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SALES TAX ON LEASE AND HP TRANSACTIONS IN INDIA By Vinod Kothari Sales-tax on lease and hire-purchase transactions remains the most gray and the most painful part of leasing business in India. The following is an attempt to ansNBFCsr basic questions on sales-tax as it relates to lease and hire-purchase transactions. The questions are structured - so for best results, read them sequentially. General questions 1. When is Sales Tax leviable ? Ans Sales Tax is leviable when goods are sold. Thus there must be "Goods” and there must be a sale . " Goods " includes all types of movable property, which is merchantable and sold and purchased in normal course of commerce. " Sale " means a transfer of property in goods from one person to another for a consideration. But Sales Tax is leviable only on a person who is a dealer. A casual transaction by a non-dealer is not subject to Sales Tax. Thus, if an individual salary earner sells off his personal car , there is no Sales Tax attracted. To summarise , Sales Tax is leviable on sale of goods by a dealer. From the viewpoint of sales-tax, the meaning of the word “sale” has been expanded by including several transactions which are not sales in normal parlance. A “transfer of right to use goods” is included in this expanded definition. A delivery of goods on hire purchase is also included. 2. Is Finance Lease a " Sale " for the purposes of Sales Tax ? Ans In a Finance Lease , NBFCs are the owner of the Goods and the lessee only has the right to use the goods on payment of lease rentals. It is a contract of hiring or bailment . Hence there is no " sale " as defined. However , there is a transfer of the right to use the goods from the lessor to the lessee . And this has become taxable as a deemed sale. 3. Is operating Lease a " Sale " for the purposes of Sales Tax ? Ans. Since in an operating lease also, there is transfer of right to use goods, there is a sale. 4. Is there a sales-tax on a rental contract? Ans. If it is a rental of movable property, in which possession, control and right to use goods is transferred to the user, there is no difference between a lease and a rental. 5. Is Hire Purchase a Sale for the purposes of Sales Tax ? Ans. Yes , Hire Purchase is a deemed sale of the goods at the time it is delivered to the Hirer by the hire-vendor under the Hire Purchase agreement . This creates an anomalous position for Hire Purchase, as in case of a lease, a dichotomy between general law and Sales-tax treatment. Under Sales Tax law the goods are treated as sold . But under the Sale of Goods Act , the goods are not yet sold to the Hirer since the property in the goods is still with the NBFC. The goods are sold legally only when after fulfilling all his obligations under the hire purchase agreement the hirer exercises his option to purchase the goods. At that time the sale invoice , if any is raised, will be disregarded in Sales Tax, since it is in pursuance of an embedded option in the contract, and is not independent sale by itself. 6. What is the difference between HP and Lease in Sales Tax ? Ans. From the point of the flow of the commercial transaction, there is no difference. The supplier sells the goods to the lessor/hire vendor, who in turn leases/hires out the goods Thus, there are two legs of the commercial transaction – sale by supplier to the lessor, and thereafter a lease/hire purchase. Both are “sales” in sales-tax parlance. Commercially speaking, the two transactions are not different. There are two contracts in either case, usually bundled in a single delivery from the supplier to the end-user. Therefore, in a Lease , there will be a Sales Tax on the Sale and a Lease Tax ( if any ) on the transfer of the right to use. In a Hire Purchase there will be 2 Sales Taxes applicable on 2 separate sales. However, sales-tax laws (for historical reasons only) treat lease and hire-purchase substantially differently. Since the choice of the instrument, viz., lease or hire-purchase, may lead to material sales-tax difference, it is important that the sales-tax implications are analysed before choosing the instrument or concluding the transaction. Understanding jurisdiction and applicable law 7. Under which law, in which state will a lease/HP be taxable? Ans. The classification of taxing powers on sales in general in India is based on a constitutional principle, apparently looking simple, but in practice quite contentious. An inter-state sale is taxable under the CST Act. An intra-state sale is taxable only by the local government. An import/export sale is not chargeable to sales-tax. Inter-state sales are those based on which delivery of goods across a state is caused, or a sale that happens during such movement by endorsement of commercial documents. Intra-state sale is one that does not cause or happen during such movement. Based on Supreme Court ruling in 20th Century Finance, a lease will be inter- state if the purchase of the goods was also inter-state, and the lessor did not receive or cause physical delivery of goods. The same argument should apply in case of hire purchase also. On inter-state sales, sales-tax is imposed by the CST, and collected by the State from where the movement of goods commences. On local sales, the tax is charged by the local government. 8. What are the exemption/ concessional tax rules? Ans. If the lease/HP is inter-state: a. based on certain conditions, an exemption for the second sale (lease or HP) may be claimed under sec. 6 (2) (b) of the CST Act (see below); b. the lessor may issue a concessional declaration form (C Form), based on which the rate of tax on the initial purchase from the supplier may be reduced to 4% c. the lessee may issue a concessional declaration form (C Form), based on which the rate of tax on the lease/hire purchase supplier may be reduced to 4% If the lease/HP is intra-state: a. some states have a specific charging section/ charging law for lease transactions and impose tax on the lease even if the goods have been bought from the same state. b. Some other states treat a lease as the sale of a commodity, and impose a commodity tax on the lease. In this case, generally, if the state has a single point tax system, the lease of locally-bought goods will not be chargeable to further tax. c. The lessee being a manufacturer may be allowed certain concessional benefits. d. Hire purchase is typically not distinguished from a normal sale and the same tax rates/exemptions as apply to a normal sale apply to hire purchase too. 9. What is Section 6(2)(b) procedure ? Ans. The following is the procedure : a. Supplier bills the lessor and issues E1 Form . b. Lessor issues its C form to the supplier (this is not a pre-condition – if this is not done, the normal rate of tax will be charged by supplier) c. Lessor endorses the LR/ consignment note to lessee/hirer during transit. d. Lessee/hirer gives Lessor a C Form . The procedure in Section 6 (2)(b) is cumbersome and should be followed properly . Otherwise lessor will land up having to pay double tax. 10. Does it make sense to localize a lease/HP transaction? How can this be done? Since a lease/HP will be always a second sale (goods having been bought from the supplier first), the general tax rule is that localizing the second sale at the same place as the first one, is always better. Hence, localizing the lease/HP will be useful except in cases where the state in question has a second tax on the lease/HP. The localization may be achieved as under (all are cumulative conditions): a. Hirer must take delivery in Supplier/Dealer state. b. Supplier must charge local Sales Tax. c. Transportation documents , if any , should show hirers name. d. Transportation cost to be borne by Hirer. e. Temporary Registration should be in the name of the hirer in the Supplier state. f. Transit insurance should be in hirers name. g. Hire Purchase agreement should be on the same day or before the date of delivery . h. Hirer to take sanction from us for moving the vehicle. i. If any permission is required for moving the goods into the state of use, such as a permit or way bill, the same should be obtained by the hirer. j. After delivery of the goods to the hirer in the supplier state, no subsequent expenditure should be borne or financed by the lessor. For example, if the chassis is delivered in one state, and thereafter moved to another where the body is built, if lessor finances the body also, Lessor cannot legitimately take the stand that lessor had delivered the chassis in the supplier state to the hirer. k. Since the onus of proving a local delivery in the supplier state will be on the lessor, lessor must have all the above evidence on our record. Value-added tax 11. What is VAT ? Ans. VAT is a tax on value added, that is, on the difference between the cost of “inputs” and the value “outputs”. In terms of actual imposition, sales-tax is computed on the value of the output first. Then, the sales-tax actually paid, in the State, on the inputs will be deducted (set-off) from the tax calculated on outputs. The net tax is paid to the government. 12. Is VAT multipoint? Ans. Quite obviously, VAT is imposed at every stage where there is a value added. Therefore, VAT is multi-point. 13. Will VAT be imposed on local transactions only or inter-state sales also? Ans. As per current understanding, VAT will not replace inter-state sales – it will replace intra-state sales only. Therefore, inter-state transactions will continue to be subject to central sales-tax law. 14. Is there a set-off for input taxes paid in other states/ CST? Ans. Currently no. 15. What is “output”? Ans. Whatever are the sales taxable currently. 16. What are “inputs”? Ans. Raw materials, packing materials, capital goods, etc. qualify as inputs. 17. What is the applicability of VAT to lease/HP transactions? Ans. Like for all sales, for all local lease/HP transactions, VAT will be applicable. Since lease/HP are sales, the goods bought for the purpose of lease/HP are clearly “inputs”. They are inputs not as capital goods, but as goods bought for the purpose of resale. The input tax paid on purchase will be allowed to be set off against the tax payable on rentals/receivables. As is easy to understand, the tax payable on the receivables is computed only on the receivables maturing during the year, while the tax paid on input is paid on the purchase price. Therefore, it would be possible to defer the actual tax outflow depending on the growth rate of the leasing portfolio. Besides, if the lessee is using the leased goods as capital goods, he may claim a set off of the tax charged by the lessor (which may not be actually paid for the deferral impact discussed above) on the lease receivables. The net impact of the VAT on lease/HP, after considering the deferral impact discussed above, is to pay the VAT only on the excess of the lease receivables over the cost of the asset. Service tax versus sales-tax 18. Can there be a sales-tax and a service tax on a lease/HP transaction? Ans. While it looks illogical, and is arguably unconstitutional also, the reality is that today, there is a service tax on financial lease and hire purchase transactions.