Education

Judicial flip-flop on tax depreciation

Nabin Ballodia | Updated on February 03, 2013

Tax benefits make the leasing model more attractive than outright purchase of an asset. However, complex leasing models lead to vexed tax issues.

Dynamic ecosystems, coupled with global experiences and divergent interpretations, have resulted in complex business models and operations — one such relates to ‘leasing’.

Asset leasing models have assumed significance due to an assortment of benefits, including hedging against obsolescence and clearing financial bottlenecks. In addition, tax benefits make the leasing model more attractive than outright purchase of an asset. Having said that, complex leasing models lead to vexed tax issues.

One issue relates to depreciation claims under Section 32 of the Income-Tax Act, 1961. Taxpayers and revenue authorities often disagree on whether the lessor or lessee can claim the tax depreciation. This old controversy received fresh attention after the Supreme Court’s recent decision in the case of ICDS Ltd.

In a typical leasing transaction (commercially referred to as finance lease), the owner (lessor) buys the asset according to the requirements/ specifications of the customer (lessee) and hands it over for the latter’s use. At the end of the contract period, the asset will be transferred to the lessee at a pre-agreed value.

Section 32 allows tax depreciation attributable to the general wear and tear associated with the use of the asset. It sets out two conditions for depreciation claims: The asset should be ‘owned’ by the taxpayer; and the asset should be ‘used’ for a business or profession.

The differences over who should claim tax depreciation in a leasing transaction arises because the legal ownership and usage rights rest with different entities. In the ICDS case, the Supreme Court allowed the benefit of depreciation to the lessor based on the “legal ownership” of the asset.

However, the Court has overlooked its previous ruling in Mysore Minerals Ltd vs. CIT, where it held that the ‘right to use’ the asset is the determining condition for ownership rather than the legal title. Hence, usage rights should be considered while looking at ownership for depreciation.

On the same lines, the special bench of the Mumbai appellate tribunal in IndusInd Bank Ltd vs. ACIT has given a detailed reason for allowing depreciation to the lessee. Similar views have been expressed by the Delhi tribunal in ACIT vs. Great Eastern Energy Corporation Ltd. The principle of allowing depreciation to the lessee in finance lease transactions is also in line with the draft Direct Taxes Code as well as the Tax Accounting Standard.

Nabin Ballodia is Partner – Global International Corporate Tax, KPMG in India

Published on February 03, 2013

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