Depreciation on leased assets

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From: Nandkishore Hegde <hegdenandkishore@yahoo.com>
Date: Sat, Feb 2, 2013 at 12:59 PM
Subject: Depreciation on leased assets

 

Dear colleagues,

 

A recent decision of the Supreme Court in the case of ICDs Limited has created a new twist to the ever controversial topic of depreciation on leased assets. The Supreme Court has held that the lessor would be entitled to the depreciation even if  at the end of the lease period, the ownership of the vehicle is transferred to the lessee at a nominal value not exceeding 1% of the original cost of the vehicle.

 

In light of the decision the many rulings drawing a distinction between an operating lease and a finance lease and disallowing depreciation to the lessor may no longer hold the field. Unfortunately the Supreme Court decision was mainly concerned with whether the taxpayer could be considered an owner even if it had leased the asset and the observations were limited to the facts before it in that context.

 

A small synopsis of the ruling is enclosed.

 

 

 

 

I.C.D.S Limited, ("taxpayer") is a non-banking finance public company which is engaged in the business of hire purchase, leasing and real estate etc. The taxpayer claimed depreciation on vehicles at a rate higher than those prescribed, on the ground that the vehicles are used in the business of running them on hire. The vehicles on which depreciation was claimed was purchased by the taxpayer directly from the manufacturers and leased out to its customers. However, in the certificate of registration issued under the Motor Vehicles Act, 1988 ("the MV Act") lessees were registered as owners of the vehicles

 

·         The key facts of the lease agreement were:

 

–    The taxpayer was the exclusive owner of the vehicle at all points of time;

–    If the lessee committed a default, the taxpayer is empowered to re-possess the vehicle (and not merely recover money from the customer);

–    At the conclusion of the lease period, the lessee was obliged to return the vehicle to the taxpayer;

–    The taxpayer had the right of inspection of the vehicle at all times.

 

·          The Assessing Officer ("AO") disallowed the claims, both on account of depreciation and higher rate, on the ground that the taxpayer had merely financed the purchase of these assets and was neither the owner nor the user of such assets.

 

·         Aggrieved by the AO order, the taxpayer filed an appeal before the Commissioner of Income Tax, Appeals ("CIT(A)"). The CIT (A) allowed the taxpayer's claim for depreciation but disallowed the higher rate.

 

·         Being aggrieved by the order of CIT(A), both the taxpayer and the Revenue authorities appealed before the Income-tax Appellate Tribunal ("ITAT"). The ITAT held that the taxpayer is engaged in the business of leasing and hiring of vehicles and other machinery. Accordingly, the ITAT held that the taxpayer, having used the trucks for the purpose of business, was entitled to a higher rate of depreciation at 50% on the trucks leased out.

 

·         Aggrieved by the ITAT order, the Revenue filed an appeal before the High Court. The High Court held that since the vehicles were not registered in taxpayer's name and it had only financed the transaction, the taxpayer would not be owner of the vehicles and was not entitled to claim depreciation on such vehicles. The taxpayer filed an appeal before the Supreme Court against the High Court order.

 

Issue before the Supreme Court of India ("Supreme Court")

 

·         Whether the taxpayer is the owner of the vehicles which are leased by it to its customers; and

 

·         Whether the taxpayer is entitled to the higher rate of depreciation on the said vehicles, on the ground that they were hired out to the taxpayer's customers.

 

Observations and Ruling of the Supreme Court

 

·         Section 32 of the Act provides that the asset must be "owned, wholly or partly, by the taxpayer and used for the purposes of the business". Accordingly, there is requirement to satisfy twin conditions of 'ownership' and 'usage for business' to claim depreciation under Section 32 of the Act.

 

·         The section requires that the taxpayer must use the asset for the 'purpose of business'. It does not mandate usage of the asset by the taxpayer itself. As long as the asset is utilized for the purpose of business of the taxpayer, the requirement of Section 32 will be satisfied.

·         In the taxpayer's case, it used the vehicles in the course of its leasing business and accordingly, should be entitled to a higher rate of depreciation.

 

·         As far as ownership is concerned, the taxpayer had the right to retain the legal title to the vehicles and hence, would be treated as rightful owner of the vehicles in the eyes of law.

 

 Best regards

NC Hegde

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