Aircraft 'Dry Lease' Taxable Where Lessor Retains Possession, Effective Control: CESTAT Chennai

The Chennai Bench of the Customs, Excise and Service Tax Appellate Tribunal (CESTAT) has held that merely calling an aircraft arrangement a “lease” does not mean that possession and effective control have been transferred to the other party.

The tribunal found that Orient Flight School retained effective control and legal possession of the aircraft, and upheld the service tax levy on the arrangement as “Supply of Tangible Goods Service."

"Though the agreement uses terms like “lease” and “lessee”, the actual operational clauses show that the lessor retains effective control and legal possession of the aircraft and it is not a transfer of right to use with possession and effective control.,” the tribunal observed.

A Bench comprising Judicial Member Ajayan T.V. and Technical Member Vasa Seshagiri Rao partly allowed Orient Flight School's appeals. It confined the service tax demand to the normal limitation period and set aside all penalties.

Orient Flight School provides flight training to students. It had entered into a five-year agreement with its related concern, Orient Flights Pvt. Ltd. (OFPL), for use of its aircraft under an arrangement described as a “dry lease”.

The Department treated the arrangement as “Supply of Tangible Goods Service”. At the relevant time, this covered the supply of tangible goods for use without transferring possession and effective control. Service tax demands were raised for the period from 2008-09 to December 2012.

Orient Flight School argued that the dry lease had transferred possession and effective control to OFPL. It also pointed out that an earlier show cause notice issued to OFPL had proposed service tax on receipts that included the same lease payments.

The tribunal found that OFPL did not have exclusive custody of the aircraft. Under the agreement, the flight school could use the aircraft for student training whenever it was not being used by OFPL or its clients. OFPL also had to return the aircraft after every trip.

The agreement required the lessor to bear all expenses on the aircraft during the lease period. The tribunal also noted the per-flying-hour charges and minimum monthly commitment. Taken together, these terms supported its finding that the flight school retained effective control and legal possession of the aircraft.

The tribunal therefore upheld the classification of the arrangement as “Supply of Tangible Goods Service”.

On double taxation, the tribunal accepted the flight school's contention. It found that the identical lease receipts had already formed part of the demand raised on OFPL. Taxing the same receipts again in the hands of the flight school would result in double taxation.

The tribunal clarified that the Department could still proceed against the person ultimately found liable for those receipts, strictly in accordance with law.

The tribunal also rejected the Department's attempt to invoke the extended limitation period. The transaction and receipts were already within the Department's knowledge when the earlier notice was issued to OFPL. The later notice was based on the same facts, and no fresh act of suppression was established.

It found no evidence of a positive act by the flight school, coupled with an intention to evade tax, that could justify the extended period. The demand was therefore confined to the normal limitation period.

The tribunal also excluded “other collections”, stated to include receipts from joy rides and sale of scrap, from the taxable value. The show cause notices contained no allegation concerning these receipts. An adjudicating authority, the tribunal observed, cannot travel beyond the allegations in a show cause notice.

The tribunal set aside the penalties after finding that fraud, collusion, wilful misstatement or suppression with intent to evade tax had not been established. It also set aside the separate penalty under Section 77(1)(a).

The appeals were accordingly partly allowed. The service tax demand was upheld only for the normal limitation period and all penalties were set aside.

For Appellant: Advocate N. Viswanathan,

For Respondent: N. Satyanarayana, Authorised Representative