Commissioner Of Income Tax Vi vs Virtual Soft Systems Ltd.

REPORTABLE IN THE SUPREME COURT OF INDIA CIVIL APPELLATE JURISDICTION CIVIL APPEAL NO. 4358 OF 2018 (Arising out of Special Leave Petition (C) NO. 25006 OF 2012) Commissioner of Income Tax-VI ….Appellant(s)

Versus

Virtual Soft Systems Ltd. …. Respondent(s)

WITH

CIVIL APPEAL NO. 4359 OF 2018 (Arising out of Special Leave Petition (C) NO. 29129 OF 2012)

CIVIL APPEAL NO. 4360 OF 2018 (Arising out of Special Leave Petition (C) NO. 35430 OF 2012)

CIVIL APPEAL NO. 4361 OF 2018 (Arising out of Special Leave Petition (C) NO. 33942 OF 2012)

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CIVIL APPEAL NO. 4362 OF 2018 (Arising out of Special Leave Petition (C) NO. 5262 OF 2013) Signature Not Verified

CIVIL APPEAL NO. 4363 OF 2018 Digitally signed by ASHA SUNDRIYAL Date: 2018.04.25 17:36:12 IST

(Arising out of Special Leave Petition (C) NO. 3610 OF Reason:

2013)

1 CIVIL APPEAL NO. 4364 OF 2018 (Arising out of Special Leave Petition (C) NO. 5229 OF 2013)

CIVIL APPEAL Nos.4366-4367 OF 2018 (Arising out of Special Leave Petition (C) NOs. 22197-22198 OF 2013)

CIVIL APPEAL NO. 4368 OF 2018 (Arising out of Special Leave Petition (C) NO. 8586 OF 2014)

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CIVIL APPEAL NO. 4376 OF 2018 (Arising out of Special Leave Petition (C) NO. 25944 OF 2015)

JUDGMENT

R.K.Agrawal, J.

SLP (C) No. 25006 of 2012

1) Leave granted.

2) This batch of appeals has been filed against the

impugned judgment and order dated 07.02.2012 passed by

the High Court of Delhi at New Delhi in ITA Nos. 216, 398,

403, 404 and 680 of 2011 whereby the Division Bench of the

High Court upheld the decision of the Income Tax Appellate

Tribunal (in short ‘the Tribunal’) dated 19.02.2010. Since the

moot question of law in all these appeals is akin, hence, vide

this common judgment, all the appeals would stand disposed

of.

3) In order to appreciate the controversy at hand, it is

pertinent to allude to the relevant facts in a summarized way

for the proper insightful of the instant case.

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(a) The appellant herein is the Income Tax Department, on

the other hand, the Respondent - M/s Virtual Soft Systems

Ltd. is a company registered under the provisions of the

Companies Act, 1956.

(b) On 29.12.1999, the Respondent filed return of income for

the Assessment Year 1999-2000 declaring loss of Rs

70,24,178/- while claiming an amount of Rs 1,65,12,077/- as

deduction for lease equalization charges.

(c) On scrutiny, the Assessing Officer, after perusal of the

return and hearing the parties, vide Assessment Order dated

28.01.2005 disallowed deduction claimed as the lease

equalization charges amounting to Rs. 1,65,12,077/- and

added the same to the income of the Respondent under the

Income Tax Act, 1961 (in short ‘the IT Act’).

(d) Being aggrieved with the said Assessment Order, the

Respondent preferred an appeal before the Commissioner of

Income Tax (Appeals). Learned CIT (Appeals), vide order dated

15.09.2005, upheld the order of the Assessing Officer and

dismissed the appeal.

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(e) Being dissatisfied, the Respondent preferred an appeal

before the ITAT. Vide order dated 19.02.2010, the ITAT allowed

the appeal of the Respondent while setting aside the orders

passed by Learned CIT (Appeals) and the Assessing Officer.

(f) Being aggrieved, the Revenue took the matter before the

High Court. The High Court, vide judgment and order dated

07.02.2012, dismissed the appeals at the preliminary stage

while confirming the decision of the ITAT.

(g) Hence, this instant appeal has been filed before this

Court by the Revenue.

4) We have given our thoughtful consideration to the

submissions of learned senior counsel for the parties and

perused the relevant records of the case.

Point(s) for consideration:-

5) The short question that arises for consideration before

this Court is whether the deduction on account of lease

equalization charges from lease rental income can be allowed

under the Income Tax Act, 1961, on the basis of Guidance

Note issued by the Institute of Chartered Accountants of India

(ICAI)?

5

Rival submissions:-

6) At the outset, learned senior counsel for the Revenue

contended that the lease equalization charge is an additional

deduction debited to Profit and Loss Account (P&L) in addition

to the depreciation claimed in books so as to make it equal to

capital recovery. This is an artificial calculation which

bifurcates lease rental to capital recovery and interest

component. Learned senior counsel further contended that in

fact the entire lease income constitutes income of the

assessee. Also, there is no concept of deduction regarding the

lease equalization charges under the IT Act. Hence, learned

senior counsel contended that impugned decision of the High

Court is perverse and is liable to be set aside.

7) On the other hand, learned senior counsel for the

Respondent submitted that this issue is no longer res integra.

Now, it is a settled principle that a Guidance Note issued by

the ICAI carries great weight and by adopting a method of

accounting prescribed in such a Guidance Note, in order to

compute real income and offering the same for taxation,

cannot be disregarded by the Assessing Officer unless such

6 action falls within the scope and ambit of Section 145(3) of the

IT Act. Further, it was submitted that the lease equalization

charge was nothing but a method of adjusting the depreciation

claimed in the books of accounts to enable the Respondent to

represent its real income by adopting an accounting

methodology which had surely the seal of approval of a

professional body such as the ICAI. Learned senior counsel

finally submitted that the judgment passed by the High Court

is well-versed and within the parameters of law and no

interference is sought for by this Court in the matter.

Discussion:-

8) Prior to critically examining the case, it would be

appropriate to have an understanding and significance of the

Guidance Note issued by the ICAI. The ICAI is an expert body,

created by the Parliament under the Chartered Accountants

Act, 1949. The ICAI’s publication on the subject indicates that

the Guidance Note on Accounting for Leases was issued by it

for the first time in 1988 which was later on revised in 1995.

The Guidance Note reflects the best practices adopted by the

accountants throughout the world. The ICAI is a recognized

7 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

financial statements.

9) Section 211 of the Companies Act, 1956 as it stood

before the amendment dealt with “the Form and contents of

balance-sheet and profit and loss account”. Sub clause (3C) of

Section 211 was added vide 1999 amendment with

retrospective effect. The relevant portion of Section 211 of the

Companies Act is reproduced herein as under:

“(3C) For the purposes of this section, the expression “accounting standards” means the standards of accounting recommended by the Institute of Chartered Accountants of India constituted under the Chartered Accountants Act, 1949 (38 of 1949), as may be prescribed by the Central Government in consultation with the National Advisory Committee on Accounting Standards established under sub-section (1) of section 210A:

Provided that the standards of accounting specified by the Institute of Chartered Accountants of India shall be deemed to be the accounting standards until the accounting standards are prescribed by the Central Government under this sub-section.” (Emphasis supplied by us)

10) The purpose behind the amendment in Section 211 of the

Companies Act, 1956 was to give clear sight that the

8 accounting standards, as prescribed by the ICAI, shall prevail

until the accounting standards are prescribed by the Central

Government under this sub-section. The purpose behind the

accounting standards was to arrive at a computation of real

income after adjusting the permissible deprecation. It is not

disputed that these accounting standards are made by the

body of experts after extensive study and research.

11) At this stage, it would be pertinent to reproduce the

relevant provisions of the Guidance Note on Accounting for

Leases, revised in 1995, which is as under:-

“Accounting for leases in the Books of a lessor Finance Leases

9. Assets leased under finance leases should be disclosed as “Assets given on lease”, as a separate section under the head “Fixed Assets” in the balance sheet of the lessor. The classification of ‘Assets given on lease’ should correspond to that adopted in respect of other fixed assets. In addition to the particulars required by statute, e.g., Schedule VI to the Companies Act, 1956, particulars relating to Lease Adjustment Account should be disclosed as stated in Para

11.

10. Lease rentals (those received and those due but not received) under a finance lease should be shown separately under ‘Gross Income’ in the profit and loss account of the relevant period.

11. It is appropriate that against the lease rental, a matching lease annual charge is made to the profit and loss account.

This annual lease charge should represent recovery of the net investment/ fair value of the leased asset over the lease term. The said charge should be calculated by deducting the

9 finance income for the period (as per para 12 below) from the lease rental for that period. This annual lease charge would comprise (i) minimum statutory depreciation (e.g., as per the Companies Act, 1956) and (ii) lease equalization charge, where the annual lease charge is less than minimum statutory depreciation. However, where annual lease charge is less than minimum statutory depreciation, a lease equalization credit would arise. In this regard the following accounting entries/disclosure should be made.

(a) A separate Lease Equalization Account should be opened with a corresponding debit or credit to Lease Adjustment Account, as the case may be.

(b) Lease Equalisation Account should be transferred every year to the Profit and Loss Account and disclosed separately as a deduction from/addition to gross value of lease rentals shown under the head “Gross Income”.

(c) Statutory depreciation should be shown separately in the profit and loss account. Accumulated statutory depreciation should be deducted from the original cost of the leased asset in the balance sheet of the lessor to arrive at the net book value.

(d) Balance standing in Lease Adjustment Account should be adjusted in the net book value of the leased assets. The amount of adjustment in respect of each class of fixed assets may be shown either in the main balance sheet or in the Fixed Assets Schedule as a separate column in the section related to leased assets.

(e) The aggregate amount included under Lease Adjustment Account on account of lease equalisation credits should be disclosed separately.

The method of income measurement suggested in this paragraph, is in consonance with the inherent nature of a finance lease.

The above method is illustrated in the Appendix to this Guidance Note.

12. The finance income for the period should be calculated by applying the interest rate implicit in the lease to the net investment in the lease during the relevant period. This method would ensure recognition of net income in respect of a finance lease at a constant periodic rate of return on the lessor’s net investment outstanding in the lease. However,

10 some lessor use a simpler method for calculating the finance income for each of the periods comprising the lease term by appropriating the total finance income from the lease in the ratio of minimum lease payments outstanding during each of the respective periods comprising the lease term. (The total finance income from the lease is the difference between the aggregate minimum lease payments receivable over the lease term and the fair value of the leased asset at the inception of the lease.) This method may be used where the finance income in respect of all individual periods as per this method approximate the finance income for the corresponding periods determined according to the former method. It is however clarified that where this method is used, overdue lease rentals, i.e., lease rentals fallen due but not collected should not be taken into account for determining the amount of minimum lease payments outstanding during each of the respective periods comprising the lease term.”

12) At the first look, it appears that the method of accounting

provided in the Guidance Note of 1995, on the one hand,

adjusts the inflated cost of interest of the assets in the balance

sheet. Secondly, it captures “real income” by separating the

element of capital recovery (essentially representing repayment

of principal amount by the lessee, the principal amount being

the net investment in the lease), and the finance income,

which is the revenue receipt of the lessor as

remuneration/reward for the lessor’s investment. As per the

Guidance Note, the annual lease charge represents recovery of

the net investment/fair value of the asset lease term. The

finance income reflects a constant periodic rate of return on

11 the net investment of the lessor outstanding in respect of the

finance lease. While the finance income represents a revenue

receipt to be included in income for the purpose of taxation,

the capital recovery element (annual lease charge) is not

classifiable as income, as it is not, in essence, a revenue

receipt chargeable to income tax.

13) The method of accounting followed, as derived from the

ICAI’s Guidance Note, is a valid method of capturing real

income based on the substance of finance lease transaction.

The rule of substance over form is a fundamental principle of

accounting, and is in fact, incorporated in the ICAI’s

Accounting Standards on Disclosure of Accounting Policies

being accounting standards which is a kind of guidelines for

accounting periods starting from 01.04.1991. It is a cardinal

principle of law that the difference between capital recovery

and interest or finance income is essential for accounting for

such a transaction with reference to its substance. If the same

was not carried out, the Respondent would be assessed for

income tax not merely on revenue receipts but also on

12 non-revenue items which is completely contrary to the

principles of the IT Act and to its Scheme and spirit.

14) The bifurcation of the lease rental is, by no stretch of

imagination, an artificial calculation and, therefore, lease

equalization is an essential step in the accounting process to

ensure that real income from the transaction in the form of

revenue receipts only is captured for the purposes of income

tax. Moreover, we do not find any express bar in the IT Act

which bars the bifurcation of the lease rental. This bifurcation

is analogous to the manner in which a bank would treat an

EMI payment made by the debtor on a loan advanced by the

bank. The repayment of principal would be a balance sheet

item and not a revenue item. Only the interest earned would

be a revenue receipt chargeable to income tax. Hence, we do

not find any force in the contentions of the Revenue that whole

revenue from lease shall be subjected to tax under the IT Act.

15) Without a doubt, in a catena of cases, this court has

discussed the relevancy of the Guidance Note. While dealing

with one of such matters, this Court, in Commissioner of

13 Income Tax-VII, New Delhi vs. Punjab Stainless Steel

Industries (2014) 15 SCC 129 held as under:

“17. So as to be more accurate about the word “Turnover”, one can either refer to dictionaries or to material which are published by bodies of Accountants. The Institute of Chartered Accountants of India (hereinafter referred to as the “ICAI”) has published some material under the head “Guidance Note on Tax Audit under Section 44B of the Income Tax Act”. The said material has been published so as to guide the members of the ICAI. In our opinion, when a recognized body of Accountants, after due deliberation and consideration publishes certain materials for its members, one can rely upon the same….”

16) In the present case, the relevant Assessment Year is

1999-2000. 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

14 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 IT Act read with

Section 211 (un-amended) of the Companies Act make it clear

that the Respondent is entitled to do such bifurcation and in

our view there is no illegality in such bifurcation as it is

according to the principles of law. Moreover, the rule of

interpretation says that when internal aid is not available then

for the proper interpretation of the Statute, the court may take

the help of external aid. If a term is not defined in a Statute

then its meaning can be taken as is prevalent in ordinary or

commercial parlance. Hence, we do not find any force in the

contentions of the Revenue that the accounting standards

prescribed by the Guidance Note cannot be used to bifurcate

the lease rental to reach the real income for the purpose of tax

under the IT Act.

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17) To sum up, we are of the view that the Respondent is

entitled for bifurcation of lease rental as per the accounting

standards prescribed by the ICAI. Moreover, there is no

express bar in the IT Act regarding the application of such

accounting standards.

18) In view of above detailed discussion, we are not inclined

to interfere in the impugned decision of the High Court.

Accordingly, the appeal is hereby dismissed leaving parties to

bear their own cost. In view of the above, other connected

appeals are also disposed off accordingly.

…….....…………………………………J. (R.K. AGRAWAL)

…….…………….………………………J. (ABHAY MANOHAR SAPRE) NEW DELHI;

APRIL 24, 2018.

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