Vildirect: IncomeTax-caselaws-2003-VIL-200-ITAT-MUM

2003-VIL-200-ITAT-MUM

Equivalent Citation: [2004] 271 ITR (A. T.) 87

Income Tax Appellate Tribunal MUMBAI

I. T. A. Nos. 5616/Mum/1999, 3300/Mum/1997 and 5403/Mum of 1999

Date: 14.08.2003

MID EAST PORTFOLIO MANAGEMENT LTD., ICICI LIMITED

DEPUTY COMMISSIONER OF INCOME-TAX

BENCH

Order

JUDGMENT

R. V. Easwar (Judicial Member).—These two appeals were heard by the Special Bench as directed by the hon’ble President, Income-tax Appellate Tribunal. The events leading up to the reference may be briefly noticed.

The appeal of the assessee M/s. Mid East Portfolio Management Ltd. before the Tribunal involved several issues, one of which was whether the assessee was entitled to the depreciation amounting to Rs. 97.50 lakhs on the air-pollution equipments purchased from the Rajasthan State Electricity Board (hereinafter referred to as "RSEB") and leased back to it. In the course of the hearing of the appeal, the Bench felt that in view of the complexity of the issue and its general importance the question should be considered and decided by a larger Bench. In the course of the arguments, several orders of various Benches of the Tribunal were cited on behalf of the assessee where the view had been taken that depreciation was allowable. On behalf of the Department, the main contention was that the documentation had been so created as to give the transaction a touch of a genuine sale and lease-back arrangement and therefore, on the basis of the rule laid down by the Supreme Court in McDowell and Co. Ltd. v. CTO [1985] 154 ITR 148, the assessee should not be allowed depreciation. It was contended that the transaction in truth was borrowing of monies by the RSEB on the security of the assets, but the documentation had been so prepared as if it was a sale and lease-back arrangement. If it is a simple borrowing on the security of the assets, the assessee would not be entitled to depreciation. The Division Bench, for reasons recorded in the referral order, took the view that the matter may require “deeper consideration not only because it affects many assessees who have adopted such sale and leaseback transactions, but also because of the complexity of the issue”. It observed that “the true effect of the documentation may need to be considered in deeper perspective because the Department is questioning the very stand of the assessee that the true effect of the documentation is that of a lease. In the opinion of the Department, the documentation does not add anything to what the transaction really is—that it is nothing more than a mere finance transaction—and that the entire documentation is a smoke screen to create an illusion as if it is a lease”. According to the Bench, “one very important aspect to be kept in view, which was not shown to have been considered in the other orders of the Tribunal where the electricity boards of some of the States were involved, is that whether it can be postulated that the electricity boards could sell their assets”. The Bench opined that “the real question would be whether the consideration moving from RSEB to the assessee represents compensation for the use of the monies (as in a finance lease) or represents compensation for the use of the assets (as in an operational lease) ………. The terms of the lease agreement will have to be considered in depth to find out the substance of the transactions. The real nature and effect of the transactions will have to be considered and a decision rendered, even if they are not sham”. Accordingly, the following question was proposed by the Bench for the consideration of the hon’ble President for being referred to a larger Bench :

“On the facts and in the circumstances of the case, was the transaction entered into between the assessee and RSEB rightly treated by the departmental authorities as one attracting the rule laid down by the Supreme Court in McDowell’s case [1985] 154 ITR 148 and consequently, were they right in disallowing the assessee’s claim for depreciation ?”

The hon’ble President was pleased to constitute a Special Bench consisting of three Members to decide the appeal of Mid East Portfolio Management Ltd.

In the meantime, ICICI Ltd., which was the appellant in ITA No. 3300/Mum of 1999 sought to intervene in the matter since the identical issue had also arisen in its appeal in respect of the assets purchased from and leased back to the Gujarat State Electricity Board. Initially, permission was granted to it to intervene and subsequently, on its further application, the hon’ble President was pleased to place the appeal of ICICI also before the Special Bench, acceding to its request that its status be converted from an intervener to an appellant before the Special Bench. Accordingly both Mid East Portfolio Management Ltd. and ICICI Ltd. were heard as appellants, through senior counsel Mr. V. H. Patil and Mr. S. E. Dastur, respectively. West Coast Paper Mills Ltd., the intervener, was heard through Mr. Dastur. The Income-tax Department was heard through Mr. Sahai, Commissioner of Income-tax (DR) and Mr. Girish Dave, Commissioner of Income-tax (DR), respectively. Since the matter is one of general importance for the taxpayers as well as the Income-tax Department and also because of its complexity, we have bestowed upon it our careful and deep consideration to the best of our ability and grasp and by holding several rounds of discussions amongst us. We are indebted to learned counsel who appeared for both the appellants and the learned Commissioner of Income-tax (DRs) who appeared for the Income-tax Department. Their incisive and intellectual analysis of the issue and assiduous and able presentation with the supporting documentation, laced with case law, have been of enormous assistance to us in coming to a decision.

Facts of Mid East Portfolio Management

The facts in Mid East Portfolio Management Ltd. are these. In the return, the assessee claimed depreciation of Rs. 97.50 lakhs in respect of purchase of air pollution equipment, being Electrostatic Precipitation System, the cost of which was Rs. 1.95 crores. The depreciation was claimed at 50 per cent. because the asset concerned was used, according to the assessee in the leasing business for less than 180 days during the relevant accounting year. The equipment was purchased from RSEB on March 27, 1995, just four days before the close of the accounting year. This was embodied in the form of a sale deed. The equipment was leased back to RSEB on the very same day for a period of ten years. The equipment was lying at Kota in Rajasthan and before its purchase by the assessee was being used by RSEB for its purposes, viz., the generation and distribution of electricity. The assessee also clarified in the course of the assessment proceedings that it did not take out any insurance policy in respect of the assets leased to RSEB. The Assessing Officer was of the prima facie view that the transaction was a colourable device to claim depreciation and in actuality it was a mere lending of monies by the assessee on the security of the assets belonging to RSEB. He, therefore, called upon RSEB to furnish the relevant details of the sale and lease back arrangement. After a few reminders, RSEB filed a letter dated February 17, 1998, clarifying the following :

1. The booking of the capitalised cost of plant, machinery and equipment is in block and, therefore, it is difficult to ascertain the written down value of the particular equipment sold to the assessee.

2. That the valuation of the assets was got done from a registered valuer by name M. Choudhary and Associates, New Delhi.

3. That the statement showing the details of the lease rentals were enclosed.

4. That the capital gain has been worked out on sale of block of assets and has been shown in the books of account.

Not satisfied with the aforesaid clarification, the Assessing Officer called upon the assessee by letter dated February 23, 1998, to discharge the burden to show that the transaction entered into with RSEB was bona fide and genuine. Various other details were also called for in this connection such as the date of purchase of the equipment by RSEB along with the purchase invoice, purchase price, etc., written down value of the equipment at the time of sale and lease back in the books of RSEB, exact location and identification of the equipment, details of any inspection of the asset carried out by the assessee and details of expenditure incurred in connection therewith, evidence as to how the assessee was satisfied that the price it paid to RSEB was in conformity with the market value of the equipment at the time of purchase, explanation as to how the assessee has the right of ownership without the right of removal, shifting, sale, etc., of the equipment as per the agreement and so on. The Assessing Officer also informed the assessee that as a result of independent enquiries conducted with RSEB, it transpired that the genuineness of the lease transaction has not been proved and it appears to be a mere finance transaction. He enclosed the copies of the replies submitted by RSEB with the letter. Accordingly, the assessee was required “to prove genuineness of lease transaction with irrefutable evidence”.

In reply, the assessee furnished a detailed explanation in its letters dated March 10, 1998, and March 18, 1998. It was admitted that no physical inspection of its own was undertaken before purchasing the equipment from RSEB but the assessee relied on the valuation done by Choudhary and Associates. This was in the letter dated March 18, 1998. However, in the first letter dated March 10, 1998, it had been stated by the assessee that inspection of assets was done by one Sanjay Nagar, an employee and the travelling expenses on this score was Rs. 8,004. Reliance was placed generally on the various clauses of the lease agreement and it was strongly contended that there was a genuine sale and lease-back transaction and accordingly the assessee was entitled to the depreciation under section 32.

The Assessing Officer was not convinced by the assessee’s explanation. He gave detailed reasons in paragraphs 6.4 to 6.8 of the assessment order. Briefly, the following were his objections to accepting the assessee’s contention :

(a) The whole arrangement was put through with the motive of infusing funds into RSEB which was financially very weak. There was no intention to purchase the assets and lease them back. The sole intention was to finance RSEB on the security of the equipment.

(b) There was no delivery of the assets alleged to be sold by RSEB.

(d) As per enquiries conducted by the Director of Income-tax (Inv.), Jaipur, RSEB has not filed any information about the written down value of the assets before the sale to the assessee.

(e) The assets are lying at Kota, Rajasthan, even according to the assessee and therefore the visit of the assessee’s employee to Jaipur does not serve any purpose. Certainly it was not for inspection of the assets. Further, the assessee was quite casual in verifying even the existence of the assets. This shows that the assessee never intended to purchase the assets.

(f) The assessee never became the real owner of the equipment since it had no rights of ownership as per the sale deed. The assessee did not even have the right to sell the asset, which showed that the assessee had never purchased the assets.

(g) RSEB cannot afford to remove the asset which will affect and disrupt the working of its entire plan.

For the above reasons, the Assessing Officer came to the conclusion that the transaction entered into by the assessee was nothing but a paper transaction.

Thereafter, the Assessing Officer made certain general observations in paragraph 6.7 of the assessment order. He referred to the fact that in the past few years, various State Electricity Boards were running into huge losses and were facing real financial difficulties, forcing them to approach companies to provide funds to them under the nomenclature of sale and lease-back arrangement. This suited both the parties. The Electricity Boards got the funds they needed and the financiers got the benefit of depreciation. RSEB itself, as per its own information, sold and took back on lease various assets worth Rs. 175 crores from companies at Delhi, Mumbai and Madras as on March 31, 1995.

After making the above general observations, the Assessing Officer proceeded to invoke the doctrine of McDowell [1985] 154 ITR 148 (SC). He observed that if the form of purchase and lease back given by the assessee to the transaction is to be disregarded and if the reality of the situation is to be viewed, it will be apparent that what the assessee has done is merely to advance monies to RSEB for fixed returns, which is nothing but a loan transaction. Therefore, the assessee’s claim for depreciation has to be disallowed. Accordingly, the depreciation claim of Rs. 97.50 lakhs was disallowed. The lease rent received by the assessee was treated as income received pursuant to the financing transaction.

The assessee appealed to the Commissioner of Income-tax (Appeals) and raised several contentions which are summed up in paragraph 27 of the order of the Commissioner of Income-tax (Appeals). Briefly speaking, it was contended that the transaction was between unrelated parties, it was in the course of the regular leasing business and put through with total transparency, that even Explanation 4A to section 43(1) has recognised sale and lease-back transactions, the vendor has credited the sale price to the block of assets and claimed lesser depreciation, that there is no loss to the Revenue by accepting the transaction, that the depreciation has been disallowed in the hands of RSEB, that physical possession of the assets is not necessary in a lease transaction and it does not affect the ownership rights and that Explanation 4A to section 43(1) is effective only from October 1, 1996, and hence not applicable for the assessment year under consideration. Some decisions of the Tribunal and High Courts were also relied upon.

The Commissioner of Income-tax (Appeals) examined the matter elaborately in paragraphs 28 to 35 of his order. He also examined the sale deed and the lease deed. He recorded the following findings :

(a) Since there is no physical transfer of the assets, the transaction stands wrapped up in suspicion. There has been no acquisition of assets physically. Therefore, the inference is that it is a paper transaction entered into with the sole aim of claiming depreciation at 100 per cent.

(b) It was only a finance transaction. The Reserve Bank of India in a circular dated February 14, 1994, has stipulated that leasing activity is to be treated on par with loans and advances.

(c) The fact that it is only a finance transaction is strengthened by various clauses in the lease agreement such as clauses (5), (6), (8), (9), (10), 13(c), etc. These clauses show that the assessee did not undertake any risk incidental to ownership of the assets which is contrary to section 26 of the Sale of Goods Act. No warranty for fitness, suitability or usability of the asset has been given in favour of RSEB which is normally given. RSEB has been made liable to the assessee for any loss or damage occurring during transportation, delivery, etc., which is contrary to the legal position that a lessee would be liable for the loss only while the asset is in his possession. Since the RSEB is liable to bear the entire loss, it is almost clear that the assessee is not the owner of the assets. In other words, the Commissioner of Income-tax (Appeals) held that since the assessee was not the owner, he did not undertake to bear any loss.

(d) The intention of the assessee gathered from the surrounding circumstances is not to enter into a genuine lease transaction, but to enter into only a finance transaction. He placed strong reliance on the decision of the Supreme Court in the case of Sundaram Finance Ltd. v. State of Kerala, AIR 1966 SC 1178 ; [1966] 17 STC 489, where it was held that the true effect of a transaction may be determined from the terms of the agreement considered in the light of the surrounding circumstances. Several other decisions were also referred to by him. He also referred to the CBDT Circular No. 760 dated January 13, 1998 (see [1998] 229 ITR (St.) 42), where it was observed that in ascertaining whether a transaction is a hire purchase or a loan, regard must be had to the substance thereof by looking into the terms of the agreement, its nature, etc., so as to determine the real intention of the parties.

(e) The intention of the assessee was only to reduce its taxable income by entering into the so-called lease transaction which enabled it to claim 100 per cent. depreciation. The assessee never became the owner of the assets. It never undertook any risk incidental to ownership. RSEB is the real owner because it has undertaken all the risks attached to ownership. Reference was made to the decision of the Supreme Court in CIT v. Podar Cement Pvt. Ltd. [1997] 226 ITR 625 where the full rights of an owner recognised by law were held to be (a) power of enjoyment, (b) possession, which includes the right to exclude others, (c) power to alienate inter vivos or to charge security, and (d) power to leave the asset by will. None of these rights were available to the assessee. Therefore, it is only a finance transaction with no lease actually taking place.

(f) The judgment of the Supreme Court in CIT v. Shaan Finance (P.) Ltd. [1998] 231 ITR 308 relied on by the assessee is not applicable to the facts of the present case since that decision related to the claim of investment allowance and the business of the assessee was that of leasing only. The other decisions, particularly orders of the Tribunal relied on by the assessee were not applicable to the present case.

On the basis of the above findings, the Commissioner of Income-tax (Appeals) confirmed the disallowance of the depreciation.

The assessee is in further appeal before the Tribunal. Ground No. IV relates to the claim of depreciation. The other grounds are not before us.

Before proceeding to advert to the arguments of Mr. Patil, learned counsel for Mid East Portfolio Management Ltd., it would be convenient to advert to the facts in the case of ICICI Ltd. which is the other appellant. In that case also, the issue of depreciation on leased assets arises. We may refer to the facts of ICICI Ltd. and thereafter conveniently take up the rival contentions for discussion.

Facts of ICICI :

ICICI Ltd. is now a public limited company. It is in existence from 1955 and in the past several years was active in engaging itself in leasing transactions. Page 152B of the paperbook shows the volume of leasing transactions. Up to March 31, 1993, the assessee entered into 617 lease agreements. Of these, sale and lease-back transactions were 64. During the year, sale and lease-back transactions (hereinafter referred to as SLB) were 45, the lease rentals received being Rs. 2,23,21,546. Out of these, only one transaction is in dispute, viz., the lease of boiler package and auxiliaries acquired from the Gujarat Electricity Board (hereinafter referred to as “GEB”) on March 12, 1993, and leased to them on the same day. The amount received from GEB as lease rental during the year was Rs. 1,18,25,000. These details are available in the form of a chart at page 145 of the paperbook. In the assessment proceedings, the Assessing Officer appears to have raised queries with regard to the SLB transactions entered into between Wipro Infotech and GEB, but finally seems to have accepted the transaction with the former. In respect of the SLB transaction with GEB, the facts are these. GEB acquired two boilers, one in the year 1990 and the other in the year 1991 at the cost of Rs. 65.54 crores. In the year 1993, the assessee acquired these boilers from GEB for Rs. 50 crores. The amount was paid in five installments between February 2, 1993, and February 22, 1993. The equipment was leased to GEB for a period of five years under a lease agreement dated January 29, 1993. In the return of income, the assessee bifurcated the assets into “own assets” and “leased assets” for purposes of claiming depreciation. The depreciation on leased assets was Rs. 57,60,68,000 and on its own assets Rs. 3,42,96,000. Out of the depreciation claimed in respect of leased assets, the depreciation on the boiler package and auxiliaries leased to GEB amounted to Rs. 25 crores representing half of the rate of depreciation which is 100 per cent., since the assets were put to use for a period of less than 180 days in the leasing business. The assessee supported the claim of depreciation with reference to certain documentation which is referred to at pages 9 and 10 of the assessment order. The Assessing Officer took the view that the “transactions resorted to by the assessee relating to leasehold rights are sham with a view to claim of depreciation on the assets which was available at 100 per cent. and thereby to reduce its income without proper formalities and procedures having been complied with, in this connection”. According to the Assessing Officer, the assessee was not the owner of the assets purchased from GEB and the lease-back of the assets “is a story which has been concocted with the sole purpose of claiming depreciation by means of collusive transaction between the two concerns. . .”. He found certain defects in the invoices for the purchase of the equipment. GEB had certified that the asset registers in respect of the Kutch Lignite Power Station (KLTPS) where the boiler package and auxiliaries for Units I and II were said to be located have not been maintained and therefore the written down value and the correct details of depreciation claimed in respect of those assets could not be verified. The Assessing Officer therefore required GEB to give the basis of valuation of the boiler. A copy of the notice issued to GEB is said to have been sent to the assessee also, but this did not evoke any response from the assessee or GEB. The Assessing Officer noted further that the sale proceeds of Rs. 50 crores has not been reduced by GEB from its block of assets for the assessment year 1993-94 and that if the sale proceeds had exceeded the written down value of the assets it was duty bound to declare capital gains under section 50. Since both these had not been done by GEB, the Assessing Officer took the view that there was no sale of the boiler by GEB to the assessee in the first place. The Assessing Officer further noted that GEB has provided depreciation on the assets for the purpose of company law as per the rates provided by the Electricity (Supply) Act, 1948, because these assets form part of the block of assets and from this it was clear that the “agreement of lease and papers relating to sale are sham transactions and are totally unreliable”. According to the Assessing Officer, the non-furnishing of the details such as the proper cost of the assets, the profit which GEB earned on the sale, etc., was deliberate and leads to an inference that the SLB transaction was a sham. The assessee also did not enjoy the rights of ownership such as right of removal, shifting, sale, demolition, etc. The assessee was not able to exercise these rights since the boiler was being used by the power station of GEB and it cannot be conceived that such rights which are incidental to ownership could be exercised by the assessee. In the annual accounts for the year ended March 31, 1993, in paragraph 22, the board of directors of the GEB have stated that GEB has availed finance under lease finance arrangements from various institutions and under the said arrangements, “the leased assets will get transferred to the board on expiry of the lease period on payment of terminal value ranging from 1 to 2 per cent. of the original cost of the relevant assets”. Accordingly the board’s financial obligations under the lease arrangements have been provided as liability in the books of account and correspondingly the leased assets were taken under the block of fixed assets. Depreciation was also provided for on the leased assets for the use of these assets. From this note appended to the annual accounts of GEB the Assessing Officer inferred that the assessee had no rights of ownership in the boiler and auxiliaries, but was only providing finance to GEB on the security of the assets.

The Assessing Officer also took the view that the assessee was only a fractional owner of the assets and was therefore not entitled to depreciation. This line of approach however has not been adopted by the department before us.

The Assessing Officer further proceeded to question the validity of the lease agreement for various reasons which are not reproduced here for the sake of brevity. He took the view that the agreement did not embody a lease but it was only the giving of a simple loan by the assessee to GEB on the security of the assets. In fact, the Assessing Officer went to the extent of saying that the transaction is not even a finance lease, but it was only a simple financing because in the case of finance lease, the lessor becomes the legal owner of the asset, which is not the case here, while in the case of a normal finance, the person giving the finance is not the owner of the asset charged as security. The present case, according to the Assessing Officer, falls to be considered as only a normal financing transaction. In support of this conclusion, the Assessing Officer referred to the accounting policies adopted by GEB in its accounts. He noticed that in the accounts for the year ended March 31, 1993, GEB had not distinguished the leased assets from its own assets. The entire assets have been shown as if they are owned by GEB. GEB had also provided depreciation on the leased assets at the rate prescribed by the Electricity (Supply) Act, 1948. In Schedule 19 to the accounts (the schedule of fixed assets), the depreciation so provided on the leased assets has been quantified during the year at Rs. 5.6 crores. Paragraph 22 at page 63 of the annual accounts of GEB contained a note to the effect that the lease rentals payable by GEB in installments to the leasing company (i.e., ICICI) have been provided towards charges for interest and balance towards the liability for the assets on lease. GEB had also shown in its accounts the sale proceeds or lease liabilities as loans in Schedule 32 at page 53 of the annual accounts. From these facts, the Assessing Officer concluded that without any doubt this was only a loan finance and not a lease finance. Accordingly, he rejected the assessee’s claim for depreciation on the boiler and auxiliaries which are the leased assets.

On appeal, the Commissioner of Income-tax (Appeals) considered the matter in paragraphs 16 to 23 of his order. His conclusions are contained in paragraphs 24 and 25. He found that the equipment was ordered by GEB from BHEL and the latter had received payment directly from GEB. Therefore, when the lease agreement was entered into, the equipment had already been installed and commissioned and the payments were already made. The amount paid by the assessee was admittedly not utilized by GEB for the acquisition of the equipment, but was utilized for meeting its commitments for new schemes. He therefore concluded that the transaction was only a loan and not a lease finance. The Commissioner of Income-tax (Appeals) further held that a situation was created on paper in order to give an impression of sale/purchase of boiler package and to vest artificial ownership on the assessee so as to give the transaction a colour of lease finance in order to claim lease rentals and depreciation. Accordingly, he agreed with the Assessing Officer and upheld the disallowance of depreciation.

Before we proceed to deal with the rival contentions advanced before us, it is necessary to deal with certain preliminary points debated before us. It is also considered necessary to deal with some points which are general in nature and touch upon the basic issues before applying our decision in respect of them to the facts of the two cases before us.

Frame of the question and the relevance of McDowell [1985] 154 ITR 148 (SC) :

Some arguments were advanced on behalf of the assessee regarding the language in which the question referred to the Special Bench is couched. It was argued that the rule laid down in McDowell [1985] 154 ITR 148 (SC) would apply only if the transaction is genuine or valid and since the question posed is whether the said rule would apply, it must be assumed that the transaction is genuine. It was therefore submitted that the validity and genuineness of the transaction are not really in question. Another facet of the argument was that the ratio of the judgment in McDowell [1985] 154 ITR 148 (SC) is simply that excise duty collected by a dealer on behalf of the manufacturer would form part of the turnover of the manufacturer and nothing more and that the observations therein regarding tax avoidance or evasion are not the ratio of the judgment but only obiter. Since these contentions deserve serious consideration, we proceed to give our views on them.

We must first look at McDowell [1985] 154 ITR 148 (SC) itself to find out what has been said there. In that case, the assessee which was manufacturing liquor was assessed to sales tax. The assessee was also liable to pay excise duty on the manufacture of liquor. The buyers of the liquor from the company’s distillery obtained distillery passes for release of liquor after making payment of excise duty and present the same at the distillery whereupon the bill of sale or invoice is prepared by the company’s distillery showing the price of the liquor, but excluding the excise duty. The assessee’s accounts did not contain any reference to the excise duty paid by the purchaser. For the purposes of sales tax, the assessee had to declare its turnover which under the relevant sales tax law included excise duty. However, the company declared the turnover excluding the excise duty paid by the purchaser. The Sales Tax Officer took the view that the excise duty paid by the purchasers should be included in the turnover. The assessee contested this and the matter reached the Supreme Court. The Supreme Court held that the excise duty paid by the purchasers did not go into the common bill of the company and, therefore, the sales tax authorities were not competent to include the same in the turnover. After the judgment of the Supreme Court, the relevant Distillery Rules were amended to provide that the excise duty paid by the purchaser of the liquor is includible in the turnover. Consequent to the amendment, notices were issued by the Sales Tax Officer to the company proposing to include such excise duty in the turnover. The matter again reached the Supreme Court at the instance of the assessee. The Supreme Court held that its earlier judgment that the intending purchasers of the liquor were also legally responsible for payment of the excise duty was too broadly stated, that the duty was primarily a burden which the manufacturer of the liquor had to bear, that even if the purchasers paid the same as per the Distillery Rules, those Rules were merely enabling and did not give rise to any legal responsibility or obligation for meeting the burden. The Supreme Court held that the amendment to the Distillery Rules had affirmed this position. According to the court, the Distillery Rules do not detract from the position that payment of excise duty is the primary and exclusive obligation of the manufacturer and if the payment is made under a contract or arrangement by any other person, it would amount to meeting of the obligation of the manufacturer and nothing more. It was held that by a prior arrangement or agreement, the manufacturer cannot shift or avoid his liability to pay the excise duty and even if it is done, the payment of the excise duty is to be considered only as a satisfaction of the liability of the manufacturer and hence includible in the turnover for purposes of sales tax.

Before the Supreme Court in McDowell [1985] 154 ITR 148 (SC) an argument was advanced by counsel on behalf of the company (page 170) “as his last submission that it is open to everyone to so arrange his affairs as to reduce the brunt of taxation to the minimum and such a process does not constitute tax evasion ; nor does it carry any ignominy”. Several authorities were cited in support of this submission and after considering all of them, His Lordship Justice Ranganath Misra held as under : (page 171 of the report) :

“Tax planning may be legitimate provided it is within the framework of law. Colourable devices cannot be part of tax planning and it is wrong to encourage or entertain the belief that it is honourable to avoid the payment of tax by resorting to dubious methods. It is the obligation of every citizen to pay the taxes honestly without resorting to subterfuges.

On this aspect, one of us, Chinnappa Reddy, J. has proposed a separate and detailed opinion with which we agree.”

His Lordship Justice Chinnappa Reddy, while dealing with the last submission of counsel for the company, observed as under (pp. 160-161 of the report) :

“We think that the time has come for us to depart from the Westminster principle as emphatically as the British Courts have done and to dissociate ourselves from the observations of Shah, J. and similar observations made elsewhere. The evil consequences of tax avoidance are manifold. First, there is substantial loss of much needed public revenue, particularly in a welfare state like ours. Next, there is the serious disturbance caused to the economy of the country by the piling up of mountains of blackmoney, directly causing inflation. Then there is ‘the large hidden loss’ to the community (as pointed out by Master Wheatcroft in 18 Modern Law Review 209) by some of the best brains in the country being involved in the perpetual war waged between the taxavoider and his expert team of advisers, lawyers and accountants on the one side and the tax-gatherers and his perhaps not so skilful advisers on the other side. Then again there is the ‘sense of injustice and inequality which tax avoidance arouses in the breasts of those who are unwilling or unable to profit by it’. Last, but not the least is the ethics (to be precise, the lack of it) of transferring the burden of tax liability to the shoulders of the guideless, good citizens from those of the ‘artful dodgers’. It may, indeed, be difficult for lesser mortals to attain the state of mind of Mr. Justice Holmes, who said, ‘Taxes are what we pay for a civilized society. I like to pay taxes. With them I buy civilization’. But, surely, it is high time for the judiciary in India too to part its ways from the principle of Westminster and the alluring logic of tax avoidance. We now live in a welfare state whose financial needs, if backed by the law, have to be respected and met. We must recognise that there is behind taxation laws as much moral sanction as behind any other welfare legislation and it is a pretence to say that avoidance of taxation is not unethical and that it stands on no less a moral plane than honest payment of taxation. In our view, the proper way to construe a taxing statute, while considering a device to avoid tax, is not to ask whether the provisions should be con strued literally or liberally, nor whether the transaction is not unreal and not prohibited by the statute, but whether the transaction is a device to avoid tax, and whether the transaction is such that the judicial process may accord its approval to it. A hint of this approach is to be found in the judgment of Desai J. in Wood Polymer Ltd. In re and Bengal Hotels Limited, In re [1977] 109 ITR 177 (Guj) ; [1977] 47 Comp Cas 597 (Guj), where the learned judge refused to accord sanction to the amalgamation of companies as it would lead to avoidance of tax.

It is neither fair nor desirable to expect the Legislature to intervene and take care of every device and scheme to avoid taxation. It is up to the court to take stock to determine the nature of the new and sophisticated legal devices to avoid tax and consider whether the situation created by the devices could be related to the existing legislation with the aid of ‘emerging’ techniques of interpretation as was done in Ramsay, Burma Oil and Dawson, to expose the devices for what they really are and to refuse to give judicial benediction.”

The contention advanced on behalf of the appellants before us was that the above observations of their Lordships were not necessary for the disposal of the case before them, which stood effectively dismissed when their Lordships held, as a matter of law, that the excise duty paid by the purchasers of liquor from the company directly to the excise authorities under an arrangement made with the company would amount to payment on behalf of the company and hence includible in the company’s turnover for purposes of sales tax and that this was always the correct legal position, recognised by the amendment made to the Distillery Rules. It was contended that this is the ratio of the judgment which is binding on all the lower courts and the observations regarding tax evasion or avoidance are not binding. It was said that the observations were not necessary for the disposal of the case before the court. We were referred by Mr. Dastur to Additional District Magistrate v. Shivakant Shukla [1976] AIR 1976 SC 1207, and portions of the judgment were read out where guidelines were laid down as to how a judgment of a court should be read and understood. It was contended on the basis of this judgment that no judgment can be read as if it is a statute, that the general expressions found in a judgment are not intended to be expositions of the whole law, but are governed and qualified by the particular facts of the case, that the essence of a decision is its ratio and not every observation found therein, that an obiter cannot take the place of the ratio, that obiter does not have any binding effect nor are they conclusive and that when the observations of the Supreme Court are being considered, the greatest possible care must be taken to relate them to the precise issues before the court and to confine the observations, though expressed in broad terms, to the general compass of the question before the court unless the court makes it clear that the remarks are intended to have a wider ambit. It was submitted that the observations of His Lordship Justice Chinnappa Reddy in McDowell [1985] 154 ITR 148 (SC) relating to tax evasion have to be read in the context and we should not lose sight of the fact that the other hon’ble judges who decided the case have agreed with the observations of His Lordship Justice Chinnappa Reddy only subject to what they have expressed about tax evasion and it is significant to observe that they have coined three expressions—”colourable devices, dubious methods and subterfuges”.

The legal position under article 141 of the Constitution of India may be that it is the ratio laid down by the Supreme Court that is binding on all the courts below and not the obiter or casual observations, but that does not mean that those observations need not be kept in view or can be ignored by the lower courts. As counsel themselves submitted, McDowell [1985] 154 ITR 148 (SC) is more of an approach to the facts of a particular case and the observations of His Lordship Justice Chinnappa Reddy are guidelines to be followed in a case where tax evasion is alleged. The observations regarding tax evasion or avoidance are weighty observations coming as they do from the highest court of the country and even assuming for the sake of argument that the observations do not constitute the ratio of the decision, they are indicative of the approach to be adopted by the lower courts, which includes the Income-tax Appellate Tribunal (which deals exclusively with tax matters), to the question of tax avoidance. Therefore, without seriously entering into the complex question as to whether the observations amount to obiter, as opposed to the ratio, of the Supreme Court and if so, whether they are binding on the other courts, we hold that the observations relating to the question of tax evasion or avoidance made in McDowell [1985] 154 ITR 148 (SC) have to be followed as guiding principles while deciding whether there was tax evasion or not on the facts and circumstances of a given case. In the absence of any such guidelines, the approach to the question of tax avoidance is likely to be arbitrary or whimsical or uncertain or even perverse, a situation which certainly does not augur well for the tax administration.

As a matter of fact in the course of his arguments, Mr. Dastur, the learned counsel for ICICI did submit on the strength of the House of Lords decision in Macniven (H. M. Inspector of Taxes) v. Westmoreland Investments Ltd. [2002] 255 ITR 612 that McDowell [1985] 154 ITR 148 (SC) “does not lay down any rule” and that “at best (it lays down) only an approach”. McDowell [1985] 154 ITR 148 (SC), in our opinion also, is more of an approach to the facts of a particular case than any inviolable rule laid down regarding tax evasion. It is a call to the courts and Tribunals to expose subterfuges, colourable devices and dubious methods in tax cases. It is a caution administered that lawful dues to the State cannot be withheld under schemes acquired off-the-shelf or through transactions that have no commercial or economic value or by taking certain pre-ordained steps which are calculated to cancel out each other. The approach in such cases must be to take the entire transaction or arrangement as a whole and see if it makes any economic or commercial sense without attaching weight to the steps that go to make up the scheme, each of which may be legally valid. The genuineness of the arrangement has to be viewed not in relation to every step taken to achieve the result but in relation to the final result. This is only a different way of saying that you have to look at the truth of the transaction (and if permissible) by going behind the facade of documentation or the series of steps taken. In our country, this approach has been approved by the Supreme Court every now and then and in one of the earliest cases Jiyajeerao Cotton Mills Ltd. v. CIT/EPT [1958] 34 ITR 888 (SC) it was held by his Lordship Justice T. L. Venkatarama Aiyar (at page 897) that :

“Mr. Kolah argues that there is nothing wrong in business being done in such a way as to escape taxation. No exception can be taken to that statement. Every person is entitled so to arrange his affairs as to avoid taxation. But the arrangement must be real and genuine and not a sham or make believe, and the question now under consideration is whether the contracts with the brokers were genuine.” (emphasis supplied)

That the courts (and Tribunals) always have the freedom to “go behind” the documents to find out the real intention of the parties has always been recognised. This rule presupposes that in a given case the real intention of the parties to a document/transaction/arrangement could be different from what it appears from it ex facie. The court must normally proceed on the basis of the professed intention, but if that is under doubt or is disputed or challenged, then its power to find out the real intention of the parties by ignoring the apparent has to be, and has always been conceded. It is difficult to imagine where this is possible except in cases of a make believe arrangement or a subterfuge or a dubious or colourable device adopted. In such a case, the court will be merely removing the facade to expose the real intention of the parties cleverly cloaked and if that intention is discovered to be the evasion of taxes, it cannot be given effect to merely because all the steps taken as component parts of the arrangement are legally correct or valid. This is far different from saying that the court cannot re-write an agreement for the parties. A case of re-writing the agreement arises where what the income-tax authorities do is not to doubt or dispute the genuineness of the transaction/agreement/document, but to add to its terms what they think should be added or delete therefrom what according to them should be deleted so that it can be interpreted in their favour enabling them to collect more taxes. This approach has been strongly deprecated by the courts. The right of the parties to enter into transactions according to their free will and choice has always been protected, the only rider being that both the professed intention and the real intention should be the same. The income-tax authorities have without exception been denied the right to vary the terms of the contract between the parties merely because the agreed terms are not to their liking in the sense that they do not add to the statistics of collection of taxes. Cases on point are CIT v. Motors and General Stores (P.) Ltd. [1967] 66 ITR 692 (SC) and CIT v. B. M. Kharwar [1969] 72 ITR 603 (SC). This approach has been reiterated recently by the Gujarat High Court in Banyan and Berry v. CIT [1996] 222 ITR 831.

McDowell [1985] 154 ITR 148 (SC) therefore did not depart from what has already been laid down by the Supreme Court earlier except that the law regarding tax evasion was restated in much stronger expressions such as “dubious device”, “subterfuge”, “colourable transaction”, etc. The judgment did not permit the income-tax authorities to re-write or make a new contract for the parties nor did it say that they could not go behind the documentation in an attempt to find out the real intention of the parties. If the real intention of the parties is discovered to be something different from the intention professed in the document, the income-tax authorities are at liberty to brand the same as a subterfuge or a dubious device or a colourable transaction.

Our attention was drawn to the decisions of the Supreme Court and High Courts rendered after the judgment in McDowell [1985] 154 ITR 148. We may first refer to CWT v. Arvind Narottam [1988] 173 ITR 479 (SC) where the Supreme Court refused to apply McDowell [1985] 154 ITR 148 to a case where the deeds were clearly worded and admitted of no ambiguity. But in this case there was no suggestion that the deeds did not intend to convey what they professed. The McDowell’s case [1985] 154 ITR 148 (SC) rule was canvassed by the Revenue before the Supreme Court without any evidence to show that the documents were a subterfuge, an artifice or embodied colourable transactions. In M. V. Valliappan v. ITO [1988] 170 ITR 238 (Mad), the amendment made to the Income-tax Act to enable the assessing authority to refuse to recognise partial partitions of the Hindu undivided families was challenged and the Revenue relied on McDowell [1985] 154 ITR 148 (SC) before the Madras High Court. McDowell [1985] 154 ITR 148 (SC) could not be invoked by the Assessing Officer in that case because the orders were all passed by him in 1983 and 1984, before McDowell [1985] 154 ITR 148 (SC) was decided (in 1985). While recognising that the rule would not apply to a genuine transaction or arrangement in which the assessee really and in fact parts with a part of his property, just because there is a reduction of tax liability, it was held that honest and bona fide transactions cannot be hit by the McDowell [1985] 154 ITR 148 (SC) approach merely because there is a reduction in the tax liability. The Madras High Court did not understand the McDowell’s case [1985] 154 ITR 148 (SC) ruling as holding that all transactions, irrespective of their genuineness, which resulted in a reduction of tax liability would be hit by a rule. In Banyan and Berry [1996] 222 ITR 831, the Gujarat High Court confirmed the right of freedom of business and to enter into commercial transactions and confined the applicability of the rule in McDowell [1985] 154 ITR 148 (SC) to a case where a colourable device or a subterfuge is adopted to evade the tax liability. The applicability of the approach in McDowell [1985] 154 ITR 148 (SC) should be confined to a case where the sole motive of the parties to the transaction is the avoidance of tax and for this purpose the courts are bound to enquire into the reality. Union of India v. Playworld Electronics Pvt. Ltd. [1990] 184 ITR 308 (SC) is a case where it was reiterated that tax planning may be legitimate provided it is within the framework of the law. It was stated that colourable devices cannot be part of tax planning. It was also observed that one must find out the true nature of the transaction. In the light of these cases in which McDowell [1985] 154 ITR 148 (SC) has been considered, it seems to us that the proper way to understand the observations in McDowell [1985] 154 ITR 148 (SC) regarding tax evasion, read as a whole and in perspective, is to hold that all commercial arrangements and documents or transactions have to be given effect to, even though they result in a reduction of the tax liability, provided that they are genuine, bona fide and not colourable transactions.

The contention that the validity of the transactions cannot be looked into within the frame of the question is, with respect, off the mark because merely legal validity does not necessarily give a touch of genuineness to the transaction, which depends on various other considerations. Therefore, the further contention that since the question referred to the Special Bench is limited to the application of the rule laid down in McDowell [1985] 154 ITR 148 (SC), it presupposes that the sale and lease-back transaction is valid and therefore it cannot be held to be non-genuine, cannot be accepted. Every step in the whole transaction may be legally correct, but still whether the whole transaction is genuine in the sense that it is not a subterfuge or colourable device or a dubious method is an entirely different question not dependent solely on the fact that every step in the transaction is legally valid or correct. Mr. Dastur, arguing for ICICI Ltd. took us through the judgment of the House of Lords in W. T. Ramsay Ltd. v. IRC [1982] AC 300. where the House of Lords had to consider a scheme of tax avoidance which consisted of a series or a combination of transactions each of which was individually genuine, but the result of all was the avoidance of tax. He laid stress on the speech of Lord Wilberforce to submit that the decision should be understood and appreciated in the light of the facts of the case. He pointed out that in this case the facts disclosed that the taxpayer had arranged to set off the gain which he earned in certain transactions by purchasing a ready-made scheme from another company which created the desired loss. In the course of the speech, Lord Wilberforce had referred to a sham transaction as meaning one that while professing to be one thing, is in fact something different and that to say that a document or transaction is genuine means that in law it is what it professes to be and it does not mean anything more than that. The learned law Lord proceeded to observe that it is the task of the court to ascertain the legal nature of any transaction to which it is sought to attach a tax or a tax consequence and if that emerges from a series or a combination of transactions, intended to operate as such, it is that series or combination which shall be regarded. We understand the learned law Lord as saying that we are not bound to consider individually each separate step in a composite transaction intended to be carried through as a whole and that we are to look at the transaction as a whole to find out if it is a subterfuge. The learned law Lord had also observed that while the court was under an obligation to accept documents and transactions found to be genuine as such, it is under no compulsion to look at the document or transaction in blinkers, isolated from any context to which it properly belongs. If it can be seen that a document or a transaction was intended to have effect as part of a nexus or series of transactions, or as an ingredient of a wider transaction intended as a whole, there is nothing in the doctrine to prevent it being so regarded. To do so is not to prefer form to substance, or substance to form.

We were treated by counsel to some classic observations from recent English cases where the rule of W. T. Ramsay [1982] AC 300 (HL) was considerably whittled down. These are Craven (Inspector of Taxes) v. White (Stephen) [1990] 183 ITR 216 (HL) ; Ensign Tankers (Leasing) Ltd. v. Stokes (Inspector of Taxes) [1994] 209 ITR 231 (HL) and Macniven (H. M. Inspector of Taxes) v. Westmoreland Investments Ltd. [2002] 255 ITR 612 (HL). Passages from IRC v. Burmah Oil Co. Ltd. [1982] Simon Tax Cases 30, were also read out to show that the noble law Lords were quite aware of the difference between “tax avoidance or tax mitigation” on the one hand and “tax evasion” on the other. It was pointed out that in some of these cases, the House of Lords refused to apply the W. T. Ramsay [1982] AC 300 (HL) decision though the facts in those cases seem to suggest that what was intended by the circular and self-cancelling transactions was the evasion of taxes. It was stressed, particularly by Mr. Dastur, that in Macniven (H. M. Inspector of Taxes) v. Westmoreland Investments Ltd. [2002] 255 ITR 612 (HL) that, the House of Lords refused to consider W. T. Ramsay [1982] AC 300 (HL) as anything more than an approach to, or a rule of construction to be put upon, the transactions.

We must admit that these English decisions constitute high authority having a persuasive value, but we are bound to apply McDowell [1985] 154 ITR 148 (SC) approach in India. Perhaps, there is a change in the approach of the courts in England as is evident from the cases cited above ; that may be attributed to different social and economic conditions existing there. It must also be conceded that Macniven [2002] 255 ITR 612 (HL), seems to have gone very far and away from Ramsay [1982] AC 300 (HL) but we must also advert to the fact that in that case though the aim was to mitigate the tax liability the means adopted were straightforward. A company which wanted to pay interest and get an allowance therefor but did not have sufficient finances, borrowed from its creditor, to whom it already owed huge sums, and paid the interest. The creditor being a pension scheme was exempt from tax and so the tax deducted from the interest paid by the company was finally reclaimed. The House of Lords could find no valid objection to the arrangement through which the taxpayer company achieved its aim. There was no requirement, according to the House of Lords, that the taxpayer should use its own funds to pay interest in order to obtain the allowance. Since the means adopted were not objectionable, and the only objection being that it resulted in tax mitigation, the House of Lords held that the arrangement must be given effect to. It thus appears to us that where the means adopted are bona fide and not a subterfuge and the series of transactions which are followed as the means are not colourable devices or dubious methods, the mere fact that there is tax mitigation does not attract the approach in McDowell [1985] 154 ITR 148 (SC). As Mr. Dastur put it, you would apply the McDowell [1985] 154 ITR 148 (SC) approach to a case where prima facie the transaction is not what it purports to be, an approach which was adopted by the Mumbai Bench of the Tribunal in Kantilal Manilal and Co. v. Deputy CIT [2002] 82 ITD 354, or to a “fake” transaction.

It is in the light of our above understanding of the observations relating to tax avoidance made in McDowell [1985] 154 ITR 148 (SC), that we set out to deal with the issues raised before us in the appeals.

What is a sale and lease-back transaction (SLB) ? Can it be misused ?

A sale and lease-back transaction is one where an asset is sold by A to B and simultaneously B agrees to lease out the asset to A for a consideration which is known as lease rental. According to the approach paper prepared by the CBDT and sent to FICCI, CII, ASSOCHAM, ICAI and the Association of Leasing & Finance Companies (pages 199 to 206 of the paperbook filed by ICICI), there are three main types of leases : (i) finance lease ; (ii) operating lease ; and (iii) hire purchase contract. A finance lease is stated to be a lease “that transfers substantially all the risks and returns of ownership of an asset to the lessee. Under this arrangement, the lessee is the economic owner. He can and usually does exclude the legal owner from the use of the asset for a period long enough to reduce the value of the property to a point where the legal title is economically insignificant”. An operating lease is a lease other than a finance lease. A hire purchase agreement is a contract for the hire of an asset which contains a provision giving the hirer an option to acquire legal title to the asset upon the fulfilment of certain conditions stated in the contract. Finance leasing is basically a method of financing. In a finance lease, the asset is transferred to the lessor first as and by way of security for the finance. This is invariably the case in SLB transactions where the seller of the asset becomes the lessee subsequently. In the case of an operational lease, where the owner of the assessee effects a simple lease thereof to the lessee for lease rentals, the question of the asset itself being security is satisfied by appropriate safeguards in the lease agreements. Here, the idea is not to finance the lessee, but to enable him to operate the asset and earn profits. In such cases, the asset is not previously owned by the lessee. However, in the case of a SLB which is a specie of a finance lease, the asset is first purchased by the assessee and almost simultaneously leased back to the seller, who thereafter holds and uses the same in a different capacity. The erstwhile owner becomes the lessee after the lease. The advantage he gets is the money on sale of the asset to the assessee. The assessee is thus the owner of the asset but at the same time, the asset continues to remain with the seller, who has now become the lessee. In other words, the asset does not actually change hands, but the same person holds it in a different capacity and in the meantime has secured the funds on “sale” thereof. Normally in such a transaction, if it is viewed as a pure financing transaction with the asset continuing to be owned by the assessee who has lent the money merely for purposes of security, what is received by the assessee from the lessee must be considered as interest on the monies advanced. The business would be that of money lending. The assessee would not be entitled to the depreciation on the asset because it is not used in the business of money-lending. In order to get over this situation, the SLB arrangement was thought of. If the SLB arrangement is viewed as a leasing transaction, the assessee-lessor would be entitled to depreciation on the asset leased out since his business would be that of leasing and not mere money-lending. That an assessee who is engaged in the business of leasing is eligible for depreciation on the assets leased out has been recognised by the Supreme Court in the case of Shaan Finance [1998] 231 ITR 308. The same decision is sought to be invoked in support of the claim for depreciation in respect of assets leased out in a SLB arrangement. The finance lease is normally a method of financing the assets through the medium of a lease. For example, company A which is a leasing company purchases gas cylinders which are leased out to company B which actually puts the cylinders to use in its business. The assets are paid for by company A. Company B pays the lease rentals which are allowed as a deduction in its income-tax assessments. Company A claims depreciation in respect of the cylinders, because they are used in its leasing business. This basic idea is slightly modified in the case of a SLB transaction. Instead of company A buying the assets from the manufacturer of gas cylinders, it purchases the gas cylinders from company B itself and simultaneously leases them back to company B. The same tax treatment as was given in the earlier illustration is sought to be given to this arrangement also. Here also, company A claims depreciation, whereas company B claims the lease rentals as a deduction. In the former illustration, company B genuinely required the gas cylinders but could not buy them due to lack of funds. Company A had the funds and so acquired the cylinders from the manufacturers and leased them to company B. The problem was solved so far as company B was concerned. What would have been allowed as depreciation if it had owned the cylinders was more or less achieved by claiming the lease rentals as deduction. The leasing company, i.e., company A being owner of the cylinders and the cylinders having been used in its business which is that of leasing, obtained the depreciation allowance and quite rightly so. In the latter illustration, the real requirement of company B is not the gas cylinders, but finance. It has no funds but it has some assets. It has located company A which can spare the funds. It may be that company A is also engaged in the money-lending business. But it requires security before it could advance monies to company B. Company B can offer its assets as security for the monies and company A can accept the same. In this transaction, company A will be receiving the interest on the monies advanced. Company B would be getting the depreciation allowance in respect of the assets held by it. What the parties do now is to adopt the SLB mode. The asset is sold to company A for a price. Thus, company B gets the money. Simultaneously the assets are leased back by company A to company B. Company A can now claim that it is engaged in the leasing business and on the strength of Shaan Finance [1998] 231 ITR 308 can claim depreciation in respect of the assets leased out. This is the modification brought about to a simple loan arrangement.

A question may arise like this : As far as depreciation is concerned, it was earlier being claimed by company B, whereas the same is now being claimed by company A and therefore what is the advantage ? The answer to this depends on the fact as to what would be the benefit derived by the allowance of depreciation or rather which of the two parties, company A or company B, would derive more benefit because of the allowance of depreciation. This would depend on the profit figures of both the companies. If company B is a loss-making company and therefore the allowance of depreciation would make no difference in its income-tax assessments, it would be more beneficial to have the depreciation allowed in the assessments of company A, if it is a profit-making company. Now the further question would arise as to how to shift the depreciation allowance from company B to company A. Under section 32 of the Income-tax Act, two conditions have to be satisfied before depreciation allowance can be claimed. First, the assessee should be the owner of the asset ; and second, the asset should be used in the business of the assessee. In the illustration given above, if it is a normal loan transaction, company B would remain the owner of the asset and would be entitled to the depreciation, whereas company A would receive the interest on the loan on which it would pay tax. If the depreciation allowance is shifted to company A, it would benefit it and would make no difference to company B. Therefore, it would be beneficial to adopt the SLB mode. Company B would “sell” the asset to company A and company A would “lease” it back to company B. Company B, instead of paying interest on the loan would be paying lease rentals and claiming the same as deduction. Company A would claim depreciation on the asset on the footing of having used the same in its leasing business and set off the lease rentals against the depreciation allowance. This is the motive behind making a modification to a simple loan transaction to make it a SLB transaction.

A further question may arise this way. If the asset concerned is of little or no value, the depreciation figure is also bound to be low and of no significance and therefore how can it benefit company A ? The only way to overcome this situation is to place a high value on the asset for the purposes of sale. An asset which stands at Rs. 100 in the books of company B may be sold at an agreed value of Rs. 1 lakh which would be the cost to company A on which it can claim depreciation. So the valuation of the asset becomes an important tool by which the depreciation allowance could be regulated. In addition to the question of valuation, another important point to be noticed is the choice of the asset which is the subject matter of SLB. Normally, a genuine or bona fide finance lease should not be unduly concerned about the depreciation that is allowable on the asset for income-tax purposes because the more important consideration should be the availability/provision of funds. This does not mean that considerations of income-tax cannot enter into the picture in the case of a bona fide or genuine SLB, but what is meant to be conveyed is only that such considerations would normally be only incidental, the main object being the provision of finance/funds. But one feature of many of the SLB transactions which have been the subject matter of scrutiny by various Benches of the Tribunal, whose orders were placed before us, as also the transactions in the present cases, is that the parties are particular that the asset is one which enjoys 100 per cent. depreciation allowance under the Income-tax Act. We shall presently see that in the case of Mid East Portfolio Management Ltd. there is repeated reference to assets eligible for 100 per cent. depreciation under the Act, in the negotiations and the documentation such as the agenda note, etc. Both under finance and operational leases, normally the parties should not be unduly concerned about the choice of the assets, for that would be determined by the needs of the lessee’s business. But where the parties show undue interest in ensuring that the asset which is to be sold and leased back is one which enjoys 100 per cent. depreciation allowance under the Act, it would raise doubt as to the motive of the parties. The Act and the Rules provide for depreciation allowance at 100 per cent. of the cost/written down value of energy-saving devices, pollution-control devices, waste-control or management devices, etc. These provisions were apparently introduced with the object of controlling pollution, efficient management of waste, conservation of energy, etc. In the case of SLBs whose object is the avoidance or evasion of taxes, the choice of assets is almost always the single most decisive criterion. There is a great temptation to make use (abuse ?) of the provisions of the Act and Rules relating to depreciation allowance at 100 per cent. of the cost of the assets so as to reduce the taxable profits. The question of valuation of the asset and selecting assets enjoying 100 per cent. depreciation allowance are often inter-connected, because the higher the cost of the asset the higher the depreciation allowance and lesser the taxable profits. Therefore, what would otherwise be an ordinary finance or loan transaction where the consideration for the use of the monies is the interest and the asset concerned is merely a security for the loan, can be cosmetically altered to bear the characteristics of a sale and lease back, so that the lessor-financier can claim to own the asset and use it in his leasing business and seek to set off the depreciation allowance (under section 32) against the lease rentals which are nothing but interest. These aspects have got to be borne in mind.

Now a question would logically arise as to whether it can be said with any justification that all SLB transactions involve a tax evasion motive and that there can be no genuine SLB transaction. SLB transactions have been recognised and acted upon in the commercial world for quite some-time. Mr. Dastur placed before us a judgment of the Chancery Division in Yorkshire Railway Wagon Co. v. Maclure [1882] 21 Ch. D. 309, which was a decision rendered in the 19th century (in the year 1882). In this case, a railway company was in need of money, but it had no power to borrow. It therefore sold a part of its rolling stock to a wagon company simultaneously making a contract with the wagon company for the hire of the same rolling stock at a rent which would repay the money borrowed with interest in 5 years and then for its repurchase at a nominal price. Three directors of the railway company guaranteed the payment of rent to the wagon company. The wagon company brought an action against the railway company and the sureties for non-payment of the rent due. The trial court held that the transaction was void as against the railway company, but could be enforced against the sureties. On appeal, the Chancery Division of the Court of Appeal held that the transaction was not a borrowing of money, but a bona fide sale and hiring of the rolling stock, and was therefore valid both against the railway company and the sureties. This case was placed before us to show that SLB transactions have been recognised in the commercial world for long and that by a judicial decision they cannot be done away with. Our attention was also drawn to the fact that in that case what originally started as a simple loan arrangement was altered in the course of negotiations between the companies on taking counsel’s opinion with respect to the powers to borrow and lend monies and thereafter it took the colour of sale and hire back transaction and that notwithstanding this, the Chancery Division did not hold that the transaction was a simple borrowing of money, but held that it was a bona fide sale and hire back transaction, valid against both the companies.

We have considered this aspect of the matter very carefully. There can be no doubt that SLB transactions have been recognised and acted upon in the commercial world for quite sometime, if the judgment of the Chancery Division cited above is any indication. Undoubtedly, they cannot be derecognised or invalidated by a judicial decision. Judicial forays into the commercial world and its transactions are limited to examining the genuineness of the particular transaction and it is taboo for persons not connected with the commercial world to advise what form a commercial transaction should take. But the judicial eye can certainly unearth a device or a smoke-screen created to conceal the real intention of the parties and for this purpose, can examine the genuineness of the particular transaction which is called in question. This jurisdiction has to be conceded and in fairness to counsel appearing for the appellants, it must be stated that they did not dispute this right, but what they contended was that what can be done is only to examine the particular facts of each case for the purpose of ascertaining the true intention of the parties without generalizing that a particular method of carrying out a transaction is in all circumstances to be considered as a device or subterfuge or a colourable transaction. Yorkshire case [1882] 21 Ch D 309 (CA) was rendered towards the closing years of the 19th century when income-tax was probably not a popular tool of raising revenues (we do not know what the position was in England) and the importance of fiscal laws may not have been what it is today. Commercial transactions were left alone as it was considered that the businessmen were the best judges as to how business should be carried on. Apart from this generalized view of ours, Yorkshire itself recognizes the distinction between a bona fide transaction and a transaction wearing a cloak to conceal the real intention. It is important to remember that there was a bona fide need of funds on the part of the railway company. They thought they had the power to borrow the money and so applied for a loan to the wagon company. The wagon company did not have power to advance the loan as it was not formed for that purpose. It was formed for the purpose of lending wagons or railway rolling stock. This is referred to by the Master of the Rolls at page 312 of the judgment. Nevertheless, the wagon company resolved to advance the monies by way of loan with the personal guarantee of the directors of the railway company. It was only when counsel opined that a simple loan was not possible and suggested that the only way of carrying out the real object of the railway company would be to sell the rolling stock and then to take a lease of it from the purchasers and in that way to retain the use of it on payment of what was equivalent to the loan and interest in 5 years by way or rent, that the events took a different turn, resolutions were altered and documents were prepared on the basis of counsel’s advice. Considerations of income-tax did not enter the picture at all. It was held that the original intention of the railway company was modified and they adopted a different method to achieve the object, viz., the obtaining of funds. The object of wagon company was to get back the money with interest over a period of 5 years and the mode of carrying it out was indifferent to them so long as they were safe and the finding is that therefore they acceded to the terms suggested to them by the railway company to make it a sale and lease. Lindley, L. J. in his separate judgment, observed that the learned judge of the court below considered the transaction of hire as a mere device or cloak to conceal a loan and admitted that if he had been of the same view of the facts, he also would have come to the same conclusion and in that case, he would have “disregard(ed) or throw(n) aside the cloak, and look(ed) at the real transaction alone”. He was satisfied that the purchase and hire transaction was the real transaction in the sense that “the parties meant it to operate according to its tenor as comprised in the deeds. It was not intended by them as a mere blind or cloak for something behind, it was a transaction substituted for another, but bona fide substituted, and intended to be acted upon according to its purport and apparent effect”. Lindley J. further observed that (page 318) “if it were a mere cloak or screen for another transaction one could see through it, but once come to the conclusion that it was the bona fide real transaction between the parties, intended by both sides to operate according to its tenor, there is no mode that I know of holding it illegal unless you find it prohibited by some Act of Parliament or void by reason of some principles of law”.

We are therefore of the opinion that all SLB transactions as such cannot be considered to be dubious or colourable devices or subterfuges aimed at tax evasion. The enquiry which a court or Tribunal can make, when faced with an SLB transaction, is to find out the real intention of the parties and ascertain whether a simple loan transaction masquerades as an SLB transaction. Any transaction in which the professed intention and the intention gathered from the documentation are the same, viz., a sale and a lease back, must be considered to be a genuine SLB transaction.

Mid East Portfolio Management Ltd.—Rival Contentions

Contentions of the assessee :

Before we proceed to notice the contentions of Mr. V. H. Patil, learned counsel for the assessee, we may place on record that he did not object to the paper-book filed by Mr. Sahai, the learned CIT(DR), which contained certain additional evidence and submitted that he would meet the arguments based on those papers on merits.

(A) Was there a genuine sale by RSEB to the assessee ?

Mr. V. H. Patil, learned counsel for the assessee contended that there was a genuine sale by RSEB to the assessee of the air-pollution equipment. In support of the contention, he referred to the following :

(i) Resolution of the Board of RSEB to sell the air-pollution equipment before March 31, 1995, at a value not exceeding Rs. 150 crores.

(ii) Decision of the Board taken at their 443rd meeting held on January 6, 1995, to raise money at a low rate of interest by notional sale of plant and machinery and to take them back on lease.

(iii) The valuation report prepared by Choudhary and Associates.

It was submitted that RSEB intended to sell the plant & machinery and then take it back on lease and thus there was a real sale. It was submitted that the word “notional” used by the Board of RSEB in their decision should be understood in the context without attributing any other meaning, and certainly not the meaning that the sale was not a real sale. The word “notional” was not used in the sense of being fictional. It was used in the sense that the equipment had to come back to RSEB as lease. At any rate, no adverse inference is possible merely because of the use of the word “notional” by RSEB and not by the assessee. RSEB, it was pointed out, did not claim any depreciation in its return, consistent with the position that there was a real sale. Our attention was also drawn to the fact that the Government of Rajasthan issued a Notification exempting the sale of the equipment by RSEB from the levy of sales tax, which was quite unnecessary if there was no real sale. The sale was exempt from sales tax on grounds of public interest and it presupposes that there was a sale by RSEB.

So far as the attributes of a sale are concerned, whose absence in the present case was marked by the Assessing Officer in paragraph 6 of the assessment order, Mr. Patil submitted as under :

(a) As regards the allegation that there was no delivery of the assets, which is a normal attribute of sale, from RSEB to the assessee, there was a constructive or symbolic delivery of the equipment, which was sufficient for the validity of the sale. According to him, too much emphasis has been laid on the physical movement of the equipment from RSEB to the assessee which was not proper or justified. As regards the allegation that no details of the sale consideration were mentioned in the sale deed, Mr. Patil submitted that it was not necessary to mention the details of the sale consideration in the sale deed itself and what is required is that the consideration has to be stated. According to him, the passing of the property is not dependent on payment of consideration, but depends on delivery. At our instance, Mr. Patil filed the particulars of the payment made as per the sale deed, which shows that a demand draft dated March 29, 1995, was given by the assessee to the RSEB for a sum of Rs. 1,51,76,612. With regard to the allegation of the department that the equipment was deliberately valued at an inflated figure in the valuation report prepared by Choudhary and Associates, Mr. Patil countered the same by submitting that no counter-valuation had been made by the Department which they ought to have done if they wanted to question the valuation made by Choudhary and Associates. He pointed out that even the Assessing Officer has not visited or inspected the assets at their location. The Assessing Officer had also noticed that though the valuer had stated that the valuation has been made as per the annexures to the report, no annexures were actually found. Mr. Patil did not dispute the allegation that the annexures were not found along with the report, but submitted that the assessee is not concerned as to how the valuer arrived at the figure, which is what the annexures would contain and that he (the assessee) was only interested in the ultimate figure of valuation. It was not of much relevance that the annexures were not furnished along with the valuation report because the valuer had applied the relevant principles of valuation. At any rate, according to him, there was nothing to show overvaluation of the assets.

(b) The Assessing Officer had also taken the objection that the assessee did not become the real owner of the equipment since the rights remaining with the assessee after the lease deed was executed were not mentioned in the same. With regard to this objection, Mr. Patil submitted that there was no need to specify the rights remaining with the assessee in the lease deed. With regard to the Assessing Officer’s query as to why the sale deed as well as the lease deed were executed simultaneously, Mr. Patil submitted that, that was the feature of an SLB transaction and there was nothing unusual about the same.

(c) One of the allegations of the Assessing Officer was that the written down value figures had not been furnished by the assessee. To this, Mr. Patil submitted that after the block asset concept introduced from April 1, 1988, it is difficult to ascertain the written down value of each asset and hence could not be furnished.

(d) Mr. Patil also criticized the conclusions drawn by the Commissioner of Income-tax (Appeals) in paragraphs 28 to 34 of his order and submitted that the various clauses of the lease agreement on which reliance has been placed by the Commissioner of Income-tax (Appeals) to show that the risk has been completely pinned upon RSEB without the assessee undertaking any risk in relation to the equipment, Mr. Patil submitted that all the risks attended to the ownership of the equipment lay with the assessee and only the risk due to the operation of the equipment was transferred to the lessees (RSEB). He pointed out that clause (8) of the lease deed which transferred the risks in relation to the equipment to RSEB is normally found in all leases and there was nothing unusual about the same.

(B) Is a finance lease per se entitled to depreciation ?

The argument was that such finance leases as was entered into in the present case per se entitles the lessor to depreciation in respect of the asset leased out. Mr. Patil referred to the following circulars of the Central Board of Direct Taxes :

1. Circular dated January 23, 1996 in F. No. 131/53/96-TPL.

2. Circular No. 2 dated February 9, 2001 in F. No. 225/186/2000 ITA-II (see [2001] 247 ITR (St.) 53).

On the strength of these Circulars, Mr. Patil submitted that finance leases are per se entitled to depreciation and that the board itself has opined that there is no difference between a finance lease and an operating lease so far as depreciation is concerned. Reliance was placed on orders of various Benches of the Tribunal (Compiled in paperbook No. IV) as well as on the following judgments :

1. CIT v. Dayalal Meghji and Co. [1998] 149 CTR (MP) 126.

2. The judgment of the hon’ble Bombay High Court (hon’ble Justice S.H. Kapadia) dated September 16, 1998 in Development Credit Bank Ltd. v. Prakash Industries Ltd. affirmed by the Division Bench of the hon’ble Bombay High Court by judgment dated January 28, 1999 (compiled at pages 136 to 167 of paperbook No. IV).

Mr. Patil then submitted that the Income-tax Act itself recognizes the concept of sale and lease back. He invited our attention to Explanation (4A) to section 43(1) introduced by the Finance (No. 2) Act, 1996 with effect from October 1, 1996. Our attention was also drawn to the Memorandum explaining the amendment which is reported in [1996] 220 ITR (St.) 270-271. It was submitted that the only effect of the amendment was that earlier the assessee was entitled to a higher depreciation in respect of assets leased out under a SLB arrangement, whereas after the amendment, the assessee would be entitled to a lesser amount of depreciation. This, according to Mr. Patil, was the only change in the law with effect from October 1, 1996. Thus, both before and after the amendment, the Income-tax Act itself recognizes the claim for depreciation in respect of assets leased out under a SLB transaction. It was therefore contended that SLB transactions as such should not be viewed with any suspicion or a preconceived notion and so long as such transactions are genuine, the law itself recognizes the right of the lessor to depreciation. Since the present transaction with the RSEB is a genuine lease under a SLB arrangement, the assessee was entitled to the depreciation as claimed.

It was thus pointed out by Mr. Patil that the Income-tax Department and the judiciary have accepted a finance lease to be essentially a lease and not a mere money-lending transaction, and if so, the assessee is entitled to depreciation on the assets leased out.

Apart from the general arguments regarding McDowell, which we have already adverted to, Mr. Patil contended that on the facts of the present case, there was no scope for applying the rule. He contended that the SLB transaction in the present case was thought of because of the genuine need for finance felt by the RSEB. The resolution and the decision taken by the board of the RSEB on the basis of the detailed agenda note placed before the Board on January 6, 1995, showed that there was an acute need for finance by the RSEB which forced them to approach the leasing companies for finance. Newspaper advertisements were given by the RSEB seeking finance. All these are referred to in the documentation. Thus, the very genesis of the SLB transaction in the present case was the genuine need for finance felt by the RSEB. The negotiations started in January, 1995 itself with the publication of the advertisements in the newspapers. They culminated in the SLB transaction on March 27, 1995. Therefore, it was not as if the transactions all of a sudden materialized towards the end of the accounting year. The assessee-company intended to engage itself in the leasing business in October, 1993 and made a public issue of shares in November, 1993. According to the prospectus issued by the assessee-company the company was going to undertake leasing, hire purchase and bill discounting activities for which it had the necessary authority in the memorandum of association. A special resolution was also passed at the extraordinary general meeting held on June 22, 1993. Pursuant to this object, the assessee-company responded to the advertisement issued by the RSEB. The assessee was part of a syndicate formed to finance the RSEB. The advantage of entering into a SLB transaction was that the assessee was better secured in respect of its monies since it became the owner of the asset. In case there were difficulties in recovering the monies, the assessee need not go to a court of law for enforcement of the security, but can sell the equipment, being the owner thereof, and realize the monies. It was because of this advantage that the parties thought of the SLB arrangement. Therefore, it was a well considered decision taken not merely to obtain a tax benefit, which was only incidental, but mainly to have a better security for the loan. The assessee had two options before it—a simple loan for interest with security or a SLB transaction which will afford a better security to the assessee and also incidentally confer some tax benefit. If two options are open to achieve the same business result, it is open to the assessee to choose the one with a reduced tax liability without attracting McDowell. This is only a tax planning or tax mitigating effort and not tax evasion or tax avoidance. Mr. Patil contended that the assessee was merely taking the benefit of tax advantage given by the law itself and therefore there is nothing colourable or dubious about it. The very essence of a SLB transaction is that there would be a sale first to the would be lessor and thereafter a lease back to the erstwhile owner of the asset and it was this form which the parties chose to adopt with all sincerity and genuineness, the tax benefit by way of depreciation allowance to the assessee being only an incidental consideration.

Mr. Patil also filed a statement titled “cash flow for Income-tax liabilities” to demonstrate that there was no tax avoidance if a period of 5 to 10 years is taken into consideration. In fact, he even went to the extent of saying that the assessee would end up paying more taxes if its claim is accepted. Mr. Patil assured us that all the assumptions on the basis of which the calculations were made in the statement are valid.

Contentions of the Department :

Mr. Sahai, the learned Commissioner of Income-tax (DR) formulated four broad contentions which he canvassed before us at considerable length. They are the following :

(i) There is no sale of assets by the RSEB to the assessee.

(ii) If it is held that there is a real sale, then does the lease document embody (a) a lease ; or (b) a hire purchase; or (c) a conditional sale ?

(iii) If it embodies a lease of equipment by the assessee to the RSEB, to what depreciation is the assessee entitled : (i) Under section 43(1), i.e., on the “actual cost” ? (ii) Does Explanation (3) to section 43(1) apply ? or (iii) Does Explanation (4A) to section 43(1) apply ?

(iv) Is the case covered by the rule in McDowell ?

(A) There is no sale by RSEB to the assessee

In support of this proposition, Mr. Sahai, referred to the following facts :

(a) In the agenda note placed before the board of RSEB on January 6, 1995, there is repeated reference to the sale of equipment being “notional”. The agenda note also shows that offers were received from various lease financing companies to make available funds under SLB arrangements and these offers appear to have come without any solicitation.

(b) The agenda note also shows that the leasing companies were willing to make available funds under SLB arrangements only against the already existing assets attracting 100 per cent. depreciation benefits, which indicates that the attraction is the depreciation allowance.

(c) There is reference to other State Electricity Boards such as Madhya Pradesh and Punjab, having resorted to SLB arrangements. This shows a pattern adopted by many Electricity Boards to raise finance through SLB arrangements which will benefit the financing companies by way of depreciation allowance.

(d) In the advertisement issued by the RSEB in the Bombay Edition of Economic Times on January 13, 1995 (page 65 of paperbook No. V), the RSEB has stated that parties desirous of entering into SLB arrangements with it “may submit their sealed offers giving full details, i.e., lease rent, lease period, residual value, if any, the quantum of lease finance offered. . . .”. Mr. Sahai’s poser was that when even the asset was not identified and the actual cost of the asset or equipment was not known at that stage, how can the residual value thereof be ascertained at all ? He further posed the question as to how the leasing company can be expected to know the residual value of the equipment without even knowing what equipment is going to be sold by the RSEB, what is its cost, etc.

(e) The agenda note submitted to the Board of Directors of the RSEB refers to the fact that the cost of raising the finance from the assessee works out to 6.67 per cent. per annum and that this rate has been computed considering the amount of initial inflow and the period for which the different amounts would be actually available for utilisation, as the monthly lease rental payable “includes the element of interest as well as the repayment of principal amount”. This shows that the RSEB considered it as a finance transaction only.

(f) In the RSEB’s letter dated February 2, 1995, to the syndicate of which the assessee was a member, the residual value of the equipment has been shown at 20 per cent. (col. 5 of the letter) which will be adjusted against 20 per cent. retained security deposit “for transfer of ownership back to the RSEB (lessee)”. This shows that the parties have decided, even at the embryo stage of the transaction that the equipment will come back to the RSEB. Thus, there is no real sale by the RSEB to the assessee of the equipment.

(g) In the same letter, the RSEB has enclosed the board’s resolution in the proforma “desired” by the syndicate. This shows that both the parties jointly conceived the format of an SLB to put through a transaction which was a pure finance transaction. It also shows, more importantly, that the assessee was actually controlling the entire show in such a way that every document, though it may relate to the role of the RSEB in the transaction, was drafted the way it (the assessee) wanted.

(h) There is also a contradiction between the board’s resolution and the above letter written by the RSEB in the sense that the resolution does not speak of any residual value, whereas the letter speaks of the same.

(i) The equipment has not been identified at all. Mr. Sahai took us through the sale deed dated March 27, 1995, and pointed out that the equipment has not been identified therein. There is no identification or description therein of the equipment to be sold by the RSEB to the assessee, except a reference to the invoices enclosed with the sale deed. It is only in those invoices that the asset has been described and identified. This, according to him, is an unusual way of executing the sale deed which probably indicates that the sale deed is in a standardised form and the assets concerned are identified only in the invoices which would be attached to the sale deeds. Thus, it is for the first time that the equipment has been identified and described at the time of execution of the sale deed but even before this, the parties had agreed that 20 per cent. of the value of the asset would be the residual value and it would be adjusted at the end of the lease period against the security deposit and there will be no further liability on the part of any party. This shows that the SLB was a preordained transaction, gone through mechanically. The parties were not “ad idem” with regard to the most important aspect of the sale, viz., the asset which was sold to the assessee.

(j) Even for the application of the constructive or symbolic delivery theory canvassed on behalf of the assessee, the asset must be identified and in the absence of any identification, there can be no constructive or symbolic delivery.

(k) The valuer appointed by the assessee has not given any description of the ingredients of the equipment. He has not seen the equipment at all. The annexures stated to have been enclosed to the valuation report are not in fact enclosed. There is no discussion by the valuer as to how he arrived at the value. Mr. Sahai also referred to the letter dated March 9, 1998, written by the RSEB to the assessee stating, inter alia, that photographs of the assets may not be possible due to security reasons. He also referred to the letter written by M. Choudhary, the valuer on April 11, 2001 to the Deputy Commissioner of Income-tax, Special Range, 27, Aaykar Bhavan, Mumbai, on the subject “valuation of plant and machinery assets of M/s. Rajasthan State Electricity Board”. In this letter, the valuer has admitted that though he visited Kota Thermal Power Station on February 11, 1995, for inspection, the exact equipment mentioned in his valuation report were not seen by him and that the valuation was done on the basis of information provided by the employees of the RSEB.

(l) The security for the money advanced by the assessee to the RSEB was provided by a lien on the “Collection Account” of the RSEB with the bank, without any due diligence about the cost of asset leased out or its residual value. Our attention was drawn to clause (12) of the lease deed which says that the lessee (RSEB) has represented that a lien equal to twice the amount of monthly lease rentals shall be marked on the collection account and/or the designated account and that standing and irrevocable instructions will be issued to the State Bank of Bikaner and Jaipur to transfer every month the requisite amounts due to the designated account from the collection account before any transfer can be effected to the RSEB P.D. account. This, according to the said clause, was to ensure timely payment of the rentals due to the assessee and for other payments secured under the lease deed “so as to secure the payments due under the lease agreements”. Clause (i) defines the RSEB P.D. account as the lessee’s account operated at the Collectorate Treasury, Jaipur, in accordance with the instructions issued by the Government of Rajasthan and into which the monies lying to the credit of collection account are transferred from time to time. Schedule III to the lease deed refers to a draft letter to be obtained from the bank confirming that the bank has marked a lien on the collection account. The combined effect of these clauses in the lease deed is that the assessee has a lien on the collection account maintained with the bank in respect of the lease rentals and other monies due to it under the lease agreement. The contention of Mr. Sahai is that the real security is the lien on the collection account and thus the transaction is a simple finance transaction, given the garb of lease. Therefore, there is no intention at all on the part of the RSEB to sell any equipment or asset to the assessee. Thus, in fact, there is no sale to the assessee.

(B) Assuming there is a sale, then is there a (i) lease ; (ii) hire purchase ; or (iii) conditional sale by the assessee to the RSEB ?

The second part of Mr. Sahai’s arguments was that assuming there was a valid sale from the RSEB to the assessee of the equipment, what is the effect of the document styled as “agreement for lease of equipment” entered into on March 27, 1995, between the assessee as lessor and the RSEB as lessee : Is it a lease or a hire purchase or a conditional sale ? Mr. Sahai laid considerable emphasis on this part of his arguments. According to him, the term “lease” is not apposite to movable property and that the word “bailment” is the more appropriate word as has been used in section 148 of the Contract Act, 1872. Section 160 of the Contract Act obliges the bailee to return the goods to the bailor after the purpose of the bailment has been served. Contrary thereto, there is no provision in the lease agreement as to what will happen to the equipment at the end of the period of lease (bailment). Under the agreement, the assessee has no right to remove the asset for default in payment of lease rent during the currency of the agreement. Therefore, two essential ingredients of lease are missing.

The transaction is also not a hire purchase transaction since the lease agreement does not contain any provision conferring an option to the RSEB to purchase the equipment. However, it is argued that if one goes by the intention of the parties, it may appear as if it was considered by them to be a hire purchase transaction. Mr. Sahai filed some calculations to show that the assessee receives less than its investment and hence incurs a loss and therefore the only attraction is the depreciation, for which necessary documentation has been prepared to project a simple loan transaction as a SLB transaction.

As regards the argument that the lease agreement embodied a conditional sale of the equipment by the assessee to the RSEB, Mr. Sahai submitted that the difference between a hire purchase and a conditional sale was that whereas in the case of a hire purchase the hirer had the option to purchase the asset or not, in the case of conditional sale there is no such option. In the present case, the condition subject to which the equipment was sold by the assessee to the RSEB, according to Mr. Sahai, was stipulated in the letter written on February 2, 1995, by the RSEB to the syndicate of which the assessee was part, which is to the effect that the ownership of the equipment shall be transferred back to the RSEB. Such a condition has been agreed upon by the parties even before executing the sale deed. Clause (g) of the definition clause of the lease agreement defines “lessors” to mean those persons or entities who have provided/will provide equipment on lease to the lessee before March 31, 1995 “in terms of the mandates dated February 2, 1995, given by lessee to Anik Financial Services Private Ltd., Kotak Mahindra Finance Ltd. . . .” Thus, clause (g) of the definition clause of the lease agreement read with the letter dated February 2, 1995, leads to the conclusion that even before any documentation was prepared, the parties had agreed that there would be a sale by the RSEB of equipment to the assessee with a condition that the assessee would resell the equipment to the RSEB. In other words, the RSEB was under an obligation to purchase the equipment and that it had no option to refuse to purchase back the asset. If that is so, then there was no sale at all in the first place. Mr. Sahai clarified that his contention was that the lease agreement is in truth a conditional sale by the assessee to the RSEB under which the RSEB had no option except to purchase the asset, the purchase price being 20 per cent of the retained security deposit. In support of this contention, Mr. Sahai relied on the book by Benjamin on ”Sale”. When we asked him whether we can look into the letter dated February 2, 1995, when all the terms and conditions have been reduced into writing at a later date in another document, he clarified that it is permissible to look into the letter because the letter has been incorporated into the definition of the term “lessor” in the lease agreement. He also filed a copy of the order of the Mumbai Bench of the Tribunal in the case of CMIE where even though the lease document contained a clause that the lessor will take back the equipment on termination of the lease, it was held that the document embodied a sale, but “given the caption as agreement of lease”.

(C) Assuming that there is a valid lease by the assessee to the RSEB, to what depreciation would the assessee be entitled ?

Mr. Sahai referred to section 32(1)(ii) and submitted that in the case of any block of assets, depreciation is to be allowed at such percentage on the written down value thereof as may be prescribed. Section 43(6)(c)(i)(A) provides that the written down value, in the case of block of assets, shall be increased by the actual cost of any asset falling within that block acquired during the previous year. Section 43(1) defines “actual cost” to mean the actual cost of the assets to the assessee, reduced by that portion of the cost which has been directly or indirectly met by any other person or authority. Mr. Sahai referred to the judgment of the Delhi High Court in CIT v. Dalmia Dadri Cement Ltd. [1980] 125 ITR 510 and contended that actual cost does not mean fictional, inflated or deflated cost or a collusive cost, but it means what in reality and truth the asset had cost the assessee. In the present case, the cost estimated by the valuer (Choudhary and Associates) is an inflated cost as judged by the fact that the report is sketchy and does not contain the necessary details which are normally found in a valuation report. He referred to Explanation 3 to section 43(1) and contended that if the SLB transaction is ultimately found by the Tribunal to be genuine and not a subterfuge, the matter has to be remanded to the Assessing Officer with directions to him to examine the applicability of the said Explanation as was done by the Calcutta Bench in the case of Karam Chand Thapar and Bros. v. Deputy CIT [1998] 66 ITD 39. Explanation 3 says that where before the date of acquisition by the assessee, the assets were at any time used by any other person for the purposes of his business or profession and the Assessing Officer is satisfied that the main purpose of the transfer of the assets to the assessee was the reduction of a liability to income-tax by claiming depreciation with reference to an enhanced cost, the actual cost to the assessee shall be such an amount as the Assessing Officer, with the previous approval of the Joint Commissioner, may determine, having regard to all the circumstances of the case. When we pointed out to Mr. Sahai that this aspect of the matter does not appear to fall within the ambit of the question referred to the Special Bench, Mr. Sahai prayed that he may be given the liberty to raise this before the Division Bench, if so advised.

(D) Is McDowell [1985] 154 ITR 148 (SC) applicable to the facts of the case ?

Mr. Sahai contended that the rule laid down in McDowell [1985] 154 ITR 148 (SC) squarely applied in the present case since the entire documentation was got up only to claim enhanced depreciation in the hands of the assessee and to cover a pure finance transaction with the garb of a genuine SLB transaction. Two broad points were taken by him in support of the contention.

The first point was the valuation report of M/s. M. Choudhary and Associates. According to Mr. Sahai, the credibility of the valuation report is under serious doubt because of the following reasons :

(a) The report is not complete. The annexures are missing.

(b) There is no discussion in the report on vital issues such as original cost of the equipment, life of the equipment, date of purchase, etc.

(c) The valuation of the equipment is stated to have been carried out on a single day. It is impossible to carry out such a stupendous task in one day.

(d) The valuer has simply relied on information supplied by the staff of the RSEB without personally inspecting the equipment for valuation purposes.

(e) The credibility of Mr. Choudhary himself is in question as he has admitted before the income-tax authorities of ante-dating the valuation report in the case of Haryana State Electricity Board. Mr. Sahai referred in this connection to page 27 of the Department’s paperbook which is a statement given by Mr. Choudhary before the Income-tax Department. In answer to question No. 7 he has admitted that he had ante-dated the valuation report as required by the leasing company concerned (in the case before the income-tax authorities), that he did not visit the site where the equipment was located, nor did he physically inspect the machinery before issuing the valuation report.

(f) The amount shown as “market value” of the equipment has no relation to the intrinsic worth of the asset.

(g) Mere discussion of the principles of valuation, without demonstrating in the report as to how they were applied to the equipment concerned, has no purpose.

(h) It is not known as to how the residual value has been arrived at 20 per cent. of the amount of security deposit.

Mr. Sahai submitted that the above defects were not minor but flouted the very principles of valuation.

The second point made by Mr. Sahai, the learned Commissioner of Incometax (Departmental Representative), was that in all there were 151 leasing/ finance companies involved in SLB transactions during the same period and this by itself indicated that there was a concerted move between the various state electricity boards and leasing companies to adopt the cloak of SLB transactions in respect of a normal finance or loan transaction so that the leasing companies would reduce their profits by claiming depreciation on the leased assets. The electricity boards were not interested in the transaction beyond getting finance at a lesser rate of interest and therefore so long as this object was achieved, they were least interested in what form the transaction was put through and in this, viz., as to what form the transaction should take, they were fully guided by the leasing companies who had thought of the cloak of SLB transaction so that they would get the benefit of depreciation. Mr. Sahai submitted that the RSEB could not have really intended to enter into a SLB transaction which involved the risk of its assets being taken away by the leasing company. He drew our attention to the observations of the Calcutta Bench of the Tribunal in the case of Shaw Wallace and Co. Ltd. v. Asst. CIT (I. T. A. No. 674/Cal of 1998) where there are observations to support his claim. He also relied on the order of the Mumbai Bench of the Tribunal in Kantilal Manilal and Co. v. Deputy CIT [2002] 82 ITD 354.

Mr. Sahai drew our attention to Explanation 4A to section 43(1) and submitted that this provision, as explained in the memorandum explaining the provisions of the Finance (No. 2) Act, 1996, was intended to curb the mischief where the instrument of SLB has been used as a tax planning device to reduce tax liabilities. There have been cases where assets having nil or nearly nil written down value have been sold at higher prices especially where 100 per cent. depreciation allowance is admissible on those assets, and the buyer again claimed depreciation on these assets at the sale value. There have also been cases, as pointed out in the memorandum, where such SLB transactions have been effected at values much higher than the fair market value of the assets. In order to curb such transactions, i.e., where an asset has been sold and reacquired by an assessee by way of lease, hire or otherwise, it was proposed to make an amendment to the effect that in such cases the actual cost for the purpose of deduction of depreciation shall be the written down value at the time of transfer in the hands of the seller. While admitting that it may not be possible or proper to characterise all SLB transactions as colourable devices or subterfuges, Mr. Sahai submitted that even after the above Explanation was inserted, the power of the Department to examine whether the transaction is a real and genuine SLB or is a mere financing transaction is not taken away. If it is found to be a genuine SLB, actual cost will be computed as per the above Explanation. If on the other hand, it is found to be a mere financing transaction, the interest received will be taxed and section 32 will go out of the picture. The mischief sought to be curbed having been identified in the memorandum explaining the provisions of the Finance Bill, the Heydon’s [1584] 3 Co. rep. 7a rule requires that the same should be given due weight by recognising that such colourable practices did exist as devices to reduce the tax liabilities.

In the course of his arguments, Mr. Sahai filed a copy of the power of attorney executed by one, Mr. K. A. Shah on behalf of the assessee-company on April 4, 1995, in favour of the secretary, RSEB, authorising the secretary to sell the leased equipments to anyone including RSEB. According to Mr. Sahai, this clinched the issue in favour of the Department that there was no sale at all by the RSEB to the assessee. Mr. Patil, learned counsel for the assessee stated that he had no objection to the power of attorney being admitted and considered by us. He however drew our attention to the fact that a similar power of attorney has been considered by the Mumbai Bench of the Tribunal in the case of DGP. Windsor (India) Ltd. v. Deputy CIT [2002] 74 TTJ 291.

The above is the summary of the arguments of Mr. Sahai, the learned Commissioner of Income-tax (Departmental Representative) in support of the contention of the Department that no depreciation allowance is allowable to the assessee in respect of the equipment leased to RSEB.

Mr. Patil’s reply :

The following clarifications/points were made by Mr. Patil in his reply to the arguments of the learned Commissioner of Income-tax (Departmental Representative) :

(a) The SLB transaction cannot be branded as non-genuine just because there is a tax advantage since even in a genuine transaction the tax element is taken into consideration.

(b) There was a genuine financial crunch suffered by the electricity boards and they all found that finance leasing is the best suited method of borrowing monies because of low rate of interest. Therefore, they chose the format of SLB.

(c) The Legislature itself has accepted the existence of SLB transactions by not making Explanation 4A to section 43(1) retrospective.

(d) The word “notional” with reference to the sale of equipment by the RSEB to the assessee was used only in the agenda note submitted to the board of directors of the RSEB. It was not used in the resolution of the board or in the correspondence with the assessee. Therefore, the words “notional sale” must be considered to have been consciously discarded by both the parties. It was submitted that a loose expression coined in the agenda note should not be given undue weight.

(e) As regards the identification of the equipment, Mr. Patil filed a colour drawing of the air-pollution equipment and reiterated that the equipment was identifiable, that a price has been paid by the assessee for the same and constructive delivery was also taken and thus there was a completed sale thereof by the RSEB to the assessee.

(f) With reference to the letter dated February 2, 1995, written by the RSEB to the assessee on which heavy reliance was placed by the learned Commissioner of Income-tax (Departmental Representative), Mr. Patil pointed out that there was nothing in the lease document to show that the equipment was to be repurchased by the RSEB at the end of the lease period. Thus, it was contended, the so-called mandate given in the letter has been spurned by the assessee or if it is taken as an “offer” to the assessee, the same has been rejected. It was submitted that clause 12(g) of the lease agreement, when it refers to “mandate”, merely enables the identification of the lessor and nothing more can be read into the same. A definition clause, it was contended, does not control the operative part of the agreement.

(g) As regards the valuation report prepared by M/s. M. Choudhary and Associates, the following points were made by Mr. Patil :

(i) A personal inspection by the assessee is not a necessary requirement of valuation.

(ii) The correctness of the valuation is not before the Special Bench

(iii) The annexures to the valuation report were not available in any of the 151 cases where SLB transactions were involved. The report was a “master valuation” for all 151 cases. At any rate, annexures are only a matter of detail and the absence thereof does not affect the principle.

(iv) The departmental authorities did not examine Choudhary to seek justification for the valuation in the present case.

(v) The examination of Mr. Choudhary where he is stated to have admitted to ante-dating the report is in another case and not in the assessee’s case. There is no evidence to show that Choudhary did not carry out an inspection while preparing the valuation report in the assessee’s case. Further, no question had been put to Choudhary in the course of the examination regarding the present valuation report. Therefore the entire statement of Choudhary is irrelevant to the present case.

(vi) The surrounding circumstances may have to be looked into only if there is any ambiguity in the document as was the case in Sundaram Finance Ltd., AIR 1966 SC 1178 ; [1966] 17 STC 489 but if the document does not admit of any ambiguity then there is no need to do so. Further, the cited decision is to be confined to the facts of the case.

(vii) McDowell [1985] 154 ITR 148 (SC) is not applicable because—(a) legal effect cannot be refused to be given to the documentation in the present case on the simple ground that the motive is to avoid tax, (b) there is no evidence to show that the SLB transaction is colourable or a subterfuge, (c) income-tax considerations do play an important role in the business and there is nothing objectionable if while entering into a transaction, such considerations are kept in mind, and (d) the W. T. Ramsay’s [1982] AC 300 (HL) rule has been watered down considerably in England itself in Craven v. White [1990] 183 ITR 216 (HL) and McNiven [2002] 255 ITR 612 (HL).

(viii) The various orders of the Tribunal cited on behalf of the department are based on the facts and circumstances of those cases. For instance, in the case of Kantilal Manilal [2002] 82 ITD 354 (Mumbai), it was a case of a nongenuine transaction. In the case of Shaw Wallace (supra), the lease back bore a date which was even before the date of sale and the meters fixed in the buildings of consumers, which were the subject of lease, cannot be removed.

The above is the summary of Mr. Patil’s reply to the arguments made on behalf of the Department by Mr. Sahai.

ICICI Ltd.—Rival contentions

Contentions of the assessee :

Mr. S. E. Dastur, learned counsel for the assessee raised the following contentions :

(A) The ownership rights over the equipment (boilers) vest with the assessee

The terms of the lease agreement dated January 29, 1993, between the assessee and GEB were analysed and it was submitted that a reading of them as a whole showed that the assessee was the owner of the boilers. Clause 2.12 provides for the return of the boilers by GEB to the assessee at the end of the lease period at its own costs and expenses. There is reference to the return of the boilers in the lessee’s warranty’s clause (3.2). In clause 4.1 relating to lessee’s covenants there is reference to the delivery of the boilers back to the assessee in good order and condition. Again there is reference to return of the equipment to the assessee at the end of the lease period in clause (7.1). Thus, at least at four places in the lease agreement, there is a reference to the return of the boilers to the assessee on termination of the agreement indicating that the assessee is the owner of the boilers. As regards insurance of the boilers, the assessee has been described in clause 4.7 of the lease agreement as the owner of the asset and “loss payee” for its full replacement value. According to clause 4.8, the assessee is to receive the insurance proceeds in the event of any claim arising under insurance and in case GEB receives the same, it will hold the proceeds in trust. According to clause 4.12, the lessee (GEB) cannot deal with the boilers as owners thereof. The assessee could impose this condition upon GEB only by virtue of its rights of ownership of the boilers. Clause 4.13 says that GEB cannot make any alteration, addition or improvement to the equipment or change the condition thereof without the prior consent of the lessor in writing and all such additions, improvements and attachments, when made, whether at the cost of GEB and whether with or without the approval of the assessee, shall belong to the lessor (the assessee), and be deemed to be part of the equipment. This clause is a negation of ownership rights over the boilers being exercised by GEB. Clause 4.18 says that GEB will not claim deduction or allowance which is available to the assessee as the owner of the boilers under the Income-tax Act. Clause 6.6 says that as between the assessee and GEB and their respective successors in title the boilers shall remain personal property of and shall continue to be in the ownership of the assessee. The termination clause also shows that the ownership rights are with the assessee. The lease can be terminated if the lessee fails to pay the lease rentals within time or commits a breach of the terms of the agreement or if any representation or warranty made by GEB proves to be incorrect or if GEB does something which is likely to endanger the equipment by throwing it open to attachment, distraint, etc. In all such contingencies, the assessee, without any notice, shall be entitled to remove and repossess the boilers. The assessee shall also be entitled to sell, release or otherwise dispose of the boilers in such manner as it thinks fit without being bound to account to GEB in any manner whatsoever. This right available to the assessee is inconsistent with the position that what the assessee advanced was merely a loan because in the case of a loan, the creditor, when he enforces the security, is obliged to account for the proceeds to the debtor. Clause 9.1 gives the power of assignment to the assessee of any of its rights under the lease agreement and the assignee shall be entitled to the full benefit of such rights. In contrast, clause 4.12 prohibits the lessee (GEB) from assigning its rights/obligations or interest under the lease agreement and in general from dealing with the boilers as its own. Both the clauses read together show that the assessee is the owner of the boilers. In the schedule to the lease agreement, clause 7 says that depreciation allowance has been taken into account while fixing the lease rentals. The contention was that a mere taking into account of the taxation aspect while entering into the lease agreement is not “heinous” provided the means adopted are honest and not dubious.

(B) Valuation report

It was clarified at the outset that the valuation report in the case of ICICI Ltd. was not prepared by M/s. M. Choudhary and Associates and therefore whatever has been stated against the credibility of that firm of valuers should not be allowed to have any impact in the present case. The valuation report in the present case has been prepared by one Mr. S. C. Buch, Chartered Engineer, and the same is placed at pages 109 to 113 of the paperbook filed by the assessee. This valuation report gives the necessary details such as the description of the assets, their condition, basis of valuation, etc. It also contains the annexure. The valuation report shows that the two boilers have been valued at Rs. 60.60 crores as on March 31, 1992, as “realisation value”. These were sold by GEB to the assessee for Rs. 50 crores in January, 1993, after a period of nine months. Therefore, it is not a case of over-valuation at all. Our attention was drawn to the letter written by GEB on August 5, 1996, to the assessee confirming that the boilers are independent equipments and can be utilized for steam generation for the purpose of power generation on a “stand alone” basis. It was submitted that a valuation report is not decisive of the nature of the transaction. It is necessary whether the transaction is a lease or a simple loan. It was therefore contended that nothing turns on the valuation report alone. In the present case, all that the Assessing Officer has said about the valuation of the boilers is that the basis of the valuation at Rs. 50 crores was not made known to him and he had not made out any case to the effect that the figure of written down value (WDV) of the boilers in the hands of GEB at the time of the sale to the assessee was not furnished. The WDV at any rate, was not relevant for the purpose of determining the market value of the boilers and therefore there was no justification to expect the figure of WDV to be given in the valuation report. Further, the Assessing Officer has not invoked Explanation 3 to section 43(1). He has no case that the value of Rs. 50 crores is an inflated value.

The finance department of the Government of Gujarat issued a notification on February 1, 1993, and published the same in the Gazette, granting exemption to the sale of the plant and machinery to GEB by a registered dealer or by a lease finance company or financial institution, provided the GEB furnishes to the dealer or to the lease finance company or financial institution a certificate in the form appended to the notification declaring, inter alia, that the plant and machinery so purchased shall be used by GEB in the generation and public distribution of electricity. In the same Gazette, another notification was issued granting exemption from sales tax in respect of sale of plant and machinery by GEB to any lease finance company or financial institution, if the authorised officer of the GEB incorporates a declaration in the form appended to the notification in the bill or invoice issued by him in respect of the sale. The declaration in the prescribed form is as under :

“I……………………………………(name) ………………………(designation of the authorized officer of Gujarat Electricity Board) do hereby certify that the plant and machinery sold by the Gujarat Electricity Board to M/s. ……………………………. shall be taken on lease by the Gujarat Electricity Board from the lease finance company or financial institution for the use by the Gujarat Electricity Board in the generation and public distribution of electricity.” (rest of the form omitted as considered not necessary).

Our attention was then drawn to section 2(29) of the Gujarat Sales Tax Act, 1969, where “sale price” has been defined to include consideration received for the transfer of the right to use any goods for any purpose (whether or not for a specified period). Since the right to use goods is considered to be a sale and sales tax is chargeable, a lease is also liable to sales tax, but in view of the exemption given by the first notification, no sales tax is chargeable on the lease given by the assessee to GEB. The effect of these two notifications is that the sale of the boilers by GEB to the assessee is exempt from sales tax as also the lease of the boilers by the assessee to GEB. The exemption given by the sales tax law of Gujarat confirms the position that there was a genuine sale by GEB to the assessee and a genuine lease back of the boilers by the assessee to GEB. In the sales tax return filed by the assessee “under protest” for the year ended March 31, 1993, the assessee claimed exemption from Gujarat sales tax in respect of the lease rentals of Rs. 1,18,25,000 received by it from GEB. This was consistent with the first notification issued by the Government of Gujarat.

(D) How the equipment is exhibited in the assessee’s accounts

Mr. Dastur drew our attention to page 144 of the paperbook which is the schedule of fixed assets, forming part of the assessee’s accounts for the year ended March 31, 1993, to point out that the boilers leased out to GEB were shown as part of the additions of Rs. 16,366.20 lakhs to the plant and machinery under the heading “Leased assets”. He clarified that the assets of the value of Rs. 69 crores relating to the SLB transaction were included in this figure. He also filed the details of the assets acquired during the year ended March 31, 1993. Note No. 4(ii) at page 144B of the paper-book says that depreciation on assets acquired during the course of leasing business is provided on straightline method. At page 144A, note No. 12(a) confirms the method followed for providing depreciation and clarifies that the rates are as per the basis of the primary period of lease, as stated in the lease agreements or at the rates prescribed in Schedule XIV of the Companies Act, 1956, whichever is higher.

(E) Did GEB claim depreciation in respect of the boilers ?

It was pointed out that GEB did not claim depreciation on the boilers in its income-tax assessments and that this was confirmed by its letter dated July 30, 1996, written to the assessee (page 146 of the paperbook). Attention was also drawn to page 152G of the paperbook, which is a copy of the statement of Mr. P. K. Das, General Manager (Finance), GEB recorded under section 131 of the Income-tax Act on March 21, 1996, by the Deputy Commissioner of Incometax, Special Range 36, Mumbai. In this statement, in answer to question No. 3, he has stated that in the books of GEB, depreciation was provided and was being provided till date for the purpose of arriving at the actual profit or loss for the year in terms of the provisions of section 59 read with section 63 of the Electricity (Supply) Act, 1948, and that however while working out the taxable income of the Board, a decision was taken to add back the realised value of the assets sold to their net block according to the Income-tax Act and not to claim any depreciation on the assets obtained on lease. We were also referred to an earlier letter dated March 20, 1996, written by GSEB to the Assessing Officer wherein it was clarified that the accounting treatment and the treatment for income-tax given by GEB in respect of depreciation on the boilers are different. Whereas depreciation has been provided in the accounts, the same has been added back for purposes of income-tax. This letter has been made annexure-VI to the assessment order. Reference was also made to the assessment order passed in the case of GEB under section 143(3) of the Act, a copy of which is placed at pages 153-160 of the paperbook. In para 12 of this assessment order (page 158 of the paperbook), there is reference to the fact that no depreciation has been claimed on the assets taken on lease as they have been deducted from the additions made to the plant and machinery during the year and to the fact that the claim has been verified by the Assessing Officer and the written down value of the assets were revised and depreciation calculated and allowed accordingly. The computation of the income shows that depreciation has been added back to the surplus as per the revenue account. The lease rent interest of Rs. 7,39,87,444 has also been added back. The lease rent of Rs. 21,19,81,845 has been allowed as a deduction. It was further submitted that generally electricity supply companies have to follow the Electricity (Supply) Annual Accounts Rules, 1985, under which depreciation on lease hold assets has to be charged every year in the accounts in such amount as is required to write off 100 per cent. (unlike 90 per cent. for other assets) of the cost of lease hold asset, on a straightline method (para 2.61 and para 3) (pages 151 L and 151 N of the paperbook). Thus so far as the assessee is concerned, the fact that GEB provided for depreciation in respect of the leased assets is not fatal to its claim. It was thus claimed that no depreciation was claimed on the leased assets by GEB, which supported the assessee’s stand that GEB was no longer the owner of the assets.

(F) Clarification on GEB’s statements made in its annual accounts

Annexure V to the assessment order is the photocopy of paragraph 22 of the annual statement of accounts for the year ended March 31, 1993 of GEB. In this paragraph, it has been stated as under :

“The board has availed finance under lease finance arrangements from various institutions and under the said arrangements, the leased assets will get transferred to the board on the expiry of the lease period on payment of terminal value ranging from 1 to 2 per cent. of the original cost of the relevant assets. Accordingly, the board’s financial obligations under the lease arrangements have been provided as liability in the books of account and correspondingly the leased assets are taken under the block of fixed assets. Depreciation has also been provided for on the leased assets for the use of these assets.

Having recognised position of lease arrangements and associated terms and conditions thereof and the principle followed as stated above, the lease rentals payable by the Board in instalments to the leasing company have been provided towards charges for interest and balance towards the liability for the assets on lease. (Statement 1, Schedule 12, Statement 3, Schedule 19, Schedule 21 and Schedule 32).”

The Assessing Officer has therefore raised the question as to why did GEB say that the leased assets will come back to it, when all along the claim of the assessee has been that there is no such provision in the SLB arrangement. He would appear to have started the enquiry by the letter dated March 4, 1996. Mr. Dastur has drawn our attention to GEB’s letter dated July 26, 1996, addressed to the assessee (page 147 of the paperbook), which confirms that “the lease agreement dated January 29, 1993, entered into between GEB and ICICI does not provide for transfer of assets back to GEB on the expiry of lease period and on payment of residual/terminal value at predetermined rates” and clarifies that paragraph 22 of the annual statement of GEB relied on by the Assessing Officer “is a general statement and does not refer to the lease transaction entered into with ICICI.” On the basis of this letter, it was contended that the statement relied on by the Assessing Officer is not applicable to the lease transaction entered into between GEB and the assessee.

(G) Relevance of AG’s audit of GEB’s accounts

This aspect was brought to our notice by Mr. Dastur vis-a-vis the Assessing Officer’s reliance on the fact that GEB had provided for depreciation in its accounts in respect of the leased assets. The accounts of GEB are subject to audit by the Accountant General (Audit)-I, Gujarat. Our attention was drawn to his audit certificate on the assessee’s accounts for the year ended March 31, 1996, extracts from which are placed at pages 151AA, 151BB, 152 and 152A of the assessee’s paperbook. Paragraph B. 42 of the audit certificate is under the caption “Notes on accounts”. Item (ii) under this caption is as under :

“A reference is invited to item No. 10 of this statement wherein it was stated that the leased assets will get transferred to the board on the expiry of the lease period. This note is factually incorrect inasmuch as there are no stipulation in the lease agreements to transfer the assets on expiry of lease period except for the assets worth Rs. 57.68 crores. The argument of the Board that this has been mentioned in the offer letters of the leasing companies is not acceptable as it is not provided in the final agreement.”

It was clarified by Mr. Dastur that note No. 10 referred to above is the same as note No. 22 appended to the accounts of GEB for the year ended March 31, 1993, which we have extracted earlier. The contention was that the remarks of the AG with reference to note No. 10 of the accounts for the year ended March 31, 1996, are equally applicable to note No. 22 to the accounts for the year ended March 31, 1993. The Assessing Officer has placed strong reliance on the note in support of his contention that the leased assets will get compulsorily sold to GEB and nobody else, on termination of the lease period. To counter this, Mr. Dastur has relied heavily on the remarks of the AG. According to him, the AG’s understanding of the lease agreements should prevail, and his criticism of the GEB’s view of the lease agreements must be considered valid because he is an independent authority whose duty it was to conduct an audit of the accounts of GEB. The AG has found fault with GEB’s understanding of the lease agreements to the effect that the leased assets will get transferred to it on the expiry of the lease period. Such an erroneous understanding, according to the AG, was generated by the offer letters only. Such a stipulation did not find a place in the final agreement.

Thus, according to Mr. Dastur, note No. 22 to the annual accounts of GEB for the year ended March 31, 1993, is contrary to—(a) the express provisions of the lease agreement, (b) the letter written by GEB itself to the assessee on July 26, 1996, (c) the understanding of the AG, of the lease agreements, and (d) an affidavit dated August 16, 1996, filed by one Mr. Rajendra M. Desai, Deputy Zonal Manager of the assessee, incharge of leasing activities (page 116 of the paperbook).

(H) Book treatment not decisive

Mr. Dastur next contended that the treatment given to a transaction in the books of account of the assessee was not decisive of its nature for the purposes of taxation ; “a fortiori”, the treatment given by GEB in its accounts which cannot bind the assessee. He relied on the following judgments/orders :

(a) United Commercial Bank v. CIT [1999] 240 ITR 355, 367 (SC) ;

(b) Hoshiarpur Electric Supply Co. v. CIT [1961] 41 ITR 608, 610 (SC) ; and

(I) What is the view of the CBDT with regard to SLB transactions ?

The Central Board of Direct Taxes’ letter dated January 23, 1996, addressed to the FICCI/CII/ASSOCHAM/ICAI/Association of Leasing and Financing Companies inviting suggestions for taking corrective measures to deal with colourable leasing arrangements which were used as mere tax planning devices by shifting losses from one person to another, were invited. An approach paper was enclosed to the letter which went under the heading “Tax treatment for leasing business”. The approach paper stated that the mischief sought to be remedied was that in certain cases 100 per cent. depreciation has been claimed on non-existent assets by the lessor and in some instances companies have sold assets worth negligible value for substantial consideration and took them back on lease. All these assets were entitled to a higher rate of depreciation, usually 100 per cent. The board had analysed such arrangements and have found that they worked only with the purchaser of an asset or a person requiring finance when he is having losses from business. Three possible remedies were suggested in the approach paper and they are—(1) to prescribe a separate depreciation rate of 25 per cent. for assets given on lease or hire, (2) to treat financing leases as financing arrangements and prescribe a variable rate of depreciation for the leased asset which is in consonance with the schedule of lease rentals, and (3) to go by the economic substance of the financing leases, ignoring the legal ownership. Here, the lessor is deemed to have given a loan and the lessee would capitalize the assets at its initial cost or cash price and be entitled to depreciation. The approach paper went to suggest a strict treatment in respect of finance leases. According to it, a lease may be considered to be a finance lease if any one of the following conditions are satisfied :

(1) The lease transfers the ownership of the asset to the lessee by the end of the lease term. This is nothing but hire purchase.

(2) The lease contains a bargain purchase option.

(3) Had the lessee owned the asset, 75 per cent. or more of the initial value (actual cost or WDV) of the asset would have been available as depreciation.

(4) The present value of minimum lease payments (lease rentals + guaranteed residual value) at the beginning of the lease term is 90 per cent. or more of the initial value. The rate of interest taken here is the highest rate of interest at which the lessor has taken loan from a bank or financial institution. In the absence of this information, a rate of 20 per cent. is to be taken.

According to Mr. Dastur, in order to put into effect the approach paper (as the Assessing Officer wants to), the rules framed under the Income-tax Act must provide for it, thus giving authority to the Assessing Officer to do so. No such authority has in fact been given. Therefore, at best, the approach paper can be looked at only for the purpose of ascertaining what are the evils that were sought to be remedied and what remedial actions were proposed to cure them. It was also submitted by him that the approach paper also recognised that the tax treatment did not differ depending upon whether the transaction embodied a finance lease or an operating lease.

Instruction No. 1978, dated December 31, 1999, was issued by the Central Board of Direct Taxes suggesting guidelines for investigation in the case of finance lease agreements. Paragraphs 4(v) and (vi) are part of the enquiries which have been suggested in the cases of SLB transactions. In these paragraphs, it has been suggested by the board that the Assessing Officer should examine the sale price of the asset to ensure that the sale is not effected at an exaggerated price. In such a case the applicability of Explanation 3 to section 43(1) should be examined. If necessary, to determine the correct fair market value of the asset, the valuation may be referred to the departmental valuer. It has also been suggested that the Assessing Officer should invoke the provisions of Explanation 4A to section 43(1) whereunder the depreciation is allowed to the lessor at the WDV of the asset in the hands of the lessee at the time of the transfer. These instructions issued by the board show that SLB transactions as such are not to be disapproved but are only to be regulated by the assessing authorities.

Circular No. 2 of 2001 (see [2001] 247 ITR (St.) 53), issued on February 9, 2001 refers to Instruction No. 1978 dated December 31, 1999, and says, in paragraph 2, that “in cases of sale and lease-back of assets without any alteration in the situation of assets and its working, the denial of depreciation claimed has to be considered keeping in view the principle laid down by the Supreme Court in the case of McDowell and Co. Ltd”. Mr. Dastur’s argument was that there is no basis for this view of the board because by definition a SLB transaction does not involve a change in the situation of the assets. Since the circular is adverse to the assessee in the sense that it refuses to recognise one of the basic features of a SLB transaction, it can have no effect in the assessment as held by the hon’ble Bombay High Court in Tata Iron and Steel Co. Ltd. v. N. C. Upadhyaya [1974] 96 ITR 1, 17.

(J) What is the reaction of the Legislature ?

The reaction of the Legislature, according to Mr. Dastur, to the evils brought to its notice, is the insertion of Explanation 4A to section 43(1) by the Finance (No. 2) Act, 1996, with effect from the assessment year 1997-98. The amendment was made from October 1, 1996, but the first assessment year from which it was to take effect was the assessment year 1997-98. The effect of the Explanation is that for the purposes of depreciation allowable in the hands of the lessor, the actual cost shall be the same as the WDV of the assets at the time of sale thereof by the lessee. When we know the evil sought to be remedied and the remedial provisions, it can hardly be suggested that the Assessing Officer shall disallow the claim of depreciation in the lessor’s hands. Mr. Dastur contended that when a specific tool is given to the Assessing Officer in the form of a statutory provision to tackle a particular situation, the Assessing Officer can use that tool only and none else. He cannot try to over reach the statutory provision by disallowing the depreciation in toto. If the WDV of the asset in the hands of the lessee at the time of the sale to the lessor is not known, then the same has to be ascertained in accordance with the principles laid down by the Allahabad High Court in Nathu Ram Premchand v. CIT [1963] 49 ITR 561 and by the Bombay Bench of the Tribunal in Balaji Textile Industries (P.) Ltd. v. Third ITO [1994] 49 ITD 177.

(K) Is Explanation 4A to section 43(1) retrospective ?

According to Mr. Dastur, learned counsel for the assessee, it is not retrospective since it does not specifically say so. According to paragraph 29.2 of the memorandum explaining the provisions of the Finance (No. 2) Act, 1996, the Explanation will apply in respect of SLB transactions made on or after the first day of October, 1996. Since the provision has not been expressly made retrospective and having been made expressly prospective, it cannot be applied with retrospective effect. A query was posed by the Bench as to whether a provision intended to remove a difficulty cannot be read as retrospective in nature, though not expressly made so, particularly because of its curative nature, to which Mr. Dastur replied that “when Parliament has devised a particular instrument to tackle a particular issue and did not apply other instruments which were available, the judicial process cannot apply another instrument to tackle the same issue”. In other words, what he contended was that it was open to the Legislature to totally derecognise SLB transactions in which case no depreciation would be available to the lessor ; it was also open to the Legislature to ignore the legal ownership of the assets and go by the economic substance of financing leases and accordingly provide that depreciation would be available in respect of leased assets only to the lessee who actually uses the assets and thus deny any depreciation allowance to the lessor. But these two options were not accepted by the Legislature and therefore the only way open to the income-tax authorities is to ascertain the written down value in the hands of the lessee when the lessee sold the assets to the lessor and allow depreciation in the assessment of the lessor on that basis, irrespective of the actual cost of the asset to the lessor.

(L) Inconsistent stand of the Department

It was pointed out that the Department has adopted an inconsistent stand inasmuch as in the assessment of GEB the lease rentals have been allowed as a deduction thus recognising the position that it is a lessee, but a different stand is adopted in the assessee’s case who is the lessor, thus refusing to recognize one part of the same transaction which is wholly unjustified. Two decisions were cited to show that such an inconsistent position cannot be taken by the income-tax authorities :

(1) Tribhovandas Bhimji Zaveri v. Asst. CIT [2001] 247 ITR 727, 732-734 (Bom) ; and

(2) M. V. S. Kathirvelu Nadar v. CAIT [1968] 68 ITR 786 (Mad).

(M) Is Explanation 3 to section 43(1) applicable ?

The initial objection of Mr. Dastur was that the question referred to the Special Bench does not cover this aspect and therefore cannot be gone into. He however submitted that if the Assessing Officer had felt that the actual cost of Rs. 50 crores paid by the assessee was excessive, he could have invoked this Explanation and reduced the figure of actual cost in the manner provided in the Explanation, but in any case the Assessing Officer cannot ignore the lease transaction and consider it as a simple loan. If the figure of written down value was required, the Assessing Officer was free to get the same either from the assessee or GEB and if it was not forthcoming, he could have worked it out himself as he had the figure of actual cost before him, and the year in which the boilers were purchased were also available to him. It was thus possible for him to have invoked Explanation 3 and arrived at a fair cost of the asset after taking the necessary approval of the Joint Commissioner as contemplated by the Explanation. But instead of following this procedure, the Assessing Officer took the view based on McDowell [1985] 154 ITR 148 (SC) that the assessee is not entitled to any depreciation. Consistent with this view, he could not have referred the valuation to the Valuation Officer of the Department as such a step would have been quite unnecessary. At this juncture, it was put to Mr. Dastur whether it was not open to the Tribunal, if it considers it proper and necessary, to direct the Assessing Officer to refer the matter of valuation as contemplated by the Explanation. Mr. Dastur’s reply was that the Tribunal would be going beyond its jurisdiction if such a direction is given. According to him, the Explanation only gives the Assessing Officer a power, which is not to be equated with the “prescription of law” as in Explanation 4A where the mandate is that the actual cost of the transferred assets shall be the same as the written down value of the said assets at the time of transfer thereof by the lessee. (to the lessor). (underlining ours).

(N) The requirements of a valid sale are satisfied

In the course of his arguments, Mr. Dastur contended that the requirements of a valid sale were satisfied in the present case when GEB purported to sell the boilers to the assessee. He drew our attention to section 19(1) of the Sale of Goods Act, which says that passing of property in the goods is a matter of intention of the parties, such intention to be gathered, according to section 19(2), from (1) the terms of the contract, (2) the conduct of the parties, and (3) the circumstances of the case. Section 19(3) says that if the intention of the parties cannot be gathered in accordance with section 19(2), only then can the set of rules prescribed for the purpose in sections 20 to 24 can be applied. Section 2(14) defines “specific” goods or “ascertained” goods as goods which have been identified and agreed upon by the parties. In the assessee’s case, the two high efficiency boilers have been identified and agreed upon by GEB and the assessee and therefore it is a case of specific goods. This aspect, viz., that the boilers were identified, according to Mr. Dastur, has not been doubted by the Assessing Officer. The intention of the parties was clear from the sale deed which constitutes the terms of the contract. The delivery of the goods can be constructive or symbolic under the Sale of Goods Act and in the case of a SLB transaction, delivery need not be actual—in fact, it was contended that it is always constructive. The ratio laid down by the Supreme Court in J. B. Boda and Co. (P.) Ltd. v. CBDT [1997] 223 ITR 271-277 that an empty formality need not be followed and the transaction cannot get invalidated because such an empty formality was not followed, should be adopted in such cases and there should be no insistence on the empty formality of physically handing over delivery on sale and again physical redelivery on lease back.

It was thus contended by Mr. Dastur that there was a valid sale of high efficiency boilers by GEB to the assessee in the first instance.

Case-law :

In the course of his arguments, Mr. Dastur, learned counsel for the assessee took us through several authorities, a few of which were heavily relied upon by him. We shall now notice them :

(1) 20th Century Finance and Consultancy Services Ltd. v. Khanna Rayon Industries Ltd. (judgment of the Bombay High Court dated October 24, 1991 in Notice of Motion No. 1026 of 1991 in Suit No. 1092 of 1991) (single judge).

This judgment recognizes the lease finance and holds that the property in the assets leased out remains with the lessor. It recognizes the fact that several new developments have taken place in the commercial life of the community and that there are certain global aspects of lease financing which have grown with the change of times during the recent decade. Lease financing has been accepted as a norm in the business world and its incidents are well settled.

(2) Judgment of the single judge of the Bombay High Court in Development Credit Bank Ltd. v. Prakash Industries Ltd. dated September 16, 1998, in Notice of Motion No. 2346 of 1998 in Suit No. 3196 of 1998.

The short question which arose for consideration in this case was whether a lease agreement constituted a financial agreement and not a lease agreement in fact. After analysing the various terms and conditions of the lease agreement, it was held that the document was in fact a lease and not mere financial arrangement. It was noticed that the benefit of depreciation was given to the bank which was the lessor and but for this benefit, the rent charged would have been much higher. On a prima facie view of the clauses of the lease agreement, the hon’ble High Court came to the conclusion that the lessor bank was the owner of the leased assets and that there was no other document on record to show that the bank was not the owner. The invoices read with the delivery challan showed that the purchase price has been paid by the lessor bank.

(3) Prakash Industries Ltd. v. Development Credit Bank Ltd. (judgment of the Division Bench of the Bombay High Court dated January 28, 1999).

The judgment of the hon’ble single judge was affirmed on appeal. The contention of the lessee-appellant was that it was only as a security for the advances made by the lessor-respondent that the properties were purchased in the name of the lessor, though they were purchased exclusively for the use of the appellant. The Division Bench of the hon’ble Bombay High Court reading the agreement in its entirety, held that there was no doubt that in law and in substance, the machinery belonged to the lessor-bank (respondent in the appeal) and was leased to the lessee-appellant on mutually agreed terms. The ownership of the machinery vested with the bank. The court recognised that it must construe the true effect of a transaction from the terms of the agreement considered in the light of the surrounding circumstances. In this connection, the decision of the Supreme Court in Sundaram Finance Ltd. v. State of Kerala [1966] 17 STC 489 was referred to and the test laid down in that decision were applied. The hon’ble Bombay High Court examined the conduct of the parties as well as the correspondence on record and came to the conclusion that the ownership of the machinery vested with the lessor-bank and it was only leased to the lessee-appellant on certain terms and conditions and was to be returned to the bank on the expiry of the lease period. Thus, the judgment of the hon’ble single judge was affirmed.

This judgment has become final, the special leave petition filed against the same by Prakash Industries Ltd. having been dismissed by the Supreme Court by the order dated May 11, 1989 (copy placed at page 556 of the paperbook).

Mr. Dastur filed a chart showing the similarity in clauses between the lease agreements entered into in the cited cases and the assessee’s case which has been taken on record.

(4) Sundaram Finance Ltd. v. State of Kerala [1966] 17 STC 489 ; AIR 1966 SC 1178.

This case is distinguishable from the assessee’s case on facts. The controversy before the Supreme Court was not whether there was a lease of the motor vehicles by Sundram Finance to the customer. The controversy was whether the transaction was merely a financing transaction or it was a sale of the motor vehicle by Sundaram Finance to the customer in view of the documentation executed by the parties. The majority opined that the documentation such as the sale letter executed by the customer in favour of Sundaram Finance was a mere formal document which was not made effective. Therefore, it was held that there was initially no sale at all by the customer to Sundaram Finance so that it can be said that there was sale of the vehicle by Sundaram Finance back to the customer. When the documentation is ignored, the transaction was only a financing transaction. This case, according to Mr. Dastur, did not involve a lease at all. Therefore, the propositions laid down therein in no way militate against the assessee’s contention that what was executed by it in favour of GEB was a genuine lease document.

(5) Yorkshire Railway Wagon Co. v. Maclure [1882] 21 Ch D 309 (CA).

We have already referred to this judgment in some detail in the context of Mr. Dastur’s arguments regarding applicability of McDowell [1985] 154 ITR 148 (SC). It is therefore not necessary to discuss the facts of this case in detail now. The decision was pointed out to us, firstly, for the purpose of showing that a SLB transaction has been in vogue even in the late 19th Century, and secondly, to show that in that case even though the course of events was changed midway between the two companies so that a loan was possible only on the basis of a SLB arrangement on the basis of advise of counsel, but still it was held that the sale and hire back arrangement must be given effect to and cannot be considered to be a sham. It was held that the sale and hire back arrangement was the real transaction in the sense that the parties meant it to operate according to its tenor as comprised in the deeds and was not intended by them as a mere blind or cloak for something behind. The transaction was also not an illegal transaction nor prohibited by any Act of Parliament. It was submitted that this decision actually supports the present arrangement.

(6) CMIE v. Deputy CIT (I. T. A. No. 3820/Bom of 1990 dated April 19, 1996).

It was submitted that this decision can no longer be applied as it was contrary to the judgment of the hon’ble Bombay High Court in the case of Prakash Industries Ltd. v. Development Credit Bank (supra). Even otherwise in the case before the Tribunal, there was no allegation of any malpractice or subterfuge and therefore, there was all the more reason why it should have been decided otherwise. Further, the order of the Delhi Bench of the Tribunal in Oriental Leasing Co. v. Deputy CIT [1996] 55 TTJ 294 which was decided earlier was not pointed out to the Mumbai Bench. The Delhi Bench has pointed out the circumstances under which an agreement could be treated as non-genuine.

(7) Peacock Chemicals (P.) Ltd. v. Deputy CIT [1995] 51 TTJ 264 (Delhi) affirmed in CIT v. Peacock Chemicals (P.) Ltd. [2000] 241 ITR 305 (Delhi).

(8) Shaw Wallace and Co. Ltd. v. Asst. CIT (I. T. A. No. 674/Cal of 1998).

This order is based on the special facts of the case such as the fact that the electric meters which were the subject matter of lease cannot be removed at all. It was on those facts that the Tribunal held that in reality, a loan transaction was passed off as a genuine SLB transaction. That situation does not obtain in the present case. Further, in this order the Calcutta Bench refers to the judgment of the Delhi High Court in the case of Goyal Gases (P.) Ltd. v. CIT [1997] 227 ITR 536. In the judgment there is a reference to the commonality of management between the two entities which was considered to be one of the factors against the assessee in that case. Such a situation does not obtain in the present case. Further, in the case of Goyal Gases (P.) Ltd. [1997] 227 ITR 536 (Delhi), the finding of the Tribunal was that the transaction had the colour of a mere paper transaction.

(9) PKF Finance Ltd. v. Joint. CIT (ITA No. 533 (ASR) of 1999—Amritsar Bench).

This is not a case of a sale and lease back transaction at all. The facts are completely different and therefore the order is not applicable.

(10) Braithwaite and Co. (India) Ltd. v. CIT [1978] 111 ITR 542 (Cal) (at pp. 560-561).

Contentions of the Department :

Mr. Girish Dave, the learned Commissioner of Income-tax (Departmental Representative), put forth the following contentions :

(A) Applicability of McDowell

Mr. Dave submitted that the income-tax authorities, contrary to what was contended on behalf of the assessee, have not attempted to rewrite the lease agreement for the parties. According to him, they have only attempted to examine the genuineness of the SLB transaction, which was well within their right. He filed a statement to show that all the assets of GEB were leased out in the subsequent year and wanted us to look at this aspect of the matter as a whole, which according to him, would reveal “a deeper malady” which is to be curbed. Of course, Mr. Dastur, learned counsel for the assessee objected to the statement being filed. Mr. Dave drew our attention in this behalf to the judgment of the Gujarat High Court in Wood Polymer Ltd., In re [1977] 109 ITR 177, particularly the observations at pages 182 and 184 to show that a scheme of compromise was rejected by the court on grounds of tax avoidance despite there being no objection from anybody and that the court refused to accord its sanction to a subterfuge adopted by the parties as it was against public interest to do so. Mr. Dave appealed to us to keep this spirit behind this judgment in view while deciding the present case and submitted that if it is found that the parties before us had adopted a subterfuge or colourable device aimed at tax evasion, the same should be curbed strongly. Countering the argument of the assessee, he pointed out that the observations of the Supreme Court in McDowell [1985] 154 ITR 148 regarding tax avoidance are not obiter, but they were guidelines to be followed by all the subordinate courts and Tribunals, wherever the question of tax evasion arises. Reliance was placed on the order of the Mumbai Bench of the Tribunal in Deputy CWT v. Ashwin C. Shah [2002] 254 ITR (AT) 90 at 103 where it was held that even the obiter of the Supreme Court was binding on the Income-tax Appellate Tribunal. He submitted that the observations made in McDowell [1985] 154 ITR 148 (SC) were not confined to a pre-ordained series of transactions, but were applicable generally to cases where a subterfuge or colourable device or dubious methods are practiced for the purpose of tax evasion.

(B) Are attributes of commerce present in the transaction in question ?

Mr. Dave took this point for examination under three broad divisions. The first was the sale of the two high efficiency boilers by GEB to the assessee. He filed a copy of “extracts from a book titled Electrical Engineering by M. Handa and A. Handa, 1995 reprint edition, and drew our attention to page 268 of the book where the boilers are described as follows :

“Boilers. High steaming rates at higher pressures steam call for careful designing of boilers. A power station has to operate continuously for longer periods of time, hence boiler must be available for longer period without need for shut downs on account of break downs or repairs. On one hand, a boiler furnace must have high temperature to heat the water, at the same time, the gases discharged through chimney must have low temperature (to minimise losses) and least pollution producing gases. This calls for incorporating rapid heat transfer devices. The boilers in modern power plants are water tube boilers with water walls. In addition to these super heaters, reheaters and economizer are installed to utilize maximum possible heat available inside the furnace. Furthermore, higher steaming rates require high flow velocities of water, steam, flue gases, etc., with adequate controls and safety devices.”

From this extract, Mr. Dave endeavoured to show that a boiler is a permanent fixture of a power plant and cannot be shut down even for a short period without interruption to the power generation. In this situation, can it at all be imagined that GEB which was to generate and supply power to the State of Gujarat contemplated the selling of two high efficiency boilers to the assessee ? He further referred to copy of invoice at page 84 of the assessee’s paperbook which described the equipment sold as “supply of specialised high efficiency boiler package for Units I and II of Kutch Lignite Power Station, Panandhro”. From the description, it is clear that the boiler which is attached to the earth for its functioning, was not agreed to be severed from the earth and therefore they cannot be considered “goods” under section 2(7) of the Sale of Goods Act. Accordingly, there was no question of a symbolic delivery. Section 3 of the Transfer of Property Act defines the words “attached to earth” as “rooted in the earth, attached to what is so embedded”. Section 3(26) of the General Clauses Act defines “immovable property” to include land, benefits to arise out of land and things attached to the earth, or permanently fastened to anything attached to the earth. The contention of Mr. Dave therefore was that boilers were immovable property since they are either (a) themselves attached to the earth, or (b) attached to something that is embedded to the earth. Reference was made to the judgment of the Allahabad High Court in CST v. Prahlad Industries [1999] 112 STC 548. In this judgment, it was held that the plant and machinery which were attached to the earth were immovable property and cannot be considered as “goods” within the meaning of section 2(d) of the U. P. Trade Tax Act, 1948. There was also no agreement between the parties that the lessee of the factory was entitled to sever the goods fastened to the earth.

The second division under this aspect examined by Mr. Dave was the events leading upto the execution of the lease deed which disclose the real intention of the parties. He drew our attention to the proceedings of the GEB in connection with the lease arrangement with ICICI which are at pages 18 to 21 of the Department’s paperbook No. 1. It was pointed out that the proceedings are in a standardized form which is quite unusual and showed that it was gone through mechanically and formally. It was pointed out that though the lease agreement is dated January 29, 1993, the purchase order is dated February 2, 1993, which means that even before the assessee became the owner, it leased out the boilers. This by itself is sufficient to expose the hidden designs which motivated the parties to give the transaction the form of a SLB transaction. Mr. Dave also drew our attention to pages 5, 8 and 10 of the Department’s paperbook No. 1 to buttress his point. Page 5 is the declaration required to be given by GEB in the prescribed form pursuant to the notification issued by the Finance Department in the Gazette on February 1, 1993, which we have already referred to earlier. This declaration is dated May 10, 1993. Page 8 is also a declaration to be given by GEB as required by the other notification issued by the Finance Department and published in the Gazette on the same day. This declaration is however not dated. Page 10 is a letter dated February 23, 1993, written by GEB to the manager (leasing) of the assessee-company, acknowledging that GEB has availed of lease finance from the assessee to the tune of Rs. 50 crores against sale and lease back of boiler package at KLPS, Panandhro. It was stated in the letter that at the initial stage, the certificate of the chartered accountant provided to the assessee contained only the basic price of the equipment which worked out to Rs. 53.56 crores. The letter goes on to say that GEB have “now worked out detailed calculation showing the gross cost (inclusive of taxes and duties), which works out to Rs. 59.05 crores” and that a certificate dated February 22, 1993, from a firm of chartered accountants to this effect was enclosed to the letter. Finally, the letter contains a request to the assessee-company “to kindly consider sale and lease back for the total cost of the equipment”. The argument of Mr. Dave, is that the purpose of this letter was only to upwardly revise the value of the boiler package and did not serve any other purpose. It was written on February 23, 1993, just two days before the release of funds by the assessee. It shows that what really took place was an arrangement for the grant of a loan on sufficient security and not a genuine SLB transaction. The offer letter does not show anything about the SLB arrangement.

The third division under which the question was presented was by an ana lysis of the various clauses of the lease deed. In fact, the analysis also helps, according to Mr. Dave, in gathering the real intention of the parties, which according to him, was only that this was to be a case of simple financing agreement and not a SLB arrangement. He prefixed this part of the argument with a reference to the judgment of the Supreme Court in Sundaram Finance Ltd. [1966] 17 STC 489 and the judgment of the Supreme Court in CIT v. Panipat Woollen and General Mills Ltd. [1976] 103 ITR 66. In these cases, it has been held that the intention of the parties must prevail over the words used. Having said that, Mr. Dave referred to the fact that the lease was renewable at the option of GEB after the primary period of five years and during this period, it cannot be terminated. The option was available only to GEB and not the assessee. The first lease deed has to be read with the subsequent renewal agreements to find out the real intention of the parties. Clause 2.4 of the lease deed expressly makes the lessee (GEB) responsible for the delay on the part of the manufacturer. Thus, the lessee’s liability starts even before the delivery of the equipment and this is consistent only with the position that it is a finance transaction and not a SLB transaction. Clause 2.5 provides for payment of interest by the lessee for the delay in the commencement of the lease. This is so because it is only a loan. Clause 4.9 provides that the lessor may at its option decide that any insurance proceeds received in respect of the equipment shall be applied in making good the damage or in replacing the equipment or part thereof by other similar equipment. In the event of irreparable loss or damage, the lessor shall be entitled to terminate the agreement and retain the insurance proceeds. According to Mr. Dave, this clause shows that the assessee is not interested in the asset, but was interested only in the proceeds of insurance. Clause 4.12 which says that the lessee cannot deal with the equipment as its own was a totally irrelevant clause. Clause 4.15 which says that the lessee shall not sell, mortgage, etc., or otherwise dispose of the land or building in which the equipment is installed without giving the lessor prior notice in writing. Any such sale or mortgage, etc., shall in any event be subject to the rights of the lessor as the owner of the equipment to repossess the same at any time. This clause, according to Mr. Dave, is not consistent with the situation that the boilers did not in the first place move from GEB to the assessee. Clause 6.1 which says that GEB as the agent of the assessee is responsible for obtaining timely delivery of the equipment and all other clearances is not relevant since there was no question of delivery in a SLB transaction. Clause 6.2 which clarifies that the lessor (assessee) is not the manufacturer or the dealer of the equipment and the essential function of the lessor in the lease is to purchase the equipment selected by the lessee from the manufacturer designated by the lessee is not relevant and has been mechanically inserted. As per clause 6.3 says that the lessor does not make any representation or warranty with respect to quality suitability fitness, etc., of the equipment for the purpose or use, which according to Mr. Dave shows that the assessee, as purchaser is not bothered about the use of the equipment, quite an unacceptable position. With regard to the termination clause 8.2.2(a), which says that even after termination of the lease period, the lessee is bound to pay the rental for the fixed period of the lease computed in the manner set out in the schedule on the footing and as if the lease agreement had not been terminated, Mr. Dave, countering the argument of Mr. Dastur that there is nothing strange in such a clause being inserted by a prudent lessor and that it was a matter of contract between the parties, contended that the lessee is made liable to pay rentals even after termination of the lease agreement only because of the fact that it is a loan transaction. In fact, Mr. Dave characterized this clause as “unconscionable”

It was then pointed out by Mr. Dave that under section 150 of the Contract Act (second para) if the goods are bailed for hire, the bailor is responsible for any damage, whether he was or was not aware of the existence of any faults in the goods bailed and that in the present case, this rule has not been followed and GEB has been made liable for damage arising out of faults in the goods. He also invited attention to section 152 which says that the bailee, in the absence of any special contract is not responsible for the loss, destruction or deterioration of the thing bailed, if he has taken the amount of care described in section 151, which is that he is bound to take as much care which a man of ordinary prudence would take in respect of his own goods. The terms of the lease seemed to violate these rules of the Contract Act. It was further contended that according to the terms of the lease, even the right to repossess could be exercised by the assessee only in certain circumstances such as default in payment of rental and this was inconsistent with the concept of ownership of the assets claimed by the assessee. The following judgments were cited in support of the contention that the right to exclusive possession is an attribute of ownership :

(1) Shaan Finance [1998] 231 ITR 308, 316 (SC) ;

(2) Blue Bay Fisheries (P.) Ltd. v. CIT [1987] 166 ITR 1 (Ker) (6-7) ;

(3) Sundaram Finance Ltd. [1966] 17 STC 489 (SC) ; and

(4) CIT v. Bhojraj Harichand [1946] 14 ITR 277, 285-286 (Lahore).

In connection with his arguments as to whether the boilers in the present case can be considered to be movable property, Mr. Dave placed strong reliance on the judgment of the Chancery Division in Melluish (Inspector of Taxes) v. B. M. I. (No. 3) Ltd. [1995] 212 ITR 549. In this case, the companies were members of a group carrying on the business of acquiring and hiring out plant and machinery to local authorities. In the course of their business, they had leased out several plant and machinery, heating equipment, swimming pool equipment, crematoria, alarm systems, etc. In respect of each transaction a master equipment lease was executed which specified in schedules the equipment that was to be leased and provided that the lessee would return the equipment on the expiry of the lease and that in case of non-payment of the lease rental the lease could be terminated and equipment repossessed by the companies. It was also provided that the leased equipment would remain personal or movable property which would continue in the ownership of the lessor notwithstanding that it might have become affixed to any land or building. On the expiry of the lease, the lessor had the right to require the equipment to be severed and restored to it. The allowances claimed by the company for income-tax purposes were rejected on the ground that after installation the equipment became fixtures in the premises owned by the local authorities and thus they ceased to belong to the taxpayer-company. On appeal, it was contended by the company that there was an express provision in the lease deed that the company would continue to be the owner of the equipment notwithstanding that the equipment was affixed to the land or building. The contention was accepted. The Crown appealed. It was held by the Chancery Division that even though the equipment had been affixed to the land or building belonging to the local authority, it had no right to retain the equipment except during the term of the lease and on payment of rent. However, in the case of central heating equipment installed in a council house, a tenant thereof had a right to enjoy the land free from any right of the company which had leased out the equipment to enter and remove the equipment and on this basis, the equipment ceased to belong to the company on installation and therefore any expenditure incurred by the company on such equipment did not qualify for any allowance. Mr. Dave placed reliance on this decision to show that the boilers having been permanently attached to the earth, became part of the land and GEB could enjoy it free from any right of the assessee to remove the same and this was inconsistent with the assessee’s claim that it continued to be the owner of the boilers.

Several orders of the Tribunal were cited in support of Mr. Dave’s arguments. In particular, he relied on the following orders :

(1) Shaw Wallace and Co. (Cal) (I. T. A. No. 674/Cal of 1998) ;

(2) PKF Finance Ltd. (Asr.) (I. T. A. No. 533/Asr of 1999)

(3) Interface Financial Service Ltd. v. Asst. CIT (I. T. A. No. 2417 (Ahd.) of 1998) page 1168 of assessee’s paperbook ;

(4) Om Sindhoori Capital Investment Ltd. v. Joint CIT [2002] 80 ITD 514 (Chennai) where Explanation 4A to section 43(1) was applied retrospectively to the assessment year 1996-97 ;

(5) The judgment of an American circuit court ;

(6) Sundaram Finance Ltd. [1966] 17 STC 489 (SC) ;

(7) Gowri Shankar Finance Ltd. v. CIT [2001] 248 ITR 713 (Karn) ; and

(8) Lupton (H. M. Inspector of Taxes) v. Cadogan Gardens Development Ltd. [1971] 47 Tax Cases 1 (CA).

In addition, Mr. Dave also sought to distinguish the various orders of the Tribunal on which reliance was placed on behalf of the assessee.

We shall now refer to an important aspect of Mr. Dave’s argument. He filed certain papers in volume 3 of his paperbook which fully contained papers sought to be introduced as additional evidence. These papers are as follows :

(i) Copy of computation of income of GEB for the assessment year 1990-91 ;

(ii) Copy of inspection report of GEB, Gandhinagar ;

(iii) Copy of assessment order for the assessment year 1991-92 of GEB ;

(iv) Copy of information submitted by GEB ;

(v) Copy of computation of income for the assessment year 1994-95 of GEB ;

(vi) Copy of assessment order of GEB for the assessment year 1994-95 ;

(vii) Copy of information furnished by GEB ;

(viii) Copy of audit report of GEB for the year ending March 31, 1998 ;

(ix) Copy of audit report of GEB for the year ending March 31, 1999.

He relied on the judgment of the Madras High Court in CIT v. Smt. S. Vijayalakshmi [2000] 242 ITR 46 in support of his plea that the above papers should be admitted as additional evidence. We asked Mr. Dastur, learned counsel for the assessee, at this juncture, whether he had any objection to the above being admitted as additional evidence under rule 29 of the Income-tax (Appellate Tribunal) Rules, 1963. He submitted that the papers cannot be admitted as additional evidence for the following reasons :

(a) No “substantial cause” that is going to be served by those papers has been shown.

(b) All that was said by Mr. Dave, the learned Commissioner of Income tax (Departmental Representative) was that the papers were “equally important” for the case, but that cannot be sufficient ground for admission.

(d) Pages 5 and 6 have been filed to show that the boilers are “immovable property”, but this is a totally new case made out now which cannot be permitted. Reliance is placed on CIT v. Babulal Nim [1963] 47 ITR 864 (MP).

(e) Pages 11 to 17 have been filed to show that the SLB transaction under consideration is merely an indication of a “deeper malady”.

That is wholly irrelevant for the case and hence those papers cannot be admitted.

The last limb of Mr. Dave’s arguments was that the SLB transaction does not make any economic substance or sense. His arguments in this behalf were supplemented by Mr. Anand Kedia, Joint Commissioner of Income-tax, who was present for the purpose. These arguments will be considered in some detail at a later stage, but suffice at this stage to note that the argument was that (a) the cost of borrowings (for the assessee) was 16.2 per cent. whereas the effective interest rate on the transaction was 14.73 per cent. even as per the assessee’s own working at page 163 of its paperbook—does it mean that the assessee was incurring a loss in the transaction ? (b) If the interest rate is less than 17 per cent., the cost of borrowings being 16.2 per cent., there is no economic sense in the transaction, except for the tax benefits enjoyed by the assessee-lessor (by way of depreciation at 100 per cent.), (c) the time value of money has not been taken into account in the calculations of the assessee, (d) the cash inflow figures have not been discounted, as they ought to be, taking into account the inflation, cost of capital, etc. and if these are properly considered, there would be a negative cash flow and the only reason why the assessee would put up with such a situation is the benefit of depreciation and deduction under section 36(1)(viii), (e) The assessee’s calculations do not take into account the deduction under section 36(1)(viii) against the lease income as it should be and if it is so taken into account, the lease income and interest income would be the same (this point was illustrated by Mr. Kedia at page 11 of the sheaf of papers filed in connection with this argument) and finally (f) The fiscal purpose behind the transaction is lacking.

The above is a brief summary of the arguments advanced by Mr. Dave, the learned Commissioner of Income-tax (Departmental Representative).

Reply of the assessee

Mr. Dastur, learned counsel for the assessee presented a detailed reply to the points made by Mr. Dave, the learned Commissioner of Income-tax (Departmental Representative). This is briefly noticed in the following paragraphs.

(1) Are the boilers immovable properties ?

The question whether the boilers are immovable properties has been taken up for the first time before the Tribunal by the Department and should not be admitted at all. There is no material on record to support the contention. Alternatively and without prejudice, the fact that the boilers could be considered as immovable properties does not prove what the Department aims to and therefore the argument has to be rejected on merits also. It is submitted that it is a question of fact to be proved by evidence as to whether boilers are attached to earth or attached to something which is embedded to the earth. This involves investigation into the factual position which cannot be permitted at this stage. Attention is drawn to the judgment of the Madras High Court in Perumal Naicker v. T. Ramaswami Kone, AIR 1969 Mad 346.

Referring to page 5 of the paperbook containing the additional evidence filed by the Department, Mr. Dastur pointed out that it refers to Gandhinagar TPS which is different from the power station with which we are concerned in the present case. Page 4 refers to Rs. 50 crores which is for the Gandhinagar TPS. Thus, these two pages are not relevant to the present controversy. Page 5 does not also show that the equipment mentioned therein is immovable property, which is a matter of evidence. Page 6 also refers only to Gandhinagar and not Kutch. It was further pointed out that the departmental authorities, before insisting on an agreement between the parties that the goods shall be severed from the earth, have to first show that the goods are attached to and form part of the land and this has not been discharged by them.

In support of his objections to the filing of the additional evidence, Mr. Dastur relied on the following judgments :

(i) CIT v. Fazalbhoy Investment Co. (P.) Ltd. [1977] 109 ITR 802 (Bom) (at p. 808) ;

(ii) Jnan Chand Chugh v. Jugal Kishore Agarwal, AIR 1960 Cal 331 (at p. 335) ;

(iii) Sirpur Paper Mills Ltd. v. CCE [1998] 1 SCC 400 ;

(iv) CIT v. T. M. Bhumraddi [1958] 33 ITR 82, 83 (Bom) ; and

(v) CIT v. Gilbert and Barkar Mfg. Co. [1978] 111 ITR 529 (Bom).

(2) About chronology and discrepancy in dates

Mr. Dastur clarified that the crucial question before us is whether on March 31, 1993, the assessee was the owner of the equipment. It was on January 25, 1993, that the assessee-company received the invoice which is the evidence of purchase. On January 29, 1993, the lease agreement was executed and under clause 1.2(a)(ii), the lessor decided that March 12, 1993 would be the date of commencement of the lease. In the meantime, on February 2, 1993, the purchase order was placed and payments were effected (separate sheet of paper filed to show the payments). Mr. Dastur says that the assessee became the owner on March 12, 1993, which is the date of commencement of the lease, in which case there is no gap as made out by the learned Commissioner of Income-tax (Departmental Representative). If there is no gap, there are no adverse consequences under the Boilers Act as made out by the Department. Assuming there is a gap and consequently registration ought to have been done under the Boilers Act, the fact that no registration was done is not fatal to the claim of the assessee. Mr. Dastur submitted that weighty points cannot be decided on “de minimis”.

If as made out by the Department, the boilers are immovable property, there was no need for the Gujarat Government to issue a notification exempting the same thereof under the Gujarat Sales Tax Act. The notification merely required a certificate to be issued by GEB in the prescribed format and it matters little that it was issued on May 10, 1993, much later than the sale or even the lease agreement. These are minor points and can at best be considered only as inconsequential irregularities not fatal to the assessee’s claim.

(3) Valuation report

Mr. Dastur admitted that the valuation report is dated June, 1996, and was not before the Assessing Officer. He clarified that it was filed for the first time before the Commissioner of Income-tax (Appeals) and submitted that there was no intention to mislead. As regards the question as to why valuation was not done earlier, he clarified that since only depreciation of Rs. 6.25 crores was claimed in the return filed for the assessment year 1992-93, no valuation was considered necessary. He also referred to the statement of Mr. P. K. Das under section 131 of the Income-tax Act relating to the claim of depreciation. In answer to question No. 3, Mr. Das had stated that the factual position of the exact amount of depreciation claimed in the earlier years after the assets were commissioned and the subsequent reduction of value of net block in respect of KLTPS-I + II would be intimated to the Assessing Officer on reaching Baroda. Mr. Dastur drew our attention to the letter dated March 22, 1996, written by GEB to the Assessing Officer (page 13 of the department’s paperbook No. I) in which it was clarified that only depreciation of Rs. 6.25 crores was claimed in the assessment year 1992-93. The letter of BHEL which supplied the boilers to GEB (dated March 11, 1996—page 11 of Department’s paperbook No. I) was before the Assessing Officer wherein the cost of the boilers was given at Rs. 59.04 crores. Even if the depreciation of Rs. 6.25 crores is reduced from the cost, still the WDV will be Rs. 53 crores, which is more than Rs. 50 crores which is the price paid by the assessee to GEB. In these circumstances, there was no need for any valuation.

(4) Terms of lease

Mr. Dastur drew our attention to the statement filed showing similarity of clauses between the lease deed in the present case and cases decided in the Bombay High Court in Development Credit Bank Ltd., 20th Century Finance, etc. (page 1092 of the assessee’s paperbook) and submitted that in these cases, the question before the High Court was whether on these terms, the document can be considered to be a loan or a lease. The decision was that the document constituted a valid lease. Since the same terms have been incorporated in the lease document dated January 29, 1993, it should also receive the same interpretation. He also pointed out that the clauses of the lease deed under consideration are similar to the clauses of lease deed considered by the Mumbai Bench of the Tribunal in CMIE and similar to the clauses of the lease deed considered by the hon’ble Bombay High Court in Prakash Industries Ltd. (supra) and since the decision in Prakash Industries Ltd. is that these terms were consistent with the position that it is a lease, the decision of the Mumbai Bench of the Tribunal in CMIE to the contrary must be held to be no longer good law. With regard to the argument of Mr. Dave that the assessee has adopted mechanically the standard form of lease agreement, Mr. Dastur filed a copy of the standard lease agreement and a copy of lease agreement in assessee’s case to show that they are similar.

(5) Intention of the parties vis-a-vis “upward revision of price”

It may be recalled that Mr. Dave had argued that the purpose of the letter dated February 23, 1993, written by GEB to the assessee company was only to upwardly revise the value of the equipment, something which is consistent only with the position that GEB had asked for a loan on sufficient security. Mr. Dastur replied that the price was fixed on January 25, 1993, by invoice and therefore it cannot be construed as upward revision or suggestive of a loan transaction.

(6) Sale by GEB—entries in GEB’s books

Mr. Dastur drew our attention to page No. 3 of the Department’s paperbook No. 1 where the asset has been shown to have been capitalised in the assessee’s books on March 12, 1993, at Rs. 50 crores. This shows that the property in the goods has passed on to the assessee.

(7) Tax avoidance

With reference to the judgment of the Gujarat High Court in Wood Polymer [1977] 109 ITR 177 which was approved in McDowell [1985] 154 ITR 148 (SC) Mr. Dastur submitted that there can be no quarrel with the propositions laid down in that case which were three :

(1) In the case of arrangements and compromises under the Companies Act, public interest should be the only criterion.

(2) The court should not be requested to sanction any tax evasion.

(3) However, the parties’ right to indulge in tax planning is not taken away by the judgment.

It was pointed out by Mr. Dastur that there was no justification for Mr. Dave to characterise the clause in the lease deed as “unconscionable” in the absence of any complaint from anybody. Further, the parties were not in a position to influence each other.

(8) Economic sense of the transaction

Mr. Dastur clarified that as per the GEB’s financial review, the average cost of borrowings was only 13.4 per cent. The assessee had own funds which increased from Rs. 896 crores in the earlier year to Rs. 1,206 crores for the present year. The interest paid was Rs. 1,043 crores. Therefore, the average cost of borrowings will be still less. This aspect of the matter has been ignored in the calculations given by Mr. Anand Kedia. Further, depreciation has to be certainly taken into consideration. The lease rentals have to be linked with the minimum lending rate of interest followed by commercial banks. This is only “bench-marking” and does not affect the legal consequences of the transaction. The assessments, Mr. Dastur says, are not made on arithmetical calculations. They are made on legal principles. Views cannot differ, depending on losses made by parties, availability of deduction under section 36(1)(viii), etc. The legal consequences must flow and cannot stop on grounds of economic sense, fiscal purpose etc.

Our decision—Mid East Portfolio Management Ltd.

In our view, the rule laid down in McDowell [1985] 154 ITR 148 (SC) and as understood by us applies to the case and the SLB transaction cannot be recognised for income-tax purposes, with the result that the assessee-company is not entitled to the depreciation claimed. The departmental authorities were right in denying the claim.

Reasons for our decision :

(A) Background papers of the RSEB

We have referred in some detail to the documents prepared for the purposes of the board of directors of RSEB. The origin of the transaction can be traced to these papers which indicate the intention of the parties. The use of the word “notional”, in the agenda note prepared for the board, with reference to the “sale” of the air-pollution equipment to the assessee by RSEB is a give-away. We are inclined to read it in contrast with the word “actual”. RSEB had not intended to effect a sale in truth and reality to the assessee, of the equipment. The agenda note refers to the “notional” sale at more than one place. In the very opening paragraph of the agenda note prepared for the board of directors of RSEB it has been stated that the “proposal herein is to seek approval of the board to raise money at a low rate of interest by notional sale of plant and machinery and to take the same back on lease” (underlining ours). In the third paragraph (page 35 of the Department’s paper book) there is reference to the fact that other state electricity boards “have also resorted to the course of raising money by notional sale and lease back of existing assets” (underlining1 ours). Finally, the agenda note exhorts the board to consider and approve the raising of monies “by notional sale and lease back of existing assets” and to pass the resolutions as annexed. The resolution authorizes the board “to notionally sell and take back the aforesaid plant and machinery on lease from the aforesaid lessors on the terms and conditions mutually agreed”. All this took place in the 443rd meeting of the board (RSEB) on January 6, 1995. This was followed up by a decision on January 28, 1995, to raise finance by a sale and lease back arrangement by issuing advertisements in leading newspapers. In the agenda note prepared for the meeting held on January 28, 1995, no doubt the word “notional” is not found used with reference to the sale and lease back, but this by itself is not sufficient to displace the inference drawn by us that from the very inception the intention of the parties was never to sell/purchase the air-pollution equipment in the real and true sense of the word but was only to prepare documentation to show that the assets were actually sold/purchased and then leased back to RSEB. There are reasons for this.

Firstly, we have to remember that RSEB is a statutory body constituted under section 5 of the Electricity (Supply) Act, 1948, as a body corporate, wholly owned by the Government of Rajasthan and is a public sector undertaking of the State Government. It enjoys the status of a regulated monopoly, charged with the functions of generation, transmission and distribution of power in the State of Rajasthan. This is not an easy task. It is enormous. It is actually a public utility. The overall progress of the State depends on the industrial progress and the industrial progress cannot be achieved without un-interrupted supply of power. Power generation requires costly equipment. The assets of any electricity board runs into crores and crores of rupees. They are spread throughout the State. In order to ensure continuous supply of power, it is absolutely necessary that all the assets/equipment should be maintained in good repair and should function efficiently. In this background, it is difficult to imagine a situation where an electricity board plans to dispose of a part of its equipment by way of “sale”. It may be necessary for the board to replace worn out assets or parts of the assets by way of routine repair and maintenance, but to dispose of an asset or equipment which is part of the power-generation and distribution equipment, is an entirely different matter. The very purpose of an electricity board being the provision of power, we believe that its very substratum would be gone if it takes a decision to “sell” a major part of its assets or equipment for the purpose of raising finance, or for any other purpose. We have serious doubts whether it is permissible for a public utility to do so except on peril of losing its status as a public utility. Mr. Patil, learned counsel for the assessee, referred to the definition of the words “clear profit” in the Electricity (Supply) Act, 1948, which includes proceeds from the “sale and repair of lamps and apparatus” and from this he contended that it is permissible for an electricity board to sell its assets, but we are of the opinion that those provisions come into play in an entirely different fact-situation. What Mr. Patil referred is the definition of “clear profit” of an electricity undertaking and has nothing to do with the power to sell a part of the very undertaking. The reliance on this provision, with respect, is off the mark. It does not authorise the sale of a part of the undertaking, which is required for the purpose of the generation and distribution of electricity.

It can be, and in fact it was, countered by Mr. Patil that the word “notional” was used with reference to the sale only because the equipment was to come back to RSEB in the form of a lease. The question of the equipment coming back to RSEB in the form of a lease would arise only if there was a real and genuine sale of the equipment to the assessee in the first place. The intention of the parties was that the equipment, though stated to be sold by RSEB to the assessee, would never operate as a sale in the real sense of the term. As we have already pointed out, it is impossible to appreciate as to how a public utility undertaking can plan to sell a part of its undertaking. If the answer is that it could be sold because by the very same transaction it has been ensured that it would physically remain with the seller, then that takes away the bottom of the transaction and the sale is only a shell without any substance or content which make up the ingredients of a sale. The intention of the parties is not that the property in the equipment should pass from RSEB to the assessee. There is an inherent snag in construing the transaction as a sale in the real sense of the term, since the equipment cannot be delivered to the assessee if physical delivery is insisted upon. The equipment cannot be severed from the earth without interrupting the power supply. It could never have been the intention of RSEB to allow the equipment to be severed and delivered to the assessee since that would have involved serious disruption in power supply. It is all very well to speak legally of a constructive or symbolic delivery, but when it comes to the gathering of the intention of the parties or to the tracing of the genesis of the transaction, the stark reality that RSEB or the State of Rajasthan would never think of severing and handing over physical delivery of the air pollution equipment to the assessee pursuant to the so-called sale should not be lost sight of. In our opinion, in this light, it is not possible to infer an intention that the property in the air-pollution equipment would pass from RSEB to the assessee.

The fact that the sale deed dated March 27, 1995, is in a standard form, though by itself is not conclusive, but viewed in the light of the surrounding circumstances, is a pointer to the conclusion that the whole exercise was gone through mechanically. In fact, it would appear to be a pre-planned or preordained exercise. A brief reference to the chronology would drive home the point. The agenda note prepared for the board meeting held on January 6, 1995, refers to the discussions which were earlier held between RSEB on the one hand and Kotak Mahindra Finance Ltd., and three other companies on the other. It was admitted on behalf of the assessee that the assessee belonged to the syndicate led by Kotak Mahindra Finance Ltd. The agenda note refers further to the willingness of the finance lease companies for providing funds under notional sale and lease back of existing assets. In fact, specific amounts which the leasing companies were willing to lend to RSEB were also indicated. There are detailed references to the effective rate of interest, term of the lease, outgo on account of lease rentals, etc., in the agenda note. Thus, the form in which the transaction would be put through would appear to have been finalised on January 6, 1995, itself. However, a formal advertisement was given in the newspaper on January 13, 1995. On the basis of the offers received in response to the advertisement, of which the offer from the assessee was one, another agenda note was prepared for the perusal of the board at its meeting on January 28, 1995. It appears that the board resolution was passed on January 28, 1995, in which it was decided to borrow Rs. 150 crores from Kotak Mahindra Finance or other lessors arranged by them. The assessee is one of the other lessors belonging to the syndicate formed by the Kotak Mahindra Finance and was allotted a specific amount to be advanced to RSEB. Thereafter, the actual sale deed between RSEB and the assessee was entered into on March 12, 1995. It will be seen from the chronology that even before the advertisements were issued in the newspapers inviting offers for obtaining leasing finance, a decision had been taken to enter into the SLB transaction with the members of the syndicate led by Kotak Mahindra, of which the assessee was one. Thus, the advertisement in the newspaper would only appear to be a mere formality or a ritual that was gone through in adherence to the form.

From the above events, it appears to us that right from the beginning, it had been decided between RSEB and the assessee that the assessee would advance monies at low rates of interest to RSEB. The transaction could take the form of a SLB transaction under which there would be a notional sale of the air pollution equipment to the assessee for Rs. 1.95 crores and a simultaneous lease back of the equipment by the assessee to RSEB. Thus, the entire transaction and the sequence of events were pre-ordained or pre-planned.

We also find force in the argument of Mr. Sahai, the learned Commissioner of Income-tax (Departmental Representative) that right from the beginning the transaction was controlled by the assessee. He gave the example of RSEB sending a draft of the board’s resolution in the proforma desired by the syndicate. This is an important item of evidence to show that the assessee was in a position to dictate even the wording of the resolution to be passed by the board of directors of RSEB. Actually, RSEB had written a letter to the assessee on February 2, 1995, and it was to this letter that the proforma of the board’s resolution has been enclosed for the perusal of the syndicate, of which the assessee was a member, “as desired” by the syndicate. In our opinion, this is a clear pointer to the anxiety of the assessee to ensure that the board’s resolution is appropriately worded to show as if there was an actual and real sale of the equipment to the assessee and thereafter a lease back of the same to RSEB. This shows the desperateness with which RSEB required the finance and it was willing to act according to the wishes of the assessee and willing to enter into whatever type of documentation which the assessee wanted. The assessee obviously would be guided by its own interests. RSEB has nothing to lose. Therefore, it was that it did not see any objection in playing along and taking decisions in the manner in which the assessee wanted.

We therefore conclude that the decision of RSEB to enter into the SLB transaction with the assessee was right from the inception conceived and controlled by the assessee. RSEB simply followed the documentation suggested by the assessee.

(B) Why only assets entitled to 100 per cent. depreciation?

This is an important question which was given great emphasis on behalf of the Department before us. There was no satisfactory answer to the question from the assessee’s side. The agenda note contains repeated references to assets entitled to 100 per cent. depreciation. For example, the agenda note prepared for the board meeting on January 6, 1995, refers to the fact that the board “received proposals from various lease financing companies to make available funds under sale and lease arrangements against already existing assets, attracting 100 per cent. depreciation benefit under the Income-tax Act, 1961”. (underlining ours). The agenda note contained an appeal to the board “to get the existing assets attracting 100 per cent. depreciation under the Income-tax Act, 1961, revalued through registered/Government approved valuer.” (underlining1 ours). In the agenda note prepared for the meeting held on January 28, 1995, refers to the “valuation of the actual assets available with us, which attract 100 per cent. depreciation. . . .” (underlining1 ours) and goes on to say that most equipments available with RSEB does not fall into this category. In paragraph 2 of that part of the agenda note which contains the recommendation to the board, it is stated that the board may consider and approve the raising of Rs. 150 crores from Kotak Mahindra Finance Ltd. “by availing lease finance under sale and lease back financing facility against existing assets attracting 100 per cent. depreciation at a monthly lease rental …….” (underlining1 ours). The repeated references to assets attracting 100 per cent. depreciation under the Income-tax Act shows the anxiety of the parties, especially of the assessee which was in a position to influence and control the documentation prepared by RSEB, to make sure that what would be the subject-matter of the SLB transaction were only those assets which were eligible for 100 per cent. depreciation under the Income-tax Act. Mr. Sahai asked the question, and quite pertinently, as to why the assessee should be interested only in assets eligible for 100 per cent. depreciation. The answer is obvious. The assessee was interested only in those assets which it could “purchase” from RSEB and lease them back to RSEB so that it can claim 100 per cent. depreciation in its income-tax assessments and seek to set off the same against the income by way of lease rentals. It cannot be denied that it does appear somewhat strange that a person providing finance under SLB arrangement would insist on only those assets being made the subject matter of the transaction on which 100 per cent. depreciation is available under the Income-tax Act. The repeated references to assets falling in this category shows that obtaining 100 per cent. allowance on account of depreciation in the assessee’s income-tax assessments was uppermost in the assessee’s contemplation and so long as nothing was to be lost by RSEB by agreeing to the same, it did not consider it fit to raise any objection. It is no doubt normal for a taxpayer company to take a decision relating to its business after considering the taxation aspect also. But generally taxation aspects are not the only decisive factor which have to be kept in mind. If a transaction is otherwise also beneficial to an assessee, it is generally expected that it would go through with the transaction. Any benefits on account of taxation would be incidental. But here the overriding consideration appears to us to be the prospect of obtaining 100 per cent. depreciation and the energies of the parties appear to have been diverted solely towards this end. There was of course the business proposition which was to advance monies to RSEB for compensation. But it was modified in such a manner that the benefits which accrued to the assessee on account of the business proposition were nullified, only for taxation purposes, by insisting on the acquisition of those assets which are eligible for 100 per cent. depreciation. We are unable to see any other motive behind the insistence of the assessee that it would acquire only those assets on which 100 per cent. depreciation was allowable under the Income-tax Act.

Mr. Sahai is right in saying that the equipment has not been identified in the sale deed itself. However, there is a reference in the sale deed to the invoices enclosed therein, in which the equipment is stated to be described or identified. This manner of execution of the sale deed appears to us to be quite unusual. The sale deed is in standard form with the name of the purchaser of the equipment, the consideration for the sale, the details of the cheque/DD/ Pay Order No., etc., being left blank which suggests that a number of such sale deeds have been executed by RSEB. In fact, Mr. Patil informed us that about 151 transactions have been entered into by RSEB concerning different assets or equipment. Therefore, a standardized form of sale deed was prepared and the assets were described in the invoices enclosed therewith. The invoice which was enclosed to the sale deed in question before us is dated March 27, 1995, the same day as the sale deed. The assets described and the value therefor are as under :

S. No.	Asset description	Qty.	Value (Rs.)
1.	Air pollution control equipment, being electro-static precipitation system	1	128,00,000
2.	Water pollution control equipment, being : (a) Mechanical screen system	1	62,00,000
	(b) Mechanically skimmed oil and grease removal system	1	5,00,000
	(Rupees one hundred and ninety five lakhs only)		195,00,000

Even assuming that this is a satisfactory description or identification of the equipment sold by RSEB to the assessee, still the question arises as to how even at a much earlier stage of the negotiations, the parties had agreed that 20 per cent. of the value of the assets would be taken to be the residual value which would be adjusted at the end of the lease period against the security deposit and that there will be no further liability on the part of any party. It may be recalled that Mr. Sahai had drawn our attention to RSEB’s letter dated February 2, 1995, wherein the residual value of the asset was agreed as above. A copy of this letter is at pages 56 and 57 of the department’s paperbook. At the time when the letter was written, certainly the asset had not been identified. We have also verified the resolution of the board dated January 28, 1995, which is at page 52 of the Department’s paperbook and pages 47 to 49 of the assessee’s paperbook. In the resolution it has been stated that RSEB “do sell specific equipment (hereinafter referred to as the “equipment”) before March 31, 1995. . . . .” The resolution is silent as to what is the specific equipment. There is no description. However, the resolution approves the broad terms and conditions of the lease such as the tenure, lease management fees, lease rentals per rupees one thousand, rentals payable, interest free security deposit, etc. Therefore, the parties do not appear to have been “ad idem” with regard to the equipment that was to be sold and leased back in the earlier stages of negotiations. Despite this, the price payable, the tenure of the lease period, the lease rentals and even the residual value would appear to have been agreed between the parties. To us, this appears to be a very strange situation, to say the least. This is one more pointer to the fact that the entire documentation or transaction was a pre-planned or pre-ordained affair.

(D) Valuation of the equipment

The valuation of the air-pollution equipment was the subject matter of intense debate before us. In our opinion, the valuation report of M/s. M. Choudhary and Associates, dated March 27, 1995, is unreliable. It lacks the ingredients of an acceptable valuation report. It is at pages 34 to 41 of the assessee’s paperbook No. 1. We have carefully perused the same. It first describes the three steps that are involved in the valuation process. Briefly, the first step is the collection and tabulation of the information such as description of the asset, year of purchase, year of commissioning, original cost, quantity, etc. The second step is the physical verification. The third and last step is the actual valuation of the asset by the application of various parameters such as current replacement value, technical obsolescence, adjusted current replacement value, depreciation, residual replacement value, residual life, etc. As far as the first step is concerned, no tabulated statement, which has been described in the valuation report (page 3 thereof) as the “heart of plant and machinery valuation”, has been produced before us. We have to therefore accept the statement of Mr. Sahai that such a statement does not exist. As regards the second step, viz., the physical verification, though the valuation report says that the valuer had “visited Kota Power Station from 10th—12th February, 1995, for physical verification of plant and machinery assets” and during the visit held “discussions with the technical personnel on various aspects relating to plant and machinery”, there is nothing to show the kind of discussions which he had. If he had in fact had such discussions on the technical aspects of the equipment, one would reasonably expect those discussions to be incorporated in the valuation report, considering the importance of the matter. But there is no reference to what aspects (listed in page 2 of the report) were discussed and what decisions were taken. In fact, the valuer has admitted in his letter dated April 11, 2001, to the Assessing Officer that though he visited Kota Thermal Power Station on February 11, 1995, for inspection, the exact equipment mentioned in his valuation report were not seen by him and that the valuation was done on the basis of information provided by the employees of the RSEB. But this was not mentioned in the valuation report, a reading of which would give an impression that it has been prepared after physical inspection/verification of the assets. In fact, in the “declaration” at the end of the report in Form No. O-7 (page 39 of the assessee’s paper book No. 1), the valuer has declared that “I have personally inspected the machinery/plant on February 11, 1995”, a statement which he has himself denied later. In the light of the later clarification made by the valuer himself, what purpose would have been served by his going to Kota Thermal Power Station on February 11, 1995, is anybody’s guess. What credence can be given to a valuation report which has been prepared without physical verification of the air-pollution equipment, but only on the basis of information supplied by the employees of RSEB ? In our opinion, no credence can be given. As regards the third step, i.e., the actual valuation, we find justification in Mr. Sahai’s criticism that the report merely discusses the principles to be adopted without actually demonstrating as to how those principles have been applied to the equipment in question and how the application of those principles have led the valuer to arrive at the figure of Rs. 1,95,00,000. The most vital part of the valuation report, namely, the “annexures” which are stated to be “enclosed” with the valuation report, are missing. In the prescribed format of the report (Form No. O-7), column 5 refers to “Description of the machinery/plant” and column 6 refers to “valuation of the machinery/plant”. In column 6, it has been added in brackets that “the valuer should discuss in detail the make of the machinery/plant, name of the manufacturer, original price, price to the owner if he is not the first owner, year of manufacture, present market price of similar new machinery/plant and other relevant factors”. Against these two columns, the valuer has stated “as per anenxures enclosed”. But no annexures are found enclosed. This is not an inconsequential slip or omission, but in our view it has serious repercussions. It throws grave doubts on the veracity, credibility and acceptability of the valuation report itself. When we requested Mr. Patil, learned counsel for the assessee, to clarify this, he stated that the annexures are not missing and that they are merely “not traceable”. With respect, we are unable to appreciate the subtle distinction. We are inclined to believe that the annexures were not prepared at all. If they had been prepared by the valuer, a copy would have been available with him. Since it was the assessee who engaged him, the assessee at least would be having a copy of the annexures. Both of them do not have it. Therefore, it is our belief that the annexures were never prepared. The annexures, as we have already observed, are a vital part of the valuation report since they would give the essential information regarding the equipment to be valued. It is to that information that the principles of valuation which have been discussed in the earlier part of the report, will have to be applied by the valuer. When the annexures themselves have not been prepared, a mere discussion of the relevant principles as has been done by the valuer is merely an academic exercise, possibly to give a touch of credibility to the valuation report. The overall impression gained by us on a careful perusal of the valuation report and the rival contentions with regard thereto, is that it is totally unconvincing. We therefore refuse to give any credence to the same.

At one stage of the arguments, Mr. Patil, learned counsel for the assessee, submitted that the assessee is not concerned as to how the valuer has come to the particular figure of valuation and that he is interested only in the final outcome and therefore the fact that the annexures were not available in support of the valuation made should not be taken as a serious flaw, throwing doubts on the very credibility of the report. He even said that inspection of the asset is not required for the purpose of valuation. We are unable to accept this explanation. In our opinion, and with respect, it belittles the importance of the principles of valuation and tends to decry the sanctity and integrity attached to the serious task of valuation. Further, the assessee has not obtained the valuation report for his personal or private purposes. Admittedly, it obtained the same only to support its claim for depreciation in the income-tax assessment proceedings. Therefore, the assessee was under a duty to ensure that the valuation report is complete and correct in all respects and if it has been stated therein that the annexures are enclosed, it is the assessee’s duty to ensure that the annexures are in place and are furnished along with the valuation report. The ultimate figure arrived at by the valuer or the method adopted by him may be a matter of opinion and may be accepted by one and rejected by another, but the process by which the final figure is reached must be transparent and made known to everybody who reads the valuation report. Otherwise, the whole purpose of obtaining a valuation report would be lost. Therefore, the reply of Mr. Patil, again with respect, is wholly inadequate to the requirements of the case and overlooks the importance of a valuation report.

The importance of the valuation report in a case such as the present one cannot be over-emphasised. We are constrained to make these observations because of the attitude of the assessee to the question of valuation. It indicates that the assessee has taken the matter of valuation lightly. In fact, this attitude of the assessee to the question of valuation is an aspect which has influenced us in considerable measure in assessing the applicability of the rule laid down in McDowell [1985] 154 ITR 148 (SC) to the present case.

The further argument of Mr. Patil that even the Assessing Officer has not physically verified the assets and has not carried out any counter valuation through the DVO is irrelevant to the issue. We are not herein concerned with an eye-for-eye or tooth-for-tooth situation. That would only reveal a churlish approach. It needs only to be reminded that it is the assessee which claims depreciation on a particular figure of actual cost and therefore it is for the assessee to prove and support the figure. At that stage, it is not for the income-tax authorities to prove that the figure of actual cost of an inflated figure. Secondly, the Assessing Officer took the view that the entire SLB transaction is a sham and therefore the assessee was not entitled to any depreciation. It is only for the purpose of showing that the transaction is a sham that the Assessing Officer examined the veracity and credibility of the valuation report filed by the assessee and found many flaws and serious drawbacks therein. It was therefore not for the Assessing Officer to have countered the assessee’s valuation with the Department’s own valuation report. It would have served his purpose merely to show that the valuation report filed by the assessee was unreliable. The question of the Assessing Officer obtaining a report from the Departmental Valuation Officer would have arisen only if the transaction was genuine, but in the opinion of the Assessing Officer, the figure of actual cost was inflated. Had that been the case, it was incumbent upon him to obtain a counter valuation report so that the proper amount of depreciation could be allowed. But when he takes the view that no depreciation is allowable at all on the ground that the entire arrangement is a sham, no purpose would have been served by his obtaining a counter valuation report. Therefore, we are not impressed by Mr. Patil’s argument that the Assessing Officer ought to have brought in a counter valuation of the equipment to show that the assessee’s valuer has overvalued the same.

(E) Residual value

We find force in the argument of Mr. Sahai, the learned Commissioner of Income-tax (Departmental Representative), that even when the actual cost of the asset was not known, the parties had agreed to the residual value of the asset. The advertisement issued by the RSEB calls upon the interested parties (who wish to provide leasing finance) to submit their sealed offers giving full details such as lease rent, lease period, residual value if any, etc. A pertinent question posed by Mr. Sahai, the learned Commissioner of Income-tax (Departmental Representative), which was not answered satisfactorily on behalf of the assessee is as to how the leasing company can be expected to know the residual value without knowing first of all the asset which is to be sold and taken back on lease, the cost of the asset, etc. The advertisement, it may be recalled, was issued on January 13, 1995, and a copy thereof is at page 65 of paperbook No. V filed by the assessee. At pages 56-57 of the Department’s paperbook is the copy of the letter dated February 2, 1995, written by RSEB to Kotak Mahindra Finance Ltd. which is the leader of the syndicate of which the assessee is a member. Even at this stage, it should be remembered, the asset has not been identified because the assessee’s valuer has visited KTPS only on February 11, 1995, for the purposes of valuation. His report itself is dated February 15, 1995/March 27, 1995. Therefore, as on February 2, 1995, neither the asset was known nor its cost, written down value, etc. Even so, the residual value of the asset was agreed to be taken at 20 per cent. of the value of the asset, to be adjusted against 20 per cent. retained security deposit for transfer of ownership back to RSEB. At best, the earliest point of time when the equipment may be stated to have been identified is on February 11, 1995, when the assessee’s valuer was present in Kota. But even before this date, the parties have agreed upon the residual value. The resolution of the board does not speak of any residual value. In these circumstances, we are inclined to hold that the documentation and the terms and conditions of the SLB arrangement followed a pre-determined pattern and therefore the rule in McDowell [1985] 154 ITR 148 (SC) applies.

(F) Is there a sale by RSEB to assessee ?

In our opinion, there was no sale of the air pollution equipment by RSEB to the assessee despite the documentation entered into between the parties. There is no sale in truth and reality. We have already referred to the fact that right from the inception the parties had agreed that there will be only a notional sale. We have also held that the word “notional sale” was used in contrast to the word “actual” or “real” sale. We have also held that there was no intention on the part of the RSEB to convey the property in the equipment to the assessee nor was there any intention on the part of the assessee to purchase the equipment. For this purpose, we had relied on the agenda note prepared and submitted to the board of directors of RSEB. The agenda note also contains references to the cases of other electricity boards such as the Madhya Pradesh Electricity Board and the Punjab State Electricity Board entering into similar arrangements for raising money by notional sale and lease back of existing assets. This shows a pattern followed by all electricity boards to adopt the SLB mode for the purpose of raising finance. A perusal of the sale deed dated March 27, 1995, executed by RSEB in favour of the assessee-company also leads us to the same conclusion. The sale deed is in a standard form with the names of the purchaser, the purchase price and the details of the remittance of the purchase price being left blank. This is because the assessee has entered into 151 similar transactions to raise finance by adopting the SLB mode. This fact was referred to by Mr. Patil himself in the course of his arguments. The paperbook filed by the Department contains the complete details of such arrangements in a tabular form at pages 19 to 32. There is copious reference to similar arrangements entered into between the various Electricity Boards and leasing companies in the agenda note prepared for the board meetings on January 6, 1995 and January 28, 1995. There is reference to discussions held between RSEB and various leasing companies on the various aspects of finance lease through the SLB mode. All this shows a pattern or pre-ordained series of steps to be taken by the parties, including the assessee, so that the desired result is achieved. That is why the sale deed is also in a standard form, leaving the names of the purchaser, the purchase price, etc., blank so that it can be filled up suitably. The documentation thus follows a set pattern. It is apparent that the whole scheme has been purchased by RSEB “off-the-shelf” and this is the result of the discussions held between RSEB and various leasing companies. It does not matter that the assessee’s name does not appear in the agenda note because it is common ground that the assessee is a member of the syndicate of which Kotak Mahindra Finance Ltd. is the leader. Therefore, any dealings or discussions or correspondence which RSEB had with Kotak Mahindra Finance amounts to dealings/discussions/correspondence with the assessee itself and there is no dispute about this position. Now at the very inception, it was agreed between the parties that the formalities of a sale would be gone through though no sale of the equipment in point of fact would take place. We are inclined to reiterate that the board of directors of RSEB could not have intended to sell a part of the undertaking to leasing companies. This is not an isolated transaction between RSEB and the assessee where a small part of the undertaking is sought to be sold and leased back. As already noted, there are 151 transactions which RSEB has entered into with various leasing companies for the purpose of raising finance. The total requirement of RSEB, as we see from the decision of the board dated January 6, 1995 (page 33 of the Department’s paper book) is about Rs. 450 crores. This requirement has been spread over 151 transactions. In our opinion, it would be preposterous to suggest that the board of directors of RSEB who are all highly placed Government officers, took a decision to “sell” a substantial part of the undertaking of RSEB. It is doubtful if such a decision would be within their authority, given the fact that RSEB is a public utility undertaking engaged in the generation and distribution of electricity in the State of Rajasthan which cannot be carried on without interruption and for which purpose the undertaking “sought” to be sold under 151 SLB transactions is indispensable. It cannot therefore be held that RSEB really intended to sell the assets to the leasing companies including the assessee, in the sense that the so-called purchasers would become owners of a part of the undertaking of RSEB. Such a result, in our opinion, cannot be countenanced at all. Therefore, it is that we say that it was only a notional sale by RSEB to the assessee, not intended to be acted upon, not intended that the property in the equipment should pass to the assessee, not intended to clothe the assessee with the rights of ownership over the air pollution equipment. The idea was to merely give the transaction the appearance of a sale so that the assessee is constituted the apparent but not the real owner so that the assessee can claim depreciation in respect of the assets in its income-tax assessments. Since physical delivery of the equipment “sold” would have ruined the plans and would have interrupted the power supply in the State of Rajasthan, the parties have taken the plea that physical delivery is not an essential requirement of a sale and that it is sufficient compliance with the law that symbolic or constructive delivery is given to the purchaser. This is a disingenuous argument. It serves two purposes. The first is that it absolves the RSEB from the need of giving an explanation as to how the assets of a public utility could be sold and how they could be severed from their location and delivered to the so-called purchaser. Second, it suits both the parties to say that constructive delivery is sufficient since in any case the assets are going to be leased back to RSEB. With great respect, the argument tends to undermine the theory of constructive or symbolic delivery. When there is no intention to sell in the first place, the question of delivery of the assets, either actual or symbolic, becomes wholly irrelevant. It is only with full realisation of this position that the theory of symbolic or constructive delivery has been conveniently projected before the income-tax authorities and before us.

It was asked by Mr. Patil, learned counsel for the assessee as to why the Government of Rajasthan would issue a notification exempting the sale of the assets by RSEB to the assessee, if there was no sale at all in the first place ? The situation, as we view it, is like this. The Government of Rajasthan has nothing to lose by issuing a notification exempting the so-called sale of the air pollution equipment by RSEB to the assessee. On the other hand, it was in the interest of the Government of Rajasthan to ensure that its own undertaking, the RSEB, does not starve for want of funds. For the purpose of facilitating RSEB to garner a substantial amount of Rs. 450 crores, the issue of a notification granting exemption from sales tax is a small step, without any serious consequences for the State Government. If the sale is not exempt, it would further cause hardship to RSEB in the sense that it would have to pay the sales tax also. Therefore, the issue of the notification, at best, can only be viewed as a neutral factor. It does not advance the case of the assessee before us.

(G) Pre-arranged purchase of the equipment by RSEB

While negotiations were on between RSEB and the assessee, a condition was stipulated by RSEB in its letter dated February 2, 1995, to the effect that the equipment shall be sold by the assessee to RSEB. This condition is stipulated in column 5 of the letter which speaks of residual value. The exact words used are the following :

“5. Residual value 20 per cent. of the value of assets which will be adjusted against 20 per cent. retained security deposit for transfer of ownership back to the RSEB (lessee).” (underlining1 ours)

The condition that the assessee shall transfer the ownership in the equipment back to the assessee (presumably at the end of the lease period) does not find a place in the lease deed. The contention of Mr. Sahai, the learned Commissioner of Income-tax (Departmental Representative), was that the lease was in truth a sale by the assessee to RSEB where RSEB has no option except to buy. It is thus a conditional sale according to him. Even at the time of the alleged sale of the equipment by RSEB to the assessee, it was stipulated that the ownership over the equipment shall be transferred back to it by the assessee and this cannot be considered to be a sale at all. What Mr. Sahai wants to convey is that if you agree at the time of the sale that the property shall be conveyed back to you by the purchaser, there is actually no sale in the first instance. He relied on the commentary on sale of goods by Benjamin in support of this proposition. When we asked him as to whether in the light of the definition of the “lessor” in clause (g) of the lease deed it is permissible to look into the letter dated February 2, 1995, Mr. Sahai submitted that the definition itself refers to the letter and therefore it is permissible to look into it in construing the lease document. We find force in his contention. Even when negotiations were on, there was a stipulation in the letter dated February 2, 1995, to the effect that the ownership in the equipment should be transferred back to RSEB. This is another pointer to the intention of the parties not to convey the property in the equipment. The lease document executed by the assessee in favour of RSEB is therefore only an arrangement in paper. It is permissible for us to refer to the letter dated February 2, 1995, since the definition of the word “lessor” in the lease deed itself refers to the letter. The definition is like this :

“58. ‘Lessors’ shall mean those specified persons/entities who have provided/will provide equipment on lease to the lessee before March 31, 1995, in terms of the mandates dated February 2, 1995, given by lessee to Anik Financial Services Private Ltd., Kotak Mahindra Finance Ltd……...” (underlining ours)

Thus, the terms and conditions stipulated in the letter have to be read as part of the lease deed. If so, the lessor is a person who has agreed to the stipulation (contained in the letter dated February 2, 1995) that he will transfer back the ownership rights in the equipment to RSEB. If this is agreed even at a point of time earlier to the execution of the deed of sale itself, then an intention not to convey any property in the equipment to the assessee can be inferred. It follows that the lease deed entered into on the same day as the sale deed is a mere paper arrangement.

Mr. Patil, learned counsel for the assessee, submitted that not a word in the lease document has been used to show that the equipment would be repurchased by RSEB at the end of the lease period, which shows that the so-called mandate in the letter has been spurned by the assessee. According to him, clause (12)(g) which defines “lessor”, when it refers to the “mandate” merely enables one to identify the lessor and nothing more. He contended that the definition clause cannot control the operative part of the document. We are unable to give effect to these arguments. Even without a reference to the mandate, it is possible to identify the lessor as the assessee-company as its name has been clearly mentioned in the first paragraph of the lease agreement. Therefore, the reference to the mandate contained in the letter in the definition of the word “lessor”, is conscious and deliberate. It has been included in the definition only to make sure, without appearing to do so, that the assessee shall not exercise any ownership rights over the equipment and that the ownership rights shall be transferred back to RSEB. It is a reminder that the lessor is not the owner since it has already agreed in the letter that the ownership rights shall be transferred to RSEB and that stipulation had been agreed to by the parties even during negotiations and much before the sale deed and the lease deed were executed. At any rate, it is a clear indication that the air pollution equipment never became the property of the assessee, though documentation has been put through as if there was an actual sale by RSEB to the assessee and then a lease back to RSEB. It may be the normal rule that a definition clause cannot control the operative part of the document, but we believe that it is equally true that we cannot ignore the reference to the letter dated February 2, 1995, in the definition of lessor in the lease document.

(H) It is only a finance transaction

A perusal of the lease deed dated March 27, 1995, reveals another interesting feature. Clause (9) of the preamble says that the lessee (RSEB) is maintaining a current account styled as Rajasthan State Electricity Board Account No. 1 with the State Bank of Bikaner and Jaipur, which is a collection account into which all the collections/realizations/revenues of RSEB are being deposited. Clause (10) states that RSEB is also maintaining a personal deposit account with the Collectorate Treasury, Jaipur, in which all the amounts lying to the credit of RSEB’s collection account are transferred from time to time. Clause (11) says that the lessee (RSEB) has assured the lessor that a payment mechanism and recovery procedure will be created and the lease rentals will be secured from the collection account or a designated account. Clause (12) says that RSEB has represented that a lien equal to twice the amount of monthly lease rentals shall be marked on the collection account or the designated account and the standing and irrevocable instructions would be issued to SBBJ to transfer every month the requisite amounts due to the designated account from the collection account before any transfer can be effected from the collection account to the personal deposit account. This arrangement is stated to be made so as to secure the payments due under the lease agreements. Clause (13)(a) says that RSEB has obtained the confirmation from the Government of Rajasthan for the above arrangement. Clause (13) of the deed says that if RSEB defaults in making payment of any instalment of lease rental or any other monies payable under the lease deed, it shall be liable to pay to the assessee on the amounts in default, finance charges at the rate of 20 per cent. from the date on which the amounts became payable till the date of actual payment. It is clear from these clauses in the preamble as well as the body of the lease deed that the real security for the advance of Rs. 1.95 crores made by the assessee to RSEB is the lien on the collection account. The arrangement is to the effect that even before any amount is transferred from the collection account to the personal deposit account of the RSEB, the lease rentals every month will be transferred from the collection account and deposited in the designated account. Thus the real security, as rightly contended by Mr. Sahai, is the lien on the designated account. The lease rentals are thus secured to the assessee. This shows that the amount advanced by the assessee to RSEB is a pure finance transaction on the security of a lien on the designated account. Thus, a simple finance transaction has been put under the garb of lease by means of elaborate documentation.

(I) Terms of the lease deed

Though it is strictly not necessary, in the view we have taken of the transaction right from its inception, to examine the terms and conditions of the lease deed minutely in order to find out whether it is actually a lease or a sale, in deference to the arguments advanced before us, we may briefly notice them. Before that we may straightaway record that on this aspect we are in general agreement with the findings of the Commissioner of Income-tax (Appeals). However, two further aspects may be noticed by us. There is no provision in the lease deed as to what will happen to the air pollution equipment at the end of the period of lease. Under section 160 of the Contract Act, the bailee is under a duty to return the goods. But if we keep in mind the stipulation or the mandate in the letter dated February 2, 1995, that the ownership rights in the equipment will be transferred back to RSEB, then there is no question of the equipment being returned to the assessee after the period of lease. In our opinion, therefore, advisedly, no provision has been made as to what would happen to the equipment after the tenure of the lease. The other aspect to be noticed is that under the lease deed, the assessee has no right to remove the equipment for default in payment of lease rent during the currency of the lease. We have already noticed clause (13)(a) of the terms and conditions of the lease deed which only give a right to the assessee to recover finance charges if there is a default on the part of RSEB to pay the lease rentals. This also shows that the lease document is not in truth and reality a document containing an agreement to lease. The terms and conditions are so worded that the assessee has very little rights or control over the equipment and this is in consonance with the original intention of the parties that the property in the equipment shall not pass to the assessee.

(J) Power of attorney

We had already noted that in the course of the arguments Mr. Sahai filed a copy of the power of attorney executed by K. A. Shah, managing director of the assessee-company on April 4, 1995, in favour of the Secretary, RSEB authorizing him to sell the leased equipment to anyone including RSEB. Mr. Patil had not objected to the power of attorney being admitted and considered by us. This power of attorney is also another pointer to the intention of the parties that the air-pollution equipment was never to be owned by the assessee. It gives authority to the RSEB to sell the equipment to anyone including RSEB itself. In our view, this power of attorney has no purpose to serve since the air-pollution equipment at no point of time became the property of the assessee. However, since documentation had been prepared to show as if there was a sale of the equipment to the assessee and a lease back by the assessee to RSEB. RSEB might have entertained an apprehension that the very same documentation could be relied upon by the assessee to exercise ownership rights over the equipment which would jeopardize its interests. In other words, the documentation could be taken seriously by the assessee at some future point of time for various reasons. Apprehending this kind of a situation which would put the interests of RSEB to serious prejudice, RSEB, by way of abundant caution, had taken a power of attorney in its favour from the assessee authorizing it to sell the equipment to anyone including to itself. If the arrangement does not work to the satisfaction of RSEB or if the assessee tries to act smart and claim real ownership rights over the equipment, RSEB had to save itself and that is the reason for the execution of the power of attorney. If such a situation arose in future, the Secretary, RSEB had to simply execute a sale deed in favour of RSEB by virtue of the power of attorney and protect the interests of RSEB. The execution of the power of attorney within a few days of executing the lease document is a strong circumstance in favour of the Department. It is significant to note that under the power of attorney, RSEB could sell the equipment to itself. Thus, in our view, the power of attorney exposes the device adopted by the parties to pass off a simple finance transaction as a SLB transaction.

(K) RSEB is a State Government undertaking—does it affect the applicability of McDowell [1985] 154 ITR 148 (SC) ?

In our opinion, the answer is in the negative. It has to be remembered that RSEB was in dire need of funds to the extent of Rs. 450 crores for its working capital requirements. The interest rates at which it could borrow were very high. The agenda note refers to the fact that RSEB has been raising money from financial institutions such as LIC, IDBI, Banks, etc., at interest rates ranging between 15 per cent., and 17.25 per cent. The funds were provided by them only for capital expenditure, but the requirement of RSEB was for dayto-day operations also. It was at this juncture that it came to know that other State Electricity Boards such as MPSEB, PSEB, etc., had resorted to the course of raising money by notional sale and lease back of existing assets. The interest rates were also low as offered by the financial companies with whom RSEB had discussions and negotiations on January 4 and 5, 1995. The lease rental was fixed at Rs. 13.65 per thousand with a lease management fee of 1 per cent. of the cost of the asset. The average rate of interest worked out to 8.37 per cent. for the first six years of the lease and 8.28 per cent. for the last four years. What RSEB was looking for was availability of funds at a cheap rate of interest as compared to rates charged by financial institutions. RSEB is wholly owned by the State Government of Rajasthan. Its need for funds was genuine. Its conduct shows that so long as the need was supplied, it was prepared to act in accordance with the terms and conditions set by the financing/leasing companies. It hardly mattered to it as to whether a simple financial transaction of borrowing money for interest should take the form of a sale and lease back, so long as the funds were coming in. It had nothing to lose by agreeing to enter into documentation with the assessee-company in the manner suggested by the latter. It had everything to gain. In its assessment, the interest on the borrowings would have been allowed as a deduction under section 36(1)(iii) of the Act. By the documentation which took the form of SLB, instead of interest, it had to pay lease rentals which would also be allowed as a deduction in its assessments. At the same time, the assessee-company would benefit if the transaction is given the form of a SLB instead of a finance transaction, which is what it actually was. The benefit to the assessee-company is the allowance of 100 per cent. depreciation on the assets leased to RSEB. In order to achieve the result, the transaction had to take the form of a SLB at the insistence of the assessee-company. It was agreed that the documentation would show the assessee-company to be the “owner” of the air pollution equipment, having purchased the same from RSEB, and would then show as if it has been leased out to RSEB in consideration of lease rentals. What the assessee-company wanted to achieve was hardly a matter of concern for RSEB. So long as RSEB got the funds, it would have hardly mattered to it what form the transaction took, especially when the Income-tax Department would have no objection to allowing the lease rentals as deduction in its assessment. In this situation, even if RSEB wanted, it would have perhaps not been in a position to resist the assessee’s insistence on the form in which the transaction should take place. That explains the patronising manner in which RSEB went about the whole transaction, even going to the extent of showing the proforma of the board resolution to the syndicate, of which the assessee was a member, for approval. RSEB entered into 151 SLB transactions for the purpose of raising finance. It is therefore not possible to exclude the applicability of the rule in McDowell [1985] 154 ITR 148 (SC) merely because one of the parties to the transaction is a State Government undertaking. At best, it can only be stated that RSEB was indifferent to the documentation executed.

Our decision—ICICI Ltd. :

(A) The assessee had no ownership rights over the boilers

In our opinion, there was no intention on the part of GEB to pass the property in the boilers to the assessee in the first place. The modus operandi in this case is more or less the same as in the case of Mid East Portfolio Management Ltd., except that in the present case the documentation is more sophisticated, presumably because the assessee has experience in such matters and also because the assessee is a professionally managed company. That however does not detract from the position that GEB never intended to convey the property in the equipment to the assessee by way of sale. There does not appear to be any sale deed as such as in the case of Mid East. GEB acquired two boilers, one in the year 1990 and the other in the year 1991 at the cost of Rs. 65.54 crores. The assessee acquired these boilers from GEB in 1993 for Rs. 50 crores payable in five instalments between February 2 and February 22, 1993. The boilers were leased to GEB for a period of five years under a lease agreement dated January 29, 1993. Though, no doubt, there is no evidence of any proceedings of the board of directors of GEB, similar to the proceedings of the board of directors of RSEB in the case of Mid East, to show that the events took place in a pre-ordained manner and that all the documentation was done by GEB at the behest of the assessee, the basic question remains, viz., whether GEB could have really intended to sell the boilers, which are an essential part of its undertaking, to the assessee. In this connection it is pertinent to note that a specific question was put by the Assessing Officer to Mr. P. K. Das, GM (Finance) of GEB in the course of recording his statement on March 21, 1996 under section 131 of the Act :

“Question 2. It is gathered from the statements given by BHEL vide their letter dated March 11, 1996, that the Kutch Lignite Thermal Power Station (KLTPS-IIX 70 mw) was commissioned in March 1990 and March 1991. Since these plants were dedicated to the nation, in these respective years, under what circumstances it was sold to M/s. ICICI, in other words whose approval was obtained to sell the entire plant of KLTPS to ICICI in the financial year 1992-93. Was there any agreement to sell the plant to ICICI. If yes, please produce the same ?” (emphasis supplied)

Mr. P. K. Das answered that “the aforesaid transaction for KLTPS has been concluded with ICICI in line with the existing procedures of the board, the relevant document will be forwarded to you from Baroda. There was no agreement between ICICI and GEB for sale and purchase of the subject asset of KLTPS.”

This answer is vague. What are the existing procedures authorizing the sale of the equipment to the assessee have not been made known to the income-tax authorities. Nor is there any evidence to show that the relevant documents showing the existing procedures which were stated to have been followed, were forwarded to the Deputy Commissioner of Income-tax by GEB. Therefore, it is a reasonable inference that no such procedures existed and therefore the sale was beyond the scope of the powers of the board. The board could not be imagined to have acted without any authority in this behalf, and in the absence of any specific authority conferred upon them, the inference would be that GEB did not intend at all to convey any property in the equipment to the assessee. Since GEB is functioning under the authority of the State Government of Gujarat, clearance for the arrangement of sale and lease back could have been obtained from the State Government by highlighting the fact that though the equipment was purported to be sold to the assessee, there was in fact no sale and therefore the interests of GEB were not being put to prejudice, nor was there any violation of the rules and regulations within which the board has to function. In its anxiety to ensure that funds are made available to GEB, the State Government could have cleared the proposal. This is how the proposal would have been finalised. Thus, there was no intention at any point of time on the part of GEB to pass on the title of the boilers to the assessee.

The statement of Mr. P. K. Das also reveals one more thing, viz., that the boilers cannot independently generate power and that they produce the steam for the thermo generator to generate power. In answer to questions Nos. 5 and 6, he has stated that the function of the boiler is to generate steam and that the steam so generated runs the turbine generator which ultimately generates electricity. He has further said that the boilers cannot independently generate power. In the light of this statement, it is difficult to believe that the boilers were intended to be removed and delivered to the assessee. The letter dated August 5, 1996, written by GEB to the assessee-company confirming that the boilers of Unit Nos. I and II of KLTPS at Panandhro “are independent equipments and can be utilised for steam generation for the purpose of power generation on stand alone basis” is contrary to the statement made by Mr. P. K. Das on March 21, 1996. Even, if it is assumed that there is no real contradiction between the two, it cannot be imagined how GEB would continue to generate electricity without the boilers which generate the steam. Severance of the boilers from the KLTPS would have seriously jeopardized or affected the generation of electricity. Therefore, it is not possible to infer an intention on the part of GEB to convey any property in the boilers to the assessee.

For these reasons and for the reasons which we have given in the case of Mid East, in respect of this point, we are of the opinion that GEB did not intend to sell the equipment to the assessee.

(B) Chronology of events as indicating the intention

There is considerable force in the contention of Mr. Dave, the learned Commissioner of Income-tax (Departmental Representative) that the chronology of events shows that the assessee entered into the lease arrangement with GEB even before it became the owner of the boilers. It was on January 25, 1993, that the assessee received the invoice for the purchase of boilers. The purchase order was placed by the assessee on February 2, 1993, and the payments were made between February 2, 1993, and February 22, 1993. However, the lease document has been entered into on January 29, 1993, itself, i.e., even before the purchase order was placed by the assessee. This is sought to be met by Mr. Dastur, learned counsel for the assessee, by contending that though the lease agreement was entered into on January 29, 1993, which is a date even before the purchase order was placed by the assessee, as per clause 1.2(a)(ii) of the lease deed, the date of commencement of the lease was determined as March 12, 1993, which is a date after the purchase order was placed and after the payments were completed. His contention was that the assessee became the owner of the equipment on March 12, 1993, which is also the date of commencement of the lease. The fact however remains that even before the assessee purchased the asset, it was decided that it would be leased to GEB and even an agreement of lease had been drawn up on January 29, 1993. This is an irregularity which cannot be brushed away as “de minimis” as suggested by Mr. Dastur. The irregularity is an indication of the anxiety of the parties to give the transaction an appearance of a SLB transaction. We are unable to accept the contention of Mr. Dastur that the question before us is only whether the assessee was the owner of the equipment on the last day of the accounting year, i.e., on March 31, 1993, for the purpose of section 32. Any irregularity in the documentation that has been executed prior to the date on which the lease was supposed to have become operative has to be viewed strictly and as throwing a doubt on the professed intention of the parties. Mr. Dave had also referred to the letter dated February 23, 1993, written by Mr. P. K. Das, Chief Finance Manager of GEB to R. M. Desai, Manager (Leasing) of the assessee-company, a copy of which is at page 10 of the paperbook No. 1 filed by him. The letter makes out a case for a higher price to be paid by the assessee for the equipment. It justifies the claim by clarifying that the price fixed on the basis of the certificate of the chartered accountant originally represented only the basic price of Rs. 53.56 crores and that the detailed calculation thereafter worked out shows the gross cost (including taxes and duties) of the equipment at Rs. 59.05 crores. This figure is also supported by a certificate dated February 22, 1993, from a chartered accountant. A request was accordingly made in the letter to the assessee-company “to kindly consider sale and lease back for the total cost of the equipment.” We see force in the argument of Mr. Dave that where the asset has been sold for a price which has already been agreed upon, there is no question of the price being revised upward and that the tenor of the letter shows that what was being considered was merely a finance transaction where the consideration for the finance was interest and the equipment was merely offered as security. When the sale price has already been fixed at Rs. 50 crores and the monies have also been paid between February 2, and February 22, 1993, it does not accord with the theory that the price received was for the sale of the equipment if a letter is written subsequently that the price was erroneously calculated at a lower figure. That is more in conformity with the theory that since the value of the asset is higher than what was earlier calculated, more finance was required or was even justified. It is difficult to appreciate how the assessee-company can “kindly consider sale and lease back for the total cost of the equipment.” In our opinion, these words only contain a request by GEB to the assessee for more finance on the ground that the value of the asset charged as security is more than what was originally indicated. Thus, the transaction in truth is only a finance transaction on the security of the boilers.

The Assessing Officer has relied on the fact that GEB has claimed depreciation on the boilers. He has apparently thought that this has been done only on the footing that GEB continues to be the owner of the boilers. In its letter dated July 30, 1996 (page 146 of the paperbook), GEB has pointed out to the assessee that for income-tax purposes the gross value realised out of the assets sold is reduced from the opening balance of the respective block of assets and that depreciation under the Income-tax Act is calculated at the applicable rates on such reduced amount of opening balance. In other words, GEB has stated that no depreciation has been claimed in its income-tax assessment. However, the fact remains that it has provided for depreciation in its books of account. This is confirmed by the statement of Mr. P. K. Das, General Manager (Finance) of GEB, recorded on March 21, 1996, under section 131 of the Income-tax Act by the Deputy Commissioner of Income-tax, Special Range 36, Mumbai. A copy of this statement is at pages 152G to 152J of the paperbook filed by the assessee. In this statement, in answer to a specific question (question No. 3) as to whether any depreciation was provided in the accounts of GEB in respect of the boilers installed in KLTPS, and whether any depreciation was claimed in the income-tax returns of GEB for the assessment years 1991-92 and 1992-93, Mr. Das has answered as follows :

“In accordance with the provisions of section 68 of the Electricity (Supply) Act, 1948, the depreciation is calculated from the beginning of the next financial year after the year of commission of a particular project. The rate of depreciation is adopted as per the Government of India notifications issued from time to time. The straightline method is followed for calculation of depreciation as per the said Act. In our books, the depreciation has been provided and is being provided till date for the purpose of arriving at the actual profit/loss for the year in terms of the provision of section 59 read with section 63 of the Electricity (Supply) Act, 1948.

However, while working out the taxable income of the board, the board has taken a decision to add back the realised value of sold assets to their net block according to the Income-tax Act and not to claim any depreciation on the assets obtained on lease during the assessment year relevant to the financial year in which lease transaction has taken place. The factual position of exact quantum of depreciation claimed in the earlier years after the assets were commissioned and the subsequent reduction of value of net block in respect of KLTPS-I+II would be intimated to you on reaching Baroda.”

We find it difficult to appreciate that depreciation would have been claimed by GEB in respect of the boilers in question otherwise than on the basis that it continued to be the owner of the assets, despite having claimed that the boilers have been sold to the assessee. There is no other reason, which we can think of, on the basis of which GEB could provide for depreciation in its accounts. However, we have to deal with two serious objections to this line of approach. The first is that the assessee cannot be bound by the entries made in the books of GEB indicating its (GEB’s) understanding of the dealing. What has to be seen is whether the assessee became the owner of the boilers. The second objection is that the entries made in the books of account, whether by the assessee or by GEB are not conclusive of the matter.

In our opinion, both the objections are not insurmountable. So far as the first objection is concerned, it is true that normally an assessee is not bound by the accounting treatment given to a particular transaction in somebody else’s books of account. But there are exceptions to this rule. If really, GEB had understood the transaction to be a sale in fact and in law, of the boilers to the assessee and there being only one more party to the transaction, viz., the assessee, the chances of any misunderstanding or misappreciation of the situation would be very minimal. At any rate, such a basic question as to whether there was any sale at all, cannot admit of a misunderstanding between the parties to the transaction. As we have already pointed out, the fact that GEB, despite being specifically asked by the Deputy Commissioner of Income-tax, could not produce the authority to sell the boilers and gave a vague reply about the existence of such authority, has to be kept in mind while drawing the appropriate inference from the entries made in the books of account of GEB. There was no way GEB could sell the boilers to anybody including the assessee. The boilers continued to remain in the ownership of GEB, despite the fact that an invoice had been made out to show that they have been sold to the assessee-company for Rs. 50 crores. The boilers obvi ously continued to be shown in the books of GEB as well as in their balancesheet as part of their assets, otherwise the question of providing for depreciation in their books of account would not have arisen. In this background, the only conclusion that can be drawn is that GEB did not intend to pass the title in the equipment to the assessee. The entries made in its books of account, both by showing the equipment in the balance-sheet and by providing for depreciation thereon, reflect GEB’s understanding of the transaction as one, where though an invoice is made out to show as if the equipment has been sold to the assessee, in reality, there was no such sale. It is too remote to accept that if GEB has understood this position clearly, the assessee would still be under the impression that there was in truth and reality a sale in its favour. The assessee, a professionally managed company, cannot be seen to be so naive as to be under the erroneous impression that the property has been conveyed to it. In our opinion, the assessee-company was very clear as to the reality of the transaction. Its understanding of the transaction was definite. It was not under any impression that the property in the equipment had been conveyed to it under the purchase invoice. It very well knew, as a shrewd businessman, that the arrangement is only on paper and that GEB could never afford to really sell any part of the electricity undertaking. Even if it had wanted to, the assessee-company could not have persuaded GEB to desist from providing for depreciation in its books of account in respect of the boilers alleged to be sold.

The second objection that entries made in the books of account are not conclusive is a proposition which generally holds good, but there is no rule to the effect that they should be completely ignored in ascertaining the true nature or the implications of a particular business transaction. If the entries are a cogent piece of evidence, we do not see anything wrong in relying on the same to arrive at the proper conclusion. If all other circumstances point to conclusion (A) the fact that entries have been made in the books to point to conclusion (B) is not conclusive. But when there are a number of facts and circumstances which point towards conclusion (A), the fact that the entries in the accounts also support such a conclusion cannot be ignored and it cannot be contended that the entries are not conclusive of the matter. In such circumstances, the entries add significant weight to the conclusion to be drawn and throw light on the real intention of the parties. In this view of the matter, we are inclined to attach considerable weight to the fact that GEB had provided for depreciation in its books in respect of the assets allegedly sold to the assessee and consider the fact to go a long way in establishing the case of the income-tax authorities.

It was argued on behalf of the assessee that depreciation had been provided in the books of GEB only for the purpose of arriving at the actual profit or loss for the year in terms of section 59 read with section 63 of the Electricity (Supply) Act, 1948. Mr. Das has also stated so in answer to question No. 3 in the statement recorded under section 131. We have consulted these provisions. They appear in Chapter VI of the aforesaid Act, which is titled, “The Board’s Finance, Accounts and Audit”. Section 59 lays down the general principles for the board’s finance. It, inter alia, says that the board shall carry on its operations and adjust its tariffs so as to ensure that the total revenues, after meeting all the expenses including depreciation leave such surplus as is not less than 3 per cent. or such higher percentage as may be notified, of the value of the fixed assets of the board in service at the beginning of such year. Section 63 refers to subventions to the board. The State Government may, with the approval of the State Legislature, from time to time make subventions to the board for the purposes of this Act on such terms and conditions as the State Government may determine. We do not find anything in these provisions to support the assessee’s contention that depreciation was provided in the books of GEB only for the purpose of ascertaining the actual profit or loss for the year. These sections do not throw any light on the question as to whether depreciation can be claimed by GEB even in respect of assets sold and taken back on lease.

Reference was made to paragraph 2.61 at page 595 of the book on Law of Electricity in India, by S. S. Sarkar and J. P. Bhatnagar, extracts from which are at pages 151-I to 151-N of the paperbook. In this paragraph, it has been stated that in respect of the leasehold assets, the depreciation to be charged every year shall be such an amount as is required to write off 100 per cent. of the cost of leasehold asset on a straightline method over the estimated useful life of the asset or over the period of the lease, whichever is shorter. Paragraph 3 at page 1009 of the same book says that lease premium payable on acquiring lease rights for assets shall be treated as cost of leasehold assets and depreciation shall be charged on such cost in the manner prescribed. If the leasehold rights have been acquired without payment of any premium, the fair market value of the asset shall be determined and the same shall be depreciated over the lease period. Firstly, these provisions, in our opinion, are applicable only in respect of the assets genuinely acquired by GEB on lease either by paying a premium or otherwise. Secondly, we have held that there was no sale in fact by GEB to the assessee and therefore the question of taking back those assets on lease does not arise. Therefore, the only way in which depreciation could be provided in the books of account of GEB is on the footing that it continues to be the owner of the assets. Even otherwise, the provisions of the Electricity (Supply) Annual Accounts Rules, 1985, which authorise the provision of depreciation in respect of the leasehold assets admirably suit the assessee’s purpose in the sense that the provision of depreciation in the books of account of GEB can be explained with reference to those rules. We are even inclined to believe that the presence of a rule enabling the electricity board to provide for depreciation in its accounts even in respect of lease hold assets is a blessing to the electricity boards who have entered into SLB transactions in the sense that they can continue to provide for depreciation in respect of the lease hold assets and thus claim that they still continue to be the owner of the assets and when a question arises in the manner in which it has arisen in the present case, the entries can be explained as having been made only in compliance with the rules. In other words, it is a situation where both sides win. The electricity board can defend the book entries by pointing out to the requirement of the rules. It can also, if a question arises, assert that it has not sold the assets. The financing or leasing company, on the other hand, can argue that it is only because of the requirement of the rules that the Electricity Board has made a provision for depreciation in the accounts and that it is not conclusive ; in fact it can be even argued that if depreciation is not provided on such assets, it would be a violation of the rules. Both the parties to the transaction were aware of this position, which would suit the objectives of each of them. Therefore, it was possible for them to give the transaction the cloak of a SLB transaction whereas in reality and substance it was only a finance transaction.

(D) Comments made by C and AG on the accounts of GEB

In Note No. 10 to the accounts, GEB had stated that the leased assets will get transferred to it on the expiry of the period. This note was commented upon by the AG (Audit-I), Gujarat, in the following words :

“A reference is invited to item No. 10 of this statement wherein it was stated that the leased assets will get transferred to the board on the expiry of the lease period. This note is factually incorrect in as much as there are no stipulation in the lease agreements to transfer the assets on the expiry of the lease period except for the assets worth Rs. 57.68 crores. The argument of the board that this has been mentioned in the offer letters of the leasing companies is not acceptable as it is not provided in the final agreement”.

This comment was made by the AG in his report on the assessee’s accounts for the year ended March 31, 1996 (page 151AA and page 152 of the assessee’s paperbook). We are however concerned with the assessment year 1993-94 for which the previous year ended on March 31, 1993. Unfortunately, it is not known as to whether any similar comment was made by the AG on the accounts for the year under appeal. The audit report of the AG in respect of the accounts for the year under appeal is not available in the paperbook filed by the assessee. Be that as it may, the argument made on behalf of the assessee was that the view expressed by the AG should be preferred to the view expressed by GEB itself. We are unable to accept the contention. We are inclined to accept the statement made by GEB in its accounts to the effect that the leased assets would be transferred back to it by the assessee-company. It should be remembered that GEB is a party to the transaction. It has also referred to the offer letters received from the leasing companies which contained a stipulation to the effect that the leased assets would be transferred back to GEB. The AG has stated that this stipulation did not find a place in the final agreement. However, since GEB has committed itself by making a clear statement in the notes to the accounts, we are inclined to believe that there may have been a collateral understanding between the assessee and GEB that the leased assets would be transferred back to GEB at the end of the lease period. In contrast to GEB’s statement made in the notes to the accounts, the affidavit of one Rajendra M. Desai dated August 16, 1996, on behalf of the assessee-company, a copy of which is at page 116 of the paperbook, says that in the leasing arrangements entered into by it with various lessees including the lease of equipment to GEB by the agreement dated January 29, 1993, “there is no understanding explicit or implicit to sell the equipment to the lessees after the expiry of the period of the lease of the equipment”. Mr. Rajendra Desai was the Deputy Zonal Manager of ICICI in charge of leasing activities. There is also a letter dated July 26, 1996, written by the Chief Finance Manager (B & P), of GEB addressed to Mr. Desai confirming that the lease agreement dated January 29, 1993, entered into between GEB and assessee does not provide for transfer of assets back to GEB on the expiry of the lease period. In this letter it was further clarified that the note made to the accounts for the year ended March 31, 1993, “is a general statement and does not refer to the lease transaction entered into with ICICI”. In the same letter, it was stated that after the expiry of the fixed period of lease, GEB has an option to review the lease arrangement at a prefixed rate of lease rental. On a conjoint reading of the notes made to the accounts of GEB, the AG’s comments thereon, the letter written by GEB to the assessee and the affidavit filed on behalf of the assessee (all referred to above), we are of the view that the note made in the accounts of GEB should prevail because the AG’s comment (assuming that such a comment was made even in respect of the accounts for the year under appeal), has been made as an independent authority much later than the negotiations took place between the parties. Significantly, GEB has substantiated the note by reference to the stipulation in the offer letters sent by the leasing companies which provided that at the end of the lease period, the asset will be transferred to GEB. This gives the impression that there did exist an understanding between the assessee and GEB to the effect that the leased asset would ultimately be transferred to GEB. The somewhat ambiguous manner in which the letter dated July 26, 1996, written by GEB to the assessee is worded is also to be noted. In this letter it has been clarified (after first saying that the note made to the accounts of the year under appeal does not refer to the lease transactions with ICICI) that after the expiry of the fixed period of lease, GEB has an option to review the lease arrangement at prefixed rate of lease rental. Thus, GEB could extend the lease arrangement at a prefixed rate of lease rental. It has not been clarified as to on what basis the lease could be reviewed and what would be the lease rental. The vague statement made in this letter gives room to the possibility that GEB could keep on extending the lease arrangement at a very nominal lease rental, which in effect would deny the rights of ownership of the assessee over the equipment and place GEB as practically the owners of the asset. In the light of this letter, we are unable to accept the averment made by Rajendra M. Desai, on behalf of the assessee, to the effect that there was no explicit or implicit understanding to sell the equipment to GEB after the expiry of the period of lease. The averment is guardedly worded. Of course, there is no understanding, explicit or implicit, to sell the boilers to GEB after the period of lease, but if one looks at the letter dated September 26, 1996, written by GEB to Mr. Desai, it will be seen (as already noted) that GEB has an option to review the lease arrangement at a prefixed rate of lease rental. Thus, technically the averment made in the affidavit is correct, but in substance, the lease could be continued indefinitely at a very nominal rental, as per the letter of GEB. The comment made by the AG is also technically correct because there is no stipulation in the final lease agreement for transferring the equipment back to GEB. But in the light of what has been stated by us above, the absence of such an express provision is not of much relevance since it has otherwise been ensured that GEB would have the ultimate control over the leased equipment by providing for an option in its favour to review the lease arrangement at a prefixed rate of lease rental. Therefore, we are unable to hold that the view expressed by the AG should prevail over the note made in the accounts.

(E) Valuation report

The valuation report in this case has not been prepared by M. Choudhary and Associates, but has been prepared by S. C. Buch, chartered engineer. It does give the necessary details such as description of the assets, their condition, basis of valuation, etc. It also contains an annexure. The two boilers have been valued at Rs. 60.60 crores as on March 31, 1992, as realisation value. In January, 1993, they were sold by GEB to the assessee for Rs. 50 crores. It does appear to us that so far as the valuation aspect is concerned, it cannot be stated that it contains any of the infirmities which were present in the valuation report of Choudhary and Associates in the case of Mid East Portfolio Management Ltd. All that the Assessing Officer has stated is that the basis of the valuation was not made known to him. However, this observation of the Assessing Officer appears to us to be correct because Mr. Dastur himself admitted in the course of his reply that the valuation report was not made available to the Assessing Officer, but was filed only before the Commissioner of Income-tax (Appeals) for the first time. His attempt was to support the valuation of Rs. 50 crores as reasonable, having regard to the fact that the cost of the boilers was Rs. 59.04 crores as per BHEL which supplied them to GEB and even if the depreciation of Rs. 6.52 crores claimed by GEB in the assessment year 1992-93 is reduced, the written down value will be Rs. 53 crores, which is more than the price of Rs. 50 crores paid by the assessee. It was therefore, his submission that even de hors the valuation report, the price paid by the assessee was not open to the charge of inflation. He had also submitted that the Assessing Officer had not invoked Explanation 3 to section 43(1). We are of the view that so far as the price of Rs. 50 crores paid by the assessee allegedly for the purchase of the boilers is concerned, it appears to be a reasonable price, not open to the charge of being inflated. It may even be true to say that in the opinion of the assessee, a separate valuation report under the above circumstances was not necessary to justify the price paid. However, in the view we have taken of the transaction, viz., that the property in the boilers did not pass to the assessee, the amount paid by the assessee cannot be considered to be the price paid for the boilers. In that case, the question of valuation or furnishing a valuation report before the income-tax authorities pales into insignificance. The amount is only money lent by the assessee to GEB.

(F) Notifications dated February 1, 1993

We have expressed our view with regard to similar notifications issued by the Government of Rajasthan, in the appeal of Mid East Portfolio Management Ltd. The notifications issued by the State Government of Gujarat are in substance, the same. They were relied upon by the assessee to contend that there was no need to issue them if there was no sale of the boilers by GEB to the assessee. In our opinion, the notifications cannot advance the case of the assessee if in truth and reality, there was no sale of the boilers. If in truth and reality there was a sale, only then the notifications would operate to exempt the sale from sales tax. But the notifications themselves cannot decide the question whether there was a sale of the boilers. That has to be examined independently and on the basis of the intention of the parties. We have already held that there was no intention on the part of GEB to convey the property in the boilers to the assessee-company. The argument was that even the Government of Gujarat thought that there was a sale of the boilers by GEB to the assessee. We have touched this aspect of the matter in some detail while dealing with a similar argument advanced by Mr. Patil for Mid East Portfolio Management Ltd. We have not accepted the argument. For the same reasons, we are unable to give effect to the argument in the present case also.

(G) Is there an inconsistency in the stand of the Department ?

The inconsistency pointed out by the assessee was that in the case of GEB the lease rentals are allowed in the assessments as a deduction, thus recognizing the position that there was a valid lease, whereas in the case of the assessee-company, the depreciation is disallowed on the footing that the assessee is not the owner-lessor of the assets. Our attention was drawn to the assessment orders of GEB for the assessment year 1993-94 which is at pages 153 to 170 of the paperbook. We have earlier seen that in this assessment order, the Assessing Officer has acknowledged that no depreciation has been claimed on the assets taken on lease as they have been deducted from the additions made to the plant and machinery during the year. The lease rent of Rs. 21,19,81,845 has also been allowed as a deduction. This assessment order has been passed on March 25, 1996, by the Deputy Commissioner of Incometax (Assessment), Special Range-2, Baroda. The assessment order in the case of assessee-company was passed on March 28, 1996, by the Deputy Commissioner of Income-tax, Special Range, 36, Mumbai. There is no doubt no coordination between the two Assessing Officers. The assessments have been made at two different places. Ideally speaking, officers functioning within the same Department should not take inconsistent stands. But merely because they took inconsistent stands in the assessments of the parties to the same transaction, the assessee’s claim cannot be vindicated. That would be too simplistic an approach. In our opinion, the fact that in the assessment of GEB the lease rentals were allowed as a deduction cannot bind the Assessing Officer assessing the assessee-company, more so because of the complexity of the issue involved. In our opinion, it is not a serious flaw and is not fatal to the stand taken by the income-tax authorities in the assessee’s case. Further, it is seen that the assessment was made on GEB on a total loss of Rs. 29,99,54,915. The lease rent was no doubt allowed as a deduction there, but even as interest paid on monies borrowed from the assessee-company, GEB was eligible for a deduction. These aspects have also to be kept in view. In view of these, the transaction might not have attracted the scrutiny which it has attracted in the case of the assessee-company, which has been assessed on a total income of Rs. 1,64,50,10,330. The depreciation claim itself amounts to Rs. 25 crores. Therefore, it is that the transaction has been scrutinized in detail in the assessee’s case and a different stand has been taken there by the income-tax authorities. Inconsistencies should generally be avoided, but in a case such as this, perhaps they cannot be helped. At any rate, for that reason alone, the assessee’s claim cannot be upheld.

Some common arguments :

(A) Explanation 4A to section 43(1)

The Explanation is as under :

“Explanation 4A.—Where before the date of acquisition by the assessee (hereinafter referred to as the first mentioned person), the assets were at any time used by any other person (hereinafter referred to as the second mentioned person) for the purposes of his business or profession and depreciation allowance has been claimed in respect of such assets in the case of the second mentioned person and such person acquires on lease, hire or otherwise assets from the first mentioned person, then, notwithstanding anything contained in Explanation 3, the actual cost of the transferred assets, in the case of the first mentioned person, shall be the same as the written down value of the said assets at the time of transfer thereof by the second mentioned person.”

This was inserted by the Finance (No. 2) Act, 1996, with effect from October 1, 1996. In our opinion, it is a recognition of the position, which we have adverted to in the earlier part of our order, that all SLB transactions cannot be held to be motivated only by tax evasion. To say so, would be a sweeping generalization, not justified on any principle or authority. There can be a genuine SLB transaction. The Explanation only seeks to thwart the move to inflate the value of the asset leased out in order solely to obtain the benefit of 100 per cent. depreciation. It applies to an otherwise genuine transaction. If the SLB itself is not genuine (a finding to be arrived at on the basis of evidence including surrounding circumstances and the intention of the parties), then in our opinion, there is no need to invoke the Explanation. As we have already held, genuine SLB transactions which have been recognised by the commercial world cannot by a stroke of pen be derecognized. They can only be regulated so that an assessee does not misuse them. That is the purpose of the Explanation. But if the SLB transaction is established to be non-genuine or a makebelieve, it cannot be recognised either as a fact or in law, and in that case, no depreciation would be allowable at all ; it would not be a case of merely regulating the value of the asset (as envisaged in the Explanation) for the purposes of allowing the correct amount of depreciation. With respect, the argument of Mr. Dastur, learned counsel for ICICI Ltd. ,that since the reaction of the Legislature—or the tool with which it proposed to deal with SLB transactions—was the insertion of Explanation 4A and therefore all that can be done by the income-tax authorities is only to regulate the value of the asset and the amount of depreciation (and not disallow depreciation altogether) cannot be accepted for two reasons. The first is that the Explanation came into effect from October 1, 1996—i.e., it applied to SLB transactions entered into on or after that date. It cannot be said that the Legislature was not concerned with the genuineness of the SLBs at all which were entered into on or after that date. A non-genuine transaction can be dealt with even de hors the Explanation. Secondly, if the Legislature did not distinguish between genuine and non-genuine transactions and it is assumed that they were prepared to allow depreciation in a regulated or controlled manner under the Explanation, even in respect of non-genuine transactions with effect from October 1, 1996, it follows by inference that there was no provision to deal with a non-genuine SLB prior to that date, with the result that even in the case of such a SLB, no objection could be taken to the claim of depreciation. With respect, such a consequence cannot be countenanced. In our opinion, therefore, the Explanation applies only to a genuine SLB where the value of the asset shall be determined to be the written down value in the hands of the lessee, when he sold the asset to the lessor. It recognises a SLB transaction only where the property in the asset was intended to, and actually did, pass from the lessee to the lessor. Since our finding in the present case is that the intention of the parties was not to pass the property in the assets concerned by way of sale, there was no real SLB transaction. Therefore, it was open to the Assessing Officer to disallow the depreciation altogether in the hands of the assessees. Further, we are concerned with the period prior to the introduction of the Explanation. Therefore, the Assessing Officer was justified in disallowing the depreciation. It is significant that the Explanation has not been given retrospective effect. There is also no reason why the Explanation should be given retrospective effect when it was brought into effect specifically from October 1, 1996. The memorandum explaining the Explanation says that it will apply in relation to SLB transactions entered into from October 1, 1996.

(B) CBDT’s view

This aspect was argued by both Mr. Patil and Mr. Dastur. We have referred to these arguments earlier. To recapitulate briefly, Mr. Patil had argued on the basis of the circulars dated January 23, 1996, and February 9, 2001, that finance leases are per se entitled to depreciation and that the board itself has opined that there is no difference between a finance lease and an operating lease so far as depreciation is concerned. Mr. Dastur had contended that in order to put into effect the approach paper which is an annexure to the circular dated January 23, 1996, the rules framed under the Income-tax Act must provide for it giving authority to the Assessing Officer to do so. Since no such authority has been given, the approach paper can be looked upon only for the purpose of ascertaining the evils that were sought to be remedied and what remedies were proposed. He had also contended that Instruction No. 1978 dated December 31, 1999, issued by the Central Board of Direct Taxes shows that SLB transactions as such are not to be disapproved but are only to be regulated by the assessing authorities. He had also criticised the circular issued on February 9, 2001, which had suggested that in cases of SLB without any alteration in the situation of the assets and its working, the denial of depreciation has to be considered on the principles laid down in McDowell [1985] 154 ITR 148 (SC), on the ground that there is no basis for this view because by definition a SLB transaction does not involve a change in the situation of the assets. The further contention was that since the circular refuses to recognize one of the basic features of a SLB transaction, it can have no effect in the assessment.

The circulars issued by the Central Board of Direct Taxes can be given effect to if they are beneficial to the assessee, even if they deviate from the provisions of the Act. The circulars now under consideration are not of this type. But, they serve as guides to the background of the legislation. They throw light on the evils sought to be remedied by the amendment. They also contain guidelines to the Assessing Officer regarding the investigation to be carried out in cases of SLB transactions. It is true that the circular dated February 9, 2001 (see [2001] 247 ITR (St.) 53), refers to a SLB transaction without any alteration in the situation of assets and its working, but it nowhere says that in all such cases, depreciation has to be disallowed. Had it stated so, it would have fallen within the ratio of the judgment of the hon’ble Bombay High Court in TISCO v. N. C. Upadhyaya [1974] 96 ITR 1, cited by Mr. Dastur. The circular merely cautioned or advised the Assessing Officers to consider whether depreciation should be denied in such cases on the basis of the judgment of the Supreme Court in McDowell [1985] 154 ITR 148. In other words, far from directing or advising the Assessing Officers to refuse to recognize any SLB transaction in which no alteration in the situation of assets was involved, the circular only says that in such a case, it would be the duty of the Assessing Officer to see whether it was a subterfuge or a colourable device adopted by the assessee. Only if the SLB transaction is found to be a subterfuge or a colourable device, can the depreciation be disallowed. There is no direction in the circular that wherever SLB transactions are entered into without any alteration in the situation or working of the assets, the Assessing Officer should disallow the depreciation. By recognizing the principle that depreciation can be disallowed in such cases, only if the SLB is a subterfuge or a colourable device, the circular also recognises, by implication, the position that if no subterfuge or colourable device is seen to be adopted by entering into the SLB transaction, depreciation cannot be disallowed, merely because there was no alteration in the situation or working of the assets. This in our opinion is the purport of the circular. Therefore, it cannot be said that the circular has bluntly refused to recognize one of the basic features of a SLB transaction and is therefore hit by the ratio laid down in TISCO’s case [1974] 96 ITR 1 (Bom).

The board has no doubt expressed the view that the tax treatment did not differ depending upon whether the transaction embodied a finance lease or an operating lease. But this would be so only if the lease was genuine. The property in the assets must have passed from the lessee to the lessor before the lease comes into effect and such passing of the property should be real and pursuant to the genuine intention of the parties to do so. If the passing of the property was itself only a paper transaction, without any intention that the property should in fact pass, the lease would have no effect since the lessor would derive title only under the sale.

Arguments were advanced before us on the question whether there should be actual or physical delivery of the assets sold prior to the lease arrangement or it is sufficient that there was symbolic or constructive delivery. The argument of the assessees in both the cases was that there was a symbolic or constructive delivery without any physical movement of the assets or change in location and this was sufficient for the validity of the sale. Section 33 of the Sale of Goods Act says that delivery of goods sold may be made by doing anything which the parties agree shall be treated as delivery or which has the effect of putting the goods in the possession of the buyer or of any person authorized to hold them on his behalf. A symbolic or constructive delivery as opposed to a physical or manual movement of the goods from the seller to the purchaser, also falls under the section. The absence of physical delivery may not be decisive since even in the case of genuine SLB, there could be no physical or actual delivery, for the sake of convenience. In the case of Mid East Portfolio Management Ltd., Mr. Patil put forth the argument that there was constructive delivery. For ICICI Ltd., Mr. Dastur went to the extent of saying that by definition, a SLB transaction does not admit of physical or actual delivery. We think that the fact that there was only constructive or symbolic delivery of the asset cannot by itself decide the issue. The decisive issue is whether there was an intention on the part of the parties to really convey and acquire the property in the goods. Their intention is to be gathered from surrounding circumstances. These would include the negotiations held between the parties in the initial stages and during the pre-documentation period, the correspondence exchanged between them, any collateral or parallel documentation, conduct of the parties before, during and after the documentation, whether the assets are such that they could be sold at all, whether the persons who purported to sell the assets to the lessor had the authority to do so, terms of the sale and lease documents and so on and so forth. From these surrounding circumstances, if it is possible to glean that the intention of the parties was never to pass the property in the goods or assets by way of sale, then the fact that there was a constructive or symbolic delivery does not help. Even if there was a physical or actual delivery, without any intention to pass on the title in the assets, that would be only an empty ritual without any legal effect. If there is a real intention, which could be gathered in terms of section 19(2) of the Sale of Goods Act, to pass the property in the assets to the buyer, then the fact that there was no actual or physical delivery of the assets pales into oblivion. In such a case, as pointed out by the Supreme Court in the case of J. B. Boda and Co. (P.) Ltd. [1997] 223 ITR 271, it would be an empty formality or ritualistic to insist on a two way traffic—movement of the assets from the seller to the purchaser and thereafter from the purchaser to the seller under the lease back. Sundaram Finance Ltd. [1966] 17 STC 489 (SC) affords an instance where the intention of the parties was gathered on the basis of the documentation and correspondence. We have to thus take a cumulative effect of all the facts and surrounding circumstances into consideration without giving undue weight to a single fact or circumstance.

In the cases before us, the assets are part of an electricity supply undertaking. They constitute vital parts of the undertaking. We have earlier repeatedly referred to the fact that it cannot be imagined that a public utility undertaking can think of selling the assets to anybody for raising money. The assets cannot be severed from their location and handed over to the assessees. Physical delivery was therefore inconceivable, if not impossible. In the case of Mid East Portfolio Management Ltd., the negotiations held during the pre-documentation stages to which we have already referred disclose the real intention of the parties. In the case of ICICI Ltd. also, we have already held that there was no intention on the part of GEB to convey the property in the assets to ICICI. Therefore, the argument that there was constructive delivery of the asset may be seen only as an argument of convenience. In fact, in the earlier part of our order, we have touched upon this aspect of the matter. In our opinion, therefore, the argument that there was constructive delivery of the assets does not advance the case of the assessees.

(D) Economic or commercial value of the transaction

In both the cases, arguments were advanced by both the sides on this question. Certain figures and charts were filed before us by both the sides in support of their respective stands. We have considered the arguments carefully. We believe that both sides can produce figures and calculations to justify their rival stands, but as rightly pointed out by Mr. Dastur on behalf of ICICI Ltd., assessments are not made merely on arithmetical calculations ; they are to be made on legal principles. The view to be taken with regard to a particular transaction cannot differ, depending on whether the parties have made a profit or have incurred a loss in the same. The assessments cannot be made solely on the basis of the figures or arithmetical calculations. In the cases before us, in fairness to the income-tax authorities, they have realised this position and have therefore not based their views solely on the arithmetical calculations. It is only before us that an attempt was made by them to justify the assessments on the basis of the calculations also. We do not think it would be necessary for us to enter into the complexities of such calculations involving the prevalent rate of interest, use of terms such as bench marking, the components and considerations that weigh with the assessees in such businesses to determine the returns, the preferences or choices to be adopted and so on and so forth, which require deep consideration and skilful application of principles of financial accounting and accounting for lease transactions. All these, in our opinion, fall in the realm of accounting principles and policies which cannot be the sole basis for deciding the issue. We therefore refrain from entering into the maze of calculations and figures in an attempt to examine the correctness or validity of the rival stands.

(E) Judgment of the hon’ble Bombay High Court in the case of Development Credit Bank Ltd. v. Prakash Industries Ltd. (supra)

This judgment was relied upon heavily by both Mr. Dastur and Mr. Patil. The judgment of the hon’ble single judge (September 16, 1998), the judgment of the Division Bench of the High Court affirming the judgment of the single judge (January 28, 1999) and the dismissal order of the Supreme Court dated May 11, 1999, in the special leave petition filed by Prakash Industries Ltd. have all been compiled between pages 524 and 556 of the paper book filed by ICICI Ltd. These judgments have also been compiled in pages 136 to 167 of the paper book No. IV filed by Mid East Portfolio Management Ltd.

The brief facts in this case may be noticed. Under the lease agreement dated September 27, 1995, the Development Credit Bank Ltd. (hereinafter referred to as “the bank”) leased four wind electric generators and certain rolling mills rolls to Prakash Industries Ltd. (hereinafter referred to as “the company”) and another. A suit was filed against the company which guaranteed the repayment of the amount since the Prakash Industries Ltd. was referred to the BIFR. A notice of motion was taken out by the bank seeking appointment of court receiver in respect of the equipment given on lease including the power to take possession. The equipment had been purchased by the bank directly from the manufacturers. The bank was thus the owner of the equipment. Under the lease deed, the bank agreed to lease to the company the equipment for a lease rent. The company committed a breach of the obligations under the lease agreement. The bank therefore became entitled to terminate the lease and recover the possession. The dispute before the hon’ble High Court (single judge) was whether the lease agreement constituted a financial agreement and not a lease agreement. The contention of the company was that the agreement was a loan agreement, that it was the owner of the equipment leased and that under the agreement it was to get the machinery and the finance from the bank and that the bank was to get the benefit of depreciation and interest. It was submitted that the court was entitled to go behind the terms of the agreement which was signed as lease agreement to ascertain the real nature thereof. It was further submitted that the company had no money to purchase the equipment and therefore approached the bank and the bank paid for the equipment and leased the same to the company and thus the arrangement was only a simple loan for interest. It was further alleged by the company that the agreement was entered into under the guise of a lease to enable the bank to claim rebates under the Income-tax Act. On the other hand, the bank submitted that it was the owner of the leased equipment and that the lease document contained a term that if the lease was renewed the lessee will deliver the equipment to the lessor even if the company had fulfilled all its obligations during the lease. Attention of the court was drawn to clause (15) of the lease agreement which provided that on termination of the lease, the bank was entitled to sell the equipment. Certain correspondence was relied upon to show that even the company had accepted that the bank was the owner of the assets. In the course of the arguments, the company had also placed reliance on the judgment of the Supreme Court in Sundaram Finance Ltd., AIR 1966 SC 1178 ; [1966] 17 STC 489, to show the various tests to distinguish a loan agreement from a lease agreement.

On a consideration of the arguments, the hon’ble High Court came to the conclusion that there was prima facie merit in the contention of the bank that it was a lease. It was observed, relying on the judgment of the hon’ble Bombay High Court dated October 24, 1991, in the case of 20th Century Finance and Consultancy Services Ltd. v. Khanna Rayon Industries Ltd.) (copy of the judgment placed at pages 557 to 584 of the paperbook filed by ICICI Ltd.) that lease financing is a well recognised form of legal transaction under which the lessor remains the owner of the leased equipment throughout. It was also held that the court was entitled to go behind the terms and conditions of the lease agreement and that ultimately the decision will depend on the facts of each case. It was noticed that the bank was entitled to charge rent even for the period after the lease agreement stood terminated on the ground of default in the payment of rent. This clause, according to the High Court, clearly showed that Sundaram Finance Ltd. [1966] 17 STC 489 (SC) was not applicable to the case and that the bank was the owner of the equipment. It was also observed that it was important to note that the benefit of depreciation was given to the bank. The warranties were also in favour of the bank. It was further noticed that the invoices and the delivery challans showed that the purchase price has been paid by the bank. On the basis of all the clauses in the lease deed, it was held that the bank was the owner of the leased assets. It was ultimately held that it was a valid lease and cannot be construed to be a loan agreement. Therefore, the court receiver was appointed as prayed for by the bank.

The company appealed to the Division Bench which disposed of the matter by judgment dated January 28, 1999. The Division Bench accepted the proposition that the courts must construe the true effect of a transaction from the terms of the agreement considered in the light of the surrounding circumstances. It was held that the equipment was purchased by the bank, that it belongs to the bank and was only lease to the company and that there was nothing in the conduct of the parties or the correspondence to show that the company at any time became the owner of the equipment. The judgment of the hon’ble single judge was affirmed. The special leave petition filed by the company against the judgment of the Division Bench was dismissed by order dated May 11, 1999.

The facts noted above would show that it was the bank which originally purchased the assets by paying the purchase price and it was thereafter that it entered into a lease agreement with the company. The assets had not been owned by the lessee company at any time prior to the lease. In other words, the transaction was not a sale and lease-back transaction. There was no doubt that the bank was the de jure and de facto owner of the equipment which was leased to the company. In the present cases, however, the very title of the assessee-companies to the assets which were allegedly leased out to RSEB/ GEB is under challenge. The assessee-companies derive their title only from the electricity boards concerned and if there was no sale at all, they could not have had any title to the assets. There were no circumstances in the decision relied upon by the assessees to doubt the title of the bank to the equipment leased or to suspect the genuineness of the transaction. This is a factual distinction between the present cases and the case relied upon.

The argument of the assessees however is that the judgment lays down the tests to ascertain whether the document in question is a document of lease or embodies a mere loan transaction. Mr. Dastur for ICICI Ltd. also pointed out that there are many similarities between the lease document in the cited decision and the lease document entered into between ICICI Ltd. and GEB on January 29, 1993. In fact, a comparative chart has also been filed in this regard. The question is not simply whether because of the similarities in the clauses of the lease agreement, the same conclusion should follow. In our opinion, the superficial similarity between the clauses in the lease agreement in the cited decision and the clauses of the lease agreement in the case of ICICI Ltd. is not necessarily decisive of the question as to whether the document in the present case constitutes a valid lease, enabling ICICI Ltd. to claim 100 per cent. depreciation. The judgment of the hon’ble High Court was only a limited issue as to the interpretation of the lease agreement. There were no other facts similar to the facts present in the cases before us. The transaction itself was not doubted in the case before the hon’ble High Court whereas in the cases before us, the genuineness of the entire transaction itself is under challenge. In the case before the High Court, it was nobody’s case that the lease agreement was a make believe or sham. In the cases before us, the basis of the Department’s stand is that the entire SLB transaction is a make-believe or subterfuge or a colourable device to evade taxes. The complexion of the present cases being different from the case before the hon’ble High Court, the similarity between some of the clauses in the lease agreement in the cited case and the lease agreements in the cases before us cannot be considered to be decisive.

(F) Judgment of the hon’ble Bombay High Court in the case of 20th Century Finance and Consultancy Services Ltd. v. Khanna Rayon Industries Ltd.

This judgment was relied upon by the assessees to contend firstly that the judgment recognises that “several new developments have taken place in the commercial life of the community and there are certain global aspects of lease financing which have grown with the change of times during recent decade” and further that “lease financing is an accepted norm in the business world and its incidents are well settled”. The contention has been accepted by us and we have made certain observations to that effect in the earlier part of our order. It was next contended that there were many similarities between the clauses of the lease deed which was before the hon’ble High Court and the clauses of the lease deed in the case of ICICI Ltd. We have considered a similar argument advanced by ICICI Ltd. in the preceding paragraph while discussing the applicability of the judgment of the hon’ble Bombay High Court in the case of Development Credit Bank Ltd. v. Prakash Industries Ltd. The judgment lays down guidelines to find out the true nature of a document. It has been held that the law makes a clear distinction between a lease and hire purchase transaction, that in the case of a lease, the lessee acquires no propriety right or title in the equipment, that the fact that the lessee did not show the equipment in his balance-sheet and the fact that the lessor has claimed depreciation as owner of the equipment for purposes of income-tax are all factors to be considered while ascertaining whether the document is a lease or a loan finance agreement.

That was a case between two parties arising out of a document which one of them contended to be a lease document and the other contended to be a document embodying a simple loan agreement. It was not a case of a sale and lease back of the equipment. The document was also not considered to be a colour able transaction. Here again, the complexion of the case is different from that of the cases before us. The very question before us is whether the assessees are entitled to 100 per cent. depreciation on the leased equipment. It has been held by the High Court that the document in question was a lease because the lessor was allowed depreciation for income-tax purposes as owner. That is only because there was no doubt regarding the genuineness of the transaction and therefore the allowance of depreciation in the hands of the lessor for incometax purposes was considered to be one of the points in favour of the construction of the document as a lease document. The position before us is not the same. We have a case where the very genuineness of the SLB arrangement is under challenge. The very question before us is whether the assessees are entitled to depreciation in respect of the leased equipment. The real controversy is therefore different from the controversy before the High Court. Therefore the similarity between the clauses of the lease agreements cannot advance the case of the assessees. In this view of the matter, we are of the opinion that the judgment does not further the cause of the assessees.

(G) Are the assets movable or immovable assets ?

On this aspect also, there were considerable arguments. Several authorities were also relied upon by both the sides on the question. We find that the cases have proceeded all along on the footing that the assets/equipment are only movable items. That is the reason why the Sale of Goods Act and the provisions in the Contract Act relating to bailment of goods, “opinion of Benjamin” on sale, etc., were referred to. It was only for the first time before us that an argument was raised by Mr. Dave, the learned Commissioner of Income-tax (Departmental Representative) that the boilers (in the case of ICICI Ltd.) were immovable assets. Mr. Dastur has rightly objected to this point being raised for the first time before the Special Bench. He is also right in contending that the question whether an asset is a movable or immovable asset is a matter of evidence and it is for the person contending that the asset is immovable to show first that it is attached to or forms part of the land. These objections are valid and must be upheld. We therefore hold that the assets (air pollution equipment in the case of Mid East Portfolio Management Ltd. and boilers in the case of ICICI Ltd.) are movable assets and that is how the cases have proceeded so far. In this view of the matter, it is not necessary to discuss the authorities cited by both sides on the point.

(H) Orders of various Benches of the Tribunal

Both sides relied on several orders of various Benches of the Tribunal in support of their respective stands. In our opinion, there can only be superficial similarity between those cases and the facts of the cases before us. Each case has to be decided on its own merits and on the basis of the peculiar facts obtaining in that case, more so when the question of genuineness is involved. There can be no pigeon-holing of the facts in the sense that it cannot always be held that if the facts follow a particular pattern, then the conclusion must be the same. Genuineness of a transaction is something which is to be likened to the soul ; the facts merely constitute the body and similarity between the bodies does not ipso facto mean that the souls are also identical. We have perused the orders of the various Benches of the Tribunal cited before us and we generally find that in each of those cases the Bench was satisfied with the genuineness or otherwise of the SLB transaction, whatever may be their reasons. We would resist the temptation to generalize or to lay down norms in such cases. Norms may be laid down only if it is absolutely necessary to do so. In fact, there can be no common rules for finding out the genuineness of a particular SLB transaction, which can be of universal application. Nor can any such norms be exhaustive. However, very broadly and without limiting ourselves to what has been stated in our order, the following may be considered to be relevant factors to be kept in view :

(a) Was there an intention to pass the property in the equipment to the assessee ?

(b) Was the equipment identified/ascertained with reasonable clarity ?

(c) Was the equipment valued, and if so, whether it was a bona fide valuation ? Was the value inflated ? How credible is the report of the valuer, if there is one ?

(d) What are the terms of the lease ? Is the document more of an arrangement for security for the loan and less of a lease ?

(e) Is there any parallel or collateral documentation or correspondence or an understanding between the parties which throws doubt on their intention professed by the principal documentation ?

(f) What is the conduct of the parties ? How transparent has it been ?

(g) If the lessee is a public utility undertaking, whether the sale of the equipment would be in conformity with the rationale for its existence and whether it would have an adverse impact on its working ?

These are only some of the factors that one is expected to keep in view in dealing with such cases. They are by no means exhaustive. Any other fact or circumstance which one considers relevant for reaching the soul of the matter must necessarily be taken into account. Ultimately, it is the inference to be drawn on a cumulative consideration of all the facts and circumstances of the case which is material. We have therefore perused the various orders of the Tribunal placed before us only in this perspective, viz., whether any guidelines or principles of general application could be culled from them which could be usefully applied to the cases before us for the purpose of ascertaining the genuineness of the SLB transaction. We have eschewed the temptation “to match the colour of one with the other” and draw our inferences on superficial similarities.

In the course of our order, we have referred to various minor or subsidiary points raised by both the sides, but we have not considered it necessary to deal with them in detail individually for the reason that our basic conclusion is that the transactions which have been styled as SLB transactions are in reality pure finance transactions and that the intention of the parties was not that the property in the equipment should pass to the assessees by way of sale. This finding of ours obviates the need to deal with sundry or minor points separately or in detail.

In the result, we answer the question referred to the Special Bench in the affirmative and hold that the assessees (Mid East Portfolio Management Ltd. and ICICI Ltd.) are not entitled to the 100 per cent. depreciation allowance claimed in respect of the assets/equipment leased out to RSEB and GEB, respectively. The orders of the departmental authorities on this point are confirmed.

Since there are various other grounds of appeal in both the cases, the records will now be placed before the Division Bench for disposal in accordance with law.

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