Depreciation on Leased Assets - Who Can Claim the Tax Deduction?

When an asset is used continuously for a long time, its value deteriorates due to wear and tear and obsolescence. This can be broadly called depreciation. The Income Tax Act prescribes rates and methods of computation for depreciation for different classes of assets. In this article, we will learn about depreciation and its tax implications in the case of a leased asset through interesting case law.

I.C.D.S. Ltd. v. CIT (2013) 350 ITR 527 (SC)

The Supreme Court passed the judgement on 14th January 2013.

Facts of the Case - Depreciation Claim on Leased Vehicles

• The assessee is a Non-Banking Financial company, it is in the business of hire purchase, leasing, financing, etc.,
• It has leased out vehicles to various customers and claimed depreciation on leased-out vehicles. Also, it has claimed depreciation at a higher rate available for hiring businesses.
• In this case, the assessee is the lessor and the customers are the lessees.
• The vehicles were under the name of the lessees.
• The assessing officer disallowed the depreciation claim on the grounds that
  • The vehicles were not used by the assessee, and
  • Since the vehicles were in the customers' names, the whole transaction is a mere financing arrangement, and the assessee is not the owner of the vehicles.

Key Questions on Depreciation, Asset Ownership, and Usage in Leasing Transactions

• In the case of a leasing transaction, can it be considered that the assessee has used the asset?
• Who is the owner of the asset in substance who can rightfully claim depreciation?

Depreciation Under the Income Tax Act

• Depreciation can be allowed only for assets used during the financial year. Even when the asset is kept ready for use (Passive use), depreciation is allowed.
• Depreciation can be allowed only on assets owned by the assessee.
• If the asset is co-owned, the assessee can claim depreciation proportionately.
• If the asset is used both for business and personal purposes, depreciation can be claimed only to the extent that it is used for business purposes.
• If the assessee is in the business of renting vehicles, he can claim the prescribed enhanced rate of depreciation.

The Supreme Court Decision on Depreciation Claims

Question of Usage

The Supreme Court decided that the assessee has in fact used the asset. As per the provisions of the Income Tax Act, depreciation can be claimed if the asset has been ‘used for the purpose of business’. Since the assessee is in the business of leasing vehicles, and the vehicles were used for leasing business, it can be very well regarded that the asset was used for the purpose of business.

Question of Ownership

As per the terms of the leasing agreement,

1. The assessee was the exclusive owner at all points in time.
2. The asset can be recovered by the assessee in case of default.
3. The vehicle should be returned to the assessee at the end of the lease tenure.
4. The assessee has the right to inspect at all times.

Considering these points in the lease agreement, it is evident that the assessee is the true owner of the vehicles, though the vehicles were registered under the customers' names. 

Depreciation at an Enhanced Rate

It was inferred by the court that the ‘usage for business purpose’ has the same meaning for normal depreciation under section 32(1) and enhanced rate of depreciation. Since the assessee has actually leased out the vehicles, it can be considered under the meaning of hire and the assessee is entitled to claim depreciation at a higher rate.

“The judgement came in favour of the assessee and he was allowed the enhanced rate of depreciation. Therefore, the lessor is entitled to claim depreciation according to this case law. The lessee(customers) are not entitled to claim depreciation according to this case law.”

Final Word

This case law further emphasized the importance of an asset's actual usage, rather than its legal form or documentation, when determining eligibility for claiming depreciation. The Court focused on substance over form, highlighting that the genuine use of the asset in the business is the key factor rather than merely relying on formal ownership documents or agreements.