity Board, and the lease agreement between AEL and TC restricted AEL's rights to terminate the agreement or move the equipment, indicating that the property in the equipment was never transferred to the assessee-company. Consequently, the CIT(A) confirmed the disallowance of depreciation.

3. Disallowance of 50% Depreciation on Machinery Purchased in the Assessment Year 2000-01:
The CIT(A) also confirmed the disallowance of 50% depreciation in respect of assets leased out in the preceding assessment year. The assessee argued that the assets were new and purchased at market price, and the transactions were genuine and commercially expedient. The assessee cited judgments such as CIT v. Zuari Finance Ltd. [2004] and Industrial Development Corporation of Orissa Ltd. v. CIT [2004], which supported the genuineness of SLB transactions and the entitlement to depreciation. The assessee also referred to the Supreme Court's decision in Union of India v. Azadi Bachao Andolan [2003], arguing that a valid transaction cannot be disregarded merely due to an underlying motive to reduce tax liability.

The revenue authorities, however, contended that the SLB transaction was not genuine and was intended to avoid tax, citing contradictions between the lease agreements. The ITAT Special Bench in MEPML emphasized that each SLB transaction must be judged on its own merits, considering factors such as the intention to pass property, valuation, lease terms, and conduct of parties.

Conclusion:
The Tribunal, after careful consideration, concluded that the SLB transaction between the assessee and AEL was not genuine and not intended to be acted upon, as the lease agreement between AEL and TC effectively transferred ownership rights to TC, contradicting the lease agreement between the assessee and AEL. Therefore, the disallowance of depreciation on the assets leased during the relevant assessment year was upheld. However, the Tribunal allowed the 50% depreciation of Rs. 22,44,853 for the preceding assessment year, as it was a continuation of the depreciation allowed in that year, and the transaction had been considered genuine by the AO at that time.

Final Judgment:
The appeal by the assessee was partly allowed, with the disallowance of depreciation on assets leased during the relevant assessment year upheld, but the 50% depreciation for the preceding year allowed.