The Hindu Business Line : Leash on lease rent

Following the Amendment Act, all lessees will have to deduct 20 per cent tax on the entire rental, which will obviously stifle the cash flows of leasing companies.

The Taxation Laws (Amendment) Bill, 2005, which was introduced in the Lok Sabha on May 12, 2005, has been passed into law. The Bill was introduced with the object of "rationalising and simplifying certain procedures, widening of tax base and plugging loopholes leading to leakage of revenue". Pursuant to several representations, the Bill was referred to the Standing Committee on Finance and the report of the Standing Committee was presented to both Houses of Parliament on December 13, 2005.

This Bill, as passed by both Houses of Parliament, was enacted into law effective July 14, 2006. There are some significant changes in this legislation which have far-reaching implications. One of the changes deals with widening the scope of TDS (tax deduction at source) on rent.

The genesis

In the overall exercise of expanding the scope of TDS in collecting taxes upfront, rent was brought into the TDS net by the Finance Act, 1994. The provision requires TDS at 15 per cent or 20 per cent on rent paid in excess of Rs 1,20,000 per annum to a resident assessee.

The existing scope of rent contained in Section 194-I of the Income-Tax Act, 1961 covers, inter alia, lease, sublease, tenancy or any other agreement for the use of land, building, and so on. Basically the scope and coverage of the present provision restricts the TDS to rent paid for immovable property.

This Amendment Act has expanded the scope to include payments for the use of plant, machinery and equipment.

Further, tax withholding will apply whether or not land, building, machinery, plant, equipment, furniture or fixture are rented separately or together. Effectively all types of rental arrangements, both immovable and movable, are now covered by TDS.

Financial leases

Leasing in India has a long and chequered history with major upheavals in the 1990s. Today, financial and operating leases are being transacted in the marketplace essentially for office equipment, vehicles and consumer durables. With competition being acute and the rates of interest falling in the past few years, leasing transactions generate a post-tax return of 1-1.5 per cent.

Following the Amendment Act, all lessees will have to deduct 20 per cent tax on the entire rental, which will obviously stifle the cash flows of the leasing companies. TDS is not on the interest portion but on the entire rental, which includes the principal component. The amendment raises a host of issues. Will TDS apply only for concluded agreements where rentals flow after July 14 or even for fresh agreements put through after this date? Every lease agreement is a standalone contract with the party concerned and does provide for variation clauses covering regulatory changes. But abrupt changes such as this can upset the calculations and wipe out the profits on a transaction.

One may argue that TDS can after all be adjusted during the payment of advance tax and credit utilised while filing the return of income. These are at best small mercies and cannot compensate for the curtailed cash flows which is the result of the 20 per cent TDS. One option is for the leasing company to opt for a lower deduction rate by applying to the assessing officer under Section 197 of the Act. This may be an alternative but not a solution.

TDS on hire purchase

Interestingly the law relating to TDS on hire purchase can be traced back to 1943 when the CBDT opined that the hire-purchase instalment has no element of "interest' and, hence, there is no requirement to deduct tax at source on the monthly instalments in accordance with Section 194A of the Act. This was reiterated in 1981 through CBDT's Instruction 1425 (FNo275/90/80-IT(B)) dated November 16, 1981.

In accordance with Accounting Standard 19, all financial leases are treated on a par with hire purchase for accounting purposes. Since 2001, leasing companies, with regard to financial lease, recognise only the interest portion as income in the profit and loss account. That being the case, the exemption from TDS applicable to hire purchase should be extended to leasing too, especially because both these transactions have been aligned for accounting purposes.

It is nobody's case that TDS should not apply to transactions where there is an element of income. But the issue becomes controversial if it makes inroads into the capital/principal portion of the payment. In the context of payment to contractors, this issue went up to the Supreme Court. At a time when leasing is re-emerging from a lull, caused essentially because of sales tax/VAT levy and service tax, any additional burden like TDS will put the clock back. If the economy is to grow at 10 per cent, leasing has to be encouraged and not stifled by such levies.

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