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TMI Blog2017 (3) TMI 322X X X X Extracts X X X X X X X X Extracts X X X X ..... the amount of rent equalisation reserve charged to profit and loss account is covered under clause (b) or (c) of Explanation 1 to Section 115JB of the Act, and thus needs to be added in Book profits." 3. Brief facts apropos this issue are that the assessee had debited a sum of Rs. 18,45,875/- in its Profit & Loss Account as rent equalization reserve. As per assessee's submissions before the Assessing Officer, this reserve had been created by the assessee upon straight lining of the lease rentals payable by the assessee under an operating lease for the premises occupied by it during the financial year under consideration and in accordance with the Accounting Standard 19 (AS19) : 'Accounting for Leases issued by the Institute of Chartered Accountant of India (ICAI)'. In the course of assessment proceedings, the assessee, in its submissions, dated 28.11.2011, which has been reproduced by Assessing Officer at page 2 of his draft assessment order, it had been stated that this reserve had inadvertently been left out from being added back while computing the taxable income under the normal provisions of the Act due to lack of clarity on its allowability under the normal provisions of th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Deed shall be executed on the same terms and conditions as in this Agreement. This is in the interest of the Lessee, as no matter what the current rate of rentals at the time, with an upper cap of 15%, on the previous basic rent the escalation remains restricted to any undue hike in rentals. A fresh Deed of Lease will be executed at the time of each renewal and the same shall be duly registered in accordance with the provisions of the Indian Registration Act, 1908 after the payment of the appropriate stamp duty at the then applicable rates as per the Indian Stamp Act, 1899 incorporating the same terms and conditions as are contained herein." 5. Ld. counsel referred to page 175 of Paper Book, wherein, the assessee's reply before the Assessing Officer dated 29.11.2011 is contained in which, inter-alia, it was explained as under :- "Generally, leasing agreements nowadays provides for an escalation clause in the rent payable by a Company over a period of time. In these cases, since, the lessee is deriving the same benefit from the rented premises (in physical terms), from one year to another, in order to prevent a higher amount debited in the profit and loss account in the later ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the Lease Deed was for three years and, therefore, the rent equalization reserve could not be created on the basis of 9 years lease term, which could materialize subject to renewal of lease. Ld. DR submitted that it is not a case of lease covered by AS 19 since there was no certainty of continuance of lease. He submitted that property considered in AS 19 is different. He pointed out that AS 19 is not applicable to lease of immovable property. Ld. DR further submitted that the decision of Hon'ble Karnataka High Court in the case of ICICI Venture Funds Management Co. Ltd. (supra) was with reference to financial lease and not operational lease, wherein, it was, inter-alia, observed that lease equalization charges was nothing but the difference between the statutory depreciation on rentals and the recovery of cost of capital, therefore, merely because the said amount entered into the Profit & Loss Account in effect, made no difference. He, therefore, submitted that this decision is not applicable to the facts of the present case particularly because asset involved therein was not immovable property. As regards the decision of GE Capital Transportation Financial Services Ltd. (supra), l ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 9. This paragraph deals with accounting of lease rental in an OL, from the standpoint of the lessor. "Lease income from operating leases should be recognised in the statement of profit and loss on a straight-line basis over the lease term, unless another systematic basis is more representative of the time pattern in which benefit derived from the use of the leased asset is diminished."(emphasis supplied) A harmonious reading of paragraph 23, 24 and 40 suggests that it does not visualise a situation of increasing rental over the period of lease, whether benefits from the use of the leased asset increasing or diminishing or remaining constant. Therefore, in a case involving increasing rental, which in no case can represent a time pattern in which benefit derived from the use of the leased asset is diminished, AS19 cannot be applicable. Once it is clear that paragraphs 23, its extension in paragraph 24 and paragraph 40, all postulate a possibility of a situation of diminishing benefits and decreasing returns derived from the use of the leased asset, and do not postulate a situation of increasing benefits, then it is inappropriate to apply these paragraphs to a situation of escal ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ently by the lessor and the lessee. 8. Whether a lease is a finance lease or an operating lease depends on the substance of the transaction rather than its form. Examples of situations which would normally lead to a lease being classified as a finance lease are: (a) the lease transfers ownership of the asset to the lessee by the end of the lease term; (b) the lessee has the option to purchase the asset at a price which is expected to be sufficiently lower than the fair value at the date the option becomes exercisable such that, at the inception of the lease, it is reasonably certain that the option will be exercised; (c) the lease term is for the major part of the economic life of the asset even if title is not transferred; (d) at the inception of the lease the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset; and (e) the leased asset is of a specialised nature such that only the lessee can use it without major modifications being made. 9. Indicators of situations which individually or in combination could also lead to a lease being classified as a finance lease are: (a) if the lessee can canc ..... X X X X Extracts X X X X X X X X Extracts X X X X
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