Silver Queen Limited (SQL) is having a majority of its operations in export processing zone (EPZ). The provisions of government provide that a company established in EPZ is not required to pay tax on its profits for initial eight years from the date of commencement of business. SQL is a subsidiary of Gold King Limited (GKL). GKL is in the main commercial area of Maharashtra and is liable to pay tax at the rate of 30% on its profits. The finance manager of SQL had recently scrutinized the provisions of income Indian accounting standard relating to lease accounting. He noticed that a company can enter into a ‘sale and leaseback’ transaction, which generates multiple benefits in single transaction, i.e., it can enjoy the use of the asset and at the same time can generate cash resources by selling the asset. Another benefit is in the form of lower lease rentals as compared to commercial lease rentals.

To reap the benefits of this type of lease transaction, SQL enters into a package deal whereby SQL sells main frame computer to GKL at a sales value of ₹50 lakh and agrees to take the main frame computer on lease for 10-years’ period. The carrying amount and fair value of the main frame computer are ₹45 lakh and ₹48 lakh, respectively. GKL has an implicit cost 16% per annum.

Discussion Question

1. Assuming that your are the finance manager of SQL, show how the transaction should be recognized initially in the books of SQL and GKL.

2. Calculate the minimum acceptable lease rent for GKL.

3. Had SQL not entered into a sale and leaseback deal, then what would have been the tax implication for GKL?