Formulation of Income Computation and Disclosure Standards (‘ICDS’)
The Central Government is empowered[see end note 1] to notify ‘accounting standards’ under Section 145 of the Act[see end note 2] which need to be necessarily followed while computing income under the head ‘profits and gains of business or profession’ or ‘other sources’. In the year 1996[see end note 3], two[see end note 4] ‘accounting standards’ were notified with the intention of ensuring that the income is computed precisely and objectively.
For formulating ‘accounting standards’ to be notified under the Act, a committee was also constituted later in July 2002, which recommended that the ‘accounting standards’ issued by ICAI[see end note 5] should be adopted with relevant modifications in the Act, wherever necessary. The committee was of the view that it would be impractical for a taxpayer to maintain two sets of books of accounts, i.e., one in accordance with the standards issued by ICAI while the other in accordance with the standards notified in the Act. The recommendations of the committee could not be implemented, since it would have required extensive amendments to the Act which could have rather resulted in complexities besides litigation.
Significant developments took place thereafter firstly, by way of MCA notifying certain ‘accounting standards’ in the Companies Act, then subsequently, introduction of Indian accounting standards (‘Ind-AS’) for facilitating convergence of Indian accounting standards with IFRS by MCA and lastly and more importantly, in absence of relevant accounting standards in the Act itself, uncertainty moved around some issues which led to continued litigation.
Wary of these difficulties, CBDT constituted another Committee in December 2010 to harmonise the accounting standards issued by the ICAI with the provisions of the Act and also for suggesting amendments to the Act required for transitioning to Indian accounting standards. The committee examined all the 31 accounting standards in force at that point of time and released 14 Tax accounting standards (‘TAS’) for public comments (the rest 17 were pertaining to disclosure requirements and therefore irrelevant from tax aspect) in October 2012. After examining the suggestions of stake holders the CBDT released the revised drafts of 12 Income Computation and Disclosure Standards (‘ICDS’) and invited suggestions of various stakeholders and the general public.
The names of all standards are changed from ‘TAS’ to ‘ICDS’, pursuant to amendment[see end note 6], to clarify that the ‘ICDS’ apply only to computation of taxable income and tax payers are not required to maintain separate books of account to comply with ‘ICDS’. Transitional provisions have also been inserted in all ‘ICDS’, which broadly requires recognition of the concerned contract/transaction, asset, income, expense, loss or provision existing as on or entered into on or after 1st of April, 2015.
Primarily, the intention of introducing the ‘ICDS’ is to maintain uniformity and to remove uncertainty besides reducing litigation as it attempts to purge alternative accounting/tax treatments and it is certainly a welcome move! However, to what extent it aims to settle some unsettled disputes and unsettle some settled disputes is yet to be seen.
In this Article, the author has examined one of such issues which have been a subject matter of controversy of late, that ‘whether in respect of a Finance lease transaction, the depreciation will be allowable in the hands of the ‘lessor’ or in the hands of the ‘lessee’?
The distinction between a ‘Finance lease’ and an ‘Operating lease’ is set out in Accounting Standard (‘AS-19’) on Leases[see end note 7] (as also in new set of ‘ICDS’). It further provides that in a Finance lease transaction, typically, all the risks and rewards incidental to ownership vests with the ‘lessee’ and it is the ‘lessee’ who is a actual and real owner and the ‘lessor’ is rather a nominal or symbolic owner and therefore the depreciation in such cases is available in the hands of the ‘lessee’.Tribunal (SB) decision in the case of IndusInd Bank Ltd.[see end note 8] also held that depreciation is allowable in the hands of lessee in case of a finance lease.
The relevance of Accounting Standards was highlighted by the Supreme Court in CIT v. Woodward Governor[see end note 9] wherein it was held that the Accounting Standards which are continuously adopted by an assessee, can be superseded or modified by legislative intervention. However, but for such intervention, the method of accounting undertaken by the assessee continuously is supreme.
Therefore in absence of any contrary treatment prescribed in the Act, in a Finance lease transaction, the treatment prescribed in ‘AS-19’ could thus have been followed and the depreciation would be available in the hands of the ‘lessee’. However, the controversy was ignited when the decision of the Supreme Court in I.C.D.S Ltd. v. CIT [see end note 10] was pronounced, wherein it was held the ‘lessor’ is entitled to claim the depreciation since in a finance lease transaction it is the ‘lessor’ who is the legal owner of the asset and the use by the ‘lessor’ in its leasing business would satisfy the test of use as well and physical use of the asset is not necessary.
Let us examine various provisions of the Act, to understand whether the law laid down by the decision in I.C.D.S Ltd. (supra) and its interplay with the ICDS (issued by CBDT)?
As per the mandate of section 32 of the Act, depreciation is available to the assessee who ‘owns’ the asset and ‘uses’ the same for the purposes of its business. Therefore, the twin requirement of ‘ownership’ as well as ‘use’ is required to be met.
‘Ownership’ - does not necessarily co-exist with legal title. The Supreme Court in the case of CIT v. Podar Cement[see end note 11] settled the controversy on the significance of ‘legal title’ in the context of Section 22 of the Act and held that ‘owner is the person who is entitled to receive income from property in his own right and not necessarily the person having legal title over that property’.
Further, the Supreme Court in Jodhamal Kuthiala v. CIT[see end note 12] also laid down certain propositions, (a) a property cannot be owned by two persons, each one having independent and exclusive right over it; (b) the concept has also to be looked into from practical point of view having regard to reasonability and justice; (c) the meaning given to the word ‘owner’ must not be such as to make the provision capable of being made an instrument of oppression; (d) the word ‘owner’ has different meanings in different contexts; (e) under certain circumstances a lessee may be considered as the owner of the property leased to him.
It was thus held in the above case that ‘an assessee whose house property is vested in the hands of a custodian, cannot be assessed as owner since the word ‘owner’ must mean, a person who can exercise the rights of the owner and is entitled to the income from the property’.
The Supreme court, again, in the case of Mysore Minerals v. CIT[see end note 13] applying the above decisions, observed in the context of Section 32 of the Act, that the term ‘owned’ must be assigned a wider meaning and anyone in possession of property in his own title exercising dominion over the property as would enable others being excluded there from and having the right to use and occupy the property or to enjoy its usufruct in his own right would be the owner of the building though a formal deed to title may not have been executed and registered.
It therefore emerges from the above decisions that, (a) legal title over the asset is not decisive to determine the owner of the said asset; (b) depreciation under Section 32 of the Act is a periodic allowance of the capital cost incurred and hence should be available to the person incurring that cost in real sense having regard to reasonableness and justice; (c) the lessee could also be treated as the owner of the asset provided the lessee exercises such rights over the asset which gives him the dominion over the asset and enable him to enjoy the benefits there from.
‘Use’ - the assets should be used by the lessee for the purposes of business which is being carried on and thus this test could be satisfied in a relatively easier way.
CBDT Circular[see end note 14] states that the accounting treatment will have no bearing on the allowance of depreciation on assets under the Act and ownership of the asset needs to be determined having regard to the substance of the terms between the ‘lessor’ and the ‘lessee’. Therefore, it does leave scope for a case where based on terms, the ‘lessee’ would be treated to be owner for the purpose of depreciation.
In a finance lease transaction, where the terms of the lease are such that the substantive rights incidental to ownership vests with the ‘lessee’ while the ‘lessor’ continues to be the symbolic or nominal owner, the depreciation could be claimed by the ‘lessee’. Therefore, where the substantive rights vests with the ‘lessee’ and a sliced down legal tile with the ‘lessor’, it is the ‘lessee’ who should be considered to be the owner of the asset for the purpose of Section 32 of the Act.
The Supreme Court’s decision in I.C.D.S (supra) may be considered supreme for the set of facts. Yet the ICDS issued by CBDT and Tribunal (SB) decision in the case of IndusInd Bank Ltd.[see end note 15] can still be validly applied in certain cases.
Undoubtedly, the new set of ICDS seeks to put an end to the protracted litigation and bring uniformity amidst the varied treatments prescribed in ICAI -AS and the MCA notified Ind-AS, yet to some extent it settles some unsettled disputes and unsettles some settled disputes.
[The author is a Senior Associate, Direct Tax Practice, Lakshmikumaran & Sridharan, Delhi]
- Vide Finance Act, 1995
- Income Tax Act, 1961 (hereinafter referred to as ‘Act’
- Notification No. SO 69(E) dated 25-1-1996
- Relating to ‘Disclosure of Accounting Policies’ and ‘Disclosure of Prior period and extraordinary items and changes in accounting policies’
- Institute of Chartered Accountants of India
- By Finance Act (No. 2) 2014
- Issued by Institute of Chartered Accountants of India
- ITA No. 6566/Mum/2002 & ITA No. 606/Mum/2003
-  312 ITR 254 (SC) (2 JB)
-  29 taxmann.com 129 (SC)
- 226 ITR 625 (SC)
- 82 ITR 570 (SC)
- 239 ITR 775 (SC)
- 2/2001 dated 9-2-2001
- ITA No. 6566/Mum/2002 & ITA No. 606/Mum/2003