Expert Advisory Committee

1.17 Query

Accounting Treatment of Lump-Sum

Payments in Respect of Lease.

Facts

1.	Lease Matter	: Land ( not being agricultural one) transferred to the Lessee under Lease Agreement
2.	Parties to Lease agreement	: Lessors Lessee Mrs. A X Company Pvt. Ltd. Mr. B Mr. C
3.	Date of commencement	: from 3^rd June, 1962
4.	Period of Lease	: 30 years
5.	Payments (Rs. Written in the Agreement)	: Lump sum Rs. 47,590 and token rent Rs. 600/- per annum
6.	Another stipulation for consideration (as per agreement)	: In the event the Lessee sells out or transfers the Lease, its interest in the premises, to any person or persons, Company, Corporation, body and /or otherwise to any one, such sale and/or transfer shall have to be got approved by the Lessors and the Lessors will be entitled to 75% share for themselves out of the receipt and amount realized towards the value of Land calculated. In doing so, Reasonable allowance will be made for the lump sum amount paid by the Lessee adjusting the same for the unexpired period of Lease.

Query Points :

1.What treatment can justifiably be given to lump sum payment made by the Lessee – i.e., ‘X’ Pvt. Ltd., - in Income-tax matters?

2. Taking into consideration the following points : -

(a) Period of 30 years (period does not reflect the sense of the period of perpetuity)

(b) And (which forms concomitant part and which produces sense of original intention of the parties to the Lease agreement while signing it) in between Lump sum and Token Rent.

Can the “lump receipt” be validly treated as “Deferred Revenue Expenditure”? And also on the same grounds the same amount can be split up over the period of 30 years (as the deferred benefits of not paying the higher rent per annum by simply paying “Lump sum” at initial stage of Lease Agreements).

3. What treatment can be held to be valid and justifiable, if X Co. Pvt. Ltd. be converted into a public limited before the expiry of Lease period? (With a specific reference to Income-tax matters only.)

Opinion July 21, 1969

1. The lump-sum payment made at the time of the taking of the lease should be capitalized and thereafter amortised over the period of the lease. The annual rentals should be charged to revenue.

2.The querist has stated that the annual rentals represent only token rent. This does not make any difference to the answer to the questions raised by the querist. However, if the querist implies that, since the annual rentals are based only on token amounts, the initial lump sum payment is of the nature of advance rent, the advance rental may be reflected in the accounts as “deferred revenue expenditure” and amortised over the period of the lease. It will be appreciated that this will make no fundamental difference in the accounting treatment except only that the advance rental would be reflected as “deferred revenue expenditure” rather than as “capital expenditure”. If necessary and appropriate, the lump sum payment may have to be apportioned, depending upon the facts and circumstances of the case, partly as capital expenditure and partly as deferred revenue expenditure.

3.In the event of the transfer of the lease during the lease period of thirty years, the unamortised balance of the lease premium would represent the value for the unexpired period of the lease. This should be adjusted suitably against the consideration on which the transfer has been arranged, and the resultant profit or loss should then be transferred to revenue account.

4.The mere conversion of a private company into a public limited company before the expiry of the lease period would not involve any accounting entries, since such conversion would not amount to a sale or transfer of the lease-hold property. For the same reason, the stipulations in the lease deed relating to sale or transfer of the lease will not be applicable in the event of a mere conversion of the private company into a public company.

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