Section 48(i) — Compensation paid by the assessee to lessee to terminate the leasehold rights and surrender possession of the aircraft to the purchaser of the aircraft from the assessee is eligible for deduction while computing capital gain.
Facts:
The assessee-company, engaged in the business of travel-related services, gave an offer to Mafatlal Finance Co. Ltd. (MFL) for purchase from MFL an aircraft which MFL owned and was leased by MFL to Megapode Airlines Ltd. (MAL), for a period of 7 years commencing on 30-12-1994 and ending on 29-12-2001, under a lease agreement dated 30-12-1994, with an option to renew the lease for an indefinite period of time. The terms of sale of air-craft by MFL to the assessee were that the assessee would pay MFL a consideration of Rs.43,75,000 and sale would be subject to the rights of the lessee (MAL) under the lease agreement dated 30-12-1994 and in particular the right of MAL to extension of the tenure of the lease. In addition to the consideration, the assessee was also to pay to MAL a sum of Rs.3.18 crores spent by MAL to refurbish the aircraft to make it air-worthy. On 15-1-2002, MFL raised an invoice on the assessee for sale of aircraft. On 1-3-2002, the Directorate General of Civil Aviation issued a certificate of registration, registering the assessee as the owner of the aircraft. This certificate also recognised MAL as the operator of the aircraft. According to the assessee, it acquired the aircraft on 28-12-2001.
The assessee informed MAL that since it proposed to sell the aircraft without any encumbrances, the assessee proposed to foreclose the lease and requested MAL to handover the aircraft. The assessee gave 3 months’ notice of termination and informed MAL that the termination would be effective 6-5-2002.
Consequent to various negotiations which took place between the assessee and MAL, it was agreed by the assessee with MAL that the assessee would give Rs.4.70 crore to MAL as compensation for premature closure of the lease agreement and MAL agreed to deliver the aircraft in good working condition on or before 6-5-2002. Also, by lease agreement dated 25-2-2002 between the assessee as owner and lessor of the aircraft and MAL as the lessee, the lease period of the aircraft to MAL was extended by 5 years effective from 30-12-2011.
The assessee sold the aircraft without any encumbrances for a consideration of Rs.8,92,87,147. While computing short-term capital gains arising on transfer of aircraft, the assessee inter alia claimed a deduction of Rs.4,70,00,000, being amount of compensation paid for premature termination of the lease agreement, u/s.48(i) of the Act, as being expenditure incurred wholly and exclusively in connection with transfer of capital asset.
The AO while assessing the total income of the assessee did not allow this amount as a deduction on the ground that also that MFL having earned Rs.17.51 crore as lease rentals from MAL till date of sale could have sold the aircraft to MFL or MAL for a consideration of Rs.43.75 lakh and the amount which would have been taxable in that case would have been greater; the assessee and MAL were part of the same group and that MAL was suffering losses and therefore payment for foreclosure of lease agreement was to avoid tax liability. Also, the transaction was not a genuine transaction since the termination of lease by the assessee was on 6-2-2002, whereas the renewal agreement with MAL was entered only on 25-2-2002 and even this lease agreement did not contain clauses for termination of the lease and the monetary compensation quantified and agreed between the parties.
Aggrieved, the assessee preferred an appeal to the CIT(A) who distinguished the decisions relied upon by the AO and allowed the appeal filed by the assessee on the ground that once it is established that the assessee was under a contractual obligation to provide the aircraft free of any encumbrances for which it had paid compensation to MAL, such compensation is inextricably incidental to transfer and, hence, allowable as deduction u/s.48(i) of the Act.
Aggrieved the Revenue preferred an appeal to the Tribunal.
Held:
The Tribunal held that the compensation paid to MAL for surrendering its pre-existing rights as the lessee is inextricably connected to the transfer of the aircraft as one of the condition for sale of the aircraft by the assessee was surrender of possession to the purchaser free from all encumbrances. It noted that the renewal agreement had to be signed between the assessee and MAL on 25-2-2002 so that possession of the aircraft by MAL till delivery to the purchaser is made remains lawful. It also held that there can be no complaint regarding compensation paid to MAL being excessive. It is for the parties to the agreement to decide on the rightful compensation. There is no material available on record to show that there was any ulterior motive in paying the sum of Rs.4.70 crore as compensation by the assessee to MAL for surrendering leasehold rights and delivering possession of the aircraft. It also observed that the alternative computation filed by the assessee clearly demolishes the case of the AO that there was any motive to avoid tax.
This ground of appeal filed by the Revenue was dismissed.
