Finance Lease Principal is Capital Recovery – Not Taxable Income: ITAT Mumbai

DCIT Vs Capsave Finance Pvt. Ltd. (ITAT Mumbai)

Depreciation Surrender & Principal Exclusion Intrinsically Linked- Only Interest Taxable in Finance Lease, Principal is Capital – Goetze case limits AO’s jurisdiction but not appellate powers

Capsave Finance Pvt Ltd, a NBFC engaged in leasing & asset financing, had filed return for AY 2018-19 offering entire finance lease rental income to tax & claiming depreciation on both operating & finance lease assets. During assessment, it revised computation, surrendering depreciation on finance lease assets (₹15.27 crore) & offering only interest component of finance lease rentals as taxable income, contending that principal recovery is capital in nature.

AO accepted surrender of depreciation but rejected exclusion of ₹6.81 crore representing principal recovery, holding it as a fresh claim not made in revised return u/s 139(5), relying on Goetze (India) Ltd (284 ITR 323 SC). Thus, AO added entire ₹15.27 crore depreciation back, without corresponding deduction of principal portion, leading to double taxation.

CIT(A) allowed partial relief. Relying on SC in Shriram Investments v. CIT (Civil Appeal No.6274/2013, dt 4.10.2024), it noted AO lacked power to entertain fresh claims, but held that Assessee’s revised computation was not a new claim but an intrinsic corollary of surrendering depreciation. To avoid taxing both depreciation disallowance & principal recovery, CIT(A) restricted addition to ₹8.45 crore (₹15.27 crore minus ₹6.81 crore).

On appeal, ITAT upheld CIT(A). It observed that a finance lease is substantively a financing arrangement where only interest is income, while principal recovery is mere capital recoupment. Once depreciation on leased assets is surrendered, taxing principal recovery as income would create an “incongruity” & violate the real income principle. The Tribunal clarified that Goetze (India) Ltd limits AO’s jurisdiction but not the appellate powers of CIT(A)/ITAT to compute correct income. It also noted that assessee had consistently followed the same method in earlier years, even foregoing larger losses, evidencing bona fides. Accordingly, ITAT dismissed Revenue’s appeal & confirmed CIT(A)’s restriction of addition to ₹8.45 crore.

FULL TEXT OF THE ORDER OF ITAT MUMBAI

This appeal has been preferred by the Revenue against the order dated 20.03.2025 passed by the learned Commissioner of Income Tax (Appeals)–52, Mumbai [“CIT(A)”], arising from the assessment framed under section 143(3) of the Income-tax Act, 1961 (“the Act”) for Assessment Year 2018–19.

2. The Revenue has raised the following grounds of appeal:

“1. On the facts and in the circumstances of the case, the learned CIT(A) erred in not appreciating the fact that a finance lease is a type of lease wherein the lessor transfers all the risks and rewards associated with the asset to the lessee before the lease agreement expires, and therefore the assessee is not entitled to claim depreciation on finance lease.

2. On the facts and in the circumstances of the case, the learned CIT(A) erred in restricting the addition to ₹8,45,72,646/– by ignoring the fact that the assessee had made a fresh claim during the course of assessment, which cannot be allowed in the absence of a valid return.

3. On the facts and in the circumstances of the case, the learned CIT(A) erred in not appreciating the ratio laid down by the Hon’ble Supreme Court in Goetze (India) Ltd. v. CIT (284 ITR 323), which establishes that the Assessing Officer has no power to entertain a claim of deduction otherwise than through a revised return.”

3. The brief factual background may be recounted. The assessee, a Non-Banking Financial Company engaged in the business of leasing and asset financing, filed its return of income for A.Y. 2018–19 on 25.09.2018 declaring nil income, followed by a revised return on 28.03.2019, again declaring nil income. In its books, the assessee has consistently followed generally accepted accounting principles and Accounting Standards, offering rental income and claiming depreciation on operating leases, but in the case of finance leases, recognising only the interest component as income. However, in its return of income, the assessee, deviating from such accounting treatment, offered the entire finance lease rental income to tax and claimed depreciation on all assets, whether under operating lease or finance lease. Subsequently, during the course of assessment proceedings, the assessee revised its computation, surrendering depreciation on finance lease assets and offering only the interest component of finance lease as taxable income, contending that the principal recovery does not constitute income.

A summary of the computation, as originally filed and as revised, is set out hereunder:

4. The Assessing Officer noted that the assessee had claimed withdrawal of finance lease rental receipts and corresponding depreciation through the revised computation. While the AO accepted the surrender of depreciation of ₹15,27,17,719/–, he did not allow the assessee’s claim for deduction of ₹6,81,45,073/– representing the principal recovery embedded in finance lease rentals, holding it to be a fresh claim not made in either the original return or the revised return filed under section 139(5). For this proposition, he invoked the dictum of the Hon’ble Supreme Court in Goetze (India) Ltd. (supra).

5. Before the learned CIT(A), the assessee argued that its revised computation was merely a rationalisation of treatment, aimed at avoiding double taxation. It was submitted that if depreciation on finance lease assets was surrendered, it would be wholly illogical to continue taxing the principal recovery portion of lease rentals, since in a finance lease, only the interest component represents income. The learned CIT(A), upon careful consideration, accepted this plea and held as under:

9. “Having considered the entire facts carefully, I am of the view that the consistent practice adopted by the appellant has to be accepted. The only issue here is whether the claim of ₹6,81,45,073/– is a fresh claim or not and whether it can be allowed in the absence of a valid return.

10. In the recent case of M/s. Shriram Investments v. CIT, Civil Appeal No. 6274 of 2013, judgment dated 04.10.2024, the Hon’ble Supreme Court has held:

“8. The assessing officer had no jurisdiction to consider theclaim made by the assessee in the revised return filed after the time prescribed by Section 139(5) for filing a revisedreturn had already expired.”

11. Thus, a view can be taken that the appellant is not entitled to the deduction of claim of Rs. 6,81,45,073/-, However, one needs to be conscious of the fact that this deduction cannot be viewed on a stand-alone basis. It has linkage with the reversal of depreciation of Rs. 15,27,17,719/-, for which addition has been made by the AO. In effect, what the appellant is requesting is that the addition made by the AO be confined to Rs. 8,45,72,646/- (15,27,17,719 less 6,81,45,073). I am of the view that the claim of the appellant is justified and reasonable. One has to treat the transaction as a whole and not in bits and pieces. When the appellant has changed the methodology for its claim (both for offering income and for claim of deduction of finance lease), the net effect has to be taken into account. In the instant case, it is evident that both offering of income and claiming of deduction are intrinsically linked to each other and cannot be seen in isolation. The reasonableness of the appellant’s claim can also be tested by the fact that it had foregone the higher brought forward losses of AY 2017-18 by following the same method, even though a revised return was not filed for such year.

12. In view of the above, I am of the view that as against addition of Rs. 15,27,17,719/- made by the AO, it is appropriate that such addition be restricted to Rs. 8,45,72,646/-, Accordingly, Ground No. 1 to 7 stand PARTLY ALLOWED.

11. Thus, a view can be taken that the appellant is not entitled to deduction of the claim of ₹6,81,45,073/–. However, one needs to be conscious of the fact that this deduction cannot be viewed on a stand-alone basis. It has linkage with the reversal of depreciation of ₹15,27,17,719/–, for which addition has been made by the AO. In effect, what the appellant is requesting is that the addition made by the AO be confined to ₹8,45,72,646/– (₹15,27,17,719 less ₹6,81,45,073). I am of the view that the claim of the appellant is justified and reasonable. One has to treat the transaction as a whole and not in bits and pieces. When the appellant has changed the methodology for its claim (both for offering income and for claiming deduction of finance lease), the net effect has to be taken into account. In the instant case, it is evident that both offering of income and claiming of deduction are intrinsically linked to each other and cannot be seen in isolation. The reasonableness of the appellant’s claim can also be tested by the fact that it had foregone the higher brought-forward losses of A.Y. 2017–18 by following the same method, even though a revised return was not filed for such year.

12. In view of the above, I am of the view that as against the addition of ₹15,27,17,719/– made by the AO, it is appropriate that such addition be restricted to ₹8,45,72,646/–. Accordingly, Grounds No. 1 to 7 stand partly allowed.”

6. We have given our thoughtful consideration to the rival submissions and the material on record. The controversy pivots on whether the assessee is entitled to deduction of ₹6,81,45,073/– being the principal recovery component in finance lease transactions. The essential character of a finance lease is well-settled: it is not a lease in substance, but a financing arrangement, in which the lessor recoups the capital cost through recovery of principal, and earns income only in the form of interest. This economic reality is also reflected in the accounting standards. If depreciation on finance lease assets has been surrendered, then it follows inexorably that the principal recovery is a mere return of capital and cannot be taxed as income. To hold otherwise would amount to simultaneously taxing the principal as income and disallowing depreciation, a manifest incongruity.

6.1. The Assessing Officer himself accepted the surrender of depreciation. Once that is accepted, logical consistency compels acceptance of the corresponding exclusion of principal recovery. To bifurcate the two and adopt a piecemeal approach would be antithetical to the principle of taxing real income. The Revenue’s reliance on Goetze (India) Ltd. is misplaced. That judgment merely limits the Assessing Officer’s jurisdiction to entertain new claims absent a revised return; it does not curtail the plenary appellate jurisdiction of the CIT(A) or this Tribunal to determine the correct taxable income on the basis of the record. More importantly, the present claim is not an independent or extraneous deduction, but an intrinsic corollary of the accepted treatment of finance leases.

7. We find ourselves in agreement with the observation of CIT(A) in para 11 as incorporated above and his approach.

The bona fides of the assessee are further evidenced by the fact that in earlier years it has consistently foregone set-off of higher losses to maintain this method, even without filing a revised return. This lends credence to its claim of consistency and fairness. In light of the foregoing, we hold that the deduction of ₹6,81,45,073/– cannot be disallowed as a prohibited fresh claim but must be allowed as a necessary corollary of the surrendered depreciation. Accordingly, the restriction of addition to ₹8,45,72,646/– by the learned CIT(A) is upheld.

8. In the result, the appeal of the Revenue is dismissed.

Order pronounced in the open court on 24^th September 2025.