In the English case of Melluish (Inspector of Taxes) Vs. B.M.I. (No. 3) Ltd. (213ITR236) the assessee companies (lesser’s) carried on the business of finance leasing, i.e. the purchase of plant and the leasing to end-users of the plant. The lesser companies incurred capital expenditure on the provision of the plant and machinery for the purposes of their trade. A large part of the expenditure related to central heating equipment for installation by local authorities (Lessee) in council houses. Other expenditure was incurred on swimming pool equipment, replacement cremators for crematoria, alarm systems for installation in sheltered housing, lifts for installation in car parks and boiler equipment. In respect of each transaction a master equipment lease was executed between a taxpayer company and a local authority that specified in inserted schedules the equipment that was to be leased, and provided that the lessee would return the equipment on the expiry of the lease, and that in the event of non-payment of the rental the lease could be terminated and the equipment repossessed by the lesser. It was also provided that leased equipment would remain personal or movable property which would continue in the ownership of the lesser notwithstanding that it might have become affixed to any land or building. On the expiry of a lease the lesser had the right to require the equipment to be severed and restored to it.
The relevant terms of the master lease (including the relevant schedule) were: (a) the local authority agreed to take the equipment on lease for a term, typically, of ten years, renewable on a year to year basis thereafter, the hirer agreeing to pay a rent annually in advance to the taxpayer company for the use of the equipment. (b) The local authority agreed to use the equipment properly and to allow the taxpayer company access to inspect the equipment: clauses 2.2 and 2.6 (c) The local authority agreed to keep the equipment properly repaired and maintained: clause 2.5. (d) The local authority agreed to allow the taxpayer company to indicate its ownership on the equipment being leased: clause 2.7. (e) The local authority agreed to keep the equipment in its sole possession and not to sell, assign, mortgage, and charge or sublet the equipment: clause 2.8. (f) The local authority agreed to insure the equipment for the benefit of the taxpayer company: clause 2.9. (g) The local authority agreed to return the equipment to the taxpayer company on the expiry or sooner determination of the lease: clause 3.7. (h) The taxpayer company was given the right to repossess the equipment on the happening of certain specified events including the non-payment of rent and other breaches of the provisions of the agreement by the local authority, or the insolvency of the local authority: clause 3.8. (i) Clause 3.10 of the master lease provided:
” As between the lesser and the lessee the equipment hereby leased shall remain personal or moveable properly and shall continue in the ownership of the lesser notwithstanding that the same may have been affixed to any land or building. The lessee shall be responsible for any damage caused to any such land or building by the affixing to or removal there from of the equipment (whether such affixing or removal be effected by the lesser or the lessee) and shall indemnify the lesser against any claim made in respect of such damage.”
The issue before the Court of Appeal (CA) was whether the machinery belonged (owned by) to the lesser or the lessee. The Court of Appeal (CA) (equivalent to High Court) unanimously allowed the appeal of the revenue in relation to the plant fixed to the property of which the local authority (lessee) retained possession. It held that the future right to remove equipment at the expiry of the term or in the event of a default by the local authority did not mean that the equipment “belongs” to the assessee companies (lessor’s) so long as it remains attached to the realty.
It further held that the leasing agreements, which were made for financial reasons, gave to the assessee companies (lessor’s) contractual rights against the local authorities (lessee) for payment of rent for the equipment and, despite their rights to enter and remove the equipment on expiry of the term of a lease or in default of payment of rent, on a fair use of language the lease equipment could not be said to continue to belong to the assessee companies (Lesser’s).
After referring to the various clauses of the agreement relied by the assessee the House of Lords on Page 560 of their decision in Melluish (Inspector of Taxes) Vs. Fitzroy Finance Ltd. (218ITR548) held as under:
“I turn then to consider whether the bundle of rights enjoyed by the taxpayer companies (including the limited equitable right to which I have referred) is sufficient to justify describing the equipment as “belonging” to the taxpayer company for the purposes of section 44 (Unquote-similar to section 32 of the Indian Income tax Act, 1961). In my judgment the factors relied upon are not sufficient to constitute “belonging”. The taxpayer company has never been the owner of the equipment, whether in law or in equity; it became a fixture (and therefore the property of the local authority) before the lease was entered into. Unless and until the local authority is in default or decides not to renew the lease the taxpayer company has no right to possession of the equipment or to direct how it shall be used. Its only property right is a contingent right to become the owner at a future date. In the meantime the property is owned and enjoyed exclusively by the local authority. The fact that the taxpayer company has an equitable right which may in the future be enforceable against some third parties does not, in my judgment, carry much weight; it indicates that there are rights relating to the equipment which belong to the taxpayer company, not that the equipment itself belongs to them.”
Further in answering the question as to the ownership of the asset the HL on page 561 pointed out that the rights enjoyed by the assessee confer no immediate right of any kind to enjoyment of the asset and only nebulous, contingent, future rights so to do.
Further, on page 569 the HL explained that this principle will hold good irrespective of the fact whether the assets under such lease is movable or fixed to the land. The relevant portion of the judgment is reproduced hereunder:
“I can find no good reason why the Legislature should seek to produce differing results dependent upon whether or not the equipment purchased is fixed to the land.”
In our opinion therefore the lease transaction that is basically entered into as a means to finance certain assets can risk claim for depreciation in the hands of the Lesser and it is thus necessary to consider such an important factor upfront in determining the lease price.