I.C.D.S Ltd. v. Commissioner Of Income-Tax (And Vice Versa)

Income-tax Appeal No. 101 of 2000 connected with Income-tax Appeal No. 345 of 2001

Decided on February 9, 2007

The Judgment of the Court was delivered by

Anand Byrareddy, J.:— The appeal in I.T.A No. 101 of 2000 by the assessee pertains to the assessment year 1994-95, challenging the order of the Income-tax Appellate Tribunal. The assessee is a public limited company, engaged, inter alia, in the business of leasing, financing and hire-purchase.

2. The assessee had entered into several “leasing” transactions involving movables, with M/s. Kasturba Medical College, M/s. Manipal Institute of Technology and other educational institutions and trusts. Under the terms of the several identical contracts, the appellant has purchased assets and leased the same to the aforesaid institutions. The appellant has received refundable security deposits, which sums were equivalent to the purchase value of the assets. The security deposits were interest bearing. The lease rental payable by the lessee was equal to the interest payable on the security deposit.

3. The appellant claimed depreciation in respect of the assets under these transactions, the assessing authority denied the same, holding:

(a) The appellant-company and the institution to which the assets were leased, were controlled by common members.

(b) The transaction was a “self-cancelling transaction”—one where the appellant is in a position to use the security deposit to purchase the asset leased and claim to adjust the lease rental against interest payable on the security deposit.

(c) The educational institutions which are not liable to pay income-tax cannot also claim depreciation on any asset purchased by it. The net result of the above transactions however, enables a taxable entity to claim depreciation on an asset which is actually purchased with the funds of a nontaxable entity.

4. Accordingly, the quantum of depreciation claimed amounting to Rs. 44,22,955 was added back to the appellant's income. The same having been challenged unsuccessfully before the first appellate authority and in further appeal before the Income-tax Appellate Tribunal, the assessee is before this court.

5. In I.T.A No. 345 of 2001, the Revenue is before this court challenging the order of the Appellate Tribunal, pertaining to the very assessee, who is the appellant in I.T.A No. 101 of 2000.

6. In respect of identical transactions entered into during the assessment year 1995-96, the Assessing Officer had denied the claim for depreciation as had been done for the earlier assessment year. This was confirmed in an appeal preferred by the appellant. However, in a further appeal before the Appellate Tribunal, the Tribunal remanded the matter to the first appellate authority as the first appellate authority had merely applied the view expressed for the assessment year 1994-95. This is under challenge by the Revenue.

7. Hence, the substantial question of law arising for consideration in these two appeals is:

“Whether, the assessee is entitled to depreciation upon assets owned by it and leased in favour of educational institutions which had made interest earning deposits with the assessee ?”

8. Shri Sarangan, senior advocate appearing for Shri S. Parthasarathy for the appellant in I.T.A No. 101 of 2000 and for the respondent in I.T.A No. 345 of 2001 contends as follows:

The depreciation claimed is in respect of the assets owned by the appellant and leased in favour of the educational institutions. The transactions of lease are supported by the relevant documents. The terms of lease, as regards the rents payable, the periodicity of the same, and other relevant obligations are specified therein. The receipt of deposits from the lessees is a normal incident of the lease. The deposit is almost equal to the cost of the asset. The deposit bears interest at the same rate for all depositors including the educational institutions. The appellant has paid interest in accordance with the Acceptance of Deposit Rules framed by the Reserve Bank of India. The lease rent and the interest payment are in equal sums. The appellant has credited the lease rent to the profit and loss account and has debited the interest payable on the deposits. The appellant has been classified as an equipment leasing and hire-purchase finance company and hence the deposits can be ten times the net owned funds. The appellant has claimed depreciation upon the leased assets and did not claim exclusion of a principal sum from out of the lease rents as relatable to the return of capital from the lessee. The full lease rent was offered for taxation and depreciation was claimed upon the leased assets.

9. Senior counsel would emphasise that the interest payable on the deposits by the educational institutions was on a par with other depositors and was independent of the lease transaction. The depreciation has been worked out in accordance with the Schedule to the Income-tax Rules, 1962. Counsel would point out that there are only two requirements for being entitled to the depreciation on assets. One is the ownership of the asset and the other is its use in business. Both these conditions are satisfied and hence the appellant is entitled to the depreciation on the leased assets.

10. The senior advocate places reliance on the following authorities:

Union of India v. Azadi Bachao Andolan, [2003] 263 ITR 706—wherein the Supreme Court thought it necessary to consider the earlier judgment of the Supreme Court in McDowell and Co. Ltd. v. CTO, [1985] 154 ITR 148 in some detail as to “what it says, and what it does not say”.

11. While pointing out that though Chinnappa Reddy J., dismissed the observation of J.C Shah J., in CIT v. A. Raman and Co., [1968] 67 ITR 11 (SC), based on IRC v. Duke of Westminster, [1936] AC 1 (HL), which reflected the prevalent attitude towards tax avoidance (page 152) (“Every man is entitled if he can to order his affairs so that the tax attaching under the appropriate Acts is less than it otherwise would be. If he succeeds in ordering them so as to secure this result, then, however, unappreciative the Commissioners of Inland Revenue or his fellow tax gatherers may be of his ingenuity, he cannot be compelled to pay an increased tax”) by saying (page 160):

“We think that the time has come for us to depart from the Westminster principle as emphatically as the British Courts have done and to dissociate ourselves from the observations of Shah J. and similar observations made elsewhere.”

12. The court observes that the rest of the judges of the Constitutional Bench did not share this view, as is evident from the majority view which is as follows (page 171):

“Tax planning may be legitimate provided it is within the framework of law. Colourable devices cannot be part of tax planning and it is wrong to encourage or entertain the belief that it is honourable to avoid the payment of tax by resorting to dubious methods. It is the obligation of every citizen to pay the taxes honestly without resorting to subterfuges.”

13. And, on an extensive reference to other case law, the court in Azadi Bachao Andolan, [2003] 263 ITR 706 (SC) held (page 758):

“With respect, therefore, we are unable to agree with the view that Duke of Westminster's case, [1936] AC 1 (HL); [1935] 19 TC 490 (HL) is dead, or that its ghost has been exorcised in England. The House of Lords does not seem to think so, and we agree, with respect. In our view, the principle in Duke of Westminster's case, [1936] AC 1 [HL]; [1935] 19 TC 490 [HL] is very much alive and kicking in the country of its birth. And as far as this country is concerned, the observations of Shah J. in CIT v. A. Raman and Co., [1968] 67 ITR 11 (SC) are very much relevant even today.”

14. Further the court has agreed with the view of the Madras High Court in M.V Valliappan v. ITO, [1988] 170 ITR 238, which has concluded that the decision in McDowell, [1985] 154 ITR 148 (SC) cannot be read as laying down that every attempt at tax planning is illegitimate and must be ignored, or that every transaction or arrangement which is perfectly permissible under law, which has the effect of reducing the tax burden of the assessee, must be looked upon with disfavour.

15. The court has also accepted the view of the Gujarat High Court in Banyan and Berry v. CIT, [1996] 222 ITR 831, 850 wherein the Gujarat High Court while referring to McDowell, [1985] 154 ITR 148 (SC) has observed (page 759):

“The court nowhere said that every action or inaction on the part of the taxpayer which results in reduction of tax liability to which he may be subjected in future, is to be viewed with suspicion and be treated as a device for avoidance of tax irrespective of legitimacy or genuineness of the act; an inference which unfortunately, in our opinion, the Tribunal apparently appears to have drawn from the enunciation… in the above case has not affected the freedom of the citizen to act in a manner according to his requirements, his wishes in the manner of doing any trade, activity or planning his affairs with circumspection, within the framework of law, unless the same fall in the category of colourable device which may properly be called a device or a dubious method or a subterfuge clothed with apparent dignity.”

16. The Supreme Court has concluded thus (page 762):

“If the court finds that notwithstanding a series of legal steps taken by an assessee, the intended legal result has not been achieved, the court might be justified in overlooking the intermediate steps, but it would not be permissible for the court to treat the intervening legal steps as non est based upon some hypothetical assessment of the ‘real motive’ of the assessee. In our view, the court must deal with what is tangible in an objective manner and cannot afford to chase a will-o'-the-wisp.

The judgment of the Privy Council in Bank of Chettinad's case, [1940] 8 ITR 522, wholeheartedly approving the dicta in the passage from the opinion of Lord Russel in Westminster's case, [1936] AC 1 (HL); [1935] 19 TC 490, was the law in this country when the Constitution came into force. This was the law in force then, which continued by reason of article 372. Unless abrogated by an Act of Parliament, or by a clear pronouncement of this court, we think that this legal principle would continue to hold good. Having anxiously scanned McDowell's case, [1985] 154 ITR 148 (SC), we find no reference therein to having dissented from or overruled the decision of the Privy Council in Bank of Chettinad's case, [1940] 8 ITR 522 (PC). If any, the principle appears to have been reiterated with approval by the Constitutional Bench of this court in Mathuram's case, [1999] 8 SCC 667 at page 12. We are, therefore, unable to accept the contention of the respondents that there has been a very drastic change in the fiscal jurisprudence, in India, as would entail a departure. In our judgment, from Westminster's case, [1936] AC 1 (HL); 19 TC 490 to Bank of Chettinad's case, [1940] 8 ITR 522 (PC) to Mathuram's case, [1999] 8 SCC 667, despite the hiccups of McDowell's case, [1985] 154 ITR 148 (SC), the law has remained the same.

We are unable to agree with the submission that an act which is otherwise valid in law can be treated as non est merely on the basis of some underlying motive supposedly resulting in some economic detriment or prejudice to the national interests, as perceived by the respondents.”

17. It is therefore submitted by the senior advocate, that having regard to the material on record and the settled legal position—the transactions in the case on hand cannot be dubbed a colourable device or a sham transaction aimed at evasion of tax liability or even avoidance thereof. Counsel would pray that the appeal by the assessee be allowed and that by the Revenue be dismissed.

18. Per contra, Shri M.V Seshachala, appearing on behalf of the Revenue would contend that as found by the Assessing Officer, the total quantum of investment by the assessee in the assets was received back from the lessee by way of security deposits. This coupled with the fact that the interest payable on the deposits was equal to the lease rent receivable from the lessee and that the lessees were educational institutions exempt from paying income-tax, was an uncanny co-incidence which clearly points to the transactions having been entered into in order to claim depreciation in respect of these assets without actually investing any of its funds. The fact that the personnel in the management of the assessee-company and the educational institutions are common, clinches the issue. It is indeed naive on the part of the assessee to claim any semblance of genuineness to the transaction except the seemingly candid documentation. The incidental term as regards refund of security deposit at the end of the lease period, did not materially affect the true character of the transaction. It was to be seen that many of the lease agreements are renewed and therefore, the lessee does not get back the security deposit. Counsel would submit that the scheme of the transaction is designed to pass on the depreciation claim from a non-taxable entity to a taxable entity without the taxable entity having to pay the price for it. Hence, the depreciation claim was rightly disallowed.

19. Shri Seshachala also advances an argument that from a reading of section 32(1)(ii) depreciation in respect of tangible assets shall be allowed at such percentage on the written down value for which purpose “written down value” shall have the same meaning as explained under clause (1) of section 43, which reads as follows:

“43. (1) ‘actual cost’ means the actual cost of the assets to the assessee, reduced by that portion of the cost thereof, if any, as has been met directly or indirectly by any other person or authority.”

20. Counsel would draw sustenance from the judgment in the case of Commissioner Of Income Tax, Hyderabad v. P.J Chemicals Ltd.., [1994] 210 ITR 830 (SC) and would submit, though that was not a case in the context of whether if a portion of the cost of the asset is met directly or indirectly by any other person or authority, it should be deducted or not, the observation of the court is that a plain meaning of the section is that it shall be. And hence, counsel would submit in the instant case on hand that the security deposit being equal to the cost of the asset, the cost is directly met by the lessee though the transaction is broken up into two by recourse to seemingly acceptable documentation.

21. Counsel would hence submit that the authorities have rightly denied the claim for depreciation in favour of the assessee and there was no warrant to depart from the view taken. Therefore in respect of a subsequent year the Tribunal holding that the first appellate authority was not justified in placing reliance on the earlier view and thereby remanding the matter for a reconsideration was wholly inexplicable and would seek that the question of law be answered in favour of the Revenue in these two appeals.

22. On these rival contentions, it is seen that there is no dispute on facts. The controversy centres on the point of view as to the veracity of the lease transaction. Are the said transactions to be viewed as regular commercial transactions ? Or, can it be said on the admitted factual matrix that they are designed to evade tax liability.

23. The assessee acquires the asset in its name and leases it to the educational institution which makes an interest bearing security deposit, equal to the entire value of the asset so leased, but agrees not to receive any interest which is to be adjusted entirely towards lease rentals. There is a remote possibility of termination of the lease and refund of the security deposit.

24. In the meanwhile the assessee claims depreciation on the asset, which the educational institution could not have claimed if it had directly acquired the asset, as it is exempt from payment of income-tax. The further fact that the assessee and the lessees are managed by the same group of individuals, as directors in the assessee-company and in other capacities, managing the lessees would leave no room for doubt that the transactions are blatantly geared to evade the tax liability. It would be extremely naive to accept the transactions as commercially accepted transactions. The same cannot be considered as being a tidy management of affairs in accordance with law. The assessee and the lessees are on the other hand, cocking a snook at the law. Though it remains true in general that the taxpayer, where he is in a position to carry through a transaction in two alternative ways, one which will result in liability to tax and the other which will not, is at liberty to choose the latter. The transaction in the case on hand is not an alternative chosen by the assessee but a mechanism devised to enable a non-tax paying entity to acquire an asset and also to claim depreciation on it. It cannot be said that the transactions are entered into with the effect of minimising the subject's burden of tax, but only in order to facilitate the benefit as aforesaid.

25. It does not require a vivid imagination to discern the obvious in these transactions there is no warrant to give chase to a will-o'-the-wisp. The finding that the assessee is not entitled to claim depreciation on the assets is not on the basis of the underlying motive but the direct result of the manner these transactions are engineered.

26. In the result, in our opinion—on a careful consideration of the contentions and the case law cited, we have no hesitation in holding that the question of law is required to be answered in the negative and in favour of the Revenue. Consequently, the appeal in I.T.A No. 101 of 2000 stands dismissed and the appeal in I.T.A No. 345 of 2001 stands allowed and the order of the Income-tax Appellate Tribunal is set aside.