By Anshul Mathur
Hire purchase transactions are essential for industry and business houses in acquiring equipments necessary for stimulating growth. However, meticulous planning is required to arrange financing of the assets for making timely payments. Hire purchase is a financial facility which allows a business to use an asset over a fixed period, in return for regular payments. When all the installments have been paid, the buyer becomes the owner of the equipment. This ownership can transfer either automatically or on exercise of an option to purchase. In other words, hire purchase not only appertains to agreements wherein the buyer has an option to buy the goods, but also to those agreements where the property in the goods is to pass at the end of the term.
As regards applicability of sales tax on such transactions, it has always been clear that the first sale, namely the sale by the vendor to the financier is a sale taxable under the relevant sales tax enactment. However, the transaction between the financier and the buyer has been the subject matter of dispute and judicial scrutiny (see end note 1), as it did not fulfill an essential requirement of a typical sale transaction i.e. transfer of property or title of goods upfront. The buyer‘s argument is that the sale fructifies only at the end of the term of the agreement when the option to purchase is exercised whereafter the transfer of property takes place; and that only the last installment / option fee paid to the financier should be subjected to tax. This argument did not find favour with the court (see end note 2) but there was no codified alternative available at the relevant time. The court noted that a hire purchase is a mere bailment until it fructifies into a sale, and is not analogous to sale. This difference between a sale and a hire purchase assumed importance because the states were not empowered by the Constitution to tax a hire purchase which did not result in a sale. If a hire purchase resulted in a sale then sales tax was payable, but identifying the ‘sale price’ which would attract the levy was a herculean task, especially in the absence of any codification in that regard. There was lack of clarity not only with respect to the taxability of such transactions but also the amount which would suffer tax and the time at which the levy became applicable.
These problems were referred to the Law Commission, which recommended certain amendments in the Constitution (see end note 3) and a new clause (29A) was inserted in Article 366 of the Constitution (see end note 4), which provided that ‘tax on sale or purchase of goods’ would include the delivery of goods on hire-purchase or any system of payment by instalments. In effect, the delivery of goods on hire purchase was itself deemed to be a ‘sale’ regardless of whether the ownership passed on at a later date or did not pass on certain cases. Hence, the confusion caused due to diverse opinions about the levy of sales tax on hire purchase transactions, got seemingly cleared.
In line with the constitutional amendment, hire purchase got included in the definition of ‘sale’ in all the state VAT legislations. However, as far as uniformity in the manner of taxing these transactions is concerned, it leaves much to be desired. The practices across States in respect of calculating the taxable turnover of such transactions are not uniform. While some state VAT legislations are totally silent about the method to be followed to calculate the taxable turnover in respect of a hire purchase transaction, other States have evolved highly structured practices allowing appropriate deductions while determining taxable turnover. For instance, interest charged separately and finance charges in respect of hire purchase are specifically excluded from the turnover of a dealer under the Tamil Nadu VAT Act (see end note 5). On the other hand, under the Delhi VAT Act, ‘sale price’ in relation to the delivery of goods on hire purchase is the consideration payable to a person for such delivery including hire charges, interest and other charges incidental to such transactions, and such amounts are taxable upfront (see end note 6).
Another major issue of concern is the applicability of service tax as well as sales tax/ VAT on hire purchase transactions. Service tax is levied on hire purchase transactions under ‘banking and other financial services’ (see end note 7). The Supreme Court has, in fact, upheld the constitutional validity of the levy of service tax on financial leasing services including equipment leasing and hire purchase (see end note 8). As far as the taxable value is concerned, the Supreme Court held that the sum received as principal amount is not the consideration for services rendered; and that the lease management fee/ processing fee/documentation charges and interest charges which constituted the consideration for the services rendered are accordingly taxable. Further, the government has granted exemption upto 90% of the amount representing interest (see end note 9).
Thus, as on date service tax is applicable on the processing fee, documentation charges and on ten percent of the interest charges recovered in equated monthly instalments. A perusal of the Finance Act, 2012 reveals that the transactions specified as deemed sales under the Constitution have been excluded from the definition of service. Yet the ‘activities in relation to delivery of goods on hire purchase’ have been specifically declared as a service taxable under the Act (see end note 10). Thus, the position is not likely to change in the near future.
In the absence of any specific exclusion for such charges under the VAT legislations such as Delhi VAT, these charges, namely processing fee/documentation charges and ten percent of the interest charges will attract the levies of service tax as well as VAT. In other words, there is double taxation on these amounts.
Standardisation of practices and uniformity is the need of the hour. Heterogeneous regulatory practices being followed in the realm of hire purchase transactions is inimical to the cause of a well-oiled industrial and business sector. A uniform, lucid and coherent legal regime governing such transactions is imperative to curtail time spent in squabbling over the application of the laws and allow industries and service providers to concentrate on their job.
End notes:
1 Instalment Supply (P) Ltd. v. Union of India [1961] 12 STC 489 (SC); K.L. Johar v. Deputy Commercial Tax Officer [1965] 2 SCR 112
2. K.L. Johar v. Deputy Commercial Tax Officer [1965] 2 SCR112
3. Certain problems connected with power of the States to levy a tax on the Sale of Goods and with the Central Sales Tax Act, 1956, 61st Report, Law Commission of India, 1974.
4. 46th Constitution (Amendment) Act, 1982.
5. Rule 8(1)(c), Tamil Nadu VAT Rules, 2007.
6. Section 2(1)(zd) of the Delhi Value Added Tax Act, 2004 and Rule 4 of the Delhi Value Added Tax Rules, 2005.
7. Section 65(12), Finance Act, 1994.
8. Association of Leasing and Financial Companies v. Union of India and Others, [2010] 29 STT 316
9. Notification No. 4/2006-S.T., dated 1-3-2006.
10. Section 66E of the Finance Act, 2012 read with Notification No. 13/2012-ST dated 17-3-2012.
[The author is a Principal Associate, Lakshmikumaran & Sridharan, New Delhi]
Hire purchase transactions are essential for industry and business houses in acquiring equipments necessary for stimulating growth. However, meticulous planning is required to arrange financing of the assets for making timely payments. Hire purchase is a financial facility which allows a business to use an asset over a fixed period, in return for regular payments. When all the installments have been paid, the buyer becomes the owner of the equipment. This ownership can transfer either automatically or on exercise of an option to purchase. In other words, hire purchase not only appertains to agreements wherein the buyer has an option to buy the goods, but also to those agreements where the property in the goods is to pass at the end of the term.
As regards applicability of sales tax on such transactions, it has always been clear that the first sale, namely the sale by the vendor to the financier is a sale taxable under the relevant sales tax enactment. However, the transaction between the financier and the buyer has been the subject matter of dispute and judicial scrutiny (see end note 1), as it did not fulfill an essential requirement of a typical sale transaction i.e. transfer of property or title of goods upfront. The buyer‘s argument is that the sale fructifies only at the end of the term of the agreement when the option to purchase is exercised whereafter the transfer of property takes place; and that only the last installment / option fee paid to the financier should be subjected to tax. This argument did not find favour with the court (see end note 2) but there was no codified alternative available at the relevant time. The court noted that a hire purchase is a mere bailment until it fructifies into a sale, and is not analogous to sale. This difference between a sale and a hire purchase assumed importance because the states were not empowered by the Constitution to tax a hire purchase which did not result in a sale. If a hire purchase resulted in a sale then sales tax was payable, but identifying the ‘sale price’ which would attract the levy was a herculean task, especially in the absence of any codification in that regard. There was lack of clarity not only with respect to the taxability of such transactions but also the amount which would suffer tax and the time at which the levy became applicable.
These problems were referred to the Law Commission, which recommended certain amendments in the Constitution (see end note 3) and a new clause (29A) was inserted in Article 366 of the Constitution (see end note 4), which provided that ‘tax on sale or purchase of goods’ would include the delivery of goods on hire-purchase or any system of payment by instalments. In effect, the delivery of goods on hire purchase was itself deemed to be a ‘sale’ regardless of whether the ownership passed on at a later date or did not pass on certain cases. Hence, the confusion caused due to diverse opinions about the levy of sales tax on hire purchase transactions, got seemingly cleared.
In line with the constitutional amendment, hire purchase got included in the definition of ‘sale’ in all the state VAT legislations. However, as far as uniformity in the manner of taxing these transactions is concerned, it leaves much to be desired. The practices across States in respect of calculating the taxable turnover of such transactions are not uniform. While some state VAT legislations are totally silent about the method to be followed to calculate the taxable turnover in respect of a hire purchase transaction, other States have evolved highly structured practices allowing appropriate deductions while determining taxable turnover. For instance, interest charged separately and finance charges in respect of hire purchase are specifically excluded from the turnover of a dealer under the Tamil Nadu VAT Act (see end note 5). On the other hand, under the Delhi VAT Act, ‘sale price’ in relation to the delivery of goods on hire purchase is the consideration payable to a person for such delivery including hire charges, interest and other charges incidental to such transactions, and such amounts are taxable upfront (see end note 6).
Another major issue of concern is the applicability of service tax as well as sales tax/ VAT on hire purchase transactions. Service tax is levied on hire purchase transactions under ‘banking and other financial services’ (see end note 7). The Supreme Court has, in fact, upheld the constitutional validity of the levy of service tax on financial leasing services including equipment leasing and hire purchase (see end note 8). As far as the taxable value is concerned, the Supreme Court held that the sum received as principal amount is not the consideration for services rendered; and that the lease management fee/ processing fee/documentation charges and interest charges which constituted the consideration for the services rendered are accordingly taxable. Further, the government has granted exemption upto 90% of the amount representing interest (see end note 9).
Thus, as on date service tax is applicable on the processing fee, documentation charges and on ten percent of the interest charges recovered in equated monthly instalments. A perusal of the Finance Act, 2012 reveals that the transactions specified as deemed sales under the Constitution have been excluded from the definition of service. Yet the ‘activities in relation to delivery of goods on hire purchase’ have been specifically declared as a service taxable under the Act (see end note 10). Thus, the position is not likely to change in the near future.
In the absence of any specific exclusion for such charges under the VAT legislations such as Delhi VAT, these charges, namely processing fee/documentation charges and ten percent of the interest charges will attract the levies of service tax as well as VAT. In other words, there is double taxation on these amounts.
Standardisation of practices and uniformity is the need of the hour. Heterogeneous regulatory practices being followed in the realm of hire purchase transactions is inimical to the cause of a well-oiled industrial and business sector. A uniform, lucid and coherent legal regime governing such transactions is imperative to curtail time spent in squabbling over the application of the laws and allow industries and service providers to concentrate on their job.
End notes:
1 Instalment Supply (P) Ltd. v. Union of India [1961] 12 STC 489 (SC); K.L. Johar v. Deputy Commercial Tax Officer [1965] 2 SCR 112
2. K.L. Johar v. Deputy Commercial Tax Officer [1965] 2 SCR112
3. Certain problems connected with power of the States to levy a tax on the Sale of Goods and with the Central Sales Tax Act, 1956, 61st Report, Law Commission of India, 1974.
4. 46th Constitution (Amendment) Act, 1982.
5. Rule 8(1)(c), Tamil Nadu VAT Rules, 2007.
6. Section 2(1)(zd) of the Delhi Value Added Tax Act, 2004 and Rule 4 of the Delhi Value Added Tax Rules, 2005.
7. Section 65(12), Finance Act, 1994.
8. Association of Leasing and Financial Companies v. Union of India and Others, [2010] 29 STT 316
9. Notification No. 4/2006-S.T., dated 1-3-2006.
10. Section 66E of the Finance Act, 2012 read with Notification No. 13/2012-ST dated 17-3-2012.
[The author is a Principal Associate, Lakshmikumaran & Sridharan, New Delhi]