2007 (2) TMI 181 - HC - Income Tax

Depreciation u/s 32 - Leasing transactions involving movables - Entitled to claim depreciation upon assets owned by it and leased in favour of educational institutions which had made interest earning deposits with the assessee? - HELD THAT - The assessee acquires the asset in its name and leases it to the educational institution which makes an interest bearing security deposit, equal to the entire value of the asset so leased, but agrees not to receive any interest which is to be adjusted entirely towards lease rentals. There is a remote possibility of termination of the lease and refund of the security deposit. In the meanwhile the assessee claims depreciation on the asset, which the educational institution could not have claimed if it had directly acquired the asset, as it is exempt from payment of income-tax. The further fact that the assessee and the lessees are managed by the same group of individuals, as directors in the assessee-company and in other capacities, managing the lessees would leave no room for doubt that the transactions are blatantly geared to evade the tax liability. It would be extremely naive to accept the transactions as commercially accepted transactions. The same cannot be considered as being a tidy management of affairs in accordance with law. The assessee and the lessees are on the other hand, cocking a snook at the law. Though it remains true in general that the taxpayer, where he is in a position to carry through a transaction in two alternative ways, one which will result in liability to tax and the other which will not, is at liberty to choose the latter. The transaction in the case on hand is not an alternative chosen by the assessee but a mechanism devised to enable a non-tax paying entity to acquire an asset and also to claim depreciation on it. It cannot be said that the transactions are entered into with the effect of minimising the subject's burden of tax, but only in order to facilitate the benefit as aforesaid. The finding that the assessee is not entitled to claim depreciation on the assets is not on the basis of the underlying motive but the direct result of the manner these transactions are engineered. In the result, in our opinion-on a careful consideration of the contentions and the case law cited, we have no hesitation in holding that the question of law is required to be answered in the negative and in favour of the Revenue and the order of the Income-tax Appellate Tribunal is set aside.

Issues Involved:
1. Entitlement to depreciation on assets leased to educational institutions.
2. Legitimacy of the lease transactions and their characterization as tax avoidance mechanisms.

Detailed Analysis:

1. Entitlement to Depreciation on Assets Leased to Educational Institutions:
The primary issue revolves around whether the assessee, a public limited company engaged in leasing, financing, and hire-purchase, is entitled to claim depreciation on assets leased to educational institutions. The assessee entered into leasing transactions with various educational institutions, receiving interest-bearing security deposits equivalent to the purchase value of the assets. The lease rental was equal to the interest payable on these deposits.

The appellant claimed depreciation on these leased assets, which was denied by the assessing authority on the grounds that:
- The appellant and the lessees were controlled by common members.
- The transactions were "self-cancelling," allowing the appellant to use the security deposit to purchase the asset and adjust the lease rental against the interest payable.
- The educational institutions, being tax-exempt, could not claim depreciation, effectively enabling a taxable entity to claim depreciation on an asset purchased with funds from a non-taxable entity.

The quantum of depreciation claimed, amounting to Rs. 44,22,955, was added back to the appellant's income. This decision was upheld by the first appellate authority and the Income-tax Appellate Tribunal, leading to the present appeal.

2. Legitimacy of the Lease Transactions and Their Characterization as Tax Avoidance Mechanisms:
The court examined whether the lease transactions were genuine commercial transactions or mechanisms designed to evade tax liability. The assessee's counsel argued that the transactions were legitimate and supported by relevant documents, with the appellant owning the assets and using them in business, thereby satisfying the conditions for claiming depreciation.

The counsel relied on several legal precedents, including Union of India v. Azadi Bachao Andolan [2003] 263 ITR 706, where the Supreme Court held that tax planning within the framework of law is legitimate, and CIT v. P. J. Chemicals Ltd. [1994] 210 ITR 830 (SC), which emphasized the plain meaning of "actual cost" under section 43(1) of the Income-tax Act.

However, the Revenue's counsel contended that the transactions were designed to pass on the depreciation claim from non-taxable entities to a taxable entity without actual investment by the latter. The common management of the assessee and the lessees further indicated a lack of genuineness. The court agreed with this view, noting that the transactions were engineered to evade tax liability and were not commercially acceptable.

The court emphasized that the transactions were not an alternative method of minimizing tax but a mechanism to enable a non-tax paying entity to acquire an asset and claim depreciation on it. This was evident from the fact that the assessee acquired the asset in its name, leased it to the educational institution, and received a security deposit equal to the asset's value, which was adjusted against lease rentals.

Conclusion:
The court concluded that the assessee was not entitled to claim depreciation on the leased assets, as the transactions were designed to evade tax liability. The appeal by the assessee was dismissed, and the appeal by the Revenue was allowed, setting aside the order of the Income-tax Appellate Tribunal. The substantial question of law was answered in the negative and in favor of the Revenue.

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