Lease cannot be termed as sale if ownership rights not extinguished

The Delhi High Court in case of Teletube Electronics Ltd Vs CIT held that there has to be an extinguishment of ownership rights in order that a Lease transaction can be said to be a ‘sale’. The leasehold right is only for a period of ten years and at the end of that period the leased facilities revert to the owner. Consequently, the Court is unable to agree with the conclusion of the ITAT that in the present case there was a ‘sale” of leasehold rights by virtue of the lease agreement in question.

Facts of the case

• The Assessee had two divisions i.e. a picture tube and a glass bulb division for manufacturing glass shells/bulbs for domestic use. The said glass bulb division, which had three lines i.e. Line-I, Line-II and Line-III, became operational during the AY 1984-85. The land on which bulb division was situated was given on lease to the Assessee by the Rajasthan Industrial Development and Investment Corporation Limited (RIICO) under a lease deed.
• All three lines of the glass bulb division were leased by the Assessee to Samcor Glass Limited, Kota („SGL‟), a joint venture of Samtel India Limited („SIL‟) and Corning Inc. of USA („Corning‟). SGL was in the process of setting up manufacturing facilities for “glass panels, funnels and neck” which constitute the basic components for manufacture of black and white television picture tubes. A lease agreement was entered into between the Assessee and the SGL whereby the ”facilities” defined as the “plant and machinery and land and buildings” of the glass bulb division at Bhiwadi, Rajasthan was leased to SGL for a period of 10 years with effect from that date.
• The AO issued a show cause notice requiring the Assessee to explain why the lease agreement should not be treated as a transaction in the nature of sale of the movable/depreciable assets and capital gain not be charged under Section 45 read with Section 50. The Assessee replied on 25th March 1997 contending that the lease could not be treated as “transfer”. The AO rejected the plea of assesse and held the lease agreement was in effect a transfer within the meaning of Section 45 read with Section 2 (47).
• A survey carried out by the Income Tax Department (ITD) on 28th January 1997 showed that the Assessee had not parted with possession of either the land or the building and had only shifted the plant and machinery (barring a few items) to the plant of SGL at Kota. There was no evidence of any use of the land and building by the SGL. The use by it of the land and building in Bhiwadi on a few occasions was like the use by any other group company of SGL. This made it appear that the land and building was in fact not leased.

HELD by CIT(A)

The CIT (A) affirmed the factual findings of the AO and concluded that the fact of the use of the Bhiwadi premises by other parties; the shifting of Line-II before the date of the lease; the prohibition on the Appellant carrying on a competing business and other terms of the lease made the transaction of the lease a colourable device.

HELD by ITAT

• As far as the land and building was concerned, the ITAT observed that the contents of the lease deed clearly showed that there was a grant of lease of the land with building thereon as well as the plant and machinery against huge consideration. The finding of the AO that the Assessee was not dispossessed of the land and building “was based on suspicion and conjectures”. The AO had not given any concrete material to prove whether the lease was a sham transaction. Therefore, the conclusion reached by the ITAT was that there was a package deal for lease of the building and plant and machinery. It could not be held to be a colourable device as contended by the Revenue.
• The ITAT referred to the decisions of the Supreme and held that the transaction of lease would fall within the general meaning of transfer of a capital asset. Therefore, it would be futile to examine whether Section 269UA was applicable. The ITAT held that the Explanation to Section 2(47) could be invoked only where the transaction did not fall either in the general meaning of the word ‘transfer’ or within any of the sub-clauses in Section 2 (47) of the Act. The meaning of transfer in Section 269UA(f) has to be restricted for the purposes of Chapter XXC. The ITAT also held that merely because the payment of instalment was shown as lease rental, it could not be said that the instalments paid did not form part of the price. Once the price of the asset was fixed it was between the parties to decide about the terms of payments which unless prohibited in the statute cannot be gone behind.
• On an examination of the lease deed, the ITAT held that the leasehold rights in the business assets were sold for Rs.20.729 crore which was undoubtedly agreed to be paid in instalments with interest @ 14 per cent. Consequently, Section 45 was applicable. However, it was held that Section 50 is not applicable since the asset itself was not transferred.
• As regards the land and building, the ITAT held that their ownership continued to remain with the Assessee. The order of the CIT(A) was modified and the AO was directed to re-compute the capital gain in accordance with law. The AO was also directed to re-adjudicate the consequential issues like depreciation, investment allowance, terminal allowance, etc. in accordance with law.

 Contention of Revenue

• That the lease agreement was an exercise in tax -avoidance and, therefore, both the AO and the CIT(A) rightly held that the real transaction was one of sale of the assets constituting transfer and attracting capital gains under Section 45 read with Section 50 of the Act. He submitted that the ITAT ignored the facts revealed in the survey that was undertaken in the premises of the Assessee on 28th January 1997. The survey made it plain that only the possession of plant and machinery was given to SGL whereas the land and building were retained by the Assessee for the purposes of running a training centre. No goods belonging to the lessee SGL were found in the premises. Further it was revealed that the Line 2 of the plant and machinery at Bhiwadi had been shifted from April 1993 itself, i.e. prior to the date of the lease agreement.

 HELD by HIGH COURT

The Court discussed following points:

Was there a ‘sale’ of leasehold rights?

This brings to question whether a transaction pertaining to land and building or of plant and machinery could be treated as sale of either the leasehold rights in respect of the land or the sale of the plant and machinery itself?   There seems to be a contradiction in the order of the ITAT where in para 46 it states that in the present case the land is not a depreciable asset and that as far as the building and plant and machinery were concerned, the ownership thereof remained in the Assessee and, therefore, it could not be said that either the asset itself have been sold or the block of assets ceased to be in existence.” The ITAT appears to acknowledge that the ownership of the assets continued with the Assessee. However, the ITAT proceeded to hold that the “leasehold rights” and “not the asset itself” was sold. It is not understood how the ITAT has arrived at the concept of sale of leasehold rights because a sale connotes absolute transfer of rights with no reversion of any part thereof to the original owner. There has to be an extinguishment of ownership rights in order that a transaction can be said to be a ‘sale’. Here, as noted earlier, the lessee does not even have the right of sub-letting the facilities. The leasehold right is only for a period of ten years and at the end of that period the leased facilities revert to the owner. Consequently, the Court is unable to agree with the conclusion of the ITAT that in the present case there was a “sale” of leasehold rights by virtue of the lease agreement in question.

What appears to have weighed with the ITAT is the valuation of the business as a going concern and the said valuation forming the basis for determining the consideration for the grant of the lease and fixing of the yearly lease rentals. The explanation offered by the Assessee that the fact that it was not going to be in control of the assets or use them for its business, that there was going to be a loss of business opportunity which, therefore, had to be compensated and this weighed with the CAs in fixing the valuation appears to be a plausible one. While there is a non-compete in the agreement between the TEL and SGL, that by itself does not lead to the conclusion that the transaction of lease was in fact one of sale.

In any event this whole hypothesis stands disproved by the fact that on the expiry of the lease period, the land, building and plant and machinery reverted to the Assessee. The land and the building were sold by the Assessee to an unrelated third party. The said transactions formed the subject matter of the Assessment order for the AY 2006-07. The order of the CIT (A) dated 30th August 2011 has been perused by the Court. It holds that the sale of the land by the Assessee to an unrelated third party, M/s. Blossom Automotives, for a consideration of Rs. 4.01 crores took place on 8th September 2005 and after accepting the Assessee’s valuation of the said land the CIT (A) has directed that the Assessee be taxed on long term capital gains arising out of the said sale of the land. The said order also shows that for the building, which was also sold as part of the sale of land, the Assessee has continued to claim depreciation till the date of such sale. The fact that the Assessee continued to claim depreciation on the plant and machinery and building is another indication that the Assessee continued to assert ownership of the assets in question during the relevant AYs. The above order of the CIT (A) forms part of the records of the Department and has naturally not been disputed by it. Although this development could not have been anticipated at the time the AO or the CIT (A) decided the issue in the present case, it completely vindicates the Assessee’s stand in relation to the nature of the transaction forming the subject matter of the lease agreement.

Consequently, there are several factors in favour of the Assessee that persuade the Court to hold, with reference to question that the ITAT was not right in holding that the transaction of lease of the facilities was a sale of leasehold rights and that there was in any event a sale of the plant and machinery. The Court answers question in favour of the Assessee and against the Revenue.

Was there a capital gain under Section 45?

The last question that requires to be addressed whether there could be said to be any capital gains under Section 45 of the Act? In light of the above discussion, the question will have to be answered in favour of the Assessee and against the Revenue. The Court is of the view that the transaction in question was nothing more than a transaction of lease and has been acted upon by the parties as such. This was not a device adopted by the Assessee for tax avoidance.

. The question is accordingly answered in favour of the Assessee and against the Revenue. It is held that the ITAT erred in holding that the transaction in question was chargeable to capital gain under Section 45 . There was no occasion for the ITAT to remand the matter to the AO for re-computation of the capital gains.

The impugned order of the ITAT to the above extent is set aside and the appeal of the Assessee is allowed. The Revenue‟s appeal is dismissed