Difference between Finance Lease and Operating Lease


CIT vs. The Instalment Supply Ltd (Delhi High Court)

The assessee bought 1614 items of computer systems for Rs.40 lacs from HCL Hewlett Packard Ltd and leased back to the same company. The assessee claimed 100% depreciation on the ground that the cost of each itemswas less than Rs.5,000. The AO & CIT (A) held that the lease was not a bona fide transaction and that the transaction was a finance transaction. It was held that the assessee had advanced Rs.40 lacs to HCL Hewlett Packard Ltd and agreed to receive back this amount along with the interest over six years. However, the Tribunal upheld the claim on the ground that the conditions of a valid lease were satisfied. On appeal by the department to the High Court, HELD:

The question whether an agreement is a finance agreement or an operating lease cannot be decided by merely looking at the title of the agreement or the nomenclature given to the said agreement. The terms and conditions mentioned in the agreement may be relevant but the surrounding circumstances & type and nature of the asset have also to be considered. There is a difference between a finance agreement and an operational lease. A finance lease is one where the lessee uses the asset for substantially the whole of its useful life and the lease payments are calculated to cover the full cost together with interest charges. It is thus a disguised way of purchasing the asset with the help of a loan. An operating lease is any other type of lease where the asset is not wholly amortised during the non-cancellable period, if any, of the lease and where the lessor does not rely for his profit on the rentals in the non-cancellable period. This distinction has been explained in Asea Brown Boveri Ltd vs. IFCI (2004) 12 SCC 570, Association of Leasing and Financial Service Companies vs. UOI (2011) 2 SCC 352 & Sundaram Finance Ltd vs. Kerala AIR 1966 SC 1178. As the Tribunal has not considered the issue from the right perspective, matter remanded.

Source: itatonline.org

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