Bombay High Court

Dy Cit vs Soni Capital Markets Ltd. on 16 March, 2004

Equivalent citations: (2004) 89 TTJ Mumbai 10

ORDER

R. V. Easwar, J.M.

This appeal by the department relates to assessment year 1996-97. The assessee is a public limited company engaged in the business of leasing and hire-purchase.

2. The first ground is that the Commissioner (Appeals) erred in deleting the disallowance of depreciation of Rs. 49,16,250 claimed on assets leased to M/s Beta Napthol Ltd. The brief facts giving rise to the ground are these. During the accounting year ended 31-3-1996, the assessee issued shares and obtained Rs. 3 crores, which it utilized for the purchase of the following assets from M/s Beta Securities Ltd.

Date of purchase

Asset

Amount (Rs.)

10.3.1996

Fusion autoclave-6 Nos.

41,40,000

13.3.1996

Solution tank (ETP)-3 Nos.

29,32,500

15.3.1996

Amidation autoclave-4 Nos.

27,60,000

Total

98,32,500

3. The bills were raised by Beta Securities in the name of "M/s Beta Napthol Ltd. account. Soni Capital Markets Ltd." These assets were directly sent by Beta Securities located in Indore to Beta Napthol located in Vapi, Gujarat. The payment for the assets were made by the assessee as follows

Date

Amount (Rs.)

22.3.1996

25,00,000

25.3.1996

25,00,000

27.3.1996

10,00,000

29.3.1996

10,00,000

29.3.1996

3,74,375

9.7.1996

24,58,125

Total

98,32,500

4. On 21-3-1996, before the payments were made, the assessee entered into a lease agreement with Beta Naphthol (hereinafter referred to as the "BN") under which the aforesaid assets were leased to the latter company. The assessee received lease rentals of Rs. 10,80,000 during the year. In the return, the assessee claimed depreciation of Rs. 49,16,250 in respect of the assets leased. The assessing officer, on a perusal of the various clauses of the lease agreements came to the conclusion that the entire arrangement was only a finance transaction and there was no lease involved. According to him, the assessee was not the owner of the assets, but it was BN which was the owner and the effect of the arrangement was that the assets were offered as security for the amount advanced by the assessee towards the purchase of the assets. In this view of the matter, he held that the conditions of section 32 were not satisfied and disallowed the claim of depreciation. Out of the lease rentals, he excluded what according to him, was the principle component of the loan, with the result that only the interest income was taxed.

5. On appeal, the Commissioner (Appeals) held that there was nothing illegal or sham in the entire transaction, that the assessee is the legal owner of the asset, that the decision to purchase and lease the assets is a business decision to earn income by way of lease rental and in the process if the assessee gets tax sops to which it is lawfully entitled, it cannot be described as a colourable device, that the lessee is not related in any way to the assessee-company, that the tax aspect which affects the funds flow situation is always considered by businessman while entering into business transactions and, therefore, it cannot be said that the transaction was a finance transaction for earning interest. According to him, it was a genuine lease transaction and, therefore, the assessee was entitled to the depreciation.

6. The department is in appeal. It was submitted by the learned Departmental Representative who took us through the findings of the assessing officer and his analysis of the various clauses of the lease document, that the intention behind the arrangement was that the assets were merely secured against the loan given by the assessee to BN and that the lease rentals represented interest on the loan. He submitted that a reading of the lease deed would show that the assessee did not assume any risk of ownership nor did it enjoy any rewards of ownership, that the transaction was only a finance lease and not an operating lease. On the other hand, the learned counsel for the assessee submitted that a conjoint reading of all the terms and conditions of the lease deed would show that the assessee was the owner of the assets and that the lessee was a bailee, that the transaction was a genuine lease transaction as intended by the parties, that there was nothing in the lease deed which was inconsistent with the claim that the assessee was the owner of the assets. He also took us through the various clauses of the lease deed in an attempt to satisfy us that this was a genuine lease transaction. It was accordingly submitted by him that the Commissioner (Appeals) was right in directing the assessing officer to allow the depreciation.

7. We have carefully considered the rival submissions and the material on record. The assessee is a company engaged in the business of leasing and hire-purchase. Under section 32 of the Act, two conditions have to be satisfied before the assessee can get an allowance in respect of depreciation. The first is that he should be the owner of the assets and the second is that the assets should be used in the business of the assessee. There is no dispute about the second condition. The dispute is only with reference to the first condition, namely, ownership. A perusal of the lease document shows the following terms. Under clause 2.3, there is no security deposit. As per clause 2.4, the assets have to be delivered to the assessee after the lease term. The learned counsel for the assessee clarified that the lease was renewed till 1999, and thereafter the assets were sold for Rs. 5 lakhs which was the residual value, to the lessee. Clause 2.7 provided for the rights of the lessor during the period before delivery of the equipment. The assets were directly delivered by the manufacturer to BN and it was agreed that the entire risk, cost or any outgoing pertaining to the delivery shall be on the lessee, i.e., BN. Section 152 of the Contract Act says that in the absence of any special contract, the bailee is not responsible for the loss, destruction, or deterioration of the thing bailed, if he has taken the amount of care required of it. Clause 2.7.1 of the lease deed which fixes the risk during delivery upon BN, constitutes such a special contract. It is not unusual because the assets are to be used by BN and, therefore, it was so arranged that they should be delivered directly to BN by the supplier. The parties, therefore, thought that it would be more appropriate to hold BN responsible for any risk and cost pertaining to the delivery of the assets. Since such a special contract is permitted by law, it cannot be said that by incorporating such a condition, the assessee disclaimed its ownership over the assets. Clause 3.2.5 contains a covenant by the lessee to the effect that no right, title or interest in the equipment shall pass to it under the lease deed. The lessee, shall at no time contest or challenge the assessee's sole and exclusive right, title and interest in the equipment. There is also a joint confirmation by the assessee and BN "that their intent is that the equipment shall at all times remain as the property of the lessor". BN has also undertaken under the same clause, not to sell, assign, or otherwise encumber the equipment or even remove it from where it was originally put to use, without the prior consent of the assessee in writing. Clause 3.2.6 which was relied upon by the department says that the lease rentals shall be deemed to commence from the date of disbursement of the purchase price of the assets to the manufacturer. The department's case is that this clause clearly indicated that the intention was to finance BN and charge interest on the finance from day 1. However, as pointed out on behalf of the assessee, even before the payments were made, the assets had been delivered to BN and the lease agreement had been entered into. Therefore, on the dates on which the assessee made the payments to the supplier, BN was already in possession of the assets and the lease had already started. Therefore, this clause has remained only on paper and is not applicable to the present transaction.

8. Clause 4 provides for the lessee's (BN) continuing covenants. Clause 4.1.7 says that the lessee shall affix a name plate or other mark on the equipment identifying the sole and exclusive ownership thereof of the lessor by putting the following in block letters, viz., "UNDER LEASE FROM SONI CAPITAL MARKETS LIMITED" and not to remove the same or deface it. Clause 4.2 prohibits the lessee (BN) from parting with possession and control of the equipment leased without the prior written consent of the lessor (assessee). Clause 4.3 prohibits the lessee from affixing the equipment permanently to any immovable property or to impair the identifiability, ascertainability, severability and redeliverability of the equipment nor to affect the value of the equipment when severed or redelivered to the lessor. These clauses, in our opinion, are consistent with the claim that the equipment was owned by the lessor.

9. Clause 4.7 of the lease deed was relied upon by the department. According to this clause, BN was to keep the equipment insured. But we find that clause 4.7.1 says that the insurance policy shall be in the name of the assessee to be described therein as the owner of the equipment and as the loss payee. Further, the agreement is that the insurance shall be made by the lessee for and on behalf of the assessee only. Further, under clauses 4.7.5. and 4.7.6 if any monies become payable under the insurance policy for damage of the equipment, the assessee may agree to apply them to make good the damage. If the equipment is so damaged that it is incapable of economic repair, then the insurance monies, at the option of the assessee, be applied so far as possible in replacing the equipment with another equipment of similar type and quality. Such new equipment shall be deemed to have been leased by the assessee under the same terms and conditions. As rightly pointed out on behalf of the assessee, if the arrangement is only a finance transaction, there is no obligation on the assessee to replace the equipment and this clause would not have found a place in the lease deed.

10. Clause 4.9 provides that the lessee (BN) has no right to transfer or assign or otherwise dispose of the equipment unless agreed to in writing by the assessee-lessor. The lessee (BN) cannot even create a charge or lien upon the equipment or part with the possession thereof without the consent of the assessee-lessor. Clause 4.10 provides that the lessee (BN) cannot make any alteration, addition or improvement to the equipment or change the condition thereof without the prior written consent of the lessor (assessee). If such additions or improvements are made by the lessee (BN) whether with or without the consent of the lessor the same shall belong to the assessee-lessor and be deemed to be part of the equipment leased. These clauses are consistent with the claim that the ownership of the equipment leased out vests with the assessee- company.

11. Clause 4.20.1 clarifies that as between the lessor (assessee) and lessee (BN) the equipment given by way of lease shall "remain the exclusive property of the lessor and shall continue to remain in the ownership of the lessor notwithstanding that the same may have been affixed to any land or building and the lessee shall not have any right, title or interest therein otherwise than as a bailee". This supports the claim that the assessee retains the ownership over the equipment leased out. This clause also provides that if any damage is caused to the equipment while affixing the same to the land or building or while removing it, the costs shall be borne by the lessee (BN). This clause is not inconsistent with the rights of ownership claimed by the assessee because as bailee of the equipment, BN is expected to take reasonable care of the equipment while in its possession.

12. Clause 8.2.1, which relates to the rights of the lessor (assessee) and the obligations of 'the lessee (BN) on termination of the lease, says that on termination of the lease, the lessor has the right, without any notice or permission, to remove or repossess the equipment and to enter upon the land or building owned by the lessee, for that purpose. It further says that the lessee hereby gives a licence to the lessor to remove or dismantle the equipment and the damage, if any, caused shall not be the responsibility of the lessor. When the lessor is given the right to repossess the equipment on termination of the lease, it reiterates the claim for ownership.

13. Clauses 4.15 and 4.16 were relied upon by the department. These clauses link the lease rentals to the bank lending rate and the rates of depreciation. These are normally taken into consideration by the lessors while fixing the lease rentals and no motive to avoid tax can be spelt from them, merely because they have been of considerable force in fixing the lease rentals. The transaction is otherwise genuine. Neither the supplier company nor the lessee (BN) is connected to the assessee- company. There is no evidence or material to show that the arrangement is a paper arrangement or a hawala transaction. Funds have flowed from the assessee-company to the supplier of the equipment in Indore. The equipment has moved from Indore to Vapi in Gujarat and has been actually installed and put to use by BN. The fact that the equipment has not come first to the assessee, for being sent to Vapi thereafter, is only a matter of convenience - to save trouble and expense. There is no evidence to show that the lease rentals have been kept unconscionably low or high.

14. Clause 8.2.4 provides that in the event of termination of the lease the lessor shall be entitled to sell, release or otherwise dispose of the equipment in a manner as it thinks fit and that it will not be bound to account to the lessee nor will it be bound to give any pre-emptive right to the lessee. The proviso says that in case of termination by efflux of time or premature termination, as per clause 9, the lessor may organize open market bids for the proposed sale of the equipment and may appoint the lessee or organize such sale. In case the sale proceeds exceed the minimum guaranteed value fixed in the schedule to the lease agreement, "the lessor may pass on such excess to the lessee after deducing therefrom the expenses in organizing such sale, all sums mentioned in clauses 8.2.2.(c) and (d) as a reward for good maintenance of the asset by the lessee". We sought clarifications from the assessee as to the working of this clause. A working has been filed by the assessee. It says that a distinction was made between termination of the lease due to the default of the lessee which is dealt with in clause 8.2.2. and due to efflux of time or premature termination in the eventualities mentioned in clause 9. The working shows that in the former case (lessee's default), the interests of the lessor are protected by clause 8.2.2 and the lessee does not get any additional realisations. In fact, in case of a shortfall, it will be recovered from the lessee. But in the latter case (on default by lessee), where the lease is terminated prematurely for other reasons, the proviso to clause 8.2.4 has to be read with clause 9 and so read, it will be seen that if there is an excess realisation on sale of the equipment the lessee is allowed to enjoy a portion of the excess, after deduction of certain expenses and benefits as mentioned in clauses 8.2.2.(c) and (d). These amounts are (i) all amounts other than lease rentals due under the lease deed together with interest and (ii) costs and expenses on repairs to the equipment. In. our opinion, there is nothing in clause 8.2.4 which militates against the claim of ownership of the equipment vesting with the assessee.

15. Reference was made by the department to clause 8.2.2.(b) which provides for recovery by the lessor from the lessee, in case of termination of the lease, of the "entire amount of lease rentals for the unexpired period of the lease discounted at a rate not more than 18 per cent per annum". But this is only in the nature of penalty as per the Explanation to section 74 of the Contract Act which says that a stipulation for increased interest from the date of default may be a stipulation by way of penalty. This does not mean that the transaction is only a loan for interest.

16. The learned counsel for the assessee made a reference to the order of the Mumbai Bench of the Tribunal in Sharyans Resources Ltd. v. Jt. CIT (2002) 83 ITD 340 (Mum-Trib) and submitted that on identical facts the Bench has held that the transaction must be considered as a lease and not a finance transaction. We have gone through the order and we find the contention to be correct. In this order, the Tribunal has discussed the facts which are identical and also the terms of the lease deed which are also substantially similar and the entire case law on the subject and has held that the transaction was a genuine lease transaction and not a finance transaction. It was also held that so long as there is no evidence to show that a part of the lease consideration was unofficially received by the assessee without being disclosed, the mere fact that the assessee, in the opinion of the department, settled for a smaller consideration keeping in mind the 100 per cent depreciation allowance could not render the transaction to be a colourable device. The question of risk, as an incident to the ownership, was also considered and discussed. We find that this order squarely covers the present case.

17. For the above reasons, we see no ground to differ from the conclusion of the Commissioner (Appeals). We confirm his decision and dismiss the first ground.

18. The second ground is that the Commissioner (Appeals) erred in deleting the addition of Rs. 5 lakhs made under section 68. The amount represented the share application money received in the name of one Kunal Kapoor. The Commissioner (Appeals) has held that the assessing officer has not made any enquiry and has accordingly restored the matter to the assessing officer for verification of the claim. We make it clear that it is open to the assessing officer to verify the claim of the assessee in depth and take a decision afresh in accordance with law without being bound by any other observations made by the Commissioner (Appeals). The assessee shall be afforded adequate opportunity of being heard. We refrain from examining the merits of the addition. The ground is accordingly dismissed.

19. The third and last ground is that the Commissioner (Appeals) erred in deleting the disallowance of the claim under section 35D of the Act to the extent of Rs. 63,179 being public issue expenses. We have carefully gone through para 14 of the order of the Commissioner (Appeals). He has held that the assessee's business had already commenced and, therefore, the expenditure should be amortised over a period of 10 years. This has been accepted by the Commissioner (Appeals) and nothing was shown to us as to how his decision was wrong. We, therefore, confirm the same and ,dismiss the ground.

20. In the result, the appeal is dismissed.