Mere transfer of unexpired contracts cannot be treated as Capital Expenditure

Brief Facts and Question of Law:

Brief Facts of the Assessee:

There are 2 matters involved in the appeal filed which are explained as below:

• 1^st Matter – The assessee company is operating as Non-Banking Financial Company (NBFC). Due to downturn in NBFC business during the year ended 30.06.1998 and the defaults faced by the company in leasing business, the assessee company decided to reduce its dependence on volatile sources of revenue and complement the existing revenue streams with greater proportion of revenues of a stable and annuity nature. The assessee company paid Rs. 85,00,000/- to Citi Corp Information Technology Industries Ltd (hereinafter called “CITIL”) for purchase of their processing division. This amount was amortized over the period of 25 months being balance unexpired period of contracts. The processing service division has entered into several contracts with its clients who require CITIL to provide services pertaining to cash management, custodial services and trade finance. The Assessing Officer (hereinafter called “AO”) treated the same 85 Lakhs to be in nature of capital expenditure which was further amended u/s 154 of the Act, whereby the disallowance was reduced to 23,80,000/- as out of the unexpired period of the contract of 25 months , only 7 months fell within the previous year 31st March 1999 i.e. assessment year under appeal.

• 2^nd Matter-The assessee company is also into the business of leasing of assets like cars and computers and lease rentals derived out of such assets were treated as income by the assessee also claimed depreciation on such assets. The assests were leased by the assessee to its associated concerns and were also used for own purpose. The AO held that the lease rental is nothing but principle component plus interest component which is spread over for particular months to recover the loan amount along with the interest. Hence depreciation on such leased assets was disallowed.

Held by CIT (A):

• 1^st Matter-The CIT(A) held that the assessee company has acquired the processing service division of CITIL and thus the expenditure was for the purpose of extension of business. The said expenditure is incurred for purchase of processing contract which is capital in nature being intangible asset to be classified as business or commercial rights and entitled to depreciation at the rate of 25%.
• 2^nd Matter-The CIT(A) held that the lessees have rented the cars and the assessee company has only provided funds. The lessee is using the assets for the entire economic life and all risks and rewards incidental to ownership has been transferred to the lessee. The lease is for a fixed period and non-cancellable and thereby he held that the lease is a financial lease and hence depreciation was rightly disallowed.
  

Question of Law:

• Whether payments made for purchase of unexpired processing contracts can be treated as capital in nature.
• Whether depreciation on lease of cars and computers can be disallowed treating the same as financial lease in nature. In the event of allowance of depreciation of cars, whether the rate of depreciation could be 40 % treating the same as “Commercial vehicles” even if used for own purpose.
  

Contention of the Revenue:

• 1^st Matter-The Revenue contented that Assessee Company has acquired the processing service division of CITIL and thus the expenditure was for the purpose of extension of business and hence income earning asset in the form of processing service division has been acquired by the assessee company. Also such activities require huge telecom and power infrastructure development which has also been mentioned in the Director’s Report of the assessee company for the year ended 30th June 1999. Hence such expenditure is correctly treated as Capital Expenditure.
• 2^nd Matter-The Revenue contented that the amount received is nothing but financial transaction for transfer of assets and only the name was given by the assessee as leasing transaction to get the benefit of depreciation and also get the benefit to its associated enterprises by way of lease rent paid and also claim depreciation on car leased. Also the Assessee is selling the cars at very nominal amount at Rs. 2000 to 3000.Hence, depreciation is rightly disallowed.
  

Contention of the Assessee:

• 1^st Matter-The Assessee contented that the processing service division has entered into several contracts with its clients who require CITIL to provide. The rights and obligations in these contracts were taken over by the assessee company for the acquisition of the unexpired contracts, which were unexpired for the period of 25 months and hence the cost was amortized over a period of 25 months being the balance of unexpired period of the contract Also there is no slump sale or acquisition of division. The unexpired contracts are purchased in the ordinary course of business.
• 2^nd Matter-The Assessee contented that it is carrying out leasing activity for several years and allowance of depreciation was never objected by Revenue. The Assessee Company is the owner of the assets which have been leased to its associate concerns as per lease agreements entered and risks and rewards incidental to ownership are with the assesse. Hence it is eligible to claim depreciation.
  

Held by the Income Tax Appellate Tribunal (“ITAT”):

• 1^st Matter-The ITAT observed that the assessee has acquired the service agreement whereby all the liabilities, rights and obligation and interest in the afore-stated agreement are acquired by the assessee. The payment of Rs. 85 lakhs is treated as deferred revenue expenditure in the Books of Accounts. It is merely assignment of agreements in favour of the assessee whereby the unexpired period revenue generated contracts are assigned in favour of the assessee. The entire consideration of Rs. 85 lac is paid to acquire the unexpired portion of the service agreements which will generate revenue for the assessee during the unexpired period of this service agreement. Keeping in view the principle of matching concepts of revenue,  ITAT held that the assessee has rightly charged as revenue expenses being Rs. 23,80,000/-.
• 2^nd Matter-The ITAT observed that to claim depreciation, the asset should be owned by the assessee and it should be used for the purpose of business of the assessee. Here, the assessee is owning the assets till the same are sold to the associated concern/employees. The assessee by giving these assets on lease is in fact using the same for its own business.

In case of cars, assessee has given such cars on lease and they are commercial vehicles entitled for depreciation @ 40% if purchased after 01.10.1998 but before 1^st April 1999 and are put to use before the 1st day of April 1999 in accordance with the entry III (2) (iia) of part A of Appendix I applicable to the assessment years 1998-99 to 2002-03 as per definition of the commercial vehicles which have been defined in Note No. 3A of the Appendix I to Rule 5 below the table of rates at which depreciation is admissible which includes ‘light motor vehicles’, for the purpose of business or profession as per amended provisions of Section 32 of the Act .