Income Tax Appellate Tribunal - Hyderabad
Joint Cit vs Pact Securities & Financial Ltd. on 26 March, 2002
Equivalent citations: [2003]86ITD115(HYD)
ORDER
Per Shri J. Sudhakar Reddy (Accountant Member)
1. (This para is not reproduced here as it involves minor issues.)
2. The grounds raised by the assessee in its appeal are as under:
1. The order of the learned Commissioner (Appeals-V) (Central), Hyderabad in so far as it is against the appellant is contrary to the law and facts of the case.
2. The learned Commissioner (Appeals) ought to have held that the assessing officer has erred in invoking proviso to section 145(1) on the mistaken presumption that the method of accounting followed by the assessee does not disclose the true and correct income for income-tax purpose.
3. The learned Commissioner (Appeals) failed to see that assessing officer has not demonstrated or at least given reasons as to how the assessee's method of accounting does not disclose true and correct income for income-tax purposes without which rejection would be unlawful.
4. The learned Commissioner (Appeals) ought not to have sustained the rejection of accounts when the assessing officer himself has observed that the accounts are correct and complete and in accordance with the guidelines of the Institute of Chartered Accountants of India.
5. The learned Commissioner (Appeals) ought to have considered the detailed explanations and submissions made by the assessee to establish the correctness of the system followed by it both for the purposes of Companies Act as well as Income Tax Act.
6. The learned Commissioner (Appeals) failed to appreciate that the method followed by the assessee being based on the guidance of the Institute of Chartered Accountants of India, is very scientific and considered every aspect of the transaction and the business in contradistinction to the method followed by the assessing officer which fails to address several issues that will arise like, treatment of balancing charge at the time of completion of transaction, treatment of lease adjustment account credited etc.
7. The Commissioner (Appeals) ought not to have been carried away by the conclusions drawn by the assessing officer which appear to have been heavily based upon the consideration that the allowance for depreciation under Income Tax Act is much more than the same under the Companies Act without adverting to such important aspects like the total depreciation claimed over the period of the life of the asset would be same under both methods, the depreciation allowed under Income Tax Act would be brought to taxation by way of balancing charge credit to block etc.
8. The Commissioner (Appeals) erred in observing that by choosing the depreciation under Income Tax Act, the appellant had excluded under itself from the method of calculation of lease equalisation method for which depreciation debited in the books of account was the determining factor, whereas the main purpose of lease equalisation method is to ensure standardisation of accounting and to avoid overstatement or understatement of income by recognising the income in proportion to capital investment outstanding against the transaction as against equal income recognition method.
9. The learned Commissioner (Appeals) failed to see that disallowing lease equalisation account without suggesting comprehensive alternative method of accounting with reasoned basis year after year would result in bringing to tax more income than is earned which is unlawful.
10. In any event, in the absence of tenable basis for invoking proviso to section 145(1) and in the light of various grounds urged as above and other submissions to be made, the disallowance of lease equalisation amount is prayed for being deleted.
3 & 4. (These paras are not reproduced here as they involve minor issue.)
5. The assessee is a Limited Company engaged in the business of leasing and hire purchasing. For the assessment year 1996-97, the return of income was filed on 2-1-1996 declaring an amount of Rs. 6,00,350. It is the case of the assessee that it had followed the accounting standards and guidance notes on accounting for leases issued by the Institute of Chartered Accountants of India and debited an amount of Rs. 13,16,122 which is termed as "Lease Terminal Adjustment Accounts". The assessing officer rejected the method of accounting followed by the assessee as according to him the method does not disclose the true and correct income of the assessee for income-tax purposes. He held that though the books of account of the assessee are correct and complete, the method of accounting employed by the assessee is such that the income cannot be properly deduced therefrom. He disallowed the deduction in respect of lease terminal adjustment account amounting to Rs. 13,16,123. On appeal, the learned Commissioner (Appeals) upheld the order of the assessing officer. While doing so, he held that the method prescribed by the ICAI is perfectly alright as long as depreciation is claimed as per Companies Act but not when depreciation is claimed as per the Income Tax Act, and held that the assessee cannot have the benefit of both the system.. He held that by claiming a higher depreciation under the Income Tax Act; the assessec had already obtained more deduction than the amount of principal recovered as per its method of accounting. The learned Commissioner (Appeals) concluded that by choosing to claim depreciation as per the Income Tax Act, the assessee had already excluded itself from the method of calculation of lease equalisation method for which depreciation debited in its books of account was the determining factor. Aggrieved by this addition, the assessee preferred this appeal.
6. The learned counsel for the assessee vehemently contended that the assessing officer erred in invoking the provisions of section 145(1) of the Act. He submitted that the nature of transaction was not properly understood and appreciated by the revenue authorities. He submitted y that leases, internationally and industry-wide are classified into finance lease and operating lease. He submitted that the method of accounting prescribed for finance lease and the method of accounting prescribed for operating lease are separate and distinct. The method of accounting has been prescribed by the Institute of Chartered Accountants of India for Industry-wide practice and is codified in the "Guidance Note on Accounting for Leases." He explained the leasing transactions in the following manner. He submitted that when a prospective customer is in need of a particular asset, he will approach the assessee for financing the asset. Under the system of leasing, the company would purchase the asset for full value in its own name by paying the full consideration. The assets so purchased would be installed in the premises of the lessee and will be used by the lessee. In consideration of leasing these assets, the lessee has to pay the lessor, a periodical sum which is called lease rentals. The assessee Company has the right to repossess the assets. He further submitted that the lease rentals are fixed by taking factors such as internal rate of return, residual value, rate of depreciation, taxes involved, profile of the user of the asset, repayment potential, pay back period etc. depending on the facts and circumstances of each case. He referred to the Guidance Note of the Institute of Chartered Accountants of India wherein a comprehensive illustration is given describing the entries to be made in the books of the lessor and lessee in respect of such leases which are classified as finance leases. He submitted that the illustration given in the guidance note reflected in a scientific manner the recovery towards cost of the assets i.e. capital recovery and recovery of the financial charges calculated taking into account the internal rate of return. He reproduced the entire illustration given in the guidance note to demonstrate that this is the most appropriate way in which capital recovery and interest recovery can be considered. He further submitted that over the complete term of lease, the asset is removed from the books by adjusting the same with the balance of acpumulated lease adjustment account. He further submitted that in respect of profit and loss account, the lease equalisation will be either debited or credited depending on the quantum of allowable statutory depreciation. He submitted that if the capital recovery is more than statutory depreciation, lease equalisation will be debited and that if the capital recovery is less than statutory depreciation, lease equalisation fund will be credited. He further submitted that over the period of lease term, the targeted return implicit in the lease is disclosed in the profit and loss account.
6.1 He vehemently argued that the company has followed the method of accounting not only because this is the only method available but also because the company is legally bound to follow the method of accounting prescribed by the Institute of Chartered Accountants of India. He argued that the company is a non-banking finance company registered with the Reserve Bank of India and that the Department of Non-banking Supervision of the Reserve Bank of India in its regulatory framework for Non-Banking Financial Companies, 1998 clearly states that all NBFCs have to comply with the Guidance Note issued by the Institute of Chartered Accountants of India on accounting for leases etc. and that it is mandatory and incumbent on the part of NBFCs to follow the guidance note. He drew the attention of the Bench to notification No. DFC. 199/DG(SPT)-98, dated 31-1-1998 wherein the Reserve Bank of India has directed in Non-Banking Financial Companies Prudential Norms (Reserve Bank) Directions, 1998 wherein direction No. 5 is stated as follows :
"Accounting Standards and Guidance Notes issued by the institute of Chartered Accountants of India (referred to in these directions as ICAF) shall be followed insofar a.. they are not inconsistent with any of these directions."
He further submitted that the Reserve Bank of India in its direction known as Non-Banking Financial Companies Auditors Report (Reserve Bank) Directions, 1998 in Direction No. 3B(iv) has laid down that the auditors shall include a statement on the following matters "whether the company has complied with the prudential norms on income recognition, accounting standards, asset classification, provisioning for bad and doubtful debts, and concentration of credit/investments as specified in the directions issued by the Reserve Bank of India in terms of the Non-Banking Financial Companies Prudential Norms (Reserve Bank) Directions, 1998".
6.2 He further contended that even under the Companies Act, 1956, the assessee has to strictly follow the accounting standards prescribed by the Institute of Chartered Accountants of India. He submitted that under clauses 3A, 3B and 3C of section 211, the Company is required to follow the accounting standards specified by the Institute of Chartered Accountants of India. He further submitted that the standard of accounting specified by the institute of Chartered Accountants of India are deemed to be the accounting standards prescribed by the Central Government under sub-section (11) of section 210A, until separate standards are prescribed by the Central Government in consultation with the National Advisory Committee on Accounting Standards. He submitted that the institute had not issued any accounting standards on the accounting of leases. The guidance note was made recommendatory. He submitted that in the absence of an accounting standard, the company has followed the method of accounting recommended in the guidance note. He took the Bench through the provisions in the guidance note wherein the Chairman of the Research Committee had emphasised the importance of the Guidance Note. He argued that the Company followed the methods suggested in the Guidance Note scrupulously. The only difference, as per the counsel, is that the terminology used was 'lease terminal adjustment account' instead of 'lease adjustment account'. He further submitted that the assessing officer himself had agreed that the assessee had scrupulously followed the guidance note. The assessing officer did not agree with the method suggested in the guidance note as according to the assessing officer the accounting treatment may be good for the purpose of Companies Act or for the purpose of Reserve Bank of India regulation but not for the purpose of Income Tax Act. He submitted that the assessing officer held :
(a) that the method of accounting cannot affect the charging section itself;
(b) that the rates of depreciation under Income Tax Act are higher compared to the rates of depreciation allowed under Companies Act; and
(c) that if the rate of depreciation under the Income Tax Act is adopted for the purpose of accounting gross rentals would increase substantially.
He argued that the assessing officer with a view to demonstrate that the method of accounting suggested by the Guidance Note is not good enough for the purposes of arriving at the correct taxable profit had himself taken up an illustration which has inherent contradictions. He submitted that the assessing officer took upon himself to explain the guidance once again in his own words with his own illustration. In the process, he argued that the assessing officer had committed several mistakes and blunders in both calculations as well as observations. He further submitted that the conclusions drawn by the assessing officer are based on incomplete illustrations as compared to the guidance note which is prepared by several experts and which has complete illustrations. To demonstrate the calculation mistake and the infirmities in the illustrations given by the assessing officer the learned counsel for the assessee submitted that if the statutory depreciation is worked out as per the illustration given by the assessing officer at page 4 of the assessment order, the depreciation he proposed to allow would exceed the gross cost of the asset. He submitted that this can be known from the illustration adopted by the assessing officer for the entire period of five years. He submitted that the assessing officer wrongly thought that the value of leased assets would increase or decrease by the lease equalisation amount for the purpose of computing depreciation. This itself shows that he has not understood the concept of lease equalisation as demonstrated by his observations given in the last para of page 6 of his assessment order. He further submitted that the assessing officer has erred in considering lease equalisation charge as the difference between Schedule XIV depreciation and depreciation chargeable so as to write off the assets over the primary lease period. It was his case that the assessing officer did not understand that the lease equalisation amount which arises out of the difference between the annual lease charge and net statutory depreciation. He submitted that for the purpose of equalising the gross lease rentals and to reflect the implicit rate of return on the outstanding investments lease equalisation account is used. To illustrate, he submitted before this Bench another example. He argued that another error in which the assessing officer fell into was in thinking that lease equalisation account and lease adjustment account are one and the same. He submitted that both these accounts might be the same in the first accounting year, but in the subsequent years, there would be divergence in both. He argued that lease equalisation account is a revenue item dealt with in the profit and loss account whereas lease adjustment account is a capital item dealt with in the balance sheet. The balance in the lease adjustment account at the end of the year actually represents the cumulative position of the Lease Equalisation Account. The learned counsel for the assessee pointed out that this aspect does not appear to have been noticed by the assessing officer while disallowing the deduction of Lease Adjustment Account. Though the assessing officer has explained the lease terminal adjustment account rather correctly at page 5 of his order, according to the counsel for the assessee, he erred while illustrating the Lease Equalisation Account. It is here, he submitted that the assessing officer lost track of the concept and he might have thought that because Income Tax Rules are providing for more depreciation that Schedule XIV, it would also take care of the true and fair view of the account. The assessing officer has given an illustration at page 8 of his order to show that there would be a substantial enhancement of lease rentals. However according to the counsel this illustration too is incomplete. To complete the said unfinished illustration, the counsel has furnished the details in a table for profit & loss account according to which the income that would have been offered would be only Rs. 15,73,655 being finance charges. He, therefore, submitted that there is nothing unusual in the illustration given by the assessing officer. The assessing officer in his assessment order described the amount of Rs. 12,87,123 as "net gross rentals". The learned counsel submits that by the above description, the assessing officer must have meant gross rentals as reduced by lease adjustment account. But he submits that this amount cannot be enhanced to Rs. 38,21,814 even by adopting of depreciation of Rs. 48,51,405, as per Income Tax Act. This according to him is another instance where the assessing officer has not properly understood the concept of lease equalisation account. The learned counsel submitted that the method given in the Guidance Note is the proper method applicable in this case. He further submitted that the assessing officer has not properly understood the concepts in the guidance note and the various figures arrived at by the assessing officer are not at all realistic and that mere disallowance cannot be treated as method of accounting. The Expert Committee which formulated the Guidance Note has taken into account all time tested principles of accountancy in order to reflect the correct position over the period of lease and it would be a distortion to isolate each year as it is a continuous process over entire lease period. This method of accounting is applicable for the whole of the industry. The counsel therefore pleaded for not disturbing the method of accounting. He further argued that the assessing officer has not applied any principle while arriving at the addition ultimately made by him. Assuming that the method of accounting followed by the assessee is not correct, he arrived at the addition based on incomplete illustrations which in fact gave distorted results. On the comments of the assessing officer that the guidance note itself has clarified at page 27 that the taxable income would have to be determined in accordance with the provisions of taxation laws and as such treatment may differ from the recommendations contained in the guidance note, the counsel submitted that this clarification cannot be taken as a licence to disturb the entire method of accounting in whatever fashion one may desire. According to him, the clarification is only to be understood in the limited sense that whenever certain provisions of taxation laws are available for treating certain taxable incomes such provisions take precedence over the recommendations made in the guidance note. A statute will always have precedence over other forms of guidance available. He therefore submitted that the said clarification should not be misconstrued as otherwise it will make the entire exercise in evolving the guidance note on a complex issue like this an exercise in futility. He submitted that if a statute provided for a particular rate of depreciation that should be applied. The assessee has only followed a method of accounting recommended by a competent professional body i.e. the Institute of Chartered Accountants of India which has the statutory mandate. He pointed out that the assessee's case is not isolated one as there are large number of companies in this line of business which have published accounts almost all of whom have followed the concept lease equalisation charge as suggested in the Guidance Note issued by the ICAI. Concluding his arguments, the learned counsel submitted there is no justification for the assessing officer's action in disturbing the method of account followed by the assessee and disallowing the lease terminal adjustment account and pleaded for deletion of the addition made. For these propositions, the learned counsel for the assessee relied upon the following decisions :
(1) Shri Dinesh Mills Ltd. v. Asstt. CIT (2000) 72 ITD 110 (Ahd.).
(2) CIT v. Indo Nippon Chemical Co. Ltd. (2000) 245 ITR 384 (Bom.).
(3) Dy. CIT v. Nagarjuna Investinent Trust Ltd. (1998) 65 ITD 17 (Hyd.) (SB).
(4) CIT v. Margadarsi Chit Funds (P) Ltd. (1985) 155 ITR 442 (AP)
7. Shri Ch. Purushotham, the learned Departmental Representative, on the other hand, vehemently opposed the arguments advanced by the learned counsel for the revenue and submitted that deduction on account of lease equalisation charges cannot be allowed in the computation of total income for income-tax purposes. He submitted that lease equalisation credit also cannot be added on the same logic. He drew the attention of the Bench to page 10 of the assessment order and vehemently contended that the Guidance Note issued by the Institute of Chartered Accountants of India is only a guidance note and not an accounting standard and the same cannot be applied for tax purposes. He contended that it is clarified at para 27 of the guidance note (revised) that the specific treatment for determining the taxable income would have to be made in accordance with the provisions of Taxation Laws and that such treatments may differ from the recommendations contained in the guidance note. He took us through the following observations of the assessing officer forming part of page 10 of the assessment order:
"(a) The guidance note issued by the ICAI is only a guidance note and not an accounting standard and the same cannot be applied for tax purposes. In fact, it is clarified at para 27 of the guidance note (revised) that specific treatments for determining taxable income would have to be in accordance with the provisions of Taxation Laws; such treatments may differ from the recommendations contained in the guidance note.
(b) If the guidance note is followed for income-tax purposes also, the gross rentals of the assessee during the current year would get enhanced substantially as the depreciation rates under Income Tax Rules are much higher than what is prescribed under Schedule XIV of the Companies Act. This gives distorted picture of the profits for the current year.
(c) By following the guidance note, the assessee intends to shift his tax liabilities to another year which is an incorrect method of computing profits and gains for tax purposes. As held by the Supreme Court (supra), such assessment year is a self-contained unit and the profits of one year cannot be shifted to another year. Under section 5 of the Income Tax Act, since the income has already accrued by way of lease rentals, the same cannot be shifted to another year by way of appropriation towards lease equalisation.
(d) The method of accounting followed by the assessee for accounting lease rentals is such that true and correct profits cannot be deduced therefrom, and therefore, under the first proviso to section 145(1), the total gross lease rentals of Rs. 26,03,246 are adopted for computing income for income-tax purposes without any adjustments towards lease equalisation.
(e) The Commissioner (Appeals)-I vide order No. 25/DC(A)-I/Commissioner (Appeals)-II/97-98 dated 27-1-1998 in the case of Global Trust Bank Ltd. for the assessment year 1995-96, has upheld the action of the assessing officer and confirmed the addition on similar issue that the guidance note cannot be applied for income-tax purposes."
He further submitted that in the case of a leasing company, the lessor is the owner of the machinery and that, therefore, the entire monies earned by the machinery i.e. leasing charges is treated as income of the leasing company. For compensating the owner of the machinery for wear and tear, a notional expenditure in the form of depreciation which is normally more than the depreciation under Company Law is allowed as deduction. Since no extra sum is credited to profit and loss account, no deduction can be allowed while computing the income of the leasing company. He further submitted that there is no provision under the Income Tax Act by which lease equalisation charge can be allowed as a deduction. Deductions, he argued that are allowable under the Income Tax Act in computing the taxable profits are those which are specified or those which are incurred for the purpose of business. He further argued that the guidance note tries to create an artificial bifurcation of the lease charges into interest and principal and seeks to deduct the principal collected over and above the depreciation according to Company Law, from the profit. He further submitted that the bifurcation of lease amount into principal and interest has no basis. He argued that the entire interest is the income of the lessor. He argued that if the lessor chose to collect more in the initial years, the same is to be shown as income and cannot be postponed in the garb of showing true and correct profit as nothing prevents the leasing company to have a longer lease period. He relied on the judgment of this Tribunal in the case of Nagarjuna Investment Trust Ltd. (supra) and submitted that the same is in his favour. He also drew the attention of the Bench to Board's Circular No. 1079, dated 19-9-1977 and argued that the same is to be followed. He relied on the order of the assessing officer and sought for its sustenance.
8. In reply to the arguments of the revenue, the learned counsel for the assessee submitted that the Special Bench of this Tribunal in the case of Nagarjuna Investment Trust Ltd. (supra) held that section 145 cannot override section 5 of the Income Tax Act. He submitted that this decision is in his favour as the Special Bench found that when the method in the books of account represented real income, the same has to be taken into account and where it does not so represent, section 5 takes precedence. He submitted that he relied on this very judgment of the Tribunal as the submissions of the assessee in the present case are the same as in the above case viz., (i) that the accounts are made in accordance with the guidance note issued by the Institute of Chartered Accountants of India and (ii) that these are approved by the Board of Directors and shareholders and auditors. He then drew the attention of the Bench to the methodology adopted by the Institute of Chartered Accountants of India while issuing the guidance note to demonstrate that it was well debated by an Expert Committee after circulation of draft proposals and submitted that it should not be disturbed so easily.
9. The learned counsel for the revenue arguing on the departmental appeal submitted that the learned Commissioner (Appeals) erred in holding that methods like IRR method on the net loan amount should be adopted in determining the income from those leasing finance items covered under VDIS. He relied on the order of the assessing officer and argued that it should be upheld.
10. On the other hand, the learned counsel for the assessee argued that the claim for 100 per cent depreciation on certain plant and machinery has been withdrawn by the assessee by declaring the same under VDIS. He submitted that the Commissioner (Appeals) had rightly directed for treatment of these transactions as pure loan transactions instead of taxing the entire amount of lease rentals as income of the assessee. He relied on para 4 at page 5 of the order of the Commissioner (Appeals) and requested for upholding the same.
11. Heard both sides, read all the papers and the orders of the revenue authorities and the case laws cited. The issues that are not in dispute in this case are :
(a) The assessee has strictly adopted the method of accounting prescribed by the Institute of Chartered Accountants of India by way of Guidance Note.
(b) The transactions in question are finance leases.
On a careful examination of the issues involved, and the arguments of rival parties, we are of the considered opinion that the assessee is bound to succeed in this appeal for the following reasons. All the issues that are raised before us have been considered by the earlier judgments of this Tribunal in the case of Nagarjuna Finance Ltd. in IT Appeal Nos. 2777 and 2967/(Hyd.) of 1988 and in the case of Nagarjuna Investment Trust Ltd. (supra). The Guidance Note and the International Accounting Standards 17 have been discussed at length in these judgments and require no repetition.
11. 1 This Bench of the Tribunal in the case of Nagarjuna Finance Ltd. (supra) at page 34 in para 31 observed as follows :
"On a thorough and careful consideration of the material available on record and the position of law on the subject we are inclined to hold that the index/SOD method (IAS-17) followed by the assessee in its books is a method accepted by the Accounting Principles and sanctioned by Commercial Practice and that income can properly be deduced from the said method. Hence, the Income Tax Officer very rightly computed the income of the assessee in accordance with the said method regularly employed by the assessee. It is not permissible for the assessee to ignore its own method of accounting and its own book results and recompute its income in accordance with another method for income-tax purposes. In that view of the matter, the learned Commissioner (Appeals) wholly erred in rejecting the method of accounting employed by the assessee in its books and directing the assessing officer to recompute the income with reference to the terms contained in hire purchase agreements and leasing agreements entered into by the assessee with its customers. The learned Commissioner (Appeals) made certain uncharitable remarks against the assessee for adopting this internationally recognised and scientifically devised method of accounting under the wrong notion or belief that the assessee by adopting the said method had shown non-existent income. The assessee cannot be found fault with for adopting SOD/index method of accounting. It is in accordance with Accounting Principles from which income can properly be deduced. Accordingly we hereby set aside the order of the first appellate authority on this issue and restore that of the assessing officer rejecting the assessee's claim for deduction of the differential income of Rs. 77,18,317 from the net profit as per the profit and loss account in the printed accounts of the assessee company. Accordingly, the revenue's appeal is allowed upholding the assessment made by the assessing officer in accordance with the method of accounting employed by the assessee in its books."
Thus the Tribunal has held that the assessee cannot be found fault with, for following as its method of accounting prescribed by the Institute of Chartered Accountants of India and sanctioned by Commercial Practice and by which income can be properly deduced.
11.2 The Special Bench of this Tribunal in Nagarjuna Investment Trust Ltd. (supra) in paras 42, 42.1, 43 and 44 had considered the issue of finance leases after verbatim incorporating the Guidance Note of the Institute. This part of the judgment is extracted for convenience :
"42. We may now compare the SOD method of accounting followed by the assessee in relation to lease rentals in its books of account with the norms recommended in the aforesaid Inspecting Assistant Commissioner-17 and the Guidance Note. In the example given by the assessee reproduced at pages 40 and 41, the assessee has recognised such income as per SOD method h. the books of account as under:
First Year 150 X 5 or say 150X 5 =50 (5X6/2) 15 Second year 150 X 4 or say 150X 4 =40 (5X6/2) 15 Third year 150 X 3 or say 150X 3 =30 (5X6/2) 15 Fourth year 150 X 2 or say 150X 2 =20 (5X6/2) 15 Fifth year 150 X 1 or say 150X 1 =10 (5X6/2) 15 Gross income for 5 year =150 The cost of equipment has been shown as asset on which the lessor has claimed depreciation. In the case of lease rentals the assessee has not apportioned the total amount realised from the lessees between the finance charge and the principal component, but has credited the entire amount as income of revenue nature. The assessee has not periodically transferred any amount in lease equalisation account with a corresponding debit or credit to lease adjustment account, as indicated in the Guidance Note. In fact, the IAS-17 shows that where plant and equipment is shown as an asset and depreciation is claimed by the lessor, the rental income should be recognised on a straight linebasis over the lease term and depreciation of leased assets should be claimed on a basis consistent with the lessor's normal depreciation policy.
42.1 In the aforesaid example, the assessee has a right to receive annual lease rent of Rs. 30 per annum as per the lease agreement. The income which accrues to the assessee as per the Agreement is only Rs. 30 per annum. Any amount of income accounted for in the books of account in the first few years of the lease term beyond the amount of Rs. 30 clearly represents hypothetical income which did not in fact accrue to the assessee in the relevant accounting year.
43. The assessee in its income-tax returns has declared income by way of lease rentals on the basis of lease rent fixed in the respective lease agreements and has claimed the excess amount recognised in the books of account beyond the agreed amount of lease rental, as differential income not liable to tax on the ground that income to that extent has not accrued in the relevant previous year. The assessee in relation to the specimen lease agreement has shown income from lease rental at the rate of Rs. 7,816.20 i.e. Rs. 93,794.40 per annum for tax purposes. The assessee is entitled to receive lease rent at the rate of Rs. 7,816.20 p.m. as the lease agreement and, therefore, the income which can be said to have accrued to the assessee in accordance with the terms of the agreement, which alone comes within ambit of charging provisions is Rs. 7,816.20 p.m. only and not a pie more even though income higher than that has been accounted for on SOD method/Index method in the books of account.
44. In view of the aforesaid discussions, we hold that so far as income by way of lease rental is concerned, the only income which accrues in the relevant year is the monthly instalment specified in the respective lease agreements and in no circumstance, the income in excess of the monthly lease instalment can be said to have accrued in law. The excess income beyond the monthly lease instalment accounted for as income on the basis of SOD method/Index method does not income within the ambit and range of taxable income within the meaning of charging provisions of the Act and therefore, such excess income, termed as differential income in relation to lease agreements cannot be brought to tax. The assessing officer is, therefore, directed to exclude such excess income, if any, found on verification."
The only difference that we observe between the case of Nagarjuna Investment Trust Ltd. (supra) and this case is that instead of SOD method/Index method, the assessee has adopted IRR method. Both are recognised methods for arriving at the income accrued in a financial transaction.
12. In these two cases, the department's contentions were "that section 145 provides for computation of income of an assessee as per the method employed by him regularly and when the assessee is following an internationally recognised method of accounting which has the approval of even the Institute of Chartered Accountants of India, the assessee cannot be permitted to change it for tax purposes merely on the ground that it accounted for the higher income than what according to the assessee was alleged to have accrued or arisen in the previous year as per tax jurisprudence. The SOD/Indexing Method, according to the assessee itself, is a system for accounting income on accrual basis, how can they therefore, be allowed to say that the accounted income was higher than what had accrued to them? It cannot be alleged that SOD/Indexing Method is such as does not reflect the proper income of an assessee. This system has been accepted under the Companies Act whereunder also income is accounted on accrual, basis in an accounting year. It would, therefore, be anomalous to say that the accounts maintained by SOD/Indexing Method depict true and fair picture of the profit and loss under the Companies Act, but a different picture when it is seen with reference to income-tax."
13. In the case on hand the arguments of revenue are just the opposite to their arguments in these two cases. The pleadings of the department in those cases that the income should be computed in accordance with the guidance note of the ICAI are the pleadings of the assessee in this case. The Tribunal has upheld the contentions of the revenue in those two cases. Thus our decision cannot be otherwise and we have to follow the Special Bench decision which is binding on us and uphold the contention of the assessee that the income should be computed only in accordance with the guidance note of the ICAI.
14. Before going into what the assessing officer has done and what the Commissioner (Appeals) has opined, it would be useful to examine the various case laws brought to our notice. In the case of Margadarsi Chit Funds (P) Ltd. (supra), the Hon'ble High Court of Andhra Pradesh has observed at page 446 as under:
"It must be said at the outset that the choice to account for income on an acceptable basis is that of the assessee, and not of the department. This is, however, not an unlimited choice, because the Income Tax Officer has always the liberty to examine the system of accounting regularly employed by the assessee' to determine whether the system of accounting is defective, and whether by following such system of accounting, correct profits can be deduced from the account books maintained by the assessee. If on such scrutiny, the Income Tax Officer comes to the conclusion that with reference to the method of accounting followed by the assessee, correct profits cannot be deduced, it is open to him to apply the provisions of section 145 of the Income Tax Act and make the assessment in an appropriate manner. In the present case, there is no material to indicate why the Income Tax Officer considers the system of accounting regularly followed by the assessee to be defective, or the system of accounting followed to be such that correct profits cannot be deduced therefrom. The Income Tax Officer's power to substitute a system of accounting for the one followed by the assessee, flows from the provisions of section 145 of the Income Tax Act. It is therefore, imperative that before rejecting the system of accounting followed by the assessee, the Income Tax Officer must refer to the inherent defect in the system and record a clear finding that the system of accounting followed by the assessee is such that correct profits cannot be deduced from the books of account maintained by the assessee. As already observed above, there is no finding to that effect in this case. The Income Tax Officer's view that there could be a better system of accounting is no reason to the application of the provisions of section 145 of the Income Tax Act, especially in view of the fact that this system of accounting is followed by the assessee uniformly and regularly for the past several years, and was accepted by the department without quarrel. It is not open to the Income Tax Officer to intervene and substitute a system of accounting different from the one which is followed by the assessee, on the ground that the system which commends to the Income Tax Officer is better."
The principles that can be deduced from this jurisdictional High Court decision which to our mind are in favour of the assessee are :
(a) The choice to account for income on an acceptable basis, or in other words the choice of the Method of Accounting is that of the assessee though it is not an unlimited choice.
(b) There should be some material to indicate why the Income Tax Officer considers the system of accounting regularly employed by the assessee to be defective.
(c) There should be a finding that the system of accounting followed by the assessee is such that correct profit cannot be deduced therefrom.
(d) The assessing officer has power as per provisions of section 145 to substitute the system of accounting.
(e) Just because there is a better system of accounting provisions of section 145 cannot be invoked to reject the system of accounting followed by the assessee uniformly and regularly.
(f) The assessing officer cannot substitute a system of accounting on the ground that the system which better commends to the Income Tax Officer should be followed i.e. Method of Accounting cannot be rejected on mere revenue consideration.
14.1 The Ahmedabad Bench of this Tribunal in the case of Shri Dinesh Mills Ltd. (supra) held that when the assessee is adopting a method approved by the Institute of Chartered Accountants of India and when that method has not been disapproved by the notification of the Central Government in the Official Gazette, the lower authorities are not justified in invoking the provisions of section 145(1).
14.2 In the case of Indo Nippon Chemical Co. Ltd. (supra), the Hon'ble Bombay High Court held that when the assessee followed the method of accounting suggested by the Institute of Chartered Accountants of India, the same would be valid.
14.3 The Hon'ble Supreme Court in the case of United Commercial Bank v. CIT (1999) 240 ITR 355 (SC) at page 366 held as follows:
"(1) A method of accounting adopted by the tax payer consistently and regularly cannot be discarded by the departmental authorities on the view that he should have adopted a different method of keeping accounts or of valuation.
(2) The concept of real income is certainly applicable in judging whether there has been income or not, but, in every case, it must be applied with care and within their recognised limits.
(3) Whether the income has really accrued or arisen to the assessee must be judged in the light of the reality of the situation."
14.4 In all these cases, it has been held that section 145 can be invoked only when the method of accounting followed by the assessee does not disclose the true picture of profits. It is accepted that the Method suggested by the Institute of Chartered Accountants of India in the Guidance Note discloses the correct profit by different authorities, under different Acts i.e., the RBI, the Company Law Department the Security and Exchange Board of India etc. What is correct profit for all those departments and under all those enactments cannot be said to be incorrect for the purpose of the Income Tax Act. In fact it is mandatory, under all the enactments to follow the Guidance Note as these departments felt that this is a fair method to arrive at correct profits. The assessee has exercised his choice of the method which is considered fair and correct and thus the assessing officer has no choice to reject the same under section 145.
15. Now we shall examine the assessment order. The assessing officer has agreed that the Company has followed the methods suggested in the Guidance Note scrupulously. The first aspect to be considered is whether the assessing officer is right in coming to the conclusion that the method of accounting followed by the assessee does not show the correct profit. The second aspect to be examined is whether the assessing officer could substitute the method of accounting followed by the assessee. By a suitable alternative which can also be said to be a correct method of accounting.
15.1 Coming to the second aspect first, we observe that the assessing officer could not come out with a substitute or alternative method of accounting. The learned counsel for the assessee has clearly demonstrated that the assessing officer has erred on a number of issues and that the examples cited by him are flawed and incorrect and that when completed lead to illogical conclusions. The assessing officer with a view to demonstrate that the method of accounting suggested by the Guidance Note is not correct and is one from which correct profits cannot be deduced has tried to formulate new illustrations prepared by him. His illustrations are totally flawed for the following reasons:
"(a) Though his idea appears to be to disallow lease equalisation amount, he confused the same with lease terminal adjustment account and added the same in his assessment order. The difference between the two is not realised.
(b) The assessing officer thought that the value of the lease assets would be increased /decreased by the lease equalisation method for the purpose of computing the depreciation. This demonstrates that he has not understood the concept of lease equalisation.
(c) In the example given by the assessing officer, the depreciation he proposes to allow utlimately is more than the cost of the asset which is prima facie incorrect.
(d) The assessing officer in our opinion ultimately landed up in indirectly disallowing the statutory depreciation allowable in the Act.
(e) The illustrations so earnestly started by the assessing officelshould have been completed and if had done so would have realised the mistakes himself. They are flawed and illogical.
(f) What is required to be given by the assessing officer when he applied the provisions of section 145 is a suitable and proper alternative system of accounting. Mere disallowance of a particular item, by no stretch of imagination can be said to be a suitable and a correct alternative system of accounting devised by the assessing officer. Out of the entire scheme of entries suggested in the Guidance Note the assessing officer picked up one figure and disallowed it as he felt that by doing the same the defect in the entire method of accounting is rectified and a new and correct method of accounting comes into existence. This reasoning is basically flawed and not correct. Selective tinkering of certain entries in the method of accounting suggested by the Institute of Chartered Accountants of India does not result in a new alternative and improved method of accounting. Removing one entry from a series of entries suggested in a method of accounting is just like removing one wheel in a car and saying now it is perfectly alright. The method of accounting has to be taken as a whole or rejected as a whole and when so rejected an alternative and demonstratedly acceptable and recognised method of accounting has to be adopted. Thus we hold that the assessing officer could not come up with a suitable and acceptable method of accounting as a substitute to the one adopted by the assessee."
15.2 Coming to the first aspect, we do not agree with the proposition of the assessing officer that the method of accounting suggested by the Institute of Chartered Accountants of India is not one from which correct profit cannot be deduced. This is an internationally accepted method having the sanction of the Institute of Chartered Accountants of India. As already stated this method has been approved and made mandatory by the RBI and also under the Company Law. In fact a number of companies have been following this method. An illustrative list of companies which have published their accounts cited before us by the learned counsel for the assessee and not controverted by revenue are as under:
1. Raymond Synthetics Ltd.
2. DCM Shriram Leasing & Finance Ltd.
3. Greaves Leasing Finance Ltd.
4. Gujarat Lease Financing Ltd.
5, Gujarat Gas Financial Services Ltd.
6. ITC Bhadrachalam Finance & Investment Ltd.
7. India Equipment Leasing Ltd.
8. Larsen & Toubro Ltd.
9. Fortune Financial Services (India) Ltd.
15.3 Thus we can conclude that the assessing officer has not understood the guidance note and the method of accounting followed by the assessee He has not made out a case that by following this method of accounting, the correct income of the assessee is not brought to tax nor has he come out with suitable alternative system of accounting in place of the method of accounting followed by the assessee. This is not a question of a mere disallowance, as the item disallowed by the assessee is not a claim for expenditure but part of the sophisticated methodology designed by ICAI for deducing or arriving at an income figure and adjust the inflated cost of the asset in the balance-sheet.
16. Coming to the order of the Commissioner (Appeals), his observations in page 5 para 3 of the his order, viz., "This method prescribed by the ICAI is perfectly all right as long as the depreciation is claimed as per the Companies Act but as per the Income Tax Act, the appellant cannot have the benefit of both the systems. By claiming higher depreciation under the Income Tax Act, the appellant had already obtained more deduction than the amount of principal recovered as per its method of accounting. Hence such method of accounting is not acceptable for the purpose of computation of income from lease financing under the Income Tax Act. The Guidance Note of the ICAI may be relevant for the appellant to find out its actual earning on the lease financing but that does not give the correct picture regarding the income assessable under the Income Tax Act. The Supreme Court in the case of British Paints Ltd. (supra) and in the latest decision in the case of United Commercial Bank v. CIT (supra), has also emphasised that it is incorrect to say that the treatment given by an assessee in the books of account has to be always followed. If the method of accounting gives the correct picture of income assessable under the Income Tax Act, there was no difficulty in accepting the same. By choosing to claim depreciation as per the Income Tax Act, the appellant had already excluded itself from the method of calculation of lease equalisation method for which depreciation debited in its books of account as the determining factor. Hence, I do not find merit in the contention of the appellant."
Demonstrate to our mind, a prejudice against the higher rate of depreciation provided under the Income Tax Act rather than the method of accounting followed by the assessee. We do not understand how a higher rate of depreciation upsets a method of accounting. When we carefully go through the method of accounting given by the ICAI, we find that out of the four elements considered in the Profit & Loss account i.e.
(i) Lease rentals,
(ii) Implicit rate of return,
(iii) Depreciation, and
(iv) Lease equalisation, while three are known factors, i.e. lease rentals, I.R.R. and depreciation, the fourth one is obviously arrived at by balancing the other three. Thus the quantum of depreciation that is allowed does not invalidate the method of accounting as lease equalisation varies directly in proportion to the quantum of depreciation. The depreciation whether arrived at by applying the rates provided in the Companies Act or arrived at by rates provided under the Income Tax Act does not in any way affect the recognition of income. The logic that, when a particular rate of depreciation is applied or when a particular rate of I.R.R. is applied would result in invalidating a particular method of accounting is highly incorrect. The method of accounting suggested in the Guidance Note is not rate specific or Act specific. Thus the conclusion of the learned Commissioner (Appeals) that a higher rate of depreciation provided in the Income Tax Act if availed by the assessee disentitles him to adopt the method of accounting suggested by the Institute of Chartered Accountants of India, is totally incorrect.
17. The Guidance Note of the Institute of Chartered Accountants of India is drafted by an Expert Committee constituted for the purpose and is issued after due research public debate and on consideration of suggestions and opinions from various quarters. In our considered opinion, as held by the Income Tax Appellate Tribunal in the case of Shri Dinesh Mills Ltd. (supra), a method of accounting suggested by the ICAI should not be easily upset by the lower authorities. Expertise of the Institute in the matter of accountancy is well recognised and when the revenue has a view against a particular method it is advisable for the Central Board of Direct Taxes to take up the issue directly with the Institute of Chartered Accountants of India instead of allowing its field officers to adopt their own methods. This would save a lot of uncertainty in assessments and anxiety to the assessees. Though the assessing officer and the Commissioner (Appeals) have not come out with an alternative method of accounting which can be said to be correct and a suitable replacement the learned Departmental Representative suggested that lease rentals per se should be taken as income against which depreciation and other expenses should be allowed. If this is applied to this case, then lease rentals would be Rs. 26,03,246 and the depreciation claimed would be Rs. 48,51,405 which would result, in a loss of Rs. 22,47,159. The method followed by the assessee shows income which is at variance with the income arrived at by the method suggested by the learned Departmental Representative. This alone cannot be a reason for rejecting a method of accounting. Even otherwise the learned Departmental Representative cannot do or asked to be done what the assessing officer or the Commissioner (Appeals) has not done. He cannot suggest an entirely new method and it is not for us to consider and give a finding on a new method now suggested. Thus we reject the proposition of the learned departmental Representative as it is not the basis on which the assessment is done. This also demonstrates that the assessee has declared income as per that the method of accounting suggested by the Institute of Chartered Accountants of India which is a proper method and has to be accepted. We, therefore, hold that the method of accounting regularly followed by the assessee cannot be rejected by application of section 145 of the Act as it cannot be said that proper income cannot be deduced there from. This is an acceptable basis for arriving at income and it is the choice of the assessee, which the assessing officer should accept. This is not a case of a mere disallowance of a claim. Moreover, the judgment of the jurisdictional High Court in the case of Margadarsi Chit Funds (supra) the decision of the Tribunal in the case of Shri Dinesh Mills Ltd. (supra), of the Bombay High Court in the case of Indo Nippon Chemical Co. Ltd. (supra) and those of the Hyderabad Bench of the Tribunal in the cases of Nagarjuna Finance Ltd. (supra) and Nagarjuna Investment Trust Ltd. (supra) are in favour of the assessee.
18. In the result, the appeal of the assessee is allowed and the addition of Rs. 13,16,123 made on account of lease terminal adjustment account is deleted.
19 and 20. (These paras are not reproduced here as they involves minor issues.)