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)  

CIVIL APPEAL NO. 4365 OF 2018  (Arising out of Special Leave Petition (C) NO. 8381 OF 2013)  

CIVIL APPEAL NO. 4362 OF 2018  (Arising out of Special Leave Petition (C) NO. 5262 OF 2013)  

CIVIL APPEAL NO. 4363 OF 2018  (Arising out of Special Leave Petition (C) NO. 3610 OF 2013)  

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

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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)  

CIVIL APPEAL NO. 4370 OF 2018  (Arising out of Special Leave Petition (C) NO. 16153 OF 2014)  

CIVIL APPEAL NO. 4369 OF 2018  (Arising out of Special Leave Petition (C) NO. 13875 OF 2014)  

CIVIL APPEAL NO. 4371 OF 2018  (Arising out of Special Leave Petition (C) NO. 17581 OF 2015)  

CIVIL APPEAL NO. 4372 OF 2018  (Arising out of Special Leave Petition (C) NO. 22953 OF 2015)  

CIVIL APPEAL NO. 4373 OF 2018  (Arising out of Special Leave Petition (C) NO. 22954 OF 2015)  

CIVIL APPEAL NO. 4375 OF 2018  (Arising out of Special Leave Petition (C) NO. 24590 OF 2015)  

CIVIL APPEAL NO. 4374 OF 2018  (Arising out of Special Leave Petition (C) NO. 24576 OF 2015)  

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

J U D G M E N T R.K.Agrawal, J. SLP (C) No. 25006 of 2012  

1) Leave granted.

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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.

(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.

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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.

(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:-

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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)?

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

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Note,  in  order  to  compute  real  income  and  offering  the  same  for

taxation, cannot be disregarded by the Assessing Officer unless such

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 body vested

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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  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

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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 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

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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, 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

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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 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

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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

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,

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this Court, in Commissioner of 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 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

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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.  

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.

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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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