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A. Facts of the Case
1. A Government of India enterprise, incorporated as a public
limited company in 1986, was engaged in providing rolling stock assets to the Ministry of Railways (MOR) on finance lease terms.
It raises funds from the capital market through issue of bonds,
loans from banks/financial Institutions and overseas markets for
the acquisition of rolling stock assets which are given on lease to
MOR. The legal ownership of the assets vests with the company,
but they are put to economic use by MOR. The assets are leased
by the company to MOR under a lease agreement spanning a
primary lease period of 15 years. The company does not have any
business of operating lease.
2. Upto the year 2000-01, the company was following the
‘Guidance Note on Accounting for Leases (revised 1995)’, issued
by the Institute of Chartered Accountants of India (ICAI). According
to the querist, as per the said Guidance Note, the rolling stock
assets given on finance lease were capitalised in the accounts of
the company as fixed assets. Similarly, the gross lease rental
received was accounted as income. Depreciation on the leased
assets was provided as per Schedule XIV to the Companies Act,
1956. The depreciation so provided was adjusted against the capital
recovery component of the lease rentals and the difference was
provided in lease equalisation account. As such, the net finance
income was reflected in the profit and loss account. In the incometax
return filed, the company was adding the depreciation as per
the Companies Act, 1956 to the profit and claiming depreciation
as per the Income-tax Act, 1961.
3. From the accounting year 2001-02, the ICAI made Accounting
Standard (AS) 19, ‘Leases’, mandatory. In accordance with AS 19,
the rolling stock assets given on finance lease are not capitalised
in the books of the lessor company and, instead, are shown as
‘lease receivables’ at an amount equal to the net investment in the
leased assets. Accordingly, the company does not charge
depreciation on leased assets in its accounts as leased assets are
not shown as fixed assets in the accounts.
4. The querist has stated that post-AS 19, the finance income is
recognised in the profit and loss account and the capital recovery
portion of the lease rentals is treated as repayment of principal,
the balance constituting net investment in the leased assets. By
virtue of owning rolling stock assets, the company is allowed depreciation under the Income-tax Act, 1961. As per the querist,
even after adoption of AS 19, the company continued the practice
of adding depreciation as per the Companies Act, 1956 to the
profit and claiming deduction of depreciation as per the Incometax
Act, 1961. Even though the leased assets are not reflected as
fixed assets in the books of account, the company has been
maintaining a memoranda account of fixed assets and calculating
depreciation as per the Companies Act, 1956. Because of the
additional acquisition of assets each year, and the fact that rate of
depreciation under the Income-tax Act is higher than the Companies
Act, the unabsorbed depreciation has been increasing from year
to year. However, in the recent years, decrease in the rate of
depreciation admissible under the Income-tax Act has necessitated
utilisation of some of the unabsorbed depreciation. Further, the
querist has stated that on account of the depreciation adjustment
in the manner outlined above, the company has been paying
Minimum Alternative Tax (MAT) under section 115JB of the Incometax
Act.
5. As per Accounting Standard (AS) 22, ‘Accounting for Taxes
on Income’, the company is required to make provision for deferred
tax liability (DTL) each year based on the accounting profits. As
per the querist, the rationale behind providing for DTL primarily is
to provide matching tax expense against the profit each year.
6. AS 22 defines timing differences as “the differences between
taxable income and accounting income for a period that originate
in one period and are capable of reversal in one or more subsequent
periods”. DTL representing the tax effect due to timing differences
is required to be included in the tax expense in the statement of
profit and loss. As per the querist, the company has provided the
DTL as required by AS 22.
7. The querist has furnished the following views of the auditors
and the company:
Views of the Auditors
The accounting treatment outlined above, as adopted by the
company for providing for DTL, met with the concurrence of
the statutory auditors up to the year 2005-06. However, the newly appointed statutory auditors of the company, who
conducted the audit for the year 2006-07, were of a different
opinion. Their view is that there is no deferment of tax on
account of depreciation on the finance leased assets for the
reason that such assets are neither recorded as fixed assets
nor depreciation is provided for in the books of account in
compliance with AS 19, even though depreciation is allowed
to be claimed under the Income-tax Act on such assets. The
difference between book profit and taxable profit arises on
account of different treatment being given to such depreciation
expense in books and as per tax law. The difference is not
arising on account of the difference in the amount of
depreciation expense. There is, therefore, no likelihood of
providing for depreciation on such assets in the books of the
company because the DTL will continue to get accumulated.
In their opinion, the company should treat the same as
permanent difference and there should be no requirement for
the company to provide for deferred tax liability on this account.
Views of the Company
Since the company is adding depreciation as per the
Companies Act and claiming and obtaining depreciation benefit
as per the Income-tax Act in its Return of Income, the company
is required to make provision for DTL. The fact that the tax
treatment of depreciation as claimed by the company is in
consonance with views of the tax authorities, reflected in the
assessments on the basis outlined above getting completed,
lends credence to the stand of the company. Further, as
stated earlier, the company has already started utilising the
assessed unabsorbed depreciation in the recent years, and
there could possibly be little scope for following an alternative
approach.
B. Query
8. In view of the difference of opinion between the auditors and
the company, the querist has sought the opinion of the Expert
Advisory Committee on the following issues:
(i) Whether the depreciation differential in case of assets given on finance lease, where depreciation is not debited
in the books of the lessor company but the lessor being
the legal owner of the assets is allowed depreciation
under the Income-tax Act, represents a permanent
difference or timing difference.
(ii) Whether the depiction of depreciation adjustment in the
Return of Income wherein depreciation on finance lease
assets calculated under the Companies Act is first added
to the book profit and then depreciation calculated under
Income-tax Act is deducted for arriving at taxable income
is correct, particularly in view of the fact that depreciation
on such assets is not debited in the books of the
company.
(iii) As the company is paying tax on ‘Book Profits’ under
section 115JB of the Income-tax Act, i.e., MAT, whether
it can still be said that there is a divergence between
accounting profit and taxable profit and deferred tax is
to be accounted for.
C. Points considered by the Committee
9. The Committee notes that the basic issues raised by the
querist relate to deferred tax aspects of assets given on finance
lease in the context of AS 19 and also deferred tax implications of
Minimum Alternative Tax (MAT). Therefore, the Committee has
examined only these issues and has not examined any other issue
that may be contained in the Facts of the Case. The exact amount/
manner of determining taxable income in the Return of Income for
the purposes of income taxes is not being commented upon by
the Committee as the Committee is prohibited to answer issues
involving pure interpretation of the relevant enactments under Rule
2 of its Advisory Service Rules.
10. The Committee notes that the Central Board of Direct Taxes,
vide Circular No. 2 dated 9th February, 2001, has, inter alia, clarified
as below:
“It has come to the notice of the Board that the New Accounting
Standard on “leases” issued by the Institute of Chartered
Accountants of India requires capitalisation of the asset by the lessees in financial lease transaction. By itself, the
accounting standard will have no implication on the allowance
of depreciation on assets under the provisions of the Incometax
Act”.
In view of the above Circular, it is apparent that the lessor will
continue to avail the depreciation benefit for tax purposes even
though for accounting purposes the asset would be recognised in
the balance sheet of the lessee. Thus, for the lessor, in the case
of assets given under finance lease, there will be finance income
for accounting purposes, while, for the income-tax purposes, if
depreciation is allowed, the entire lease rent will be treated as
income (the difference between the two, i.e., lease rent and
depreciation, can be termed as ‘tax finance income’). The total
finance income recognised for accounting purposes over a period
of time will be equal to the total lease rent treated as income for
tax purposes minus total depreciation allowed as expense for
income-tax purposes, subject to the provisions of the Income-tax
Act. However, on a year-to-year basis, there will be difference
between accounting finance income and tax finance income.
11. For applying AS 22 in the situation of a finance lease, a
question arises as to whether, for computing timing differences,
individual items, such as, finance income for accounting purposes
and depreciation and lease rentals for tax purposes should be
considered in isolation or the total impact of the finance lease
transaction on the accounting income and taxable income should
be considered.
12. The Committee is of the view that, with a view to reflect the
true impact of the lease transaction on accounting income and
taxable income, the lease transaction as a whole should be
considered since the individual items are related. Accordingly, the
difference between finance income for accounting purposes and
tax finance income representing difference between the lease rental
income and depreciation allowance for income-tax purposes
originating in a particular year should be treated as timing difference
for applying AS 22. This is based on the principle of ‘substance
over form’.
13. The Committee notes that the company adds back ‘notional
depreciation’ as per the Companies Act to profits which includes
finance income and deducts depreciation as per the Income-tax
Act to recognise the same effect as the difference between the
accounting finance income and tax finance income. Presumably,
the company adds ‘notional depreciation’ to profits with a view to
adjust the finance income included in the profits to arrive at a
figure, which is more or less, equivalent to lease rent for the
period. However, it may not be so as the amount to be added
back should be the difference between the lease rental for the
period and the finance income for accounting period – this
difference may not be equal to the ‘notional depreciation’, and,
accordingly, may not represent the timing difference of accounting
finance income and tax finance income.
14. As regards treatment of depreciation differential in the context
of Minimum Alternative Tax (MAT) under section 115JB of the
Income-tax Act, the Committee notes Explanation to paragraph 21
of AS 22 notified by the Central Government under the Companies
(Accounting Standards) Rules, 2006. The said Explanation reads
as below:
“Explanation:
(a) The payment of tax under section 115JB of the
Income-tax Act, 1961 (hereinafter referred to as the
‘Act’) is a current tax for the period.
(b) In a period in which a company pays tax under
section 115JB of the Act, the deferred tax assets
and liabilities in respect of timing differences arising
during the period, tax effect of which is required to
be recognised under this Standard, is measured
using the regular tax rates and not the tax rate under
section 115JB of the Act.
(c) In case an enterprise expects that the timing
differences arising in the current period would
reverse in a period in which it may pay tax under
section 115JB of the Act, the deferred tax assets
and liabilities in respect of timing differences arising
during the current period, tax effect of which is required to be recognised under AS 22, is measured
using the regular tax rates and not the tax rate under
section 115JB of the Act.”
15. From the above, the Committee is of the view that even during
the period when the company pays ‘MAT’, timing differences should
be considered for recognition of deferred tax effects, subject to
consideration of prudence in case of deferred tax asset.
D. Opinion
16. On the basis of the above, the Committee is of the following
opinion on the issues raised in paragraph 8 above:
(i) The depreciation differential, in case of assets given on
finance lease, where depreciation is not debited in the
books of the lessor company but the lessor being the
legal owner of the assets is allowed depreciation under
the Income-tax Act, represents a timing difference, on a
consideration of treating the finance lease transaction
as a whole as explained in paragraphs 10 to 13 above.
(ii) As regards correctness of depiction of depreciation
adjustment made in the Return of Income, the Committee
has not examined the same from the angle of
correctness of the exact amount/manner of determining
taxable income in the Return of Income keeping in view
the prohibition under Rule 2 of the Advisory Service
Rules of the Committee. However, from a purely
accounting point of view, the depreciation adjustment
would be correct if it is equal to the difference between
the lease rental income and the accounting finance
income as discussed in paragraph 13 above.
(iii) Even when the company is paying tax on ‘Book Profits’
under section 115JB of the Income-tax Act, i.e., MAT, it
can be said that there is a divergence between
accounting profit and taxable profit and deferred tax is
to be accounted for, subject to considerations of
prudence in case of deferred tax asset. s
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