S.V. MEHROTRA, ACCOUNTANT MEMBER 
AND KULDIP SINGH, JUDICIAL MEMBER

Rohit Tiwari and Ms. Shruti, ARs for the Appellant. 
T.M. Shivakumar, CIT (DR) for the Respondent.

ORDER

S.V. Mehrotra, Accountant Member - This appeal filed by the assessee is directed against the order dated 26.10.2012 passed by the Assessing Officer u/s 143(3) r.w.s. 144C of the Income Tax Act, 1961 (in short "the Act") relating to assessment year 2008-09 pursuant to the direction of the Dispute Resolution Panel-II, New Delhi.

2. This appeal has been fixed as per order of Tribunal in M.A. No. 54/Del/2016 dated 21.10.2016 for the limited purpose of disposing of ground no. 9 in the appeal memo. Accordingly, we proceed to dispose of following ground no.9 of the appeal memo :—

"9. The Ld. AO has grossly erred in adding back the amount of Rent equalisation reserve of Rs.18,45,875/- to the book profits of the Appellant, declared under section 115JB of the Act, erroneously proposing that the amount of rent equalisation reserve charged to profit and loss account is covered under clause (b) or (c) of Explanation 1 to Section 115JB of the Act, and thus needs to be added in Book profits."

3. Brief facts apropos this issue are that the assessee had debited a sum of Rs.18,45,875/- in its Profit & Loss Account as rent equalization reserve. As per assessee's submissions before the Assessing Officer, this reserve had been created by the assessee upon straight lining of the lease rentals payable by the assessee under an operating lease for the premises occupied by it during the financial year under consideration and in accordance with the Accounting Standard 19 (AS19) : 'Accounting for Leases issued by the Institute of Chartered Accountant of India (ICAI)'. In the course of assessment proceedings, the assessee, in its submissions, dated 28.11.2011, which has been reproduced by Assessing Officer at page 2 of his draft assessment order, it had been stated that this reserve had inadvertently been left out from being added back while computing the taxable income under the normal provisions of the Act due to lack of clarity on its allowability under the normal provisions of the Act. Accordingly, assessee offered the amount debited as rent equalization reserve in its Profit & Loss Account during the financial year under consideration to be taxed under the normal provisions of the Act. The Assessing Officer noticed that though the assessee had offered to add back the rent equalization reserve in the computation under the normal provisions of the Act, however, the same was not added back, while computing the tax liability, for computing book profit as per Explanation 1 of clause (b) and (c) to section 115JB of the Act. He, therefore, added back this amount for computing the book profits of the assessee. Ld. DRP confirmed the Assessing Officer's action. Accordingly, the Assessing Officer gave effect to the DRP's directions.

4. Ld. counsel referred to page 182 of Paper Book, wherein, Lease Deed dated 06.09.2006 between M/s Vatika Landbase Pvt. Ltd. and assessee is contained. Ld. counsel referred to page 3 of Lease Deed, wherein, covenant in regard to lease rental and option to renew the lease reads as under :—

"(i) Lease-Rental and Option to Renew the Lease: The Lessor agrees to lease the Demised Premises unto the Lessee and the Lessee agrees to take on lease the Demised Premises together with the right to use the common facilities in the said Tower and Complex along with other occupants and the right to park 22 (Twenty Two) cars free of cost in the car parking spaces earmarked in the basement(s). The period of the lease is 3 (Three) years from the date of commencement of the same at a monthly rent of Rs.6,44,262.85 (Rupees Six Lac Forty Four Thousand Two Hundred Sixty Two and paise Eighty Five only) at the rate Rs. 35.0 (Rupees Thirty Five only) per square ft. per month of super built-up area, with an option to the Lessee to renew the Lease for another 2 (two) consecutive terms of 3 (three) years each provided that the Lessee shall give the Lessor a duly served notice for renewal in writing at least 3 (Three) months before the expiry of the Initial Term or the first renewal period but its failure to do so would not affect its unilateral right to renew/extend the same. If the option to renew the Lease is exercised by the Lessee as above, then the rate of escalation of rent shall be mutually decided but such rate of escalation shall exceed 15% (Fifteen Percent) of the rent paid in the preceding 3 (three) year term, and a fresh Lease Deed shall be executed on the same terms and conditions as in this Agreement. This is in the interest of the Lessee, as no matter what the current rate of rentals at the time, with an upper cap of 15%, on the previous basic rent the escalation remains restricted to any undue hike in rentals.

A fresh Deed of Lease will be executed at the time of each renewal and the same shall be duly registered in accordance with the provisions of the Indian Registration Act, 1908 after the payment of the appropriate stamp duty at the then applicable rates as per the Indian Stamp Act, 1899 incorporating the same terms and conditions as are contained herein."
5. Ld. counsel referred to page 175 of Paper Book, wherein, the assessee's reply before the Assessing Officer dated 29.11.2011 is contained in which, inter-alia, it was explained as under :—

"Generally, leasing agreements nowadays provides for an escalation clause in the rent payable by a Company over a period of time. In these cases, since, the lessee is deriving the same benefit from the rented premises (in physical terms), from one year to another, in order to prevent a higher amount debited in the profit and loss account in the later years of the lease, the AS 19 and the Expert Advisory Council (EAC) opinion dated September 13, 2007 provide that any escalation in the rent expense needs to be recognized in the books of accounts on a straight line basis, over the period of lease."

6. Ld. counsel further referred to page 181 of Paper Book, wherein, the statement showing details of rent equalization reserve for Vatika Towers are contained, which is reproduced hereunder :—

Particulars	Rent Per Month	SIPL Share	SGTC Share	Service Tax	Total SGTC Share	No. of Months	Amount (Rs.)
Rent payable per month (1st Year)	644,263	122,732	521,531	64,461	585,992	36	21,095,711
Rent payable per month (2nd Year)	740,902	141,142	599,760	74,130	673,891	36	24,260,068
Rent payable per month (3rd Year)	852,038	162,313	689,724	85,250	774,974	36	27,899,078
Total rent payable during 9 years						108	73,254,858
Per month charge on Straight Line basis							678,286
Month expired till March 31, 2008							20
Total Cost till March 31,2008							13,565,714
Less: Amount Payable as per Lease Agreement till March 31, 2008	644,263	122,732	521,531	64,461	585,992	20	11,719,840
Amount to be provided for rent equalization reserve under Straight Line Method							1,845,875

7. Ld. counsel referred to the definition of 'lease term' as per para 3.6, which is reproduced hereunder :—

"3.6 The lease term is the non-cancellable period for which the lessee has agreed to take on lease the asset together with any further periods for which the lessee has the option to continue the lease of the asset, with or without further payment, which option at the inception of the lease it is reasonably certain that the lessee will exercise."

8. With reference to the Lease Deed, ld. counsel pointed out that option to exercise continuation of lease was there and it was reasonably certain that lessee would exercise the option to renew the lease. He, therefore, submitted that rent equalization reserve had been created on the basis of 9 years lease term after taking into account the escalation of 15% renewal at each time. Ld. counsel relied on following decisions :—

(a)	Apollo Tyres Ltd. v. CIT [2002] 255 ITR 273/122 taxmann.com 562 (SC);
(b)	CIT v. ICICI Venture Funds Management Co. Ltd. [2015] 234 Taxman 569/62 taxmann.com 128 (Karnataka) ; and
(c)	GE Capital Transportation Financial Services Ltd. v. Asstt. CIT [2008] 113 ITD 22 (Delhi).

9. Per contra, ld. DR submitted that the Lease Deed was for three years and, therefore, the rent equalization reserve could not be created on the basis of 9 years lease term, which could materialize subject to renewal of lease. Ld. DR submitted that it is not a case of lease covered by AS 19 since there was no certainty of continuance of lease. He submitted that property considered in AS 19 is different. He pointed out that AS 19 is not applicable to lease of immovable property. Ld. DR further submitted that the decision of Hon'ble Karnataka High Court in the case of ICICI Venture Funds Management Co. Ltd. (supra) was with reference to financial lease and not operational lease, wherein, it was, inter-alia, observed that lease equalization charges was nothing but the difference between the statutory depreciation on rentals and the recovery of cost of capital, therefore, merely because the said amount entered into the Profit & Loss Account in effect, made no difference. He, therefore, submitted that this decision is not applicable to the facts of the present case particularly because asset involved therein was not immovable property. As regards the decision of GE Capital Transportation Financial Services Ltd. (supra), ld. DR pointed out that the same was also not with reference to immovable property but with reference to vehicles lease out to third parties under lease agreement. Ld. DR has filed written submissions which are reproduced hereunder :—

'Submissions
STRAIGHT-LINE ACCOUNTING OF LEASE RENTAL

Accounting Standard 19 (AS-19) deals with the subject of accounting for lease rental from the standpoint of both, the lessor and the lessee. However, it is submitted that the same is not applicable to lease of immoveable property.

AS-19 classifies leases mainly into two categories: Finance lease and Operating lease (OL). Different accounting treatments are prescribed in respect of rental from finance lease and OL.

AS-19, in paragraph 23, states the following, in the context of operating lease from the standpoint of the lessee:

"Lease payments under an operating lease should be recognised as an expense in the statement of profit and loss on a straight-line basis over the lease term, unless another systematic basis is more representative of the time pattern of the user's benefit."

Paragraph 24 of AS-19 explains the previous paragraph and provides that lease rental will be accounted on a straight-line basis, unless another systematic basis is more representative of the time pattern of the user, even if the payments are not on that basis. (Emphasis supplied)

1.6 Paragraphs 23 and 24 relate to payments of lease rental and view the matter from the standpoint of the lessee. The same view is taken in paragraph 40 of AS- 19 when the matter is viewed from the standpoint of the lessor, and the language used therein makes it clear that AS19 is not applicable to lease of immovable property whose use pattern has nothing to do with passage of time. AS-19, in substance, states that expenditure and income, both, resulting from payments and receipts under an OL, should be recognised on a straight-line basis, unless another systematic basis is more representative of the time pattern of the user's benefit. Paragraph 40 of AS-19 makes is clear that it supposes the time pattern to be such in which benefit derived from the use of the leased asset is diminished.

It is submitted that AS-19 postulates a situation in operating leases in which the benefits derived from the use of the leased asset are diminished over the period of lease. This is made clear in paragraph 40 of AS-19. This paragraph deals with accounting of lease rental in an OL, from the standpoint of the lessor.

"Lease income from operating leases should be recognised in the statement of profit and loss on a straight-line basis over the lease term, unless another systematic basis is more representative of the time pattern in which benefit derived from the use of the leased asset is diminished." (Emphasis supplied)

A harmonious reading of paragraph 23, 24 and 40 suggests that it does not visualise a situation of increasing rental over the period of lease, whether benefits from the use of the leased asset increasing or diminishing or remaining constant. Therefore, in a case involving increasing rental, which in no case can represent a time pattern in which benefit derived from the use of the leased asset is diminished, AS19 cannot be applicable.

Once it is clear that paragraphs 23, its extension in paragraph 24 and paragraph 40, all postulate a possibility of a situation of diminishing benefits and decreasing returns derived from the use of the leased asset, and do not postulate a situation of increasing benefits, then it is inappropriate to apply these paragraphs to a situation of escalating returns as in the case of immoveable property.

3.11 Moreover, when rent of an immovable property is fixed, it accounts for a large part the value of the land. Rental of a building can be split into: rental attributable to the land component and rental attributable to the superstructure. If this is done, then AS-19 becomes inapplicable to the rent attributable to the land. (It is provided in AS-19 itself that it does not apply to lease agreements for use of lands).

Sd/-

(T.M. Shivakumar)
Commissioner of Income Tax (DR)
I(2)-Bench, ITAT, New Delhi.'

10. We have considered the rival submissions and have perused the record of the case. The scope of AS 19 does not extend, inter-alia, to lease agreements to use lands. Para 2 of scope reads as under :—

"2.

This Standard applies to agreements that transfer the right to use assets even though substantial services by the lessor may be called for in connection with the operation or maintenance of such assets. On the other hand, this Standard does not apply to agreements that are contracts for services that do not transfer the right to use assets from one contracting party to the other."

11. The classification of leases for the purposes of AS 19 are as under :—
"Classification of Leases

5.	The classification of leases adopted in this Standard is based on the extent to which risks and rewards incident to ownership of a leased asset lie with the lessor or the lessee. Risks include the possibilities of losses from idle capacity or technological obsolescence and of variations in return due to changing economic conditions. Rewards may be represented by the expectation of profitable operation over the economic life of the asset and of gain from appreciation in value or realisation of residual value.
6.	A lease is classified as a finance lease if it transfers substantially all the risks and rewards incident to ownership. Title may or may not eventually be transferred. A lease is classified as an operating lease if it does not transfer substantially all the risks and rewards incident to ownership.
7.	Since the transaction between a lessor and a lessee is based on a lease agreement common to both parties, it is appropriate to use consistent definitions. The application of these definitions to the differing circumstances of the two parties may sometimes result in the same lease being classified differently by the lessor and the lessee.
8.	Whether a lease is a finance lease or an operating lease depends on the substance of the transaction rather than its form. Examples of situations which would normally lead to a lease being classified as a finance lease are:
	(a) the lease transfers ownership of the asset to the lessee by the end of the lease term;
	(b) the lessee has the option to purchase the asset at a price which is expected to be sufficiently lower than the fair value at the date the option becomes exercisable such that, at the inception of the lease, it is reasonably certain that the option will be exercised;
	(c) the lease term is for the major part of the economic life of the asset even if title is not transferred;
	(d) at the inception of the lease the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset; and
	(e) the leased asset is of a specialised nature such that only the lessee can use it without major modifications being made.
9.	Indicators of situations which individually or in combination could also lead to a lease being classified as a finance lease are:
	(a) if the lessee can cancel the lease, the lessor's losses associated with the cancellation are borne by the lessee;
	(b) gains or losses from the fluctuation in the fair value of the residual fall to the lessee (for example in the form of a rent rebate equalling most of the sales proceeds at the end of the lease); and
	(c) the lessee can continue the lease for a secondary period at a rent which is substantially lower than market rent.
10.	Lease classification is made at the inception of the lease. If at any time the lessee and the lessor agree to change the provisions of the lease, other than by renewing the lease, in a manner that would have resulted in a different classification of the lease under the criteria in paragraphs 5 to 9 had the changed terms been in effect at the inception of the lease, the revised agreement is considered as a new agreement over its revised term. Changes in estimates (for example, changes in estimates of the economic life or of the residual value of the leased asset) or changes in circumstances (for example, default by the lessee), however, do not give rise to a new classification of a lease for accounting purposes."

12. Now, if, we examine various definitions contained in paragraph 3, we find that the same deals primarily with defining of finance lease, operating lease, non-cancellable lease, lease term, fair value of asset, economic life, useful life, residual value, guaranteed residual value of lease assets. It clearly shows that the main object of the AS 19 is to deal with the leases concerning movable assets and it specifically excludes lease agreements to use lands. We find considerable force in the submissions of ld. CIT-DR that AS 19 is not applicable to lease of immovable property. Therefore, the Assessing Officer rightly added back the rent equalization reserve debited to Profit & Loss Account while computing the book profit for the purposes of section 115JB of the Act. Moreover, the assessee itself has added back this reserve for the purposes of computation of total income under the normal provisions of the Act. Therefore, in any view of the matter, the stand of the assessee is contradictory. Accordingly, this ground is dismissed.

13. In the result, the appeal of the assessee is dismissed.