Service tax on leasing and hire purchase transactions in India

Vinod Kothari

As per the Budget proposals for year 2001-2, a revenue-oriented government has gone ahead and imposed service tax on leasing and hire purchase transactions which duplicates with several other levies on the same transaction, notably sales-tax. Logically, a particular transaction cannot be sale and service at the same time, but such logic has no place in Indian law making - so over to the Courts now!

The imposition of service tax on leases and hire purchases almost coincides with a hit film from Bollywood - Lagaan - where Aamir Khan leads the fight against an illogical whimsical imposition of a tax on farmers way back in history, against the backdrop of continuous droughts for several years. History repeats itself, as they say - that the leasing industry has been facing droughts for last several years is beyond question, and that simultaneous imposition of service tax on a transaction treated as "sale" under the Constitution is also beyond doubt. Unfortunately, there is no Aamir Khan to win a cricket match of arguments with the North Block. No answers given by the Finance Ministry to the constitutionality issue at all in its clarifications - and it has gone ahead and imposed 5% service tax, prospectively though, on all lease and hire purchase transactions.

Some broad features of the new levy are as follows:

• The levy is prospective. No tax is applicable on past transactions, provided the goods have already been delivered before 16th July. So if you do not want your transaction to be subject to service tax, simply ensure that you do not do any transaction after 16th July.
• The levy is applicable only on bodies corporate. So transactions done by individuals and partnerships are not liable to service tax. Making this distinction based on the composition of the entity, the Finance Ministry has made a categorical mistake, as it is possible for a leasing company to enter into a partnership with another company, or any other person for that matter, and carry on the same business as an unincorporated joint venture. Such course of action will not be free from hassles, but if rules of economics warrant it, the industry would perhaps fall back upon such practices.
• The tax is applicable only on lease and hire purchase transactions booked by banks or financial companies. In other words, if the company in question is a non-banking non-financial company, the service tax is not applicable. So very obviously, there will be new thrust to vendor leasing - leasing by manufacturing companies, computer companies, etc.
• The tax is applicable only on the interest element inherent in lease rentals/ hire charges. The CBEC notification time and again talks of "equated monthly instalments" which is a cliche and underscores the lack of understanding of the business by the Government, as the instalments do not have to be either equal, or monthly. They may not be equated first of all, and they may not be monthly - quarterly or otherwise. In any case, as the government accepts that the value of the service is the interest fraction of the lease rentals/ hire charges, it should be understood the bifurcation of financial earnings and principal recovery as done for accounting purposes will be relevant for service tax as well. This is not clear in the official version, but we need to fill in this blank. Apparently there is nothing in the principal law, that is, the Finance Act, that permits such splitting.
• There is no service tax on loan transactions. Non-banking finance companies can give loans, and not pay service tax on such loans. There are limitations in lending business - apart from the overall ceilings under sec. 372A of the Companies Act, there are problems such as recovery difficulties, money lending laws, deduction of tax at source, etc., but one will have to weigh pros and cons when it comes to choosing between service tax and the other implications.
• As there is no service tax on loan transactions, there should be no service tax, by implication, also on certain transactions which are a hybrid between a loan and a hire purchase. In industry jargon, such transactions are sometimes referred to as "hire purchase finance transactions", which are essentially financial transactions documented as hire purchase transactions. These transactions were discussed in an old Supreme Court ruling, viz., Sundaram Finance v. State of Kerala.
• There is no service tax on operating leases. This is clear from the reading of the Finance Act, as also apparent from the fact that the tax is applicable only on the interest element inherent in the instalments, and as for operating leases, the entire inflow is treated as a rental: there is no splitting of interest and principal even under the accounting standards. See more about operating leases in my article here.

 

 

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