1.31   Query:  

Accounting for the profit arising from a sale and lease-back transaction.

1. A company registered under the Companies Act, 1913, is carrying on the business of banking. Its operations are subject to the provisions of the Banking Regulation Act, and the Reserve Bank of India Act. The company has invested sizeable amounts in acquiring movable and immovable assets for the use of its branches and administrative offices. The cost of the movable fixed assets, comprising safe deposit lockers, air-conditioners, computers, gensets, motor-vehicles and other furniture & fixtures, as on 31.3.93 was Rs.6.50 crores as against the written down value of Rs.2.52 crores (a copy of the annual reports of the company for the financial year 1992-93 has been submitted by the querist).   As per the querist, the estimated present market value of these movable fixed assets is more than Rs. 5 crores.

2. The querist has stated that the company has a proposal by which a major part of the movable fixed assets of the company would be sold to a leasing company and taken back on a 5 year lease on payment of monthly/quarterly lease rentals. By virtue of the sale, the company would be able to book a profit of about Rs. 2.50 crores which, in the view of the querist, would be outside the ambit of taxation since section 41(2) of the Income-tax Act, 1961, has been deleted with effect from the assessment year 1986-89 (the balance in the block of assets is sufficient to cover the sale proceeds of these assets). The rentals paid during the lease period would be debited to the profit and loss account.  The assets, as per the querist, would revert back to the company on the expiry of the lease period on payment of the residual value which is estimated to be 1%.  The company, as per the querist, intends to use the profit generated from the proposed scheme of sale and lease-back for meeting the provisioning requirements in respect of ‘non-performing assets’, as per the prudential accounting standards, stipulated by the Reserve Bank of India (RBI) for the commercial banks, beginning from the financial year 1992-93.

3. The querist has sought the opinion of the Expert Advisory Committee on the following issues:

(a)       Whether the company can take to the credit of its profit and loss account, the profit accruing to it under the scheme of sale and lease-back, as stated at para 2 above?

(b)        If yes, whether the profit so credited can be used for making the provision in respect of ‘non-performing assets’, as per the prudential accounting standards of the RBI?

                                             Opinion                                   February 3, 1994

1. The opinion of the Committee expressed herein is restricted to the specific accounting issues raised in the query.  Accordingly, the Committee has not considered the taxation and other aspects of the query.

2. The Committee notes paras 21 and 22 of Guidance Note on Accounting for Leases, issued by the Institute of Chartered Accountants of India, which read as follows:

“21.      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 rentals and the sale price are usually interdependent as they are negotiated as a package and may not represent fair values.

22.       If in the case of a leaseback, the rentals and the sale price are established at fair value, there has in effect been a normal sale transaction and any profit or loss is normally recognised immediately.  If the sale price is below fair value, any profit or loss is recognised immediately, except that, if the loss is compensated by future rentals at below market price, it is deferred and amortised in proportion to the rental payments over the useful life of the asset. If the sale price is above fair value, the excess over fair value is deferred and amortised over the useful life of the asset.”

3. The Committee notes that the abovesaid guidance note, defines the term “fair value” as follows:

“Fair Value:     The amount for which an asset could be exchanged between a knowledgeable, willing buyer and a knowledgeable, willing seller in an arm’s length transaction.”

4. On the basis of the above, the Committee is of the following opinion in respect of the issues raised at para 3 of the query:

(a)        The company should treat the sale and lease back transaction in question, in accordance with para 22 of Guidance Note on Accounting for Leases, issued by the Institute of Chartered Accountants of India, as reproduced at para 2 above.  Thus, the treatment would depend upon whether or not the sale price and the rentals under the transaction are at fair values.

(b)        The question of recognition of profit or loss arising out of the transaction of a sale and lease back is independent of creation of any provision.  The provision in respect of non-performing assets has to be made irrespective of the result of the said transaction.

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