A committee formed by Central Board of Direct Taxes or CBDT to harmonise the Accounting Standards and the tax rules of computing taxable income, recently proposed 14 Tax Accounting Standards or TAS.

While significant deviations have been proposed impacting the computation of taxable income, one significant area is the arrangement of right to use assets or lease.

Current position on leases

In terms of AS-19, transfer of significant risks and rewards related to the assets to the lessee is the primary basis for classification of leases into finance and operating lease. AS-19 gives the following indicative situations wherein a lease may be classified as finance lease:

Transfer of eventual ownership of the asset;

availability of purchase option, which is likely to be exercises;

tenure of the lease covering major part of the life of the asset;

present value of lease rentals being close to the fair value of the asset;

specialised nature of asset enabling only the lessee to use without substantial modifications;

leases other than finance leases are regarded as operating leases.

For finance lease, the lessee capitalises the asset and provides for depreciation in his books. However, for tax purposes, no depreciation claim is preferred. Moreover, the arrangement is treated as operating lease for tax purposes with a deduction equivalent to the lease rental charge (including principal and interest component) being claimed. This tax treatment is in lines of the circular issued by the CBDT.

In case of finance lease, although the asset is de-recognised by the lessor in its books, tax depreciation is claimed by him. Corresponding lease rentals (including principal and interest) are taxable.

For operating lease, income/ expense from leases are recognised over the period of the lease on a straight line basis. However, for tax purposes, lease rentals are offered to tax/ claimed as tax deduction in the year in which the contractual liability accrues.

TAS-12 proposals

TAS-12 mandates uniformity in classification of leases between lessor and lessee through a joint confirmation. According to AS-19, there may be scenarios wherein classification may be different from the different parties’ viewpoints.

For finance lease, TAS-12 proposes that the classification should be based on the substance of the lease rather than the form. However, contrary to this principle, it also provides for deeming finance lease in case of any of the prescribed scenarios. Moreover, since the prescribed scenarios are highly subjective, it would provide ample scope for litigation.

The lessee would be entitled to tax depreciation on the leased asset if a joint confirmation on the lease classification has been executed.

The aspect of correlative adjustments by the other party in an event of reclassification, and tax positions on non-production of the confirmation, have not been spelt out.

On the part of the lessor, the asset should be de-recognised as sale at ‘fair value’ (except where the lessor is not a dealer or manufacturer and the asset has been immediately acquired and leased).

However, in the absence of valuation norms, it may lead to litigation. The finance income component, both in case of lessor and lessee, should be apportioned over the lease tenure.

For operating lease, in line with AS-19, TAS-12 recommends that income/ expense be recognised on a straight line basis. Tax depreciation would be claimed by the lessor, subject to execution of joint confirmation on classification.

This move puts impending litigation regarding classification and tax treatment of lease arrangements to rest.

However, the proposals give rise to a new set of controversies and practical difficulties, especially for joint confirmations on lease classification.

Pallavi Singhal is Associate Director, Tax & Regulatory Services, PwC

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