Financial and Operating Lease :
Lease can be broadly classified as (a) Financial or (b) Operating lease. Financial lease is usually long term agreement covering entire economic life of asset. Whole investment is recovered by lessor (plus, of course, his profit). Asset is usually maintained by lessee. It is non-cancelable contract. Practically, lessee becomes owner, though not legally.
Operating lease is for short period. The asset may be given to more than one parties on lease during economic life of asset. Hence, cost of asset is not recovered in one contract of lease. Usually, lessor upkeeps and maintains the asset. Contract can be cancelled by lessee/lessor by giving notice of period as prescribed in contract. Giving computers or furniture on monthly charge basis is one example of ‘operating lease’.
Depreciation in case of lease – In case of operating lease, the lessor is de facto and de jure owner of the goods. He can claim depreciation. However, in case of financial lease, the lessee is de facto owner though lessor is de jure owner. Hence, in Indusind Bank Ltd. v. Addl CIT (2012) 19 taxmann.com 173 = 135 ITD 165 (ITAT Mumbai), it was held that in case of financial lease, depreciation can be claimed by the lessee and not lessor.