The Hindu Business Line : On the back of sale and leaseback

The definition
Sale and leaseback is an arrangement in which one party sells a property to a buyer and the buyer immediately leases the property back to the seller, defines www.investorwords.com.

Chennai , May 1

Quarter on quarter, Jet Airways posted a jump of 70 per cent in its net profit: from Rs 133 crore to Rs 227 crore. However, niggling behind the numbers is a Rs 344-crore `other income'. And, this included profit from sale and lease back of aircraft, amounting to Rs 271 crore.

On April 18, Jet had informed the BSE about having `finalised and concluded sale and lease back transaction of five aircraft' in the financial year 2005-06. "The company has planned the purchase of 30 aircraft over the next few years, and will continue with this policy of sale and lease back in order to maintain a balance of owned and leased aircraft in its fleet," reads the announcement posted on www.bseindia.com.

As on March 31, the owned and leased aircraft numbered 19 and 34 respectively, after counting the recently sale-and-leased-back ones in the leased category.

But what is sale and leaseback? It is an arrangement in which one party sells a property to a buyer and the buyer immediately leases the property back to the seller, defines www.investorwords.com. "This arrangement allows the initial buyer to make full use of the asset while not having capital tied up in the asset."

Accounting Standard (AS) 19 on `leases' issued by the Institute of Chartered Accountants of India (ICAI) states that a sale and leaseback transaction involves the sale of an asset by the vendor and the leasing of the same asset back to the vendor. "The lease payments and the sale price are usually interdependent as they are negotiated as a package."

How to account it?

Accounting treatment depends upon the type of lease, whether finance or operating. Finance lease transfers substantially all risks and rewards incident to ownership of an asset, as per the Institute's definition. And "operating lease is a lease other than a finance lease."

Since sale and leaseback can lead to excess or deficiency arising from the difference between sale proceeds and the carrying amount of the asset, it is important to know how it is accounted for. If the transaction results in a finance lease, the difference should not be immediately recognised as income/loss in the financial statements of the seller-lessee, stipulates the ICAI. The amount should instead be deferred and amortised over the lease term in proportion to the depreciation of the leased asset.

A recent example of such amortisation, though in the US, may be found in the results released by Southwest Airlines on April 20. `Deferred gains from sale and leaseback of aircraft' appears after `deferred income taxes'.

Where the transaction results in an operating lease, profit/loss can be recognised immediately, provided the deal is at fair value. As you know, fair value is often a fuzzy concept.

Presumably, Jet's transaction comes under this category. "If the sale price is above fair value, the excess over fair value should be deferred and amortised over the period for which the asset is expected to be used," says AS-19.

Tax implications

What are the tax implications of sale and leaseback? "Explanation 4A to section 43(1) of the Income-tax Act puts cold water on sale and leaseback strategy from the tax point of view by restricting the actual cost insofar as the buyer is concerned to the written down value (WDV) at the time of sale by the seller," opines Mr S. Murlidharan, a Delhi-based Chartered Accountant.

"To wit, if a company buys depreciable assets for Rs 1,000 crore whose WDV was Rs 100 crore in the income-tax records of the seller, the buyer will have to content himself with depreciation on Rs 100 crore despite having shelled out ten times more," he explains.

Thus, WDV at the point of sale is deemed to be the actual cost of the asset to the buyer, were he to lease back the asset to the seller forthwith.

No wonder, therefore, sale and leaseback transactions have always attracted popular attention as devices that can make abrupt differences to the bottomline, without any visible change to the assets on hand or operations.

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