LEASING: TIME TO GIVE IT A SAFE HARBOUR

By Vinod Kothari

 There were some 500 odd leasing companies in India about 5 years ago. Now, not more than 50 serious operators are left, who are searching for ways to survive in the coming 5 years. In my view, it is high time for those 50 players to join hands together, and cry out loud: "We will not write a single penny of lease transactions in India, unless the Government speaks out its mind. Enough is enough. A business can survive taxes, and duties, and sanctions, but no business can survive uncertainty. So, unless the Government clarifies what does it have in mind regarding income-tax, sales-tax, accounting and other issues that have been drifting like the nebula for last 20 years, we cannot, and shall not write a single lease."

Leasing in India would go down in history as a clear victim of legislative inaction. It is true that governments have their own way: they do not act; they react. But it is perplexing as to how could the government sleep over the fate of multi-billion dollar industry for so many years. Look at the following hard facts:

• Controversy erupted regarding leasing companies' claim for depreciation in 1995 as some companies were found to have made exaggerated claims or claims that were not genuine. The Association of Leasing and Financial Services Cos. (ALFSC) has been pleading for last 5 years that the CBDT frame rules that would help the assessing officers distinguish between genuine leases and garbed financial transactions. ALFSC has also suggested model rules drawing from several other countries. Obviously enough, there was nothing that the CBDT would have lost by enacting these rules, and nothing stood to gain by not enacting them. However, nothing has been done for last 5 years. Result: as there is no rule from the CBDT, every assessing officer, and every appellate commissioner, has framed his or her own rule. Most of these officers have looked at lease transactions with a kind of inherent vengeance: therefore, the end result is common but the reasoning is different. That is, depreciation is disallowed, for reasons that differ from case to case.
• Sales-tax was imposed on lease transactions some 16 years ago. No one was clear as to how would the jurisdiction and incidence of tax be determined. We allowed the controversy to linger for all these years waiting for the Supreme Court to give a ruling only in year 2000. In the meantime, some Rs 20000 crores worth lease transactions would have been signed in the country, and obviously enough, the Supreme Court ruling that operates 16 years back in history cannot be favourable to them all. At the same time, it cannot be favourable to the States as well. Any one who understands the ruling would agree that the States would not be happy with the ruling and would force the Central Govt to alter the law, possibly with retrospective effect. Again - we let things loose and unsettled for years, and wait for a crisis-like situation, and then correct our mistakes in history.
• Accounting standards for lease transactions have been in the limelight for quite a while. The ICAI has expressed its resolve to adopt in India something akin to the pre-1999 version of IAS-17. This is exactly what the Institute proposed sometime in year 1983-4. For last 16 years, the framing of accounting standards has been lurching, hit by a Court-stay for some time, uncertainty for a larger time. In the meantime, IAS 17 has already been amended. There is a new thinking internationally about lease accounting, and the pre-1999 version of IAS-17 that the Institute is seeking to adopt is in the process of being discarded world-over. In other words, we would be adopting a standard, just when the rest of the world is about to reject it.

Every industry needs a safe harbour: more so for lease transactions which envisage long term investments. It is the duty of the State to define what is it policy towards a business.

In the current controversy relating to accounting standards for lease transactions, some interesting issues have cropped up.

Will change of accounting standard deny tax depreciation to leases?

This is absolute rubbish. Accounting standards are meant for preparation of books for account, not for guidance of tax officers. As things exist, accounting depreciation and tax depreciation are miles apart. There are plenty of countries all over the world where leases may be capitalised for accounting purposes by lessees, and yet depreciated for tax purposes by lessors.

UK itself is a prominent example. South Africa is yet another. Even in the largest leasing market in the World, USA, tax and accounting principles for leasing depreciation are markedly different and the difference is honoured and settled over time.

So, there is no scope for the popular fear that if India adopts IAS-17-type capitalisation by lessees, it would lead to loss of tax depreciation. Unless the tax department also thinks alike (which would be a disaster, as I explain below), there is no linkage between tax treatment and accounting treatment when it comes to depreciation. Merely because a lease is capitalised by the lessee for accounting purposes does not entitled the lessee, or disentitled the lessor to claim depreciation.

Has the accounting distinction between financial and operating leases served any purpose:

It is today almost universally agreed that the accounting distinction between financial and operating leases has not served any purpose. As the accounting difference is based on fine mathematics, lessors and lessees world-over have devised leases which in essence are financial leases but qualify for operating lease definition. This is what prompted an Australian gentleman -McGregor - to make a cothetic argument against the financial-operating lease distinction. McGregor study became the basis for what is called "the new approach" to lease accounting. It is based on this approach that IAS 17 was revised with effect from 1999.

Under the revised standard, disclosure is required for non-cancellable leases in the books of the lessee, irrespective of whether the lease is a financial lease or operating lease. In other words, as far as the lessee is concerned, accounting standards no more distinguish between a financial and an operating lease.

Can the accounting distinction be used for tax laws?

It would be disastrous to adopt the accounting distinction between financial and operating leases for tax purposes. As mentioned above, the accounting distinction is based on fine mathematics which is extremely complicated and subjective. The primary test used for accounting purposes is the "present value" test. Apart from being complicated, the present value test is:

• Different for the lessor and the lessee (in case of the lessor, his IRR is used; in case of the lessee, his incremental borrowing rate is used)
• Subjective, as the incremental borrowing rate for the lessee is an arguable issue
• Prone to manipulation by using structuring elements like security deposit which are not used in computing the present value test.

Should India adopt IAS-17:

Almost the whole of civilised world has adopted. Much smaller and lesser developed economies have adopted IAS 17, many years ago, and leasing has continued to grow there. Leave aside unfamiliar names, all our neighbours - Bangla Desh, Sri Lanka and Pakistan, adopted IAS 17 several years back. That has not deterred the growth of leasing in any way in any of these countries.

So there should be no apprehension as to leasing meeting an untimely death due to accounting standards being revised to meet internationally accepted norms. If anything will cause the untimely death of the industry, it is lack of regulation, leading to lack of certainty.

What kind of tax treatment should be applicable to leases:

As discussed before, the financial lease/ operating lease distinction would be a disaster for tax laws. For tax purposes, what is more relevant is the test of a "true lease", meaning a lease that does not reflect an intent of owning and letting out an asset, but one of mere funding. There are tests in many countries to distinguish between true leases and financial transactions, which can be used in our country.

Besides this, it might make sense to use a simple but very powerful limitation: leasing tax shelter not being used against non-leasing incomes. Several countries, such as Malaysia, Sri Lanka, South Africa, have enacted this rule. This rule allows the leasing tax shelter to be absorbed within the leasing business, but not to be used against other incomes. This by itself would curb the misuse of leasing depreciation.

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