FBR panel analysing tax dispute of 'lease key money'

The Tax Facilitation Committee of the Federal Board of Revenue is analysing tax dispute of 'lease key money' during finalisation of income tax assessment of leasing companies and investment banks. 'Lease key money' is the initial deposit that someone gives to a leasing company on getting an asset on lease.
This deposit may vary from a minimum 10 percent to an agreed amount between the leasing company and lessee. Sources told Business Recorder on Tuesday the FBR will examine this issue in the light of viewpoint of the tax consultants submitted during the last TFC meeting.
The second meeting of the TFC is likely to take up the issue of income tax assessment of leasing companies here on Wednesday (today). The TFC comprise representatives of leading trade bodies, export association, tax bar associations and senior tax officials to resolve the issues raised by the private sector. The issue of taxation of leasing companies was recently discussed during the last TFC committee.
Details revealed that Muhammad Awais, Partner Ernst and Young Lahore raised this issue before the committee regarding dispute on taxation of 'Lease Key Money' while finalising the assessment of leasing companies. The leasing companies and investment banks (Lessor), allows financing facilities to various persons (Lessee), against lease of assets.
At the time of entering into leasing arrangement, lessor receive certain sum which is retained as security deposit against lease of assets and recorded in the accounts under the head "Lease Key Money".
During the lease term, lessor receives lease rentals and at the time of maturity of lease, the asset is transferred to the lessee against the residual value, which is the same, as -received at the start of lease under the head lease key money.
During the lease term, the lessor offers the entire lease rentals received against lease of assets as its income and claim tax depreciation on leased assets against these rentals and at the tune of maturity of the lease, the residual value/ lease key is treated as 'Sale Proceeds' of the assets and after deducting the tax WDV (Written Down Value) from the amount of lease key money, net gain/ loss on leased assets is offered for tax. The said treatment is in accordance with the provisions of Third Proviso to Rule 8(5)(j) of the Third Schedule to the repealed Income Tax Ordinance, 1979 and Section 77(4) of the Income Tax Ordinance, 2001.
The income tax department, while finalising the assessment has treated the security deposit/lease key money received at the start of lease agreement, as income for the year and charged tax thereon ignoring the fact that leasing companies are already offering to tax the same amount in the year of maturity of lease by considering it as sale proceed of leased asset.
According to the tax expert, if the interpretation of tax authorities be accepted, 'Lease Key Money' will be taxed twice, once in the year of receipt as taxed by the tax authorities and secondly at the time of disposal of leased assets, by treating the same as Sale Price of leased asset.
It has also been explained by the FBR through letter No F.4(5)ITP/2000 dated May 18, 2000, "that where the security deposit/ lease key money is kept separate from the lease rentals and other charges and is not adjustable against lease rentals and is refundable to the lessee at the end of the lease period, such security deposit/ lease key money is not income of the leasing company." As all the conditions as specified in the said letter have been fulfilled by the companies ie firstly, this amount has been kept separately from the lease rentals. Secondly, it has never been adjusted against the lease rentals and it is refundable/adjustable to the lessee at the time of completion of lease, consultant pointed out.
Therefore, keeping in view the instruction of above-mentioned letter, the said amount of lease key money cannot be taxed, he opined. On the complaint of Leasing Association of Pakistan, that certain tax officers are not following the instructions of FBR issued through the above mentioned circular letter, the FBR has issued another letter No 4(5) ITP/2000 dated July 2, 2001, where in it has been specified that, "specific cases of non-compliance with the Board's instructions may please be brought to the notice of concerned Commissioner or Regional Commissioner."
These circulars have been issued by the FBR in accordance with the powers vested under section 7 of the repealed Income Tax Ordinance, 1979. The explanation/ guidance given through these circulars are in accordance with the provisions contained in the law.
Referring to the judgement of Income Tax Appellate Tribunal on the issue of 'Lease Key Money', chartered accountant informed the TFC that the Income Tax Appellate Tribunal, in case of a leasing company, while giving opinion on legality of these circular letters issued by the FBR, has confirmed that interpretation of law made by the FBR through these circular letters is in accordance with the legal provisions of law.
The tax department in the case of a leasing company has made the addition on account of lease key money. The Commissioner of Income Tax (Appeals) has deleted the said addition relying upon the judgements of Income Tax Appellate Tribunal. Being dissatisfied with the order of the learned Commissioner of Income Tax (Appeals), the department filed second appeal before the Income Tax Appellate Tribunal.
The Income Tax Appellate Tribunal vide an appellate order had upheld the decision of the learned CIT (Appeals). Being still dissatisfied, the revenue prepared the reference application and sought permission from the Member (Legal) of FBR for filing the same before the learned ITAT. The FBR Member (Legal) vide letter No 1(86) S (I.T.Legal)/05 of July 4, 2005 has directed the learned Regional Commissioner of Income Tax (RCIT). Eastern Region Lahore not to file reference application against the appellate order of the Income Tax Appellate Tribunal because the issue of lease key money was settled through an amendment in the law.
The Member (Legal) further directed to the learned RCIT to withdraw the earlier reference filed by the department on the issue of lease key money. Tax expert was of the view that the FBR has finally accepted that treatment adopted by the leasing companies is in accordance with law and therefore restricted the tax authorities not to file reference in the High Court in case of Capital Asset Leasing Corporation and also directed to the Regional Heads to withdraw the earlier references filed by the department, but the implementation of these orders have not been made till to date and number of references/appeals are pending at High Court and Tribunal Level. The action required is that the FBR should direct the field formations to withdraw the cases from the tribunal and high court, wherever pending, sources added.