What is Leasing Business?

A leasing business involves renting out assets, such as vehicles, machinery, real estate, or equipment,
to customers for a specified period in exchange for regular payments. Instead of buying an asset
outright, the lessee pays the lessor for the right to use it.

1. Operating Lease:
An operating lease is more like a rental agreement where the lessee uses the asset without
ownership. The lessor retains ownership and the associated risks and rewards.

Tax Treatment for the Lessee:

 Lease Payments: Lease payments made by the lessee are considered operational expenses
and are deductible from the lessee’s taxable income as business expenses.
 Depreciation and Interest: The lessee cannot claim depreciation or interest on the leased
asset since they do not own the asset.

Tax Treatment for the Lessor:

 Income: The lease payments received are treated as regular income and taxed accordingly.
 Depreciation: Since the lessor owns the asset, they can claim depreciation on the asset,
which is an expense that reduces taxable income.

2. Finance (Capital) Lease:

A finance lease is treated more like a purchase than a rental. The lessee gains control of the asset for
most of its useful life and often assumes most risks and rewards associated with ownership.

Tax Treatment for the Lessee:

 Depreciation: The lessee is treated as the owner of the asset for tax purposes and can claim
depreciation on the asset, reducing taxable income.

 Interest Expense: Finance lease payments include both an interest component and a
principal component. The interest portion is treated as a deductible expense.

 Lease Payments: Only the interest portion of the lease payments is deductible, not the
entire payment. The principal portion is not deductible since it's treated as repayment of a
loan.

Tax Treatment for the Lessor:

 Income: The lessor treats the lease payments as interest income and recovery of principal.

 Ownership Transfer: Since the asset is transferred or treated as sold, the lessor does not
claim depreciation once the lease is classified as a finance lease. Instead, the lessor may
recognize a sale at the commencement of the lease.
General Criteria for Finance Lease Classification:

1. Transfer of Ownership: The lease transfers ownership of the asset to the lessee by the end of
the lease term.
2. Purchase Option: The lease includes an option for the lessee to purchase the asset at a price
significantly lower than its fair value at the date the option becomes exercisable, making it
reasonably certain that the option will be exercised.
3. Lease Term: The lease term covers the major part of the economic life of the asset, even if
title is not transferred. Typically, this is considered to be 75% or more of the asset’s useful
life.
4. Present Value of Payments: The present value of the lease payments amounts to
substantially all of the fair value of the asset. This is often considered to be 90% or more of
the asset’s fair value.
5. Specialized Nature: The asset is of such a specialized nature that only the lessee can use it
without major modifications.

A comprehensive view of the applicability of the Income Tax Act,

1961, on leasing businesses from the lessor's perspective:
1. Tax Treatment of Lease Income:

 Operating Lease:

o Rental Income as Business Income: The rental income received by the lessor in an
operating lease is considered "business income" under the Income Tax Act, 1961.

o Depreciation: The lessor is entitled to claim depreciation on the asset being leased
out, since the ownership remains with the lessor.

o Other Deductions: The lessor may claim deductions for operating expenses such as
repairs, maintenance, insurance, and other business-related expenses.

 Finance Lease:

o Finance Income: In a finance lease, the lessor receives lease payments, which consist
of both principal and interest components. The interest component is recognized as
income and taxed under the "income from other sources" or "business income"
head, depending on the nature of the business of the lessor.

o Principal Component: The principal repayment is typically considered a return of

capital and not taxable as income.

o Depreciation: In a finance lease, since the asset is treated as effectively being

transferred to the lessee, the lessor is generally not eligible to claim depreciation.
However, the lessee may be entitled to claim depreciation on the asset.

2. Tax Deductions:

 Business Expenses: Under Section 37 of the Income Tax Act, the lessor may deduct ordinary
and necessary business expenses from their taxable income. This includes expenses directly
related to the leasing activity such as legal fees, commissions, repair costs, and marketing
expenses.
  Interest on Borrowings: If the lessor has borrowed funds to acquire the asset that is being
leased, the interest paid on such borrowings may be deducted from the taxable income
under Section 36(1)(iii).

3. Depreciation Allowance (Section 32):

 For operating leases, the lessor can claim depreciation on the leased asset at the rates
prescribed in the Income Tax Act. Depreciation can be a significant deduction, especially in
the case of high-cost assets.

 The rate of depreciation depends on the type of asset, e.g., machinery, vehicles, plant, etc.
Special provisions and rates may apply for specific assets like energy-saving devices or
pollution control equipment.

4. Transfer of Ownership and Capital Gains:

 Operating Lease: If the lessor eventually sells the leased asset, the sale will attract capital
gains tax. The gain will be classified as either short-term or long-term, depending on the
holding period of the asset.

 Finance Lease: Since finance leases involve a transfer of effective ownership, any sale or
transfer of the asset at the end of the lease term may attract capital gains tax as well.

5. Goods and Services Tax (GST):

 In addition to income tax, lease transactions may also attract Goods and Services Tax (GST).
For operating leases, lease rentals are subject to GST, and the lessor must charge GST on the
lease payments. Input tax credit (ITC) can be claimed by the lessor on goods and services
used for leasing.

 Finance leases may be treated similarly to sale transactions for GST purposes, and tax
treatment will depend on the specifics of the lease contract.

6. Taxability in Special Cases:

 Cross-border Leases: In cases where the lessor or lessee is located outside India, additional
rules related to the taxability of foreign income, withholding tax, and Double Taxation
Avoidance Agreements (DTAA) may apply.

 Leasing of Intangible Assets: If the lessor is leasing out intangible assets (e.g., patents,
software), specific tax provisions related to the treatment of royalty income and capital gains
may apply.

7. Advance Rulings and Judicial Precedents:

 Over the years, several judicial precedents have emerged regarding the classification and
treatment of leases for tax purposes. For instance, the Supreme Court has made distinctions
between operating and finance leases in certain rulings, which may impact the taxability of
the lessor's income.

8. Impact of Section 43B:

 Interest Payments: If the lessor has taken loans for the acquisition of leased assets, Section
43B of the Act may apply, which disallows certain expenses like interest payments unless
they are actually paid before the due date of filing the tax return.
 A comprehensive view of the applicability of the Income Tax
Act, 1961, on leasing businesses from the lessor's perspective:

1. Tax Treatment of Lease Payments:

 Operating Lease:
o Business Expense Deductibility:
 Lease payments made under an operating lease are considered business
expenses under Section 37 of the Income Tax Act, 1961. As such, they can be
deducted from the lessee’s taxable income, provided the asset is used for
business purposes.
 GST Component: GST paid on lease rentals is not deductible under the
Income Tax Act, but it may be eligible for Input Tax Credit (ITC) under GST
law if the asset is used for taxable supplies.
 Finance Lease:
o Interest Component:
 Lease payments in a finance lease include both principal and interest. The
interest portion is deductible under Section 36(1)(iii) of the Income Tax Act,
as it is considered a business expense.
o Principal Component:
 The principal repayment is not deductible as an expense. Instead, the asset
can be capitalized, and depreciation can be claimed on it.
2. Depreciation (Section 32):
 Operating Lease:
o Depreciation:
 The lessee cannot claim depreciation on assets under an operating lease, as
the ownership remains with the lessor.
 Finance Lease:
o Depreciation:
 The lessee can claim depreciation on the asset under a finance lease if the
lease substantially transfers the risks and rewards of ownership to the
lessee. The depreciation is claimed at the rates prescribed in the Income Tax
Act, depending on the type of asset.
3. GST Compliance:
 GST on Lease Payments:
o Liability: The lessee is liable to pay GST on lease rentals. The applicable GST rate
depends on the type of asset being leased (e.g., 18% GST on commercial property).
o Input Tax Credit (ITC):
 The lessee may claim ITC on the GST paid on lease rentals if the asset is used
for business purposes. This credit helps offset the GST liability on the lessee’s
sales.
4. Section 43B – Disallowance of Certain Expenses:
 Interest Payments:
o Under Section 43B, interest expenses (including those on finance leases) are
deductible only when actually paid, not merely accrued. This means the lessee must
ensure that interest payments are made before the due date for filing the tax return
to claim the deduction.
 5. Special Cases:
 Cross-Border Leases:
o Withholding Tax: If the lessor is a non-resident, the lessee must comply with
withholding tax obligations under the relevant Double Taxation Avoidance
Agreement (DTAA) and file Form 15CA/15CB if required.
o Compliance: The lessee must ensure compliance with cross-border tax regulations to
avoid penalties and interest.
 Leasing of Intangible Assets:
o If the lease involves intangible assets (e.g., software, patents), specific provisions
related to royalty payments under the Income Tax Act may apply. TDS may be
applicable on royalty payments, and the lessee must ensure proper compliance.
6. Capital Gains Tax:
 Operating Lease:
o Sub-Leasing: If the lessee engages in sub-leasing, capital gains tax may arise
depending on the nature and terms of the sub-lease.
 Finance Lease:
o Asset Disposal: Upon the termination of the finance lease, if the lessee sells or
disposes of the asset, capital gains tax may apply to any profits from the sale.
7. Advance Rulings and Judicial Precedents:
 Judicial Precedents:
o Past judicial decisions and advance rulings have clarified the tax treatment of leasing
transactions. These precedents may impact how lease payments and asset
depreciation are treated for tax purposes.

TDS on Lease Rentals (Section 194-I):

 Applicability:

o Under Section 194-I of the Income Tax Act, 1961, TDS is applicable on rental income
paid by a lessee to a lessor for the use of any land, building (including factory
buildings), machinery, plant, equipment, furniture, or fittings. This section applies to
both operating leases and finance leases where rental payments are involved.

 Rate of TDS:

o For the use of land, building, or furniture and fittings: TDS is deducted at the rate of
10% on the rental income.

o For the use of machinery, plant, or equipment: TDS is deducted at the rate of 2% on
the rental income.

 Threshold Limit:

o TDS under Section 194-I is applicable only if the total rental income from the lease
exceeds ₹2,40,000 in a financial year. If the total rental income is below this
threshold, no TDS needs to be deducted.

 Exemptions:

o If the lessor is a government body, a local authority, or certain other specified

entities, the lessee is not required to deduct TDS.
 o If the lessor is an individual or HUF not subject to tax audit, TDS may not be
applicable.

 Remittance of TDS:

o The lessee is responsible for deducting the applicable TDS at the time of crediting
the payment or making the payment to the lessor, whichever is earlier.

o The deducted TDS must be remitted to the government within the prescribed time
limits.