The Hindu Business Line : No special dispensation

FINANCIAL leases are virtually extinct, thanks to acute competition from loan products offered by banks and other agencies. Project financing, which was the forte of banks in the years gone by, has given way to large-scale retail funding through loan arrangements. Leasing in the context of VAT has its own set of problems. The inherent complex nature of a leasing transaction was resulting in litigation in various States. The Supreme Court had, in the 20th Century Finance Corporation (2000 119 STC 182) case, to decide, among other things, the manner in which leasing transaction was to be taxed.

Haryana was the first State to introduce VAT effective April 1, 2003, and is quoted as a role model for other States to follow. Political and revenue sharing implications apart, Haryana has become a trendsetter as far as VAT is concerned. The first major clarificatory order dated May 2, 2005, issued by the Haryana Government on the subject of leasing merits attention and discussion.

This order was passed under Section 56(3) of the Haryana VAT Act, 2003 [HVAT] pursuant to an application filed by GE Capital Transportation Financial Services Ltd, Gurgaon.

Facts, issues

In 2001, the applicant, GE Capital Transportation Financial Services Ltd, a major financial services company registered under the HVAT Act, 2003 at Gurgaon, executed a leasing agreement with Sunil Autocomp Pvt Ltd, Gurgaon, wherein the machinery was transferred by way of right to use goods to the lessee, purchased from Maruti Udyog Ltd. The tenure of the agreement was from 2001 to 2007 and VAT in Haryana came into operation from April 1, 2003. GE took the stand that transfer of right to use has taken place prior to 2003 and was covered by the old Haryana General Sales Tax Act.

Accordingly, rentals forthcoming after April 1, 2003, are not liable to VAT in Haryana. GE did not include the rentals received in the monthly returns filed under the HVAT Act, 2003, from April 1, 2003, onwards. Section 2(iv) of the HVAT Act defines sale to mean "any transfer of property in goods for cash or deferred payment or other valuable consideration except a mortgage or hypothecation of or a charge or pledge on goods... "The short issue here for consideration is whether the taxable event relating to transfer of right to use goods is a onetime event that took place in 2001 or a continuous event starting in 2001 and terminating in 2007. The Supreme Court had observed that the taxable event is the transfer of right to use goods and takes place at the point of executing the agreement.

In Haryana, input tax credit is available for capital goods, as defined under Section 2(i)(g), purchased after April 1, 2003, provided the goods have been capitalised, and not as an expenditure. And the goods are not to be used for the manufacture of exempted goods or in telecommunication or power projects. No specific provisions have been prescribed for getting credit for capital goods in instalments.

Haryana`s clarificatory order

The Commissioner of Haryana passed a clarificatory order stating that i) the taxable event occurred in 2001 and is completed at that point of time itself; and ii) the consideration of the lease is the entire rentals payable for the period of the lease in 2001 itself.

The reasoning of the clarificatory order goes thus: "The lease agreement in the present case is for a fixed period. There is no provision in the agreement providing lessee a right to terminate the lease before the expiry of the lease period. This would show that the consideration for the lease is the aggregate of lease rental payable for the entire fixed period of lease. This entire consideration is the price payable for the transfer of right to use the machinery. It is fixed under the agreement. Though the rentals are payable every month, the price of transfer of right to use the machinery remains the same much in the same way as the price in case of a outright sale of the machinery would remain the same even though the price may be payable by instalments.

"So the sale price of the transfer of the right to use the machinery is the aggregate of lease rentals receivable for the entire fixed period of lease. It is pertinent to observe that the transfer of right to use the machinery has been transferred once i.e., on July 14, 2001, and not from year to year. It is, therefore, one single transaction of lease and not a lease renewable from month to month or year to year. It would therefore be taxable only once and not on year-to-year basis for the period of lease. There is no special dispensation under the HGST Act permitting taxation of lease on year-to-year basis on the basis of instalment received or similar dispensation exists under the HVAT Act.

"In the given facts and circumstances and the observations made above, the taxable event occurred on July 14, 2001 (date of execution of agreement to transfer the right to use). Further, the aggregate of the amount of lease payable under the agreement is the sale price regardless of when the rentals are received. Therefore, in the instant case, the aggregate of rentals received or receivable under the agreement dated July 14, 2001, is assessable in the year 2001-2002 and specifically form part of the gross turnover for the second quarter of the assessment year 2001-02."

This order, in the VAT context, reopens the debate on the taxable event in a leasing transaction. VAT also envisages input tax credit where clarity is needed in several States. While instalments in a leasing transaction arise on a monthly/ quarterly basis, it would be presumptuous to tax the entire consideration upfront at the point of executing the agreement. The inherent risks in the business of collecting dues and sometimes not collecting them at all could land the company in serious problems if the VAT is paid upfront and instalments are not forthcoming later.

Further, there would then be no need to have a separate definition for leasing as distinct from hire purchase. The most appropriate way to deal with the issue is that lease rentals should be liable to VAT on the basis of as and when received, with input set-off as provided in the respective rules.

(The author is a Chennai-based chartered accountant.)

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