NFRA’s reminder to fill gaps under two-way communication with Statutory Auditors
Watch our video here: https://youtu.be/toXUw96L5jo
Buyback taxation rationalised with limited relief to promoter shareholders
– Finance Bill 2026 omits deemed dividend treatment on buyback consideration
– Payal Agarwal, Partner | corplaw@vinodkothari.com
Our quick bytes on Union Budget 2026 can be accessed here – https://vinodkothari.com/2026/02/quick-bytes-on-union-budget-2026/
The recent Finance Bill 2026 brings relief to investors in the form of changes in taxation for buyback consideration. With the omission of sub-clause (f) from Section 2(40) of the Income Tax Act, 2025 [dealing with deemed dividend], the position as it existed prior to 1st October, 2024, has been restored, except for additional tax rates in case of promoter shareholders.
- Applicability of the amended provisions
- For any buyback of shares on or after 1st April, 2026
- Existing provisions on taxability of buyback
- Included u/s 2(40)(f) of IT Act
- The entire amount paid by the company taxable as “dividend”
- Tax payable by shareholders
- Entire buyback consideration taxable as dividend
- TDS provisions as applicable to dividends apply
- Taxable at slab rates as applicable to respective shareholders, with a flat surcharge @ 15%
- Entire cost of acquisition in respect of shares bought back to be booked as “capital loss” [section 69 of IT Act]
- Such capital loss may be set off against capital gains subsequently
- As per section 111 of IT Act, the set-off is available for a period of 8 AYs immediately after the AY in which loss arises
- Amended provisions on taxability of buyback
- Buyback consideration not to be treated as deemed dividend [omission of clause (f) to Sec 2(40)]
- Difference between consideration received and cost of acquisition taxable as capital gains [S. 69(1)]
- In the hands of the recipient shareholder
- In case of promoter shareholders, tax payable at higher rates depending on whether promoter is a domestic company or not
- Effective rate of 22% in case of domestic company and 30% in case of persons other than domestic company
- Meaning of promoter
- In case of a listed company,
- As per Reg 2(1)(k) of SEBI (Buy-Back of Securities) Regulations, 2018
- Refers to the definition of promoter under SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018
- As per Reg 2(1)(k) of SEBI (Buy-Back of Securities) Regulations, 2018
- In any other case
- As per Section 2(69) of the Companies Act, 2013, or
- A person who holds, directly or indirectly, more than 10% of the shareholding in the company
- In case of a listed company,
- Example to understand taxability under old regime v/s new regime
| Particulars | Price per share | No. of shares | Amount (Rs.) |
| Total cost of acquisition | Rs. 50 | 100 | 5,000 |
| Shares tendered and accepted for buyback | Rs. 80 | 40 | 3,200 |
| Tax under old regime (effective 1st Oct, 2024) | Rs. 80 | 40 | 3,200 as dividend @ applicable tax slabs |
| Tax under new regime (effective 1st Apr, 2026) | Rs. (80-50) = Rs. 30 | 40 | 1,200 as capital gains @ short-term/ long-term capital gain rates |
- Intent of the amendments
- The extant tax regime on treating buyback consideration as deemed dividend resulted in taxing a “receipt” as income, without factoring the cost incurred in such receipts. See our article on the same here. The amended tax regime restores back the past position, by treating the difference between the buyback consideration and cost of acquisition as capital gains.
- Additional tax rates have been proposed for promoters, in view of the distinct position
- and influence of promoters in corporate decision-making, particularly in relation to buy-back transactions.
See our other resources on buyback – https://vinodkothari.com/2024/08/resource-centre-on-buyback/
From Capital Assets to Stock-in-Trade: Taxing “Notional” Gains in Amalgamations
Decoding Supreme Court ruling in Jindal Equipment Leasing Consultancy Services Ltd. v. Commissioner of Income Tax Delhi-II, New Delhi
– Sourish Kundu | corplaw@vinodkothari.com
One of the most common modes of corporate restructuring is merger, and one of the most crucial aspects in assessing the commercial viability of a proposed merger is its tax implications. Typically, in a merger, the shareholders of the transferor company are issued shares of the transferee company in order to avail the exemption under section 70(1)(f) of the IT Act, 2025 [corresponding to section 47(vii) of the IT Act, 1961]. The said provision grants exemption in case of scheme of amalgamation in respect of the transfer of a capital asset, being shares held by a shareholder in the transferor company, where (i) the transfer is made in consideration of the allotment of shares in the transferee company (other than where the shareholder itself is the transferee company) and (ii) the amalgamated company is an Indian company.
However, a recent Supreme Court ruling in the matter of Jindal Equipment Leasing Consultancy Services Ltd. v. Commissioner of Income Tax Delhi-II, New Delhi [2026 INSC 46] has opened a new avenue for debate w.r.t the taxation on receipt of shares of the transferee company in a scheme of amalgamation. In this case, the Supreme Court ruled that the exemption as provided under section 47(vii) of the IT Act, 1961 [corresponding to section 70(1)(f) of the IT Act, 2025] shall not be available to shareholders of the transferor company who are not perceived as “investors”, that is to say long term investors as opposed to traders, in the transferor company. And accordingly, any notional gain in a share swap deal pursuant to an amalgamation shall be taxed u/2 28 of the IT Act, 1961 [corresponding to section 26 of the IT Act, 2025].
In this article, we decode the nuances of the ruling, the impact it is expected to have in the sphere of merger deals and other related concerns.
Difference between capital and business assets
So far, the common understanding of consideration in case of amalgamations was that an amalgamation is merely a statutory replacement of one scrip for another, with no real “transfer” or “income” until the new shares are actually sold for cash, or in other words, mere substitution of shares in the books of the involved entities. However, the Apex Court in the instant judgement has now effectively set a different precedent for those holding shares as stock-in-trade, i.e. current investments.
The Court clarified that while Section 47(vii) provides a safe harbor for investors (treating mergers as tax-neutral corporate restructuring), this exemption does not extend to “business assets”, a.k.a. stock in trade. For a trader and investment houses, shares held in stock-in-trade represent “circulating capital”, and the objective of holding them is not capital appreciation, but conversion into money in the ordinary course of business. Therefore, replacing shares of an amalgamating company with those of an amalgamated company of a higher, ascertainable value constitutes a “commercial realisation in kind”.
The 3 pillar test for taxability
The SC applying the doctrine of real income emphasised in Commissioner of Income-Tax v. Excel Industries Ltd. and Anr. [(2013) 358 ITR 295 (SC)], established a three-pillar test, which is to be applied on a case to case basis to determine if allotment of shares pursuant to a merger triggers taxation of business income u/s 28 of the IT Act, 1961:
- Cessation of the Old Asset: The original shares must be extinguished in the books of the assessee.
- Definite Valuation: The new shares must have an ascertainable market value.
- Present Realisability: The shareholder must be in a position to immediately dispose of the shares and realise money.
This test was further elaborated by two situations viz. allotted shares being subject to a statutory lock-in, which hinders the disposability of the asset, and allotted shares being unlisted, which cannot be said to be realisable, since no open market exists to ascribe a fair disposal value.
Additionally, the SC also held that the trigger is the date of allotment of the shares of the amalgamated entity, and neither the “appointed date” nor the “date of court sanction” or what is called as “effective date” in the general parlance, as no tradable asset exists in the shareholder’s hands until the scrips are actually issued.
Critical Concerns
While the ruling provides reasonable clarity on the treatment of shares received as a result of amalgamation, when the same is held in inventory, it leaves several operational questions unanswered, leaving a gap to determine the commercial feasibility of these deals.
- Treatment of profits and losses alike
If the Revenue can tax “notional” gains arising from a higher market value at allotment, correspondingly assessees should be allowed to book notional losses, if any on such deals as well. In cases where a merger swap ratio or a market dip results in the new shares being worth less than the cost of the original holding, the taxpayer should, by the same logic, be entitled to claim a business loss u/s 28 of the IT Act, 1961, or in other words, if the substitution is a “realisation” for profit, it must be a “realisation” for loss as well.
- Increase in cost of acquisition
A major concern is the potential for double taxation. If the assessee is taxed on notional gain, being the difference between the cost of acquisition of the original shares and the FMV of the shares of the transferee company on the date of allotment, such FMV should logically become the new cost of acquisition. If an assessee is taxed on the difference between the book value and the FMV at the time of allotment, but the increased cost of acquisition is not allowed, the same appreciation gets taxed twice. It is first taxed as business income at the time of allotment and again at the time of the actual sale.
- Determination of the nature of shares as “stock in trade” vs “capital asset”
This issue remains prone to litigation, that is, who determines the nature of the investment, whether it is current or non-current? Will it be determined basis the books of account of the investor?
A CBDT circular lays down certain principles along with some case laws to distinguish between shares held as stock-in-trade and shares held as investments, and decide the treatment of shares held by the investing company. Further, factors such as intention of the party purchasing the shares, [discussed by Lord Reid in J. Harrison (Watford) Ltd. v. Griffiths (H.M. Inspector of Taxes); (1962) 40 TC 281 (HL)], and method of recording the investments [highlighted in CIT v. Associated Industrial Development Co (P) Ltd (AIR1972SC445)], are considered as the deciding factors for making a demarcation between treating an asset as capital asset or stock-in-trade.
As highlighted in the instant case, while the initial classification is made by the companies in the financial statements, the AO is empowered to overlook the same, and determine whether the shares were held as stock-in-trade or as capital assets, as without that determination, the taxability or eligibility for exemption u/s 47 could not be ascertained.
It should be noted that the line between a long-term strategic investment and a trading asset is often thin, and the Jindal ruling places the burden on the Revenue to prove the stock status and the “present realisability” of the shares.
Conclusion
Proving by contradiction, the Apex Court has added that: “If amalgamations involving trading stock were insulated from tax by judicial interpretation, it would open a ready avenue for tax evasion. Enterprises could create shell entities, warehouse trading stock or unrealised profits therein, and then amalgamate so as to convert them into new shares without ever subjecting the commercial gain to tax. Equally, losses could be engineered and shifted across entities to depress taxable income. Unlike genuine investors who merely restructure their holdings, traders deal with stock-in-trade as part of their profit-making apparatus; to exempt them from charge at the point of substitution would undermine the integrity of the tax base”
Discussing the concept of “transfer”, “exchange” and “realisability”, the SC has affirmed that mergers do not entail a mere replacement of shares of one company with that of another, as for persons holding the same as stock-in-trade cannot be said to be a continue their investment, instead the new shares being capable of commercial realisation gives rise to taxable business income. The Jindal Equipment ruling seems to effectively end the assumption of automatic tax neutrality for all merger participants, subject to fulfillment of applicable conditions prescribed in the IT Act. As a result, if the tax officers believe that the shareholders hold the shares as stock in trade, and could cash out the same at the next possible instance, the assessee shall be under the obligation to pay tax even without encashing any gain in actuals. Further, the tax implications in such cases shall not be at the special rates prescribed for capital gains.
Read more:
Understanding “Undertaking” in the Context of Investment Demergers
Budget 2025: Mergers not to be used for evergreening of losses
When “Profit” Isn’t Always Distributable
– Understanding Reportable vs Distributable Profits under Ind AS and the Companies Act, 2013
– Sourish Kundu | corplaw@vinodkothari.com
In the sphere of corporate law intertwined with accounting principles, there arises a question on profits that are reported in the financials of a company and the amount that can actually be distributed, that is to say, a company’s reported profits may be impacted by several accounting standards, yet that does not mean it can distribute all of that profit as dividends. Under Indian law and accounting rules, there is a clear distinction between reportable profits (what appears in the financial statements) and distributable profits (what a company is legally permitted to pay out to shareholders). In this article, we decode the difference between reportable profits and distributable profits and the implications of this difference, whether companies are expected to prepare two statements of profit or loss, how investors are expected to read the financials to ascertain what can be expected as dividend.
What are Reportable Profits?
“Reportable profits” refers to the profits (or loss) shown in the Statement of Profit & Loss prepared under Indian Accounting Standards (Ind AS). It includes all recognised items of income, expenses, gains and losses, whether realised or unrealised, so long as they meet the recognition and measurement rules in terms of the relevant accounting standards. For example, under Ind AS 109 (Financial Instruments), paragraph 5.7.1 states that changes in fair value of financial assets or liabilities measured at fair value through profit or loss (FVTPL) must be recognised in the PnL. Similarly, fair-value measurement principles under Ind AS 113 (Fair Value Measurement) apply where other Ind ASs require or permit fair value.
Because reportable profits include unrealised fair value gains, remeasurements, or other accounting adjustments, there is always a possibility of an inflated or deflated picture being painted wherein there is a difference between a company’s “profit” number from the perspective of distribution.
What are Distributable Profits?
“Distributable profits” are that portion of profits (or reserves) out of which a company can legally declare and pay dividends to its shareholders under the Companies Act, 2013. Section 123(1) of the Act states that a company shall not declare or pay any dividend for a financial year except:
- out of the profits of the company for that year, after providing for depreciation, and
- out of the profits of any previous financial years, after providing for depreciation and remaining undistributed.
The first proviso to section 123(1) further clarifies that unrealised gains, notional gains or revaluation surplus arising from measurement at fair value shall not be treated as realised profits for the purpose of dividend declaration.
“Provided that in computing profits any amount representing unrealised gains, notional gains or revaluation of assets and any change in carrying amount of an asset or of a liability on measurement of the asset or the liability at fair value shall be excluded”
Thus, even though accounting standards allow recognition of such gains/losses in the PnL statement, the law restricts their distribution and ensures distribution can be made of only actual realised profits.
As per the section, following adjustments are required to be made to reportable profits to compute distributable profits
| Reportable Profits | XXX |
| Less: | |
| (b) unrealised gains | (XXX) |
| (c) notional gains | (XXX) |
| (d) revaluation of assets (positive) | (XXX) |
| (e) any change in carrying amount of assets (positive) on measurement at FV | (XXX) |
| (f) any change in carrying amount of liability (reduction) on measurement at FV | |
| Add: | |
| (a) revaluation of assets (negative) | XXX |
| (b) any change in carrying amount of assets (reduction) on measurement at FV | XXX |
| (c) any change in carrying amount of liability (increment) on measurement at FV | XXX |
| Distributable Profits | XXX |
So effectively, it is not the case that companies need to maintain or prepare parallel PnL, one for the accounting purpose and one for the purpose of ascertaining distributable profits, the adjustments as illustrated above needs to be carried out. This is similar to adjustments carried out for the purpose of ascertaining profits in terms of Section 198 of the Companies Act, 2013, which is broadly used for determining CSR expenditure and the limits of managerial remuneration. Interestingly, the treatment of fair value changes in assets and liabilities is akin to how it is treated here, that is, fair value gains are not given credit and hence reversed, and on the other hand, fair value losses are not deducted and hence added back to arrive at the figure out of which managerial remuneration is to be paid, or CSR expenditure is required to be made.
Some examples of such fair value changes and their impact on the reportable and distributable profit figures are given below:
Examples:
Consider the following scenarios for company following Ind AS principles of accounting:
- Treatment of FVTPL
| Date | Particulars | Value | Reportable Profits | Distributable Profits |
| July, 2024 | Acquisition of investment | Rs. 100 | – | – |
| 31st March, 2025 | Value of investments | Rs. 150 | 50 (represents fair value gains routed through PnL) | – |
| January, 2026 | Sale of investments | Rs. 200 | – | 100 (realised gain) |
- Deferred Tax Asset
| Date | Particulars | Value | Reportable Profits | Distributable Profits |
| July, 2024 | Acquisition of investment | Rs. 100 | – | – |
| 31st March, 2025 | Value of investments | Rs. 70 | -30 (represents fair value loss routed through PnL) | – |
| Deferred tax asset | Rs. 9 (30% tax on Rs. 30) | 9 | – | |
| January, 2026 | Sale of investments | Rs. 90 | – | -10 |
Why the Difference Exists
The divergence arises because accounting standards and company-law provisions serve different purposes:
- The Ind AS framework aims to present true and fair information about an entity’s financial performance and position, which includes remeasurements and accounting for fair value changes.
- The company law legislation aims to protect the company’s capital base and ensure dividends are paid out of “real” profits, thereby protecting creditor interests and preventing erosion of capital.
Thus, distributing unrealised or notional gains could expose the company (and its creditors) to risk if those gains reversed. The legal restriction is a form of capital maintenance concept.
Conclusion
In sum: reportable profits (what Ind AS shows) is not always the same as distributable profits (what a company can legally pay out). The presence of items such as unrealised fair-value gains, which are recognised in profit but not “realised” and hence, not available for distribution under company law, creates this difference. Understanding this distinction is essential because in the end, the dividend cheque flows only from the legally distributable pool and not simply from what the profit and loss account might suggest.
Read more:
Should you expect adjustment in profits for “Expected Credit Loss”?
Expected to bleed: ECL framework to cause ₹60,000 Cr. hole to Bank Profits
Dayita Kanodia and Chirag Agarwal | finserv@vinodkothari.com
The proposed ECL framework marks a major regulatory shift for India’s banking sector; it is long overdue, and therefore, there is no case that the RBI should have deferred it further. However, it comes coupled with regulatory floors for provisions, which would cause a major increase in provisioning requirements over the present requirements. Our assessment, on a very conservative basis, is that the first hit to Bank P/Ls will be at least Rs 60000 crores in the aggregate.
RBI came up with a draft framework on ECL pursuant to the Statement on Developmental and Regulatory Policies, wherein it indicated its intention to replace the extant framework based on incurred loss with an ECL approach. The highlights can be accessed here.
A major impact that the draft directions will have on the Banking sector is the need to maintain increased provisioning pursuant to a shift from an incurred loss framework to the ECL framework. Under the existing framework, banks make provisions only after a loss has been incurred, i.e., when loans actually turn non-performing. The proposed ECL model, however, requires banks to anticipate potential credit losses and set aside provisions for such anticipated losses.
Banks presently classify an asset as SMA1 when it hits 30 DPD, and SMA2 when it turns 60. Both these, however, are standard assets, which currently call for 0.4% provision. Under ECL norms, both these will be treated as Stage 2 assets, which calls for a lifetime probability of loss, with a regulatory floor of 5%. Thus, the differential provision here becomes 4.6%.
Once an asset turns NPA, the present regulatory requirement is a 15% provision; the ECL framework puts these assets under Stage 3, where the regulatory minimum provision, depending on the collateral and ageing, may range from 25% to 100%. Our Table below gives more granular comparison.
| Type of asset | Asset classification | Existing requirement | Proposed requirement | Difference |
| Farm Credit, Loan to Small and Micro Enterprises | SMA 0 | 0.25% | 0.25% | – |
| SMA 1 | 0.25% | 5% | 4.75% | |
| SMA 2 | 0.25% | 5% | 4.75% | |
| NPA | 15% | 25%-100% based on Vintage | 10%-85% based on Vintage | |
| Commercial real estate loans | SMA 0 | 1% | Construction Phase -1.25% Operational Phase – 1% | Construction Phase -0.25% Operational Phase – Nil |
| SMA 1 | 1% | Construction Phase -1.8125% Operational Phase – 1.5625% | Construction Phase -0.8125% Operational Phase – 0.5625% | |
| SMA 2 | 1% | Construction Phase -1.8125% Operational Phase – 1.5625% | Construction Phase -0.8125% Operational Phase – 0.5625% | |
| NPA | 15% | 25%-100% based on Vintage | 10%-85% based on Vintage | |
| Secured retail loans, Corporate Loan, Loan to Medium Enterprises | SMA 0 | 0.4% | 0.4% | – |
| SMA 1 | 0.4% | 5% | 4.6% | |
| SMA 2 | 0.4% | 5% | 4.6% | |
| NPA | 15% | 25%-100% based on Vintage | 10%-85% based on Vintage | |
| Home Loans | SMA 0 | 0.25% | 0.40% | 0.15% |
| SMA 1 | 0.25% | 1.5% | 1.25% | |
| SMA 2 | 0.25% | 1.5% | 1.25% | |
| NPA | 15% | 10%-100% based on Vintage | (-)5% – 85% based on Vintage | |
| LAP | SMA 0 | 0.4% | 0.4% | – |
| SMA 1 | 0.4% | 1.5% | 1.1% | |
| SMA 2 | 0.4% | 1.5% | 1.1% | |
| NPA | 15% | 10%-100% based on Vintage | (-)5% – 85% based on Vintage | |
| Unsecured Retail loan | SMA 0 | 0.4% | 1% | 0.6% |
| SMA 1 | 0.4% | 5% | 4.6% | |
| SMA 2 | 0.4% | 5% | 4.6% | |
| NPA | 25% | 25%-100% based on Vintage | 0%-75% based on Vintage |
The actual impact of such additional provisioning will be a hit of more than 3% to the profit of banks1. Based on the RBI Financial Stability Report of FY 24-252, the current level of SMA and NPA is estimated to be ₹3,78,000 crores (2%) and ₹4,28,000 crores (2.3%), respectively.
Accordingly, an additional provision of approximately₹ 18,000 crores (4.6% of SMA volume) and ₹ 42,000 crores (10% of NPA volume) will be required for SMA and NPA respectively, leading to a total impact of at least ₹60,000 crores. This estimate has been arrived at by considering the % of NPAs and SMA-1 & SMA-2 portfolios of banks. The actual impact may be higher, as lot of loans may be unsecured, and may have ageing exceeding 1 year, in which case the differential provision may be higher.
It may be noted that while the draft directions allow Banks to add back the excess ECL provisioning to the CET 1 capital, it does not neutralize the immediate profitability impact, as the additional provisions would still flow through the profit and loss account.
How do we expect banks to smoothen this hit that may affect the FY 27-28 P/L statements? We hold the view that it will be prudent for banks, who have system capabilities, to estimate their ECL differential, and create an additional provision in FY 25-26, or do technical write-offs.
Other Resources
- Expected credit losses on loans: Guide for NBFCs
- Impact of restructuring on ECL computation
- Tattva Session 3 – RBI Provisions and Expected Credit Loss (ECL): Understanding their Interplay
- The total Net profit of SCBs is ₹ 23.50 Lakh Crore for FY 24. (https://ddnews.gov.in/en/indian-scbs-post-record-net-profit-of-%E2%82%B923-50-lakh-crore-in-fy24-reduce-npas/ )
↩︎ - Based on our rough estimate of the data available here: https://www.rbi.org.in/Scripts/PublicationReportDetails.aspx?UrlPage=&ID=1300 ↩︎
ECL Framework for Banks: Key Highlights
Reload document 
Open in new tab Rentals on finance leases: To deduct it all or just the interest slice?
Tax accounting standard ICDS IX raises an unanswered question
– Chirag Agarwal | Assistant Manager (finserv@vinodkothari.com)
While leasing in India has developed much lesser as compared to other countries12, there is an interesting and growing line of business in India – CTC leasing, that is, lease of assets offered to employees of large companies with the rentals forming part of the employee’s CTC. The key to the tax neutrality of a CTC lease to the employer is the full deductibility of the lease rentals, as the rentals replace what would otherwise have been the employment benefit expense. But if the lease is intrinsically a financial lease, is it that the employer will still be able to expense the rentals, particularly after tax accounting standard ICDS IX, providing that the interest component of a financial lease will be treated as a cost of borrowing? CTC leasing practices in the past may have depended on some tax rulings, which pertain to the period before the applicability of the ICDS – hence, the question is still an open one.
CTC leasing of passenger cars alone is nearly Rs 6000 crores annual volume business in India, constituting roughly 1% of passenger vehicles sold in the country.
In this article, we explore:
- What is a financial lease? Is there a concept of financial lease, from the lessee perspective, now that accounting standards have eliminated the distinction from the lessee perspective?
- Why is a financial lease equivalent to a borrowing transaction?
- Why is the tax neutrality of a CTC lease to an employer important?
- Past rulings that may or may not hold the answer?
- So, is ICDS IX decisive?
- So, if ICDS IX does not apply, does ICDS I (substance over form) apply?
What is a Financial Lease and its accounting from the perspective of a lessee?
Finance Lease is an alternative to taking a loan. In this type of lease, all major risks and benefits of owning the asset are passed from the lessor to the lessee. The lessor only provides finance and keeps the legal ownership. At the end of the lease, the ownership of the equipment usually gets transferred to the lessee.
In Asea Brown Boveri vs IFCI, the Supreme Court quoted the following para from Vinod Kothari’s book Lease Financing and Hire Purchase, with approval specifying the features of a financial lease:
“1. The asset is use-specific and is selected for the lessee specifically. Usually, the lessee is allowed to select it himself.
2. The risks and rewards incident to ownership are passed on to the lessee. The lessor only remains the legal owner of the asset.
3. Therefore, the lessee bears the risk of obsolescence.
4. The lessor is interested in his rentals and not in the asset. He must get his principal back along with interest. Therefore, the lease is non- cancellable by either party.
5. The lease period usually coincides with the economic life of the asset and may be broken into primary and secondary period.
6. The lessor enters into the transaction only as a financier. He does not bear the costs of repairs, maintenance or operation.
7. The lessor is typically a financial institution and cannot render specialized service in connection with the asset.
8. The lease is usually full-pay-out, that is, the single lease repays the cost of the asset together with the interest.”
As per AS 19, in a financial lease, the rent paid is divided into two parts, i.e., finance charges and capital recovery.
With Ind AS 116, this changed. Under Ind AS 116, the lessee will need to show all leases as a “right of use asset” (ROU Asset) along with a liability to pay rent over time.
In this case, only the lessor needs to classify leases as financial or operating. For the lessee, there is no such difference and the asset will simply be recorded as a ROU asset. This position is supported by Para 61 of Ind AS 116 which states “A lessor shall classify each of its leases as either an operating lease or a finance lease.”. Further, Paras 22 to 60A, which deal specifically with lessee accounting, do not mention any requirement for classifying leases into finance or operating categories.
Why is a financial lease equivalent to a borrowing transaction?
A financial lease is considered similar to a borrowing transaction because, in substance, it functions like a loan. The lessor recovers the full cost of the asset along with a financing return through lease rentals, while the lessee gains the right to use the asset and repays the cost over time. The lessor’s primary risk relates to the lessee’s repayment capacity rather than the asset’s residual value, making it economically similar to a borrowing arrangement rather than a traditional lease.
Why is the tax neutrality of a CTC lease to an employer important?
The entire CTC leasing model is based on the taxation benefit, where the employer claims the entire lease rental as a deduction while computing income under “Profits and Gains from Business or Profession.” This also benefits the employee since the taxable value under perquisites is comparatively lower than if the same amount were paid as direct salary.
However, if we were to say that the employer, as the lessee, cannot claim full deduction for the lease rental, the employer would likely prefer paying the equivalent amount directly as salary. This is because salary expenses are fully deductible, making direct salary payments more tax-efficient in such a scenario for the employer.
There is yet another way the neutrality to the employer is impacted: the employer books an ROU assset and a related OTP liability; however, that may still be okay considering the employees’ interest. However, losing a tax benefit may be an added cost.
So, is ICDS IX decisive?
ICDS IX deals with borrowing costs, which defines the same as,
are interest and other costs incurred by a person in connection with the borrowing of funds and include:
(iv) finance charges in respect of assets acquired under finance leases or under other similar arrangements.
Hence, as per ICDS IX, the interest component of a financial lease will be treated as a cost of borrowing, and the deduction can be claimed only for the interest portion which is relevant only for the lessee.
However, as discussed above, under Ind AS 116, there is no difference between FL/OL for the lessee. Accordingly, ICDS IX should not apply here.
So, if ICDS IX does not apply, does ICDS I (substance over form) apply?
It may be noted that the ICAI Technical Guide on ICDS warrants that substance should prevail over the form (ICDS I).
Hence, if we say that ICDS IX does not apply whether ICDS I should also not apply in case of financial lease? In our view, the substance of the lease would definitely matter. Even if the accounting distinction does not matter, if the transaction of lease is so structured so as to be equivalent to a loan, the deductibility of entire lease rentals would not be allowed.
Hence, to get the benefit of deductibility, the lease shall be a true lease. The following may be considered as essential features of a true lease:
Past rulings that may or may not hold the answer?
The Supreme Court in its decision in the case of ICDS Limited Vs CIT (350 ITR 527) held that in a leasing transaction, the lessor would be entitled to claim depreciation under section 32 of the IT Act on the leased assets. On the other hand, the lessee would be entitled to claim the entire lease rentals as a deduction while computing its total income.
Similarly, in the case of Wipro Ge Healthcare Private Limited vs Assistant Commissioner Of Income Tax, 2023, it was held that the assessee is entitled to claim a deduction on account of lease rentals paid as it is a revenue expenditure on the ground that the assessee is only a lessee and the lessor is the owner of the assets leased.
A similar judgment was passed in the case of Tesco Bangalore Private Limited vs Deputy Commissioner Of Income Tax, on 23 May, 2022.
However, the case laws relate to the assessment year before the introduction of ICDS IX and hence the same cannot be relied upon now.
Thus, tax treatment of leases for lessees is still a grey area. While Ind AS 116 has made accounting simple by removing the difference between operating and finance leases, the taxability of leases still remains a question because of ICDS IX.
Therefore, there is a need for a clear guideline by the IT dept that finally settles this question.
Footnotes:
- We have discussed the evolution of leasing in India in this publication: https://www.ifc.org/content/dam/ifc/doc/mgrt/evolution-of-leasing-in-india-aug-30-2019.pdf ↩︎
- See India chapter in WLY 2023 volume: https://www.world-leasing-yearbook.com/wp-content/uploads/2023/12/India_WLY.pdf ↩︎
From Trade Payables to Financial Liabilities: Ind AS Disclosure Reforms for Supply Chain Finance arrangements
Dayita Kanodia | finserv@vinodkothari.com
The amendments in Ind AS 7 emanate from similar amendments in IAS 7 by the IASB, made in May 2023, which itself is the culmination of a project that was initiated in 2020.
The amendments related to Supply Chain Financing (SCF) or reverse factoring arrangements. Globally, the SCF volumes increased by 8% to USD 2,462bn by the end of 2024.
Read our article explaining the Supply Chain Finance here.
The key features of a supply chain finance arrangement to require specific disclosure under the revised Standard are:
- The trade payables of the entity are paid by a financial institution; the entity then pays to the financial institution.
- The entity either gets extended payment terms, or the suppliers get earlier payment terms, than the terms as contained in the relevant supply invoices/agreements.
- Examples: X Ltd acquires goods/services from vendors with a 90 days’ credit. It organises a supply chain financing arrangement where Bank A discounts the receivables and pays off the vendor within 30 days, whereas the Bank will collect payment from X on 90 days of the invoice. The arrangement is covered.
- Same facts as above; but X is required to pay to the Bank in 180 days, whereas the Vendor is paid in 90 days. The arrangement is covered.
- If the due date of payment to the Bank is the same as the due date of payment to the vendor, the arrangement has no economic value, and does not impact either party’s cashflows – hence, does not require any specific disclosures.
- Note that the amendments do not affect asset side financing arrangements, that is to say, receivables financing or forward factoring.
An Overview of GST Implications on Lease Transactions
Yuttika Dalmia | finserv@vinodkothari.com
Classification of Lease under GST: Supply of Goods or Services?
Application of Goods-Equivalent GST Rates on Leasing Services
Leasing under GST as Mixed and Composite Supply
Should CGST +SGST or IGST be charged on the supply ?
Introduction
In today’s dynamic business environment, leasing has emerged as a powerful financial strategy, allowing companies to access capital assets without significant upfront capital investment. While traditional forms of funding such as equity and loans serve to inject owned or borrowed capital into a business, leasing offers rented capital which enables operational agility with reduced financial commitment. For businesses aiming to streamline their operations and be future-ready, leasing is the smart way forward.
Under the GST framework, leasing is unequivocally classified as a supply of service, irrespective of whether the lease relates to movable or immovable property. Under accounting parlance, Leasing is classified into two categories: financial lease and operating lease. These classifications are based on the extent to which risks and rewards of ownership are transferred from the lessor to the lessee.
GST implications on leasing are governed by specific provisions relating to nature of supply, place of supply, time of supply, utilization of input tax credit and applicable tax rates. Understanding these is critical for lessors and lessees alike to ensure compliance, proper tax treatment , and optimal input tax credit management.
This note presents an overview of the GST framework applicable to leasing transactions.
Read more →Should you expect adjustment in profits for “Expected Credit Loss”?
– Customised profits for CSR and managerial remuneration under Section 198 of the CA, 2013
– Pammy Jaiswal and Sourish Kundu | corplaw@vinodkothari.com
Background
The presentation of the profit and loss account has been outlined under the Schedule III of the Companies Act, 2013 (‘Act’) and the profit computation method has been provided for under the applicable accounting standards [See IND AS 1]. The basic principle is to showcase a true and fair view of the financial position of a company. Having said that, it is also significant to mention that the Act provides for an alternative method for computing net profits, the basic intent of which is to arrive at an adjusted net profit which does not have elements of unrealised gains or losses, capital gains or losses and in fact any item which is extraordinary in its very nature. The same is contained under the provisions of section 198 of the Act. This section, unlike the general computation method, has a limited objective i.e., calculation of net profits for managerial remuneration as well as corporate social responsibility.
There are four operating sub-sections under section 198 which provides for the adjustment items:
- Allowing the credit of certain items – usual income in the form of govt subsidies
- Disallowing the credit given to certain items – unrealised gains, capital profits, etc.
- Allowing the debit of certain items – usual working charges, interests, depreciation, etc
- Disallowing the debit of certain items – capital losses, unrealised losses, usual income tax, etc
It is important to note that items other than those mentioned above need not be specifically adjusted unless their nature calls for adjustment under the said section. Now if we discuss specifically for items in the nature of Expected Credit Loss (‘ECL’) for companies following IND AS, it is important to understand the nature of ECL in the context of making adjustments under section 198 of the Act. See our write on Expected Credit Losses on Loans: Guide for NBFCs.
Understanding ECL and Its Accounting Treatment
Reference shall be drawn from Ind AS 109 which defines ‘credit loss’ as ‘the difference between all contractual cash flows that are due to an entity in accordance with the contract and all the cash flows that the entity expects to receive (i.e. cash shortfalls), including cash flows from the sale of collateral held.’ ECL is essentially a way of estimating future credit losses, even on loans that appear to be fully performing at the time of such analysis (Stage 1 assets). It is based on expected delays or defaults, and the estimated loss is recorded as a charge to the profit and loss account, based on a 12-month probability of default.
As per Ind AS 109, ECL is used for the recognition and measurement of impairment on financial assets both at the time of origination as well as at the end of every reporting period. ECL is a forward-looking approach that requires entities to recognize credit losses based on the probability of future defaults/ delays.
However, this does not result in a reduction in the carrying value of the asset (unless the asset is already credit-impaired, i.e., Stage 3). In that sense, while ECL reflects asset impairment, it does not operate like a direct write-down. And unlike conventional provisioning, ECL is not a “provision” under traditional accounting – it is a loss allowance rooted in forward-looking estimations. Further, it is also important to understand that the booking of ECL does not mean that there has been a credit loss in the actual sense, the same is a methodical manner of estimating the probable default risk association with the asset value.
Treatment of ECL under Section 198
Section 198 requires excluding unrealised or notional adjustments, such as fair value changes or revaluation impacts in terms of Section 198(3) of theAct.
The section also refers specifically to actual bad debts, under Section 198(4)(o). This raises the natural interpretational question: should model-driven, probability-weighted ECL charges – which do not reflect realised losses – really be allowed to remain deducted while computing such customised profits? Well, the answer lies in the requirement and nature of such an item being required to be deducted from the profit and loss account under IND AS 109.
Alternative approaches -Treatment of ECL
The question around the treatment of ECL can be viewed from two perspectives. The first being the nature of ECL and the second on the routine treatment and calculation of ECL. If we look at the nature, it is clear that while it is imperative for companies to compute ECL at the time of origination as well as at the end of every reporting period, it is important to note that there is no loss or default in the actual sense. This means that the amount computed as ECL has not been an actual default.
On the other hand, if we look at the need for such computation and the methodical approach to arrive at the value of ECL, the same is likely to be considered as a usual working charge which is charged to the profit and loss account. Accordingly, we have come across two possible and permissible approaches to the treatment of ECL while computing the profits under section 198. The same has been discussed below with the help of illustrations.
Approach 1: Disallowing ECL in the year of its booking and subsequent adjustment of bad debt
| Year 1 | Year 2 |
| PBT – 1000 Depreciation – 20 ECL – 40 Loss on sale of fixed asset – 15 | PBT – 1200 Depreciation – 20 ECL – 35 Actual Bad Debt – 15 Profit on sale of equity shares – 25 |
| Year 1 | Amount | Year 2 | Amount |
| PBT | 1000 | PBT | 1200 |
| Depreciation | – | Depreciation | – |
| Add: ECL | 40 | Add: ECL | 35 |
| Add: Loss on sale of fixed asset | 15 | Less: Profit on sale of equity shares | (25) |
| PBT u/s 198 | 1055 | PBT u/s 198 | 1210 |
Notes:
- ECL has been ignored in profit computation u/s 198 considering the same is an unrealised loss and therefore reversed.
- Depreciation and actual bad debt has not been adjusted again as it has already been deducted under normal profit computation.
- Capital gains and losses have been adjusted/ reversed under the computation.
Approach 2: Allowing ECL in profit computation and netting off actual bad debt from the same in subsequent period
| Year 1 | Year 2 |
| PBT – 1000 Depreciation – 20 ECL – 40 Loss on sale of fixed asset – 15 | PBT – 1200 Depreciation – 20 ECL recovered – 35 Actual Bad Debt – 15 Profit on sale of equity shares – 25 |
| Year 1 | Amount | Year 2 | Amount |
| PBT | 1000 | PBT | 1200 |
| Depreciation | – | Depreciation | – |
| ECL | – | ECL | – |
| Add: Loss on sale of fixed asset | 15 | Actual bad debt | – |
| ECL recovered | – | ||
| Less: Profit on sale of equity shares | (25) | ||
| PBT u/s 198 | 1015 | PBT u/s 198 | 1185 |
Notes:
- ECL has been considered in profit computation u/s 198 and therefore, not adjusted to reverse the impact
- Similarly, ECL recovered has been considered part of normal or routine adjustment and hence, not reversed.
- Actual bad debt is not to be considered at the time of profit computation under the regular computation since it can be adjusted from the ECL already booked.
- Capital gains and losses have been adjusted/ reversed under the computation.
Concluding remarks
All listed companies are required to comply with Ind AS and given that an instance of a company having nil receivables is a rare occurrence, the discussion on how ECL is to be treated while computing net profit in terms of Section 198 becomes more than just an academic debate.
As long as the impact of any P&L item being extra ordinary in nature is taken off from the profits computed u/s 198, the same serves the purpose and intent of section 198 of the Act. ECL, while valid for accounting, is fundamentally an estimated, non-actual loss. It exists because accounting standards demand alignment of income with credit risk and not because a real outflow has occurred. However, it cannot be said that ECL already deducted while calculating profit before tax as per applicable accounting standards will be reversed while calculating profits in terms of Section 198.
Further, given that ECL is based on expectation calculated using due accounting principles, the actual bed debt, if within the ECL limit, does not impact the P&L. On the contrary, in case of the actual bad debt being in excess, the P&L warrants a subsequent debit of the net amount. For example, under approach 2 if the actual bad debt would have been 50, i.e. in excess of the ECL booked in the previous period by 10, the normal profit computation would have allowed a debit of 10.
In fact, both the approaches lead to the fulfilment of the intent of section 198 and hence, it is not necessary to consider any one approach as correct. Having said that, it is imperative to follow uniform practice in this regard in the absence of which the profits u/s 198 may be impacted.
Therefore, where the statutory and accounting frameworks intersect – but are not necessarily aligned – companies must adopt a carefully considered, principle-based approach as even a single line item like ECL can materially influence the base for managerial remuneration and CSR spending unlike other estimate based items such as revenue deferrals viz. sales returns or warranties, which are made as a matter of accounting prudence, but does not represent outflows for statutory computation purposes. Accordingly, there is no reason for deviating from the Indian GAAP principles for the purpose of customised calculation of net profits for specific purposes.
Read more:
Cash in Hand, But Still a Loss?