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Lease and Depreciation claim-An analysis

Yogesh Agarwal 
on 07 November 2015

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Lease and Depreciation claim-An analysis Lease nowadays a method of using the tangible material or equipment like Machinery, Vehicles and in a nature of like assets. Instead of buying the same the lessee takes them on lease or say hire from the lessor in consideration of systematic payments to the lessor. In common parlance, a lease is understood as hiring of an asset for a periodic payment; parties involved in the transaction are classified as lessor and lessee whilst the periodic payment to be made by lessee is termed as lease rental. From an accounting standpoint, simplistically, lease can be classified in three forms - 

a. Finance Lease
b. Operating Lease and
c. Hire Purchase.

As per Accounting Standard-19, a lease is classified as a finance lease if it is for the entire economic life of the asset and under the lease arrangement all risks and rewards incidental to the ownership of the asset is transferred to the lessee. As per AS-19, the assets shall be capitalized in the books of accounts of the Lessee. By capitalizing the lease in the books means the leased asset shall be reflected in books of the lessee as lessee's fixed asset. In turn in the books of the lessor, a lease appears as current asset.

An operating Lease is a lease other than finance lease that is lease term is for less than the economic life of an asset and all risk and rewards incidental to the ownership is substantially not transferred to the Lessee. As per AS-19 on leases provide that the Depreciation shall be claimed by the Lessee in case of Finance Lease and by the Lessor if it is in the nature of the Operating Lease. So far the claim of Depreciation is concerned under the Income Tax Law there is a test of two aspects which should be satisfied and these are "Ownership" and "Usage". An assesse can claim depreciation on an asset only when it is owned and used for the business purpose by the assesse.

The twin tests of Ownership and Usage in order to claim the depreciation is more critical and tedious task when it is under lease transactions. As in the case of lease the actual owner gives the possession to Lessee and lessee enjoys the use of the assets under lease arrangement. The department has come up with circular in the year 1999 which is basically a guidance issued to the Income Tax Authorities on investigating the lease transactions.

Next circular issued in the year 2001 when AS – 19 was issued by the ICAI dealing in LEASE. As per circular of 2001, it clearly thumbs down the principal given for the treatment of finance lease with respect to its ownership and claim of depreciation to Lessee. So far the method of treatment of depreciation of an asset under operating lease is concerned the department has similar view with the AS-19. Hence, there is no issue in that.

The reading of the circulars makes it obvious that there is no distinction between Finance Lease and Operating Lease for the tax purpose. If the basic idea of the legal and beneficial ownership is satisfied the lessor shall be eligible to claim depreciation. Presumably, as the CBDT holds that the accounting standard will not be relevant for tax purposes, a lessee may not be debiting the full amount of rentals for accounting purposes, but nevertheless will claim the rentals as expense for tax purposes, as he does today. At the same time, a lessee might be capitalizing and depreciating the leased asset for accounting purposes, but will not do the same for tax purposes.

The absurd situation which shall arise due to difference in treatment of deprecation of leased assets under finance lease can be imagined. The lessor shall claim the depreciation for the assets which it has not accounted for and the lessee cannot claim the depreciation on the assets which it has accounted for. A summary table clears the picture on the standing of the statute and AS with respect to the ownership of the asset: Comparative view of lease Legal ownership Tax laws Accounting standards Financial lease Lessor Lessor Lessee Operating lease Lessor Lessor Lessor Scheme of Planning: Even though the depreciation shall be allowed in the hands of the Lessor be it Finance Lease or be it Operating Lease, the lessee can still claim the depreciation in the books of accounts as per AS-19. Under the MAT regime the tax is based on book profit and book profit shall be computed as per the accounts maintained under the provision of Companies Act. The depreciation provided for in the books by the lessee shall be the reduced one for the purpose of arriving at Net profit. With an anticipation that this article will be helpful to get an idea on lease and depreciation on the lease.

With Regards!
CA Yogesh Kr Agarwal
Yka421@gmail.com


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