Lease of land

Growth in industries, both manufacturing and services has been the prime focus of the Governments – Central and State. To sprout the growth, State Governments have been offering land or land and buildings on a long-term lease to companies to set up units. These long-term leases are typically for a period of 99 years. Most cases leases will be that of a land rather than land and buildings together. These leases are characterized by lump-sum payments upfront, either refundable or non-refundable. Various accounting and taxation concerns are around these models, which are discussed in the following article.

The GAAP for companies comprise Accounting Standards notified u/s 211 (3C) of the Companies Act, 1956 and requirements of Schedule VI to the Companies Act, 1956. Present provision of Accounting Standards excludes leases from its scope. The accounting has to comply with the requirements of Schedule VI.

Model I

Lets comprehend with an example. A company takes land on lease from SIPCOT for a period of 99 years by payment of non-refundable premium of Rs. 10 Crores. The company cannot transfer the land to any third party during the lease period unless it is under a business combination. If the land is handed back to SIPCOT during the lease period, it is not entitled to refund of any portion of the premium paid.

Accounting: Schedule VI requires disclosure of leaseholds in the Fixed Assets schedule under a separate head. Hence, the land should be disclosed under “Leasehold Land” in Fixed Assets schedule. At what Value? The entire non-refundable premium should be taken as cost and amortised over the lease term (99 years) on Straight Line Basis. Each year amortization is taken to Profit and loss account.

Taxation: The primary analysis to be made is whether the expenditure is revenue expenditure or capital expenditure. The decision of tribunal in the case of Jt. CIT vs Mukand Ltd forms the basis for tax treatment. The assessee argued that the entire expenditure is revenue in nature and should be allowed as a deduction. CIT (A) held that the expenditure is revenue in nature but is attributable to 99 years and hence should be claimed as deduction in each year. The case was before the special bench of the tribunal to determine whether the stand of CIT (A) to allow 1/99^th of expenditure is correct. The tribunal noticed that the payment is a premium for leasing of land and it is not in the nature of advance rent to be adjusted against any future payments required to be made. Further, the tribunal noted that the expenditure bore the characteristics of capital expenditure, since the payment is for a benefit of enduring nature. The tribunal held that the premium is capital in nature and not allowable as a deduction to the assessee. The position of revenue is still questionable. Since, the expenditure is very much business expenditure, it can be argued that if the business expenditure is not allowed as a deduction in a single installment, the expenditure need to be allowed over the lease term.

Model II

A company takes land on lease from SIPCOT for a period of 99 years by payment of a refundable deposit of Rs. 15 crores. The company cannot transfer the land to any third party during the lease period unless it is under a business combination.

Accounting: Present GAAP position, the amount should be treated as refundable deposit. But where should it be included? Under Current Assets or Leaseholds? My view is that it should be held under “Leaseholds” rather than “Current Assets”. Considering that the present scenario will be short-lived with the introduction of AS 30,31 and 32, the new treatment needs to be looked into. The deposit which is a financial asset, should be recognised at its fair value – which will be present of value of discounted cash flows. The deposit amount would be increased each year with interest portion with a corresponding credit to profit and loss account. Again regarding the question of presentation, it is only appropriate to present under “fixed assets” rather than under “current assets”. These issues will be addressed once the existing leases standard is revamped based on the discussion paper issued by IASB.

Taxation: The revenue position is unambiguous here, since the amount is refundable it cannot be revenue expenditure or for that matter any expenditure and no expense can be claimed in this regard. On the new treatment as per AS 30,31,32 – the position of revenue cannot be speculated upon.

There will be these never ending spiral issues surrounding the topic of leases in the future as there will be lot of understanding and learning in this regard from the regulatory angle as well as the angle of revenue and professionals.