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SUPREME COURT RULING ON LEASE TAXATION PUTS LEASING INDUSTRY ON THE MAT

Is this the last nail in the coffin?

By Vinod Kothari

The issue of sales-tax on lease transaction has been raging in controversy ever since the leasing industry started in India. Till date, there were two major schools of thought: now, the Supreme Court has seemingly given a new twist to the balance altogether, and the already-bleeding leasing industry would probably find it an unbearable jolt to reckon that all those leases that were presumed to be tax-free all these years are indeed taxable, or for that matter, the leases on which tax has been paid in Karnataka are rather taxable in Haryana or Bihar! In other words, the Supreme Court ruling has brought in a principle which was never envisaged by the tax payers, let alone complied with.

The ruling in question is 20th Century Finance Corporation and another v. State of Maharashtra decided in May, 2000.

The two major schools of thought were:

Bombay High Court ruling in 20th Century Finance Corporation denying the concept of inter-state leases and holding that every lease is taxable in the State where the goods are put to use. The Bombay High Court ruling was favored by the Tamil Nadu Taxation Tribunal in the case of Upasana Finance Limited. Besides, tax officers all over the country were happily taxing leases based on the Bombay High Court ruling, as it gave them the maximum taxing potential based on the physical location of goods.
AP High Court ruling in ITC Classic Finance holding that sec. 3/4/5 of the Central Sales-tax Act apply to leases, and leases where inter-state movement of goods has taken place because of the lease are inter-state, and hence exempt from tax. As for the leases where no inter-state movement of goods took place, it the physical location of the goods that will decide taxability. The AP High Court ruling found favour with the Karnataka High Court in India Equipment Leasing and later in IFCI.

Though the Supreme Court ruling has reversed the Bombay High Court ruling and affirmed the AP High Court ruling, it has laid down a wholly new rule for fixing the situs of the sale. Quite interestingly, the Supreme Court ruling creates a new taxing rule for lease transactions which has never been heard of before under sales-tax law. In the Supreme Court's decision, it is the place of signing the lease agreement which will decide the situs, that is, the taxing jurisdiction of the lease. The reasoning given by the Supreme Court is that the provisions of the Central Sales-tax law (sections 3,4 and 5) that decide situs or inter-state character in case of normal sales, are not applicable to leases as the Central law has not been amended to apply to leases.

There is apparently no reason why the Central law should not have been amended, 18 years after the Constitution was amended in 1982 to include several "deemed sales" into the fold of "sales" for sales-tax purposes. Inaction - that is the only answer. Be that as it might, the fact that the law has left a void led the Supreme Court to create what may be called a "judicial law". As a golden rule of interpretation, Courts are made to interpret a law, not to make one, but there have been plenty of cases in the past where judges have had to fill in gaps left by the law makers.

Thus, while the Supreme Court's so-called gap-filling effort is appreciable, the problem it has created is that no one had ever envisaged such interpretation. Reason: there was a ruling of the Supreme Court in Gannon Dunkerly's case that clearly went on to suggest that sections 3.4 and 5 of the Central law were applicable to deemed sales, notwithstanding the fact that the Central law was yet to be amended.

Therefore, the understanding based on which lease sales-tax was administered by almost every leasing company was, either on the basis of the Bombay High Court ruling according to which the place of use was to decide jurisdiction, or according to the AP High Court, where the only difference was that inter-state leases were not taxable, but where the lease was intra-state, the jurisdiction was still based on the place of use or delivery of the goods.

The Supreme Court ruling tells us that that was not the correct law, and it was not correct ever since 1984 ! In other words, if leasing companies have paid tax based on place of delivery or use and such place was different from the place of execution of the contract, the tax was wrongly paid, or wrongly not paid, for last 16 years! The underlying plight is: if the tax was wrongly paid and was not payable, there is only a feeble hope to get a refund, because of either time limits, or doctrine of unjust enrichment, etc. But if the tax is payable and was not paid, or paid in the wrong State, the right State would be right there to collect the same.

There are more reasons than not for the place of signing the agreement being different from the place of delivery or use of goods. Most leasing companies are located in larger cities, but their lessees would obviously have factories or business all over the country. The delivery of goods would obviously take place at the lessee's place, but the agreement would most likely be executed at head offices.

In some cases, companies were actively pursuing policy of signing agreement at a nodal place for better administration. Some were doing it for avoiding stamp duty in the State of Maharashtra. The queer, and of course, painful, consequence of the Supreme Court ruling is that if the agreement was entered into in Tamil Nadu for goods bought and delivered in Maharashtra, and this was a second sale in Maharashtra, according to the apex Court, the sale is taxable in Tamil Nadu and cannot attain second sale exemption in Maharashtra.

Sales-tax on deemed sales was introduced by way of a Constitutional amendment in 1982, based on the 60th Law Commission report. The Law Commission had, in far sighted wisdom, also envisaged that since the states were now stepping on to a new realm of taxation, the Central govt. should put fetters on the right of states to tax deemed sales by framing proper rules. Unfortunately, the rules were never framed. The law of sales-tax on deemed sales is, therefore, left totally for Court rulings to settle. Apparently enough, if Courts are to settle a law, the ripples left by various High Court rulings are settled finally by the Supreme Court - a process which takes anywhere between 10 to 20 years, and at the end of the day, the tax payers only get to realise that all that they were taught by various Courts and consultants was not the right view!

Implications of the Supreme Court ruling in 20th Century Finance: Note for leasing professionals:

By Vinod Kothari

Below, we explain the implications of the Supreme Court ruling for leasing professionals and leasing companies.

Sales-tax on inter-state leases:

First of all, the Bombay High Court ruling in 20th Century Finance has been reversed, and the AP High Court ruling in ITC Classic has been affirmed. Please do appreciate that this was the consistent view we have been taking, even before the Bombay High Court ruling was pronounced, we have been advising clients not to pay tax on inter-state transactions. Many of our clients heeded to our advice, and they are happier today.

In unambiguous terms, the Supreme Court ruling re-affirms that the states have no right to levy tax on inter-state leases, leases in course of import or export, or leases outside the State.

The dissenting judgement by the two judges does oppose the ITC Classic ruling, but given the fact that the majority has affirmed the AP High Court ruling, the dissenting judgement is only of academic significance.

The Supreme Court's determined disapproval to tax on inter-state transactions can be found in their ruling where they have read down provisions of various state laws which attempted to levy tax based on place of use. Besides, the Court has also held unequivocally that the situs of the lease is of no relevance as far as inter-state transactions are concerned.

What exactly is an inter-state lease:

It is possible to find adverse reaction from some tax consultants and the revenue officials, who would try to read between the lines. There is a remark somewhere in the Supreme Court ruling that section 4 of the CST Act, fixing situs in case of normal sales, is not applicable to leasing transactions. It may be contended that by implication that if sec. 4 of the CST Act does not apply to leases because the CST Act is yet to be amended to include leases, section 3 defining inter-state sales should also not be applicable to leases.

Hence, it is impossible to define an inter-state lease, and hence, no such leases can be exempt on the ground that they are inter-state.

There is no basis for such an apprehension. Supreme Court's remark that sec. 4 of the CST Act is not relevant in case of leases has to be read in consonance with their remark elsewhere in their ruling that situs is not important in case of inter-state transactions. That is to say, where the transaction is inter-state, one does not have to bother about section 4 at all. The Supreme Court had to carve out a new meaning of situs for lease transactions because, in the understanding of Their Lordships, the Central Govt has left a vacuum by not enacting the principles which it was supposed to frame under art 286 (3) (b) of the Constitution, and therefore, the Court had to frame a judgemental law.

That inter-state transactions cannot be taxed by any government is a guarantee under the Constitution, and the fact that the CST Act has not been amended cannot in any way undermine this guarantee. It is necessary to note that art. 366 (29A) of the Constitution merely defines "tax on sale or purchase of goods" and such tax is no different from tax on any other sale or purchase, which is subject to limitations laid down in art. 286.

Next question is, how to define an inter-state lease. Unfortunately, no guidance is available from the Supreme Court ruling in so many words. But significantly enough, the Supreme Court ruling has upheld the ruling of the AP High Court. Once the ruling has been affirmed by the Apex Court, it bears the force of the Supreme Court. The AP High Court ruling, it may be noted, has dealt in detail with the question of inter-state leases which has affirmed the integrated transactions theory, propounded in detail by us [See Vinod Kothari's book on Leasing, 1996 edition]. Therefore, we would submit that inter-state leases would continue to be interpreted in accordance with the AP High Court ruling.

The decision in the case of Upasana Finance before the Tamil Nadu Tax Tribunal, which dissented from the ruling of the AP High Court and followed the 20th Century ruling should not be regarded as good law any more.

If the lease is not inter-state:

By definition, if a transaction is not inter-state, it is intra-state. That is where the Supreme Court ruling creates a new taxing basis altogether. We have commented below as to why this new basis of taxation will not be feasible in practice and therefore, the pilgrim has not come to rest still.

The viewpoint we advocated earlier, that in case of intra-state transactions, it is the place of delivery that will determine the jurisdiction, was based on the following rationale:

A lease is deemed to be a sale.
When a transaction that is not a sale is deemed to be one, unless any different taxing principle or principle of jurisdiction has been created by law, the normal tax principles will be applied to the deemed sale also.
This was also the ratio decidendi of the SC ruling in Builders Association where the SC clearly held that a deeming fiction has to be extended to its logical conclusion and also clearly held that sections 3, 4 and 5 of the CST Act are applicable to deemed sales as well.
The only differentiating factor between a normal sale and lease is the transfer of title. Physical or symbolic delivery of goods is common in both a normal sale and a lease. If the physical or symbolic delivery of the goods (situs) has been chosen as the basis in case of normal sales, there is no reason why the same should not be the basis for a lease transaction.

These arguments were never placed before the SC in the present case. It seems that the Counsel for the petitioners argued that the place of signing was the jurisdiction, and the SC was impressed by the Counsel's argument.

Hence, the new basis for taxing intra-state transactions is:

If the goods are in existence, that is, the goods are ascertainable goods under the Sale of Goods law, on the date of the contract, the place of signing the contract is the jurisdiction.
If the goods are not in existence or not ascertainable on the date of the contract, or the contract is oral, then the place of delivery is the jurisdiction.

Place of signing as the basis:

Evidently enough, place of signing as the basis may create enormous difficulties both for the subjects and the States.

Imagine, for example, companies signing lease agreements in Calcutta for vehicles bought in Andhra and delivered there. So far, such transactions would have been taxed in Andhra as local sales. As per SC ruling, Andhra does not have, and never had, a right of taxing such leases; on the other hand, West Bengal will treat them as first sales and have a right of taxing them based on the place of signing.

It is important to understand that in traditional understanding, the place of purchase and the place of delivery to lessee determined jurisdiction. As per the present SC ruling, the place of purchase and delivery will be irrelevant: the place of signing will be the only place that can have jurisdiction.

Examples:

Traditional understanding	Implication of SC ruling
Goods bought in Maharashtra, leased in Maharashtra, but agreement signed in Tamil Nadu. Lease not taxed in Maharashtra on second sale exemption.	Lease will be taxable in Tamil Nadu
Second sale exemption granted by several states on lease transactions	These exemptions will become meaningless, unless, the lease agreement is signed in the same state where the goods have been bought and leased.
Goods bought Karnataka and leased in Maharashtra. Agreement signed in Delhi	We would treat this as a case of inter-state lease; however, even if the lease is not inter-state, the lease will be localised in Delhi where no lease-tax has been imposed.
Goods bought in Karnataka and leased in Tamil Nadu; agreement signed in Tamil Nadu	We would treat this transaction as inter-state sale; however, if treated as intra-state, the transaction will be taxable in Tamil Nadu.
Goods bought and leased in Karantaka but agreement signed in Tamil Nadu	The lease is taxable in Tamil Nadu; irrespective of whether tax has been paid in Karnataka or not.

Do the States automatically get right of taxing on place of signing:

Most of the State sales-tax laws provide for the State to have a right of taxing based on the physical situs of the goods. Some States had, specifically for lease transactions, incorporated clauses to provide for taxation based on place of use, mostly in line with the Maharashtra Act. Such provisions in the laws of Maharashtra, Tamil Nadu, Karnataka, Rajasthan, UP and Andhra Pradesh have been specifically read down by the Supreme Court. Other laws, if at all they have any similar provision, will be deemed to be read down by implication.

When a Court reads down or strikes down a particular provision, it does not thereby mean the State automatically gets a right to tax based on place of signing. Nowhere in any State law has the place of signing the agreement been made the basis of taxation. Therefore, the States will not, automatically, get a right to tax leases signed in the State even where the goods have neither been acquired in the State or leased in the State.

In our view, unless the States react adversely (as noted below), the States will have to amend their own laws to provide for taxation based on the place of signing. Otherwise, in situation such as the one noted in Example 1 or example 4 above, the State will of execution will not get a power of taxation.

In other words, the SC ruling takes away the power to tax in cases where the agreement is not signed in the State, but does not automatically confer the power to tax where it is signed, if the goods are not physically in the State also.

In case of master lease agreements:

If the lease agreement was executed even before the goods were in deliverable state, the SC has held that there, the place of delivery would form the basis of taxation.

This is a confusion position indeed: the place of delivery to be irrelevant where the goods existed and to be decisive where they did not exist. However, accepting the SC ruling with respect, the meaning of this distinction will be as follows:

Most leasing companies enter into master lease agreements or lease agreements which are executed before the goods are ordered or bought. In such cases, the goods are "unascertained goods". In such cases, the place of delivery of goods to lessee will continue to be the taxing basis, as per traditional understanding.

We are of the view that many of the lease transactions done by many companies will fall under this category, which would mean there will be no change of law in such cases. However, some companies have the practice of signing contracts after the goods are bought.

The SC has also held that in case of oral lease agreements too, the place of delivery will be decisive. Oral lease agreements are uncommon: but they might also include cases where the goods are bought and delivered without an agreement, but subsequently the terms of the contract are reduced to writing.

Effective date:

The SC ruling interprets the law: not creates a law. Therefore, the ruling will have impact from the day on which the lease tax was introduced in the various states. However, as we have opined earlier, a ruling by itself cannot give to the State a new taxing power, unless the power is exercised by the State.

We advise all our clients to strengthen their cases for relief in case of inter-state lease transactions based on the SC ruling. In case of intra-state transactions, if the agreements were signed in another state, the state where the goods were bought and delivered does not have the right to tax. Appropriate action may be taken in such cases to claim refunds if the tax has wrongly been paid.

How about hire-purchase transactions:

The ruling above does not disturb hire-purchase transactions at all. It cannot be said that section 4 of the CST Act does not apply to hire-purchase transactions since the definition in that Act covers hire-purchase transactions.

Will the pilgrim come to rest here?

It is not difficult to predict that the States as well as the subjects will find the new basis of ruling uncomfortable. More likely the States. Reasons:

Evidently, the place of signing is the most discretionary of all the elements in a transaction. For future transactions, companies will easily maneuver their agreements such that the agreement is signed in a location where there is no tax. This is hardly difficult. Hence, no state will get a penny out of lease tax.
For past transactions, leasing companies may have never-thought-of liabilities in several states, but may have refunds to claim in several others.
In future, if state X claims tax on a transaction based on place of signing, state Y will claim tax treating the goods as "unascertained" on that date. This would lead to inter-state problems.
States like AP and Gujarat which have been collecting tax on intra-state transactions also may have to cough up huge refunds since the agreements may not have been signed in their state. States like Maharashtra and Tamil Nadu were merrily collecting tax based on 20th Century may also face huge refund demands. They may try to retaliate by raiding leasing companies to find the place of execution of documents. The result will be anywhere between more chaos to total chaos.
Place of signing belongs to the 19th Century. The other day, the IT (information technology, not income-tax, stupid!) Act was amended to allow electronic signatures. How about the place of signing in such cases? How about the place of signing in case the agreement was signed in course of a flight from Chennai to Calcutta?

As such, in our view, the States or the subjects will force the Central Govt to enact the law which is long pending: the principles of levy as per article 286 (3) (b) of the Constitution. Obviously enough, the Central Govt will not be inclined to choose the place of signing as the basis of taxation. Therefore, the law remains nebulous, and unfortunately so after 18 years of the Constitutional amendment Act in 1982.

Vinod Kothari's leasing site