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TMI Blog2022 (7) TMI 269X X X X Extracts X X X X X X X X Extracts X X X X ..... CIT(A) has erred on facts and in law by confirming the action of the Ld. AO in making disallowance of Rs. 828,000 on account of lease equalization charges despite that fact that the Assessee has followed Accounting Standard -19 issued by ICAI and has submitted all documents in support of the claim. 3.1 Without prejudice to the above, the Ld. CIT(A) has erred on facts and in law in appreciating that the Assessee can be charged only on real income which can be calculated after applying the prescribed method. 4. The Ld. CIT(A) has erred on facts and in law by confirming the action of the Ld. AO in making disallowance of Rs. 36,21,491 on account of logo development expenses by treating them as capital in nature and disregarding the fact that the expenses are revenue in nature and incurred wholly and exclusively for the purpose of business. 4.1 Without prejudice to the above, the Ld. CIT(A) has erred on facts and in law in confirming the disallowance despite the fact that the contract was terminated mid way and the new logo was not delivered and no intangible asset alleged by the Ld. AO came into existence and the Assessee has submitted all documents in support of the claim. 4. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e lease and not applicable to the facts of the instant case. 5. Aggrieved the assessee filed appeal before us. 6. Heard the arguments of both the parties and perused the material available on record. 7. The assessee entered into an agreement of granting lease hold right and determined the annual rent payable by the assessee to the lessee which is as under: a. For the period commencing from April 1st 2013 till March 31st 2016 shall be Rs.7,20,000/- (Rupees Seven Lakhs Twenty Thousand Only) per annum. b. For the period commencing from April 1st 2016 to March 31st 2021, shall be Rs.18,00,000/- (Rupees Eighteen Lakhs Only) per annum and c. For the period commencing from April 1st 2016 to March 31st 2023, shall be Rs.21,60,000/- (Rupees Twentry One Lakhs Sixty Thousand Only) per annum 8. The cumulative rent per year over the lease period of 10 years is Rs.154,80,000/- i.e. 15,48,000/- per year. For the period from 2013 to 2016, the assessee claims deduction of Rs.15,48,000/- which is more than Rs.7,20,000/- whereas the subsequent period, the assessee would be claiming deduction of only Rs.15,48,000/- against the payment of Rs.18,00,000/- and Rs.21,60,000/-. Thus, the question ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... yment or series of payments the right to use an asset for an agreed period of time. 3.2 A finance lease is a lease that transfers substantially all the risks and rewards incident to ownership of an asset. 3.3 An operating lease is a lease other than a finance lease. 3.4 A non-cancellable lease is a lease that is cancellable only: (a) upon the occurrence of some remote contingency; or (b) with the permission of the lessor; or (c) if the lessee enters into a new lease for the same or an equivalent asset with the same lessor; or (d) upon payment by the lessee of an additional amount such that, at inception, continuation of the lease is reasonably certain. 3.5 The inception of the lease is the earlier of the date of the lease agreement and the date of a commitment by the parties to the principal provisions of the lease. 3.6 The lease term is the non-cancellable period for which the lessee has agreed to take on lease the asset together with any further periods for which the lessee has the option to continue the lease of the asset, with or without further payment, which option at the inception of the lease it is reasonably certain that the lessee will exercise. 3. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... minimum lease payments under a finance lease from the standpoint of the lessor and any unguaranteed residual value accruing to the lessor. 3.15 Unearned finance income is the difference between: (a) the gross investment in the lease; and (b) the present value of (i) the minimum lease payments under a finance lease from the standpoint of the lessor; and (ii) any unguaranteed residual value accruing to the lessor, at the interest rate implicit in the lease. 3.16 Net investment in the lease is the gross investment in the lease less unearned finance income. 3.17 The interest rate implicit in the lease is the discount rate that, at the inception of the lease, causes the aggregate present value of (a) the minimum lease payments under a finance lease from the standpoint of the lessor; and (b) any unguaranteed residual value accruing to the lessor, to be equal to the fair value of the leased asset. 3.18 The lessee s incremental borrowing rate of interest is the rate of interest the lessee would have to pay on a similar lease or, if that is not determinable, the rate that, at the inception of the lease, the lessee would incur to borrow over a similar term, and with ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... expected to be sufficiently lower than the fair value at the date the option becomes exercisable such that, at the inception of the lease, it is reasonably certain that the option will be exercised; (c) the lease term is for the major part of the economic life of the asset even if title is not transferred; (d) at the inception of the lease the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset; and (e) the leased asset is of a specialised nature such that only the lessee can use it without major modifications being made. 9. Indicators of situations which individually or in combination could also lead to a lease being classified as a finance lease are: (a) if the lessee can cancel the lease, the lessor s losses associated with the cancellation are borne by the lessee; (b) gains or losses from the fluctuation in the fair value of the residual fall to the lessee (for example in the form of a rent rebate equalling most of the sales proceeds at the end of the lease); and (c) the lessee can continue the lease for a secondary period at a rent which is substantially lower than market rent. 10. Lease classi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sidual value (both guaranteed and unguaranteed), n is the lease term, r is interest rate implicit in the lease. The present value of minimum lease payments from the standpoint of the lessee is Rs. 2,35,500. The lessee would record the machinery as an asset at Rs. 2,35,500 with a corresponding liability representing the present value of lease payments over the lease term (including the guaranteed residual value). (b) In the above example, suppose the lessor estimates that the machinery would have a salvage value of Rs. 17,000 on December 31, 20X2. The lessee, however, guarantees a residual value of Rs. 5,000 only. The interest rate implicit in the lease in this case would remain unchanged at 16% (approx.). The present value of the minimum lease payments from the standpoint of the lessee, using this interest rate implicit in the lease, would be Rs. 2,27,805. As this amount is lower than the fair value of the leased asset (Rs.2,35,500), the lessee would recognise the asset and the liability arising from the lease at Rs. 2,27,805. In case the interest rate implicit in the lease is not known to the lessee, the present value of the minimum lease payments from the standpoint of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s.) Outstanding liability (Rs.) Year 1 (January 1) 2,35,500 (December 31) 37,680 1,00,000 62,320 1,73,180 Year 2 (December 31) 27,709 1,00,000 72,291 1,00,889 Year 3 (December 31) 16,142 1,00,000 83,858 17,031* 17. In practice, in allocating the finance charge to periods during the lease term, some form of approximation may be used to simplify the calculation. _____________________ * The difference between this figure and guaranteed residual value (Rs.17,000) is due to approximation in computing the interest rate implicit in the lease. 18. A finance lease gives rise to a depreciation expense for the asset as well as a finance expense for each accounting period. The depreciation policy for a leased asset should be consistent with that for depreciable assets which are owned, and the depreciation recognised should be calculated on the basis set out in Accounting Standard (AS) 6, Depreciation Accounting. If there is no reasonable certainty that the lessee will obtain ownership by the end of the lease term, the asset should be fully depreciated over the lease term or its useful life, whichever is shorter. 19. The depreciable ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... balance sheet date; and (f) a general description of the lessee s significant leasing arrangements including, but not limited to, the following: (i) the basis on which contingent rent payments are determined; (ii) the existence and terms of renewal or purchase options and escalation clauses; and (iii) restrictions imposed by lease arrangements, such as those concerning dividends, additional debt and further leasing. Provided that a Small and Medium Sized Company, as defined in the notification, may not comply with sub-paragraphs (c), (e) and (f). Operating Leases 23. Lease payments under an operating lease should be recognised as an expense in the statement of profit and loss on a straight line basis over the lease term unless another systematic basis is more representative of the time pattern of the user s benefit. 24. For operating leases, lease payments (excluding costs for services such as insurance and maintenance) are recognised as an expense in the statement of profit and loss on a straight line basis unless another systematic basis is more representative of the time pattern of the user s benefit, even if the payments are not on that basis. 25. The les ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ipal and the unearned finance income. 30. Estimated unguaranteed residual values used in computing the lessor s gross investment in a lease are reviewed regularly. If there has been a reduction in the estimated unguaranteed residual value, the income allocation over the remaining lease term is revised and any reduction in respect of amounts already accrued is recognised immediately. An upward adjustment of the estimated residual value is not made. 31. Initial direct costs, such as commissions and legal fees, are often incurred by lessors in negotiating and arranging a lease. For finance leases, these initial direct costs are incurred to produce finance income and are either recognised immediately in the statement of profit and loss or allocated against the finance income over the lease term. 32. The manufacturer or dealer lessor should recognise the transaction of sale in the statement of profit and loss for the period, in accordance with the policy followed by the enterprise for outright sales. If artificially low rates of interest are quoted, profit on sale should be restricted to that which would apply if a commercial rate of interest were charged. Initial direct costs sho ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ar and not later than five years; (iii) later than five years; (b) unearned finance income; (c) the unguaranteed residual values accruing to the benefit of the lessor; (d) the accumulated provision for uncollectible minimum lease payments receivable; (e) contingent rents recognised in the statement of profit and loss for the period; (f) a general description of the significant leasing arrangements of the lessor; and (g) accounting policy adopted in respect of initial direct costs. Provided that a Small and Medium Sized Company, as defined in the Notification, may not comply with sub-paragraphs (a) and (f). 38. As an indicator of growth it is often useful to also disclose the gross investment less unearned income in new business added during the accounting period, after deducting the relevant amounts for cancelled leases. Operating Leases 39. The lessor should present an asset given under operating lease in its balance sheet under fixed assets. 40. Lease income from operating leases should be recognised in the statement of profit and loss on a straight line basis over the lease term, unless another systematic basis is more representative of the time p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t and loss for the period; (b) the future minimum lease payments under non-cancellable operating leases in the aggregate and for each of the following periods: (i) not later than one year; (ii) later than one year and not later than five years; (iii) later than five years; (c) total contingent rents recognised as income in the statement of profit and loss for the period; (d) a general description of the lessor s significant leasing arrangements; and (e) accounting policy adopted in respect of initial direct costs. Provided that a Small and Medium Sized Company, as defined in the notification, may not comply with sub-paragraphs (b) and (d). Sale and Leaseback Transactions 47. A sale and leaseback transaction involves the sale of an asset by the vendor and the leasing of the same asset back to the vendor. The lease payments and the sale price are usually interdependent as they are negotiated as a package. The accounting treatment of a sale and leaseback transaction depends upon the type of lease involved. 48. If a sale and leaseback transaction results in a finance lease, any excess or deficiency of sales proceeds over the carrying amount should not be i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ) 5, Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies. Illustration Sale and Leaseback Transactions that Result in Operating Leases The Illustration does not form part of the accounting standard. Its purpose is to illustrate the application of the accounting standard. A sale and leaseback transaction that results in an operating lease may give rise to profit or a loss, the determination and treatment of which depends on the leased asset s carrying amount, fair value and selling price. The following table shows the requirements of the accounting standard in various circumstances. Sale price established at fair value (paragraph 50) Carrying amount equal to fair value Carrying amount less than fair value Carrying amount above fair value Profit No profit Recognise profit immediately Not applicable Loss No loss Not applicable Recognise loss immediately Sale price below fair value (paragraph 50) Profit No profit Recognise profit immediately No profit (note 1) Loss not compensated by future lease payments at below market price Recognise loss immediately Recognise loss immediately (note 1) Loss comp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e equalization charges as per Accounting Standard 19 issued by the ICAI, a recognized body vested with the authority to recommend accounting standards for ultimate prescription by the Central Government in consultation with the National Advisory Committee of Accounting Standards for the presentation of true and fair view of financial statements. Para 23 of the Accounting Standard 19 specifies the treatment of operating lease payments in the statement of profit & loss account which is reproduced as under: "23. Lease payments under an operating lease should be recognized as an expense in the statement of profit and loss on a straight line basis over the lease term unless another systematic basis is more representative of the time pattern of the user's benefit." 14. Therefore, the Accounting Standard expressly allows the claim of lease rent on straight line basis over the period of lease term. 15. Further, page no. 1 of lease deed shows the amount of average rent per year which is Rs. 15,48,000/-claimed by the assessee in its profit & loss account. 16. The deduction on the basis of average rent per year will not affect the tax revenue of the department because of the reason t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sting the permissible deprecation. It is not disputed that these accounting standards are made by the body of experts after extensive study and research. .................................. 16) In the present case, the relevant Assessment Year is 19992000. The main contention of the Revenue is that the Respondent cannot be allowed to claim deduction regarding lease equalization charges since as such there is no express provision regarding such deduction in the IT Act. However, it is apt to note here that the Respondent can be charged only on real income which can be calculated only after applying the prescribed method. The IT Act is silent on such deduction. For such calculation, it is obvious that the Respondent has to take course of Guidance Note prescribed by the ICAI if it is available. Only after applying such method which is prescribed in the Guidance Note, the Respondent can show fair and real income which is liable to tax under the IT Act Therefore, it is wrong to say that the Respondent claimed deduction by virtue of Guidance Note rather it only applied the method of bifurcation as prescribed by the expert team of ICAI. Further, a conjoint reading of Section 145 of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... periods. Therefore, the AO rejected the claim of advertisement expenses claimed as revenue and treated the same as capital in nature. 23. In this regard, it was submitted that the assessee company is running hotel under name of "The Claridges". The assessee company had entered into contract with the advertisement company based in Denmark CO + Hogh A/S for the development of new logo for the assessee company to strengthen their brand and put more value into it. However, the contract could not be executed due to the failure of the advertisement company to accomplish the work of designing and creation of new logo as per the specifications and requirements of the assessee company. The contract was terminated in mid way since the advertisement company did not deliver the new logo to the assessee company and as a result thereof no further payment was made by the assessee company in this regard. There were several disagreements between the assessee company and the advertisement company over the design of new logo and its payment. Ultimately, the design of new logo could not be approved and the assessee company is still using the same logo which it has been using since inception. 24. The ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he report clearly indicated that the engagement was for the purpose of improving the operational efficiencies of the assessee and to enhance the profitability of the existing business. In those circumstances, not much importance could be attached to the fact that there was no written agreement with the said consultants to ascertain the scope of the study when such scope of study could very well be discerned from the report submitted by the consultants. The helplessness shown by the Tribunal, for want of written agreement, was, therefore, clearly inappropriate. Once it was accepted as a fact that the assignment given to the said consultants was for the purpose of improving operational efficiencies and was not to incur any enduring benefit in capita/ field, but to carry on the existing business more efficiently and profitably, the irresistible conclusion was that such expenditure was allowable as business expenditure." b) In the case of CIT vs. Priya Village Roadshows Ltd. 332 ITR 594 (Delhi) has held that "A harmonious reading of Triveni Engg. Works Ltd. vs. CIT [1998] 232 ITR 639/100 Taxman 19 (Delhi) and CIT vs. Modi Industries 200 ITR 341/68 Taxman 114 (Delhi) would demonst ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ches of existing or already developed software to improve its product is to be treated as revenue expenditure. Relevant paras are reproduced herein under: "To keep pace with the requirements and ensure product sale ability, software development companies have to constantly incur expenditure to upgrade, improve and remove problem areas of the software. They have to employ professionals whose job is to continuously upgrade the software and provide newer features and updates on a regular basis. The shelf life of the software without constant improvement would be very small. Expenditure which enables the profit making structure to work more efficiently leaving the source of profit making structure untouched, would be revenue in nature. The aforesaid expenditure did not bring into existence a new asset but rectified and improved the product being sold. It was accepted that there had to be recurring expenditure which had to be incurred in the said business to ensure sale of the software. This expenditure was incurred for removal of obstructions, restrictions or disabilities on the sale and to ensure that there was demand of the said product. These were normal day-to-day expenses ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... not therefore, be said to be an expenditure incurred for acquiring an asset of enduring nature. They were both in design and in purport the expenditure incurred only towards the execution of those contracts. It was therefore, held that the so-called development expenditure incurred was only revenue expenditure." Similarly, the amounts paid to the consultancy firms also could not be regarded as expenditure incurred in acquiring any asset of enduring nature. The amount paid to the 'NPC' was for the benefit of increasing the manufacturing efficiency and formulating incentive schemes. In an age of speedy technological progress, no degree of permanency can be attached to these opinions given by the firms like the 'NPC' on how to increase the production. They are all susceptible to modifications and alterations. For that reason, it could not held that the fee paid to 'NPC' should be regarded as an expenditure incurred for acquiring a capital asset. So was the case with the amounts paid to the ASC' and so was the case with the amounts paid to 'EMFC'. Therefore, the expenditure incurred was revenue in nature." 28. In the instant case, the contract for ..... X X X X Extracts X X X X X X X X Extracts X X X X
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