The Madras High Court has clarified that where the taxpayer, following the mercantile system, has credited full sale consideration and claimed estimated construction expenditure representing an accrued liability incidental to its business, such deduction is allowable in view of the principle recognised by the Supreme Court’s decision in Calcutta Company Limited vs. CIT [(1959)37 ITR 1(SC)].
The High Court has held that depreciation on cinematographic films acquired under a sale and leaseback transaction cannot be disallowed merely on suspicion or on the allegation of tax saving motive, where title has passed to the taxpayer, the transaction is supported by contractual documents, and the Revenue has no material to prove that the transaction is sham or illegal. Essentially, the Court ruled that sale and lease back, being a recognised business transaction, cannot be treated as a colourable device merely because it results in tax advantage.
The Division Bench comprising Dr. Justice G. Jayachandran and Justice Shamim Ahmed noted the Revenue’s contention that the respondent had shown a “rosy picture” in its profit and loss account while offering only a small taxable income and had improperly followed receipt basis for income and accrual basis for expenditure, and also that the sale and lease back transaction concerning cinematographic films was a sham because the lease allegedly preceded the purchase.
The Bench however, held that the question concerning deduction of estimated construction expenditure stood covered by the Supreme Court’s decision in Calcutta Company Limited vs. CIT [(1959)37 ITR 1(SC)], which recognised that an accrued liability to incur expenditure, under the mercantile system of accounting and in accordance with accepted commercial practice and trading principles, was an allowable deduction while computing business profits.
On the film transaction, the Bench observed that although the respondent had purchased the cinematograph film from M/s Sri Veeru Creations and immediately leased it back to the same party, the vendor as holder of the cinematograph right had become the lessee and title had been transferred in favour of the respondent; therefore, depreciation could not be disallowed merely on suspicion without supporting material.
The Bench further observed that the Assessing Officer had disallowed depreciation purely on surmises and conjectures, whereas sale and lease back is a recognised business transaction, and the records showed that the full sale consideration had been paid by cheque and encashed by the vendor; what was thereafter paid by the vendor to the respondent was lease amount and not return of sale consideration.
Briefly, for assessment year 1996-1997, the respondent filed its return disclosing income of Rs.61,070/-. The return was processed with an addition on account of excess depreciation, and thereafter the Assessing Officer held, inter alia, that the respondent had claimed land development expenses of Rs. 44.63 lakhs though such amount had not been debited to the profit and loss account but was reflected under current assets as “Property Development Project in Progress”, and also rejected depreciation claimed at 50% of invoice value on cinematograph films purchased from M/s Sri Varu Creations and immediately leased back to the same party as not being a genuine transaction.
For assessment year 1997-1998, when the respondent declared total income of Rs. 8.44 lakhs, the Assessing Officer disallowed depreciation of Rs. 91.23 lakhs and 100% depreciation on cinematographic films amounting to Rs. 53.93 lakhs, resulting in tax of Rs. 70.82 lakhs.
On the issue of construction expenses and the alleged hybrid system of accounting, the ITAT held that the respondent had credited the full sale consideration in the profit and loss account at the time of booking of flats though only a small advance had been received, and had also debited estimated construction expenditure; therefore, the ITAT found that the respondent was not adopting receipt basis for sales and accrual basis for expenditure in the manner alleged by the Assessing Officer, but was following the mercantile system read with the matching concept.
The ITAT further observed that the construction expenses had been booked in the profit and loss accounts for several years and this had been accepted by the Department in previous years, and that although the Assessing Officer rejected the estimates made by the respondent, no specific defect in the estimation was pointed out. On depreciation relating to cinematographic films, the ITAT noted that the Assessing Officer had disallowed the claim by questioning the genuineness of the sale and lease back transaction, but not on the footing that depreciation would otherwise be impermissible.
The ITAT found that the lease transaction had been entered into through a lease deed containing the terms and conditions of both the purchase and lease back arrangement, and that the subsequent issue of invoices by the vendor was in pursuance of that lease agreement and did not suffer from illegality. The ITAT also observed that even if a transaction is motivated by tax saving, it cannot be treated as a colourable device if it is otherwise permissible in law, and accordingly found no error in the order of the CIT(A) allowing the claim.
Appearances:
Advocate Dr. S. Sathiya Narayanan, for the Appellant/ Revenue
Advocates Vishnu Mohan and R. Parthasarathy, for the Respondent
