2013 (11) TMI 201 - AT - Income Tax

Nature of Lease - Whether the lease transaction was operating lease or financial lease The transaction of the assessee was only a financial lease and not that of operation lease - following Asea Brown Boveri vs. IFCI 2004 (10) TMI 325 - SUPREME COURT OF INDIA - The distinction between a Finance lease and an operating lease was set out in the Guidance Note on Accounting for Leases and Accounting Standard (AS) 19 - In a finance lease, the lessee selects the equipment & the lessor provides the funds, acquired the title to the equipment and allows the lessee to use it for its expected life - The lessee uses the asset for its entire economic life & all risks and rewards incidental to ownership are transferred to the lessee even though title may or may not be eventually transferred to the lessee. A finance lease is for a fixed period & non-cancellable. There is a fixed obligation on the lessee for payment of lease money & in case of premature termination, the lessor is entitled to recover his investment with expected interest. In substance, finance lease is a loan from the lessor to the lessee. In an operating lease, the lessor bears the risk of loss, the period is cancellable and lease rentals are not synchronized with the economic life of the asset. The assessee company claimed the lease rental by treating the said transaction as operating lease - However, in the assessment framed u/s 143(3), the AO disallowed the claim of impugned lease rental as he found the transaction was for the purpose of purchase of railway wagon by the assessee and assessee was the owner of the same by concluding the transaction as financial lease. Parial Disallowance of Interest Held that - Disallowance of proportionate interest cannot be made if the interest free advances have been made to the sister concerns for commercial expediency. Since in the instant case the assessee has conclusively proved that the amount has been paid to subsidiary companies for the purpose of business and no part of the amount of advance has been utilized by the Directors for their personal purpose and the entire amount has been utilized for the purpose of business, therefore, no proportionate disallowance of interest Following the judgement of Taurian Iron and Steel Co. (P) Ltd. Versus Addl. CIT 2011 (12) TMI 410 - ITAT, Mumbai Decided in favour of Assessee. Disallowance of Punitive Charges Regarding punitive charges as payments and not an offence or prohibited by law - According to the A.O., as per the provisions of Explanation to Sec. 37 any expenditure incurred by an assessee for any purpose which is an offence or prohibited by law shall not be deemed to have been incurred for the purposes of business and no deduction shall be allowed - It is the case of the Revenue that the same being a penalty paid to the Railways for violation of the rules and regulations, explanation to section 37(1) is attracted and therefore the same should be disallowed.

Summary

Issues Involved:
1. Classification of lease transaction as operating lease or financial lease.
2. Allowability of interest expenditure and depreciation on assets under financial lease.
3. Disallowance of interest on interest-free advances to sister concerns and directors.
4. Disallowance of punitive charges paid to Railways.

Detailed Analysis:

1. Classification of Lease Transaction:
The primary issue was whether the lease transaction involving railway wagons should be classified as an operating lease or a financial lease. The assessee treated the transaction as an operating lease in its tax returns but as a financial lease in its books, following Accounting Standard 19. The AO disallowed the lease rental claim, treating it as a financial lease. The Ld.CIT(A) confirmed this disallowance but directed the AO to verify and allow interest and depreciation claims.

The Tribunal upheld the AO's and Ld.CIT(A)'s classification of the lease as a financial lease, citing the Supreme Court's guidance in Asea Brown Boveri vs. IFCI and Association of Leasing & Financial Services Companies v. UOI. The Tribunal noted that the transaction's substance indicated a financial lease, as the lessee bore all risks and rewards of ownership, and the payments were akin to installments for asset purchase.

2. Allowability of Interest Expenditure and Depreciation:
The Tribunal addressed the allowability of interest expenditure under Section 36(1)(iii) and depreciation under Section 32(1) of the Income Tax Act. The Tribunal agreed with the Ld.CIT(A) that the assessee was entitled to these claims, provided the AO verified the specifics. The Tribunal dismissed the Revenue's contention that such verification amounted to an impermissible "set aside."

3. Disallowance of Interest on Interest-Free Advances:
The assessee and Revenue disputed the partial disallowance of interest on interest-free advances to sister concerns and directors. The AO disallowed interest based on the total outstanding amount, while the Ld.CIT(A) directed a proportionate disallowance excluding specific borrowings.

The Tribunal referred to its previous decision in the assessee's case for AY 2006-07, where it was held that no disallowance was warranted if the interest-free funds exceeded the advances and were used for business purposes. Following this precedent, the Tribunal directed the AO to delete the disallowance of Rs.69,70,175/-.

4. Disallowance of Punitive Charges:
The Revenue challenged the allowability of punitive charges paid to Railways, arguing they were penalties. The assessee contended these charges were compensatory. The Tribunal referred to its earlier decision for AY 2006-07, where it was held that such charges were compensatory and allowable under Section 37(1).

The Tribunal upheld this view, stating that the charges were compensatory for overloading wagons and not penalties for law infringement. Consequently, the Tribunal dismissed the Revenue's appeal on this ground.

Conclusion:
The Tribunal's judgment provided a detailed analysis of the lease classification, confirming it as a financial lease and allowing interest and depreciation claims subject to verification. It also upheld the deletion of interest disallowance on interest-free advances and allowed the punitive charges as compensatory, not penal. The assessee's appeal was partly allowed, and the Revenue's appeal was dismissed.