The Hindu Business Line : Element of discrimination

The financial services industry was brought within the ambit of service tax effective July 16, 2001. Since then the industry has been clamouring for saving hire purchase and leasing transactions from the clutches of this levy. The demand has become vociferous more because these transactions are anyway subject to sales tax/VAT in various States.

Multiple levies on such transactions are not only unjust but also increases the cost of transaction vis-à-vis transactions such as loan products offered by the banking industry. Budget 2006 provides necessary relief in the matter of service tax, albeit, not in full measure.

Notification

Vide Notification No. 4/06 of March 1, 2006, the Government has provided an abatement on the interest charges embedded in hire purchase and leasing transaction. The notification reads thus: "... the Central Government, ... hereby exempts the taxable service specified in sub-clause (zm) of clause (105) of Section 65 of the Finance Act, that is to say the financial leasing services, including equipment leasing and hire-purchase as defined in item (i) of sub-clause (a) of clause (12) of Section 65 of the Finance Act, provided or to be provided to any person, from so much of the service tax leviable thereon under Section 66 of the said Finance Act, as is equivalent to the service tax calculated on 90 per cent of an amount, forming or representing as interest, i.e., the difference between the instalment paid towards repayment of the lease amount and principle amount contained in such instalment paid."

This notification came into effect from March 1, 2006, and would therefore apply in respect of interest charges earned after this date even if the contractual agreement was put through prior to the aforesaid date. When the industry was first exposed to service tax effective July 16, 2001, this point came up for consideration. The department clarified the position in favour of the industry stating that agreements entered into before July 16, 2001, will not be exposed to service tax.

A typical case of how the service tax would operate in a new-vehicle hire-purchase transaction is illustrated in the Table.

It is to be noted that in respect of document charges, lease management fee, processing fee, etc., service tax would apply in toto at 12.24 per cent. As for interest charges embedded in hire purchase and leasing, 90 per cent abatement can be claimed and the balance 10 per cent would be liable for service tax at 12.24 per cent. The position of loan transaction remains as it is and no element of interest in a loan transaction is exigible to service tax.

Welcome, but..

Though the NBFC industry has welcomed this exemption, there is still an element of discrimination between a loan product offered by the banking system and hire purchase/leasing product offered by NBFCs. While the gap in the rate has narrowed to 10 per cent, this needs to be eliminated, so that all the products in the marketplace are able to compete at arm's length.

With Tamil Nadu having just indicated that post-elections VAT would come into operation, its implications on hire purchase and leasing would have to be taken into account before offering loan or hire purchase product to customers. Service tax alone cannot decide the issue, but the package of levies such as service tax and VAT would have to be considered to decide the issue.

In States such as Andhra Pradesh and Karnataka where VAT is operational, interest/finance charges on hire purchase is abated to determine the sale price. Clearly, in these States, hire purchase as a product appears superior to loans. Therefore, the call has to be taken State-wise, taking all aspects into consideration.

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