The Hindu Business Line : Why meddle with the methods

AT A TIME when financial leasing as a product is losing its sheen, the controversies which erupted a decade back is now slowly, but surely, being settled by various forums. In the 1980s several finance companies embarked on leasing as a major route of expansion. Some of them got entangled in a whole range of disputes, particularly with reference to charging of depreciation in the books of accounts and making a claim of depreciation in the income-tax returns.

In the past, the provision of depreciation by several companies lead to an artificial bloating of net worth and fuelled growth opportunities through public issues. In the late 1980s, the Institute of Chartered Accountants of India (ICAI) came down heavily on companies which under-provided depreciation in the books of accounts taking umbrage on the low straight-line rates stipulated by Schedule XIV to the Companies Act, 1956.

The ICAI Guidance Note released in 1988 envisaged adequate amortisation charge over the primary period of the finance lease. One of the components of this charge represents lease equalisation account (LEA), which had to be debited to the profit and loss account as part of book depreciation. At that time itself, there was a debate as to whether the LEA could be claimed as a business deduction in addition to the income-tax depreciation allowable in accordance with the I-T rules.

This pointed issue has now been decided in favour of the appellant company by the Hyderabad Bench of the Tribunal in the Pact Securities & Financial Ltd vs Jt CIT (2003 86 ITD 115) case.

Tribunal decision

The Tribunal allowed the issue in favour of the appellant company by holding that the lease terminal adjustment accounts (LTAA) was allowable as a business deduction. The Tribunal reasoned that the assessee-company in question was following a method of accounting accepted within the parameters laid down in Section 145 of the Act.

The question of rejecting the books of accounts will apply only if it can be adduced that the method of accounting followed does not disclose the true picture of profits. Interestingly, the Tribunal came to the categorical conclusion that in the method of accounting adopted by the company true profits can be arrived at and the company was right in providing for LTAA and claiming the same as a legitimate deduction. The Tribunal laid down the following principles on the question of system of accounting:

The choice to account for income on an acceptable basis or, in other words, the choice of the method of accounting, though not an unlimited one, is that of the assessee ;

There should be some material to indicate why the AO considers the system of accounting regularly employed by the assessee to be defective;

There should be a finding that the system of accounting followed by the assessee is such that correct profit cannot be deducted therefrom.

The AO has, as per Section 145, the power to substitute the system of accounting.

Just because there is a better system of accounting, Section 145 cannot be invoked to reject the system of accounting followed by the assessee uniformly and regularly.

The AO cannot substitute a system of accounting on the ground that the system which better commends to the AO should be followed, that is, the method of accounting cannot be rejected on mere revenue consideration.

In all fairness, the Tribunal's decision in the Pact Securities case can only be a temporary reprieve, as the final word on the subject will have to be spelt by the Supreme Court or the High Courts. The fact is, LTAA represents a part of book depreciation which has to be ignored for tax computation as depreciation for I-T has to be claimed as per the rates prescribed in the rules.

In any case, the ratio of this decision (whatever may be its ultimate outcome) will be relevant only up to March 31, 2001. For lease transactions from April 1, 2001, the Accounting Standard for Leases (AS-19) — which has completely changed the manner of accounting and disclosure for finance lease transactions — will come into operation. There can, however, be no doubt that LTAA is a legitimate charge on book profits for computing book profits tax.

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