IndusInd Bank Ltd vs. ACIT (ITAT Mumbai Special Bench)

Difference between “Finance Lease” & “Operating Lease” Explained

The assessee, a bank, purchased a boiler and gave it on lease to Indo-Gulf Fertilisers. The assessee claimed depreciation on the said boiler on the basis that it was the “owner” thereof. The AO & CIT (A) disallowed the claim for depreciation on the basis that the transaction was a “finance lease” which was akin to a loan given by the assessee and that the assessee was not the “owner“. On a reference to the Special Bench HELD:

(i) The distinction between a “Finance lease” and an “operating lease” is set out in the Guidance Note on Accounting for Leases and Accounting Standard (AS) 19. It is also set out in the judgement of the Supreme Court in Asea Brown Boveri vs. IFCI 154 TM 512 (SC) & Association of Leasing & Financial Services Companies v. UOI. In a finance lease, the lessee selects the equipment & the lessor provides the funds, acquires the title to the equipment and allows the lessee to use it for its expected life. The lessee uses the asset for its entire economic life & all risks and rewards incidental to ownership are transferred to the lessee even though title may or may not be eventually transferred to the lessee. A finance lease is for a fixed period & non-cancellable. There is a fixed obligation on the lessee for payment of lease money & in case of premature termination, the lessor is entitled to recover his investment with expected interest. In substance, finance lease is a loan from the lessor to the lessee. In an operating lease, the lessor bears the risk of loss, the period is cancellable and lease rentals are not synchronized with the economic life of the asset. On facts, the assessee’s lease agreement had all the characteristics of a finance lease;

(ii) The assessee’s argument that even in the case of a finance lease, depreciation should be allowed to the lessor is not acceptable because all risks & rewards incidental to ownership are borne by the lessee and the lessor’s “ownership” is nominal & symbolic & serves no purpose other than as security for the recoupment of the investment with interest in the form of lease rentals. It is the lessee who is the actual and real owner of the asset (Podar Cement 226 ITR 625 (SC) & Mysore Minerals 239 ITR 775 (SC) applied), MCorp Global 309 ITR 434 (SC) distinguished)

(iii) On facts, the assessee had already advanced a loan to Indo-Gulf to purchase the boiler much prior to the entering into of the lease agreement. The lease agreement was entered into subsequently with the sole purpose of enabling the assessee to artificially fulfill the twin requirements of ownership and user of the asset so as to claim depreciation, to which it was not otherwise entitled as per law and thereby reduce its income in a mala fide manner. The agreement was consequently a “sham“. The assessee’s argument that the issue of depreciation is tax neutral because the tax rates on the lessor & lessee is the same is not correct because while the assessee had huge income, the lessee had a loss. The lease agreement was thus a “dubious way” to mitigate the assessee’s tax liability.