NEWS AND DEVELOPMENTS ON INDIAN LEASING
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Supreme Court rejects substance-of-finance-lease contention: Holds lessor to be owner of equipment
This could well be a landmark ruling for establishing both the legal rights of a lessor over leased equipment as also for an extremely troublesome series of tax litigation on substance of finance leases. The Supreme Court in the case of Prakash Industries Limited v. Development Credit Bank (ruling dated 11th May, 1999) rejected a special leave petition where lessee contended that the lease between the lessee and the lessor was essentially a financial arrangement and therefore, the lessee had become a de-facto owner of the equipment.
The lessee Prakash Industries had taken several equipments on lease from the lessor Development Credit Bank. Upon failure of rentals, lessor sought repossession of leased assets. Lessee in defence cited several clauses of the lease agreement such as selection of the equipment having been made by lessee, equipment being tailored to lessee's requirement, rentals being unrelated to the wear and tear in equipment, renewal of the lease at a very nominal rental after expiry of the primary lease period, etc. These clauses, it may be noted, are typical of a finance lease where the known intention of the parties is to allow the lessee to use the asset for almost the whole of its economic life. Based on these clauses, the lessee contended that the substance of the agreement was a financial arrangement to which the ruling of the Supreme Court in Sundaram Finance Limited v. State of Kerala was applicable. In this ruling, based on facts, a hire-purchase agreement was regarded as a financial transaction.
The Bombay High Court had first rejected the lessee's contention, holding that the essential distinction between a lease and a financial transaction was a retention of title by the lessor. The lessee went for appeal before a larger bench of the Bombay High Court where also the contentions were rejected. Finally, the lessee appealed before the Supreme Court where the special leave petition was summarily rejected.
Rejection of special leave petition by the Supreme Court has the force of an affirmation of the lower courts' ruling by the apex Court.
Questions as to the substance of financial leases are troubling the leasing industry. The industry, already bleeding heavily in a difficult year, is facing most basic questions by tax authorities who have sought to disallow depreciation on the basis of the substance of a financial lease. Though no guidelines distinguishing financial and operating leases have been laid down in India, several leasing companies are facing rejected depreciation claims running in hundreds of crores on virtually the same grounds as those raised by Prakash Industries in the litigation noted above.
Apparently, the Supreme Court ruling should set the matter at rest and give the leasing industry a very badly needed sigh of relief.
RBI asks banks to follow lease accounting and provisioning rules
Though lease accounting rules [Guidance Note of the Institute of Chartered Accountants] have always been clear on this, banks have had a doubt in the past as to whether the accounting standards for lease accounting were applicable on their leasing operations. As such, banks were following their own varied practices on leasing depreciation etc.
According to a report in the Financial Express, the RBI has recently issued instructions to all banks to follow the Guidance Note on Lease Accounting, effective since 1996. This apart, the RBI has also required banks to create provisions, in case of non-performing leased assets, to the extent of 10% of the depreciated book value of leased assets. In such case, the net lease rentals remaining unrealised, that is, the excess of lease rentals over the capital recovery component, should also be reversed.
When the asset becomes a doubtful asset, the amount of provisioning required will be stepped up on a scalar basis. These norms are different from the norms applicable to finance companies, which are required to apply higher provisioning percentages for doubtful assets.
Leasing by banks remains a small fraction of the leasing market in India. It is a much smaller fraction of the banking advances in India. For example, out of a gross banking income of Rs. 220 billion, State Bank of India reports leasing income of only Rs. 186 million, less than 1% of the country's largest bank's income.
Maharashtra enacts Depositor Protection Ordinance: law drafted wide enough to cover all monetary transactions
When it comes to the State governments enacting laws, regulation is the rule, and exemption is the exception. Invariably, the laws are cast wider than the draftman ever thought or was empowered to write. So, here is the Maharashtra Government's new law that seemingly overlaps with existing machinery under the RBI Act, Companies Act and the Company Law Board quasi-judicial powers, and no matter whether such a law is covered by the State Government's law making powers, the law has been rushed under a gubernatorial ordinance.
Constitutional powers?
The law-making powers of State governments are limited by Constitution Seventh Schedule List II. State governments are not permitted to legislate in any other matter, not covered by the list. If the purpose of the law is the protection of depositors' interest, such a law-making power does not feature in the List II of Seventh Schedule. The only entries there that may by some stretch of argument cover such a law could be:
Entry 26: Trade and Commerce within the State
Entry 30: Moneylending and moneylenders.
Entry 26 is too general, and it cannot be said that the purpose of the present law is relating to trade and commerce in the State. In all likelihood, the State government would have acted on the basis that the present law is related to moneylending and moneylenders: in fact, as the provisions of the law reveal, it is more relating to regulation of borrowers, than regulation of lenders. Therefore, the Constitutional authority of the State government in issuing the present ordinance is greatly doubted.
Wide scope; unlimited applicability:
Apparently, the Ordinance relates to acceptance of deposits by "financial enterprises", but there is nothing "financial" about the way the phrase is defined, except the prefix. One is really concerned about the way these laws are drafted, and the office of the Governor is used to have them passed, for it is really doubtful if the person who drafted it read it himself; or any one else thought it is necessary to read it. A financial enterprise is defined "any person accepting any deposit under any scheme or arrangement or in any other manner". Thus, who ever has taken a deposit, either under any scheme or arrangement, or otherwise, would be a financial establishment. The nature of business of the enterprise is wholly irrelevant: that is, irrespective of what business the establishment is engaged in, if it borrows, it is a financial establishment. Note that the word "deposit" includes not only monetary loans or deposits but also "acceptance of any valuable commodity". So, all financial transactions, and all commodity transactions, other than those of sale or purchase of goods, are covered by the wide-sweeping word "deposit".
So, every one who has either borrowed, or is using some one else's "valuable commodity", is a financial establishment. So, if you have borrowed from any one, you are a financial establishment. If you have not borrowed, but you have leased in a car, you are a financial establishment. If you are using a rented space, you have, literally speaking, received a "valuable commodity" and hence you are a financial establishment. You would find it difficult to name an individual or entity who is not a financial establishment.
Further, there is nothing in the law that indicates that the financial establishment has to be domiciled in Maharashtra to attract the law. So, in a very optimistic application, all the citizens and all the business entities of India, no matter what they do and what they produce, unless they are completely self-sustained islands in the ocean of our system, are all covered by the new law!
The draftsman's vision was truly without any barriers!
And wider meaning of deposits:
Same broad thinking and universal vision extends to the meaning of deposits. Since this term includes both financial deposits as well as deposits of "valuable commodities", the sweep of the law is just extraordinary. These are a few transactions that you would not ever think such a law would regulate, but in fact it does:
If there is a fraud:
Having looked at the widest possible applicable of a law ever imaginable, let us now come to what remedies that law addresses to. The law applies if there is a "fraudulent default" by any "financial establishment" in repaying a "deposit". While we have seen the wide meanings of "financial establishment" and "deposit", we must only thank, for reasons which would be obvious by now, the draftsman who did not venture to define "fraud", or else every practice other than those listed in the law would have been fraudulent practices !
If there is a fraudulent default in "repayment of deposit on maturity" (which strictly speaking does not cover payment of interest before maturity!), or failure to render the promised service, the promoter, director, partner, manager or an employee responsible for management shall be liable, on conviction, to up to 6 months in jail, and fine.
In order to repay the deposits, not only can the State govt. attach the properties of the financial establishment, it can also attach the properties of the promoter, director, partner, manager or member of such establishment. The use of the word "member" may warn any one understanding corporate laws: no more do companies have a limited liability: since the shareholders' liability is now being rendered unlimited by the present law. There could not have been a more crude attempt in writing a law: it virtually tantamounts to saying that the State government in its discretion can do what it prefers to do: why do we need a law if it was enough to state it in so few words !
Designated courts:
The State government also intends constituting special courts to try offences under this law.
RBI asks no-depository companies also to file returns
The country's central bank that made history of sorts by asking 37000 odd companies to register as financial companies, though they had nothing to do with finance in the real sense, has now asked all of them to file returns of deposits, and to file NIL returns, if they have no such deposits. The Press Release dated 22nd January issued by the RBI runs as follows: "It (the RBI) has found that many companies, more particularly the companies having NoF of less than Rs.25 lakh, have not submitted this return to the Reserve bank despite holding public deposits although the return is statutory. The Reserve bank has taken a serious view of the non-compliance of the law by these NBFCs. ..Further, although the Reserve Bank had earlier clarified that the companies not holding public deposits need not file this return, in view of the large scale non-compliance of law, it has considered necessary to ask these companies also to file a 'Nil' return in order to comply with the provisions of law."
Though it has given an eloquent explanation for reversal of its earlier stand, the above Press Release of the RBI is a virtual about-turn as against its policy that companies not holding or accepting public deposits, though statutorily regarded as financial companies, will not be supervised or required to file regular returns. Obviously filing of returns is only a prerequisite of supervision. At one point, a Task Force appointed by the RBI even recommended that the law be amended to exclude companies not accepting public deposits from the purview of "financial companies".
Companies Ordinance 1999 gives substantial relief in inter-corporate loan and investment restrictions
One would have thought the repromulgated Companies Ordinance is the replica of the one that expired due to the inability of the Government to have requisite majority to have it approved in the Parliament. But the Ordinance goes all out to rectify the lacunae in the previous version and thus not only continues the pace of corporate reforms, but virtually frees intercorporate loans and investments from the holds of the law. In doing so, a relaxation to NBFCs, which was earlier curtailed by the previous Ordinance, has been restored.
Click here for full details of the amendments in sec. 372A of the Companies Act.
Another technical limitation imposed on sec. 138 prosecutions
Section 138 of the Negotiable Instruments Act was intended to enhance the acceptability of cheques as the commercial World's alternative to legal tender. A negotiable instrument is supposed to carry general acceptability as near-money. That is why sec. 138 made the bouncing of a cheque a criminal offence.
However, the operation of sec. 138 prosecutions has really rendered the section nugatory. Reports indicate that a sec. 138 complaint filed in Mumbai today will come for hearing in year 2002. At the same time, there are rulings and rulings on the conditions under which a 138 prosecution will fail, which sounds strange, because the very intent of sec. 138 was that the drawer of a bounced cheque should either pay up on demand or face the consequences. Admittedly, Courts should have helped to advance the cause of the section, not scuttle it by building around technicalities.
But then, none other than the Supreme Court, in a recent ruling [Sadanandan Bhadran v. Madhavan Sunil Kumar 1998 II AD (Cr.) SC 669, dated 28th August, 1998] held that once the notice demanding payment on a bounced cheque has been issued, even if the cheque be represented, the limitation period within which the prosecution has to be filed will run from the date of the first dishonour and not subsequent dishonour. This has overruled the decision of the Kerala High Court on the same point.
The Supreme Court in this case held that on a cheque being dishonoured, the holder of the cheque may "go on presenting the cheque so as to enable him to exercise such right (right of filing prosecution) at any point of time during the validity of the cheque. But, once he gives a notice under clause (b) section 138 he forfeits such right .."
Put simply, this means the holder may still represent the cheque and file prosecution based on a bouncing subsequent to the first, but only on the condition that holder must not have served notice under sec. 138 (b). The biggest difficulty that would arise in actual implementation of the apex court's order is whether any demand for payment is a notice under sec. 138 (b). Obviously, a notice under sec. 138 (b) does not have to say that it is being served under that section; at the same time, any holder of a cheque will like to make a written demand for payment at the very first dishonour. If any written demand for payment be construed as a notice under sec. 138 (b), it amounts to frustrating right of prosecution for subsequent presentations.
The entire focus of suits under sec. 138, it appears, will now shift to technicalities instead of substance. That a cheque given for payment of a liability has bounced was good enough as an offence, but no more so under sec. 138 as battered by over 5000 rulings over last 10 years.
Lender may repossess hypothecated car
There is a widely prevailing notion that the lender under a hypothecation contract does not have a right of repossession except under a Court order. We have elsewhere reported the ruling of the AP High Court in State Bank of India v. Shah Ali holding that the lender had a right of repossession without Court intervention if the hypothecation agreement contained such a right.
In conformity, the Punjab and Haryana High Court has held, in Citi Bank, NA v. State of Haryana and another 94 Comp. Cas. 449 that the lender has a right of repossessing the hypothecated goods. The Ld. Single Judge held that "the bank could take repossession of the vehicle hypothecated with them either if there was likelihood of due money not being paid, or the vehicle was likely to be transferred to defeat the security and the due amounts of the bank" This also was based on construction of the agreement of the lending bank.
This goes on to suggest that if a clause in a hypothecation agreement confers a right of repossession, such clause is to be given effect. The decision of the Court should give lot of comfort to vehicle financiers, who may like to opt for loans instead of leases and hire-purchase, to avoid vexatious tax consequences.
Adjustment of deposit required in monthly instalments, where loan payable in monthly instalments
Where the loan given by a bank to a customer carried a higher rate of interest, and the deposit placed by the customer with the bank carried 13% interest, the bank could not put the customer to disadvantage by adjusting the deposit against the outstanding loan instalments at its discretion. If the bank decides to do so, it must adjust the deposit also as and when the instalments fell due, since doing it on a later date would imply that the customer would keep paying the higher rate of interest on the loan, while the deposit will keep giving the customer a lesser interest. Smt Leela Ashok Naik and another v. State Bank of India 94 Comp. Cas. 460.
Lease and finance companies have a practice of collecting deposits as security deposits, and obviously intend to adjust them against outstanding instalments, but make sure that the above principle is either followed, or the application of the principle is excluded by a clear clause in the agreement to this effect.
Recovery of leased assets from a sick undertaking
In Kotak Mahindra Finance Limited v. Deve Paints Ltd., (1988) CLJ 241 (Bom.), the High Court interpreted sec. 22 (1) of the Sick Industrial Companies Act and held that there is no bar in that section in repossessing leased assets as the said assets belonged to the leasing company and not to the lessee.
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Click here to read more about the lessor's predominant ownership rights over leased assets. |
The noted section of the Sick Companies Act contains a restriction on any distress proceedings against the properties of the sick company. The distinction in case of leased properties is that the property belongs to the leasing company and not to the sick company.
Similar ruling was given by the Delhi High Court in case of Credit Capital Finance in case of leased assets and by the Madras High Court in case of Cholamandalam Investment in case of hire-purchase assets.
Non-payment of lease rentals to lead to winding up
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Important: Make sure the client cannot liken your lease with a loan transaction; otherwise, money-lending laws will have an applicable. |
In Goodwill India Limited v. TSP Paper Mills Ltd. (1998) 2 CLJ 147 (P&H), the High the lessee who was in default of rentals took the plea that the lease transaction was in effect at par with a loan transaction, and as such it was hit by the provisions of the Usurious Loans Act. The High Court rejecting the plea held that the lease was a valid lease, and was therefore different from a loan, and therefore, the plea that it attracted the provisions of the Usurious Loans Act was not acceptable. Since there was a default of rentals, it was held that the company was unable to pay its debts, and the required formalities have been complied with, the winding up proceedings were allowed to be initiated.
CBDT proposes re-writing of rules on leasing depreciation
Like the phoenix, it is back from its ashes - the proposal to classify leases into financial and operating leases and to allow lease depreciation to the lessee in case of financial leases. This proposal was first mooted in Nov. 1995 when a stiff opposition from the industry nipped it into its bud.
However, it is back. The reasoning, given by the CBDT is that depreciation in case of lease transactions has been misused by a number of lessors for claiming it on non-existing assets or bogus transactions.
The CBDT's point has some merit - there is no doubt that there have been a number of bogus leases in the past. But it needs to be explored whether such so-called bogus transactions were a bilateral fraud by the lessor and the lessee against the revenue, or it was a unilateral fraud, by the lessee, against both the lessor and the revenue.
In either case, no amount of sophistry can justify non-existing assets. However, incorporating anything beyond a simple and certain rule for distinguishing between genuine leases and garbed financing transactions, at this juncture, will be harmful. This juncture is a phase when the leasing industry has returned to taxability due to the backlash impact of deferred taxes. Deferred taxes have a tendency to hit hard in hard times: when the growth in fresh volumes comes down, deferred taxes of the past start maturing into an ever increasing tax liability. So what is bad for every one is worse for a lessor.
The author's views, held over a long time, are given in the article on Ideal taxation regime for leasing transactions in India. Click here to read this article.
Also, if you have a view in the matter, please contribute to our Discussion Forum - click here to reach the discussion forum.
Supreme Court renders landmark ruling on income from NPAs
In a landmark ruling, in the case of Uco Bank v. Commissioner of Income-tax 237 ITR 889, the Supreme Court has held that the interest on sticky loans which has not been credited to interest account by taken to "suspense" account is not taxable.
While holding this, the Supreme Court has not applied its famous ruling in State Bank of Travancore 158 ITR 102 (SC) and in fact reversed its own ruling in Kerala Finance Corporation 210 ITR 129 (SC).
Though the present ruling is influenced heavily by a Circular of the Department to the effect that interest on sticky loans satisfying certain conditions will not be taxable, the inclination of the Court to give effect to well-recognised accounting principles is evident: the Court cited from Spicer and Pegler's accounting text and that from Shukla and Grewal to indicate that the accounting practice being followed by the bank was in accordance with generally accepted accounting principles.
It may be noted that by a specific amendment of the Income-tax Act [sec. 43D], the problem of having to pay tax on unrealised, unrecognised income on sticky loans has been resolved as far as banks are concerned. However, the problem looms large on NBFCs for whom a corresponding provision is missing.
Accounting principles support, rather require, the cessation of income recognition when income becomes doubtful of recovery. Such a method is not even a mixed or hybrid method of accounting but very much a part of the accrual system.
However, for avoiding any difficulties, it is necessary that the CBDT should issue a suitable clarification for NBFCs.
The Supreme Court recently [see 237 ITR 132 (Stat.)] refused to admit an appeal by the Department against a ruling of the AP High Court in CIT v. A M Constructions. The AP High Court had affirmed in this case that tippers are depreciable at the rate of 40%.
The Supreme Court having refused to admit SLP in the matter implicitly means an affirmation of the ruling by the Supreme Court.
A number of tippers are leased by leasing companies - 40% depreciation rate produces healthy post-tax returns.
Deemed capital gains tax cannot be charged on transfer of leased assets at residual values
Even while the question of pre-fixed residual values in leases continues to be a knotty issue in assessment proceedings, the issue before the Patna ITAT, in Parikh Engineering and Body Building Co. Ltd. v. Asst. CIT 69 ITD 207 was whether the tax officer had a power to tax deemed capital gains on transfer of assets at residual values. In this case, lorries and cars had been transferred by the assessee to the lessees at values which were close to the book values of the assets, though the asset had a higher market value.
Taking a technical view, the Tribunal held that the only applicable provision in case of depreciable assets was sec. 50 of the IT Act under which capital gains could be charged to tax, in case of depreciable assets, only if the block value was exceeded or the complete block was sold. In normal cases, there would merely be an adjustment in the block based on the actual price at which goods were sold.
Hence, there was no scope for any deemed capital gains.
The issue of whether a pre-fixed residual value would lead to a re-characterisation of the leases was neither raised or nor discussed.
Interest-tax not applicable to hire-purchase transactions, holds Madras ITAT
In Harita Finance Limited v. Asst. Commissioner of Income-tax Order dated 29th June, 1998, the Madras ITAT Bench A has held that interest-tax is not applicable on hire-purchase transactions.
It may be recalled that the matter of applicability of interest-tax on hire-purchase transactions has been raging in controversy for a long time. Though the total revenue implications are meager, if not negative (2% levy on finance charges would be offset by the non-chargeability of interest-tax on interest earned by the banks which finance the hire-purchase financiers), the CBDT has been contending that hire-purchase transactions may be, in some cases, substantive loans, and may as such attract interest-tax.
The CBDT first issued a Circular no. 738 dated 25th March, 1996 wherein it proceeded to treat all hire-purchase transactions as financing transactions. After great protest, it came out with another Circular no. 760 dated 13th January, 1998 where it opened up the question of substance versus form, and held that if the hire-purchase transactions were loans in substance, the levy of interest tax was justifiable. To reveal the substance of hire-purchase transactions, the Circular called for a case-by-case examination of transactions by the tax officials.
The ruling of the Tribunal in this case does not do away with the Circular - rather, the Tribunal has extended credence to the Circular by expounding its provisions. Based on examination of the clauses in the agreement, the Tribunal concluded that the case before it was not one chargeable to interest-tax.
In other words, the question of substance-versus-form stands reinforced.
Yet another ruling on investment allowance - allowable where actual user not commenced
In French Motor Car Co. Ltd. v. Dy Commissioner of Income-tax 68 ITD 176, the Calcutta ITAT upheld the contention of the lessor that where an asset on lease had been leased out on 29th March, even though the lease agreement was entered on 1st April, and even though the evidence of the lessee having actually put the asset into use was not available, investment allowance was available to the lessor. The ITAT relied upon a ruling of the Calcutta High Court in CIT v. Mercantile Construction Co. 74 Taxman 41.
The above ruling of the Calcutta ITAT is obviously without the benefit of the Supreme Court ruling in First Leasing Company's case. The Supreme Court ruling in the First Leasing case has set at rest all doubts as to eligibility of leasing company per se to claim for investment allowance. However, factual issues such as whether what matters is the date of the agreement or the date of delivery of the asset, or the date of installation or the date of actual use by the lessee remain in doubt. The present case advances the body of law by ruling out the significance of the date of the agreement and the date of actual usage by the lessee. However, since the date of installation is relevant as per sec. 32A, the Tribunal remanded the matter for fresh collection of evidence to the assessing officer.
Depreciation rate change for commercial vehicles made effective FULLY: Elemis shows excellent opportunities
While the News item below dealt with the Notification dated 24th December giving partial effect to Depreciation rate changes for commercial vehicles, a new notification dated 9th January, 1999 has given full effect to the proposed changes in depreciation rates for commercial vehicles. Presumably, the Bill seeking to make amendments in the Income-tax law had already been passed by the Winter session of the Parliament, though it is not clear as to why then the previous Notification was required at all.
The changes now effected are as follows:
An amended copy of the Depreciation rate schedule is available on this site. Click here.
Leasing companies can make excellent use of the new Notification. Larger companies can use this even for acquiring portfolios already under lease by smaller companies. At the same time, 40% depreciation available in the second half is like 80% depreciation rate - very close to the fanciful 100% depreciation rate. In other words, smaller companies can even use the new facility to leverage their existing portfolios by assigning them to bigger companies.
Our calculations on Elemis [click here for details] that the required IRR for 40% full year depreciation transaction in the month of February or March is only about 14%, which would equal about 20% for a normal financial transaction. In other words, if you are targeting about 20% IRR for a plain vanilla plant and machinery lease, you would find a break even at 14% for a commercial vehicle IRR. And this, we see, is enticing enough.
Depreciation rate hike on commercial vehicles made effective partly:
As one of the measures to give support to the ailing commercial vehicles industry, the Finance Ministry recently proposed to:
The first proposal above, not requiring any legal amendment, has already been made effective, by a Notification dated 24th Dec., 1998. [Click here for a full text of the Depreciation Schedule incorporating the above Notification]. This amendment is effective for the income year relevant to Assessment year 1999-2000, but applies only to vehicles acquired on or after 1st October, 1999.
The pre-condition for availing the higher rate is that the new vehicle must replace a condemned vehicle of over 15 years of age. The conditions for availing the new benefit, from the viewpoint of leasing companies, are discussed below:
Even as this amendment was effected, the other proposal, viz., to allow full year's depreciation on vehicles bought at any time during the year, was not carried. This amendment will now possibly be carried as a Budget proposal, but giving effect from the current income year.
Extra-shift depreciation allowed in case of leasing companies:
In Commissioner of Income-tax v. Maharashtra Apex Corporation Ltd. 234 ITR 484, the Karnataka High Court held a lessor eligible for both investment allowance and extra-shift depreciation. While the investment allowance issue is now well-settled with Supreme Court ruling in First Leasing Company of India, the High Court's ruling goes to help lessors to favourably close pending litigation relating to extra-shift depreciation.
It is notable that there is a ruling of the Delhi Appellate Tribunal in Shree Leasing case where extra-shift depreciation to a lessor was not allowed.
The High Court in the above case proceeded on the simple ground that no distinction can be made between use by the lessor in his own business and use by the lessee upon the authority granted by the lessor.
PAN problem in case of vehicles
The new Rule 114B requires permanent account number (alternatively GIR, both here referred to as PAN) of the seller and the buyer, in a transaction involving sale or purchase of motor vehicles. "Which requires registration under chapter IV of the Motor Vehicles Act" is a surplusage, since every motor vehicle requires registration under Chapter IV, except a vehicle in possession of a "dealer".
So, it is clear that every person entering into a transaction of purchase or sale of a motor vehicle is required to quote his PAN. There is no mention of the value of such vehicle.
Is it necessary to have PAN:
Notably, even though Rule 114B requires quotation of PAN, there is no requirement in law which forces a person buying or selling a vehicle to have a PAN. Sec. 139A (1), which requires certain persons to compulsorily apply for PAN, does not cover the buyer or seller of a vehicle.
Hence, it must be understood that there is no bar on a person not having a PAN from entering into transactions covered by Rule 114B.
If you do not have a PAN:
The third proviso to Rule 114B provides that where a person entering into such transaction has either not been allotted a PAN or does not have one, AND is making payment in cash or otherwise than by crossed cheque or crossed bank draft, he shall be required to make a declaration in Form 60 (Form 61 in case of persons having agricultural income).
The use of the word "and" in the proviso (also in the title to Form 60) gives indication that Form 60 is required only if two conditions are satisfied:
In other words, even if the buyer/seller does not have PAN, but is making payment by crossed cheque or bank draft, he shall not be required to file the declaration in Form 60/61. Likewise, if the person has a PAN, but is making payment in cash, he shall not be required to make the declaration.
The normal meaning of the word "and" is conjunctive, and that of "or" is disjunctive. Sometimes, particularly when used in a negative sentence, "and" could be used as "or". But no such reading seems necessary here. In the title to Form 60, it seems only a person not having PAN and not making payment by crossed cheque has to file the declaration.
This, however, is not apparently the intent of the lawmaker. Understandably, the scheme of the new rule would have been that in all cases of transactions to which the rule will apply, either the parties concerned quote their PAN, or they file a declaration. The quoting of the PAN or filing of the declaration is only a means to an end - the conclusion lies in the information being sent to the Investigation wing of the Department, who is supposed to strengthen their information based on these filings. So, look at Rule 114D, which contains the filing requirement, and it obvious that there are only two types of cases covered there - either those where the PAN is quoted, or those where the Declaration is filed.
Reading "and" in Third Proviso to Rule 114B as a conjunctive would mean, there would be a class of transactions, presumably a very large one, where the PAN has not been quoted, but where payment has been made by crossed cheque. If the declaration were not to be filed in all such cases, then these transactions do not come at all for filing under Rule 114D, which would render the entire scheme of the rule futile. Rule 114D requires filing of information with the Income-tax Department of all cases where PAN has been quoted, and of all declarations received. So, if there is a class of cases where PAN has not been quoted, but where declarations are also not required to be filed because the payment is made in cash, such cases do not get reported at all, which is obviously not the scheme of the rule.
It is a pity that we are governed by more and more such rules where what the lawmaker wants to say, is not what he actually says. Therefore, one is supposed to comply with a rule, no matter what the rule says, but based on what the rule might have intended to say. That is to say, we are supposed to interpret legal gibberish, and abide by the same.
The age old golden rule of literal construction no more seems to hold ground.On balance, it appears that the requirement of making declaration in Form 60 will arise in all those cases:
Either
Where PAN has not been quoted by any of the parties to the transactions covered by Rule 114B;
Or
Payment has been made in cash or otherwise than by crossed cheque.
Who to make declaration to:
From Rule 114C (2) (b) it appears that the declaration is to be made to the registering authority, as also to the seller or buyer [rule 114C (2) (h)]. Obviously, it serves no great purpose to require the declaration to be obtained by a counter-party to the transaction, and that too, when the registering authority has been subjected to this requirement, but the rule requires declaration to be obtained by the buyer/seller, as well as the registering authority.
Here lies a difficulty: the registering authority can insist upon production of PAN, but how are they supposed to know whether the payment for the transaction was made in cash or otherwise than by crossed cheque? Not being possessed with necessary information, it appears that in practice, for every registration of a motor vehicle, the registering authorities will either ask for a PAN or require both parties to file the Form 60 declaration, thus causing a redundant information to be collected and submitted to the authorities.
The rule is not specific about the time at which the declaration is to be made. However, the understanding is that the declaration, being an alternative to PAN quotation, will be made simultaneously as the documents relating to the transaction are exchanged.
Filing of the declarations:
The person receiving declarations or required to collect PAN is required to submit the same to the authorities. The authority in question is the Director of Income-tax (Investigation).
Read literally, this rule sounds funny.
Take, for instance, the case of a sale of a motor vehicle. Say, Maruti sells a vehicle to a customer. The rule requires both the buyer and the seller to declare their PAN, or to file a declaration. Therefore, Maruti or the dealer will have to declare its PAN on the invoice, and the customer will also be required to quote his PAN on his purchase order, or alternatively file a declaration. This apart, the registering authority will be required to ensure that both the buyer and seller have quoted their PAN, or furnished a declaration. This itself may require modification of the motor vehicles registration forms.Now, each of the persons referred to in Rule 114C (2) is required to a file a statement with the tax authorities. The persons referred to in 114C (2) include the seller as well as the buyer, That is to say, there is a filing requirement on both parties to the transaction, as also the registration authority. The filing requirement is there in those cases where PAN has been quoted, as also in those cases where the PAN has not been quoted and a declaration has been filed.
So, for every vehicle sold, there will be three statements filed with Investigation cell - one by the seller (Maruti in our example), one by the buyer, and one by the registering authority. Funny as it may sound, the rule does require every buyer of a vehicle to also file a statement with the Department. If the whole idea of the Rule was to collect information about those exceptional cases where payments for vehicles have either been made in cash, or a vehicle has been bought a person not quoting his PAN, one wonders what is the point in collecting information about each and every transaction where the PAN has been quoted.
The Murphy's rule of official investigation is: redundancy overtakes relevance. We find it hard to believe in rule of reporting by exception: we find reporting by rule as more satisfying. The great idea of filing information about every vehicle in the country sold, and in addition, every vehicle in the country bought, and in addition, every vehicle in the country registered (and remember, every vehicle which is sold, is also bought, is also registered) will bury in the heap of redundancy the entire purpose of the new rule.
HIRE-PURCHASE TRANSACTION:
Technically speaking, a vehicle given on hire-purchase is the ownership of the hire-vendor. Therefore, the hirer is not the buyer of the vehicle. The finance company is owner and the buyer. This is irrespective of the manner in which the invoices are drawn up.
However, in the context of the Income-tax law, the involvement of the hirer in the hire-purchase transaction is recognised from day one.
Notably, the hirer is allowed the benefit of depreciation.
Further, sec. 4AAE of the Act, dealing with presumptive taxation in case of a goods transporter recognises the hirer of the vehicle as its owner, for the purposes of that section.
Thus, the income-tax law treats the hirer as the owner in all material aspects. The Supreme Court in the age-old ruling of K L Johar held that hire-purchase has an element of bailment and sale, and it cannot be denied that hire-purchase has an embedded sale element. In view of embedded purchase option, it cannot be said that a hire-purchase is a transaction or sale of the vehicle. Hence, it is necessary that the hirer's PAN should be quoted in case of every hire-purchase transaction.
In view of the above interpretation, the issuance of NOC under a maturing hire-purchase agreement cannot be taken as a sale, and therefore, there will be no need to require the hirer's PAN in case of termination of hire-purchase agreements.
If repossessed vehicles are being sold to any person other than the hirer, obviously the buyer's PAN will be required.
LEASE TRANSACTION:
On the other hand, a lease is a plain case of renting of the asset. The asset is bought by the lessor, and rented out to the lessee. The registration certificate carries the name of the lessee, but that is relevant only for Motor Vehicles Act.
Therefore, it cannot be said that a contract of lease is a contract of sale or purchase, as far as the lessee is concerned.
Hence, in case of lease transactions, the lessor being the purchaser has only to disclose his PAN, not the lessee. If at all a transfer of the asset is to be made to the lessee, then, of course, the disclosure of PAN of the lessee will be required.
Unpaid overdue charges on delayed rentals taxable
Not recovering rentals from a lessee is bad enough, but obviously worse is having to pay tax on the overdue charges, which were neither realised nor accrued in books. In Growth Leasing and Finance Limited v. Income-tax Officer 66 ITD 67, a very technical meaning of the accrual system of accounting was taken, and based on the contractual right of the company to receive the service charges on overdue rentals, the service charges were held taxable.
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This case shakes our belief that rentals on non-performing assets are not taxable. Not only rentals, even overdue charges are, holds the Tribunal. Click here to read the RBI's NPA accounting norms. |
The Prudential Norms of the RBI, how statutory, require a company to refrain from accruing any income if the asset has become a non-performing asset. Performing or non-performing, the income by way of service charges or overdue charges is never recognised in books. There is a good accounting principle that goes behind this - if there is an uncertainty in ultimate collection of an income, accounting standards advise that the recognition of income be postponed to the extent of uncertainty involved. Accrual, obviously, does not mean taking income into books based on a legal right of receiving, even if the income is not perceived as recoverable.
However, the Tribunal has gone on the basis of right of recovery, and held service charges, neither received nor accrued, to be taxable. This is in face of the fact that the client in the instant case was Nirlon, already declared as a relief undertaking.
Stright-line splitting of hire-purchase interest not permissible for tax purposes
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Click here to read more about methods of accounting for HP transactions. |
In Deputy Commissioner of Income-tax v. Nagarjuna Investment 65 ITD 17, the AP Tribunal has made a very detailed analysis of the two prevailing methods for recognition of interest in hire-purchase transactions - equal and sum-of-digits (SOD) methods or the index method, and held that the equal basis of splitting income does not represent the "real" income in case of a hire-purchase transaction.
The judgment runs over 50 pages, and the Tribunal has gone into detailed calculations of the straight-line and the index methods of computing interest.
Though the facts of this case are unique - here the assessee was following the SOD method for books of account and straight-line method for income-tax purposes - the detailed line of ruling by the Tribunal on what represents true and fair approximation of interest in case of hire-purchase transactions can lead tax officers to reject the splitting of finance charges on equal basis, even where the same method is adopted for books of account.
Andhra increases tax on lease transactions
This is undoubtedly the most progressive state in the country but one wonders whether the Govt has any idea of what it is doing to the leasing industry, called the engine of progress. Chief Minister Naidu is without doubt one of the best that India has had in the recent past, but he surely does not know what the bureaucracy is doing to annihilate the leasing industry in the State.
A few years ago, the State withdrew the second sale exemption in case of lease transactions. More so, the State passed an amendment to the tax law providing for imposition of tax even on inter-state lease transactions, a utterly unconstitutional attempt to tax what is not within its taxing power.
No comes the final blow on the nail in the coffin: the rate of sales-tax on lease transactions has been hiked to 8% from the existing 5%. Plainly speaking, all leases in the State are chargeable to sales-tax at 8% on the lease rentals, which in fact is an additional tax since the goods would have already suffered first point tax at the time of their purchase. That is to say, if the lessor is seeking a pre-tax rate of return of say 18%, the post-sales-tax cost to the lessee would be around 26%. So we conclude: it is either sales-tax OR leasing, not sales-tax ON leasing.
Andhra is one of the few states in the country that consciously denies the benefit of second sales exemption to lease transactions. Karnataka, Tamil Nadu, West Bengal, etc have exempted second sales-tax on leases of goods locally bought.
What can you do: Industry participants, associations and professionals should write to the powers that be and make them aware of what would be the impact of this change. For your information, the e-mail id of Shri N.Chandrababu Naidu, Chief Minister of Andhra Pradesh is cmap@ap.nic.in; cm@ap.gov.in and that of Shri P.Ashoka Gajapati Raju, Minister for Revenue is min_rev@ap.gov.in
Important changes in Maharashtra sales-tax laws
:Following are some important changes in Maharashtra sales-tax laws which would be relevant to leasing and hire-purchase entities:
Evidently, the sweep of the deeming provision is very wide, and any security or initial deposit received in connection with hire-purchase transactions will be taken as a part of the sale price. The definition is inequitable, as there are no provisions for a reduction/ benefit when the deposit is indeed refunded, but taking the law as it is, hire-purchase companies need to re-work strategies as regards security deposits.
Tamil Nadu Sales-tax ruling muddles up the inter-state lease taxation issue
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Sales-tax on inter-State leases has been a contested, hotly debated and thoroughly misinterpreted issue in India, but of late, there was clarity emerging in rulings of the AP High Court in ITC Classic, Karnataka High Court in India Equipment Leasing [See report below] and the AP Tribunal in Wimco Limited [See report below]. In this setting, it is a pain to see the Tamil Nadu Taxation Special Tribunal, though refusing to go into facts of each case before it, yet giving a guidance to tax officers stating that it would favour the ruling of the 20th Century Finance Corporation rather than that of the AP High Court.
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Are you affected by this ruling? If you are carrying on business in Tamil Nadu or have transactions in the State, you are most likely affected. We would be obliged if you could share your concerns. In particular, we will appreciate feedback on whether: (a) the case has been challenged in a higher forum? (b) what is the department stand after the ruling? |
In the case of Upasana Finance Limited v. State of Tamil Nadu and another 113 STC 403, the Tamil Nadu Taxation Special Tribunal did hold that the provisions of the CST Act are applicable to determine when does a lease transaction take place in course of inter-State trade or commerce. The Tribunal also held that the taxing officers is not supposed to go solely by the Circular of the Commissioner but examine, in light of established principles, whether the leases are inter-state leases or not. The Tribunal also refused to go into facts for which the assessees had proper remedy in regular assessment proceedings. However, the Tribunal gave enough indication of its intent in the following lines:
''.... it will always be open to the assessing authority to split the transactions involved in the case of the petitioner into a purchase by the assessee from abroad or from other states or even locally and a second transactions involving a lease, a hire purchase or a transfer of right to use the goods to the ultimate purchaser, user or transferee. If this is done, it will be easy for the assessing authority to find out as to which agreement or transactions occasioned the movement of the goods from one State to another or whether the transfer is effected during the movement of the goods from one state to another. .."
In other words, the Tribunal is influenced by the ruling of the Bombay High Court. There has never been a doubt that the contract of purchase by the lessor and that of lease are two separate contracts: had they been one, the question of levying tax on the lease would never have arisen. The only critical question was, whether these two contracts are factually independent so as to give rise to a possibility that the first one could be inter-State and the second one could be intra-state. Such a possibility should not be based on theoretical possibilities but on the factual setting of the transaction where the contract of purchase by teh lessor is never independent decision of the lessor to buy such goods but is itself is triggered by the contract of lease.
However, by dealing with the theory of "two separate contracts" , the Tribunal has said enough and this ruling would continue to affect leasing companies who would, according to this ruling, be never be able to raise a contention as to inter-State character of the leases. Besides, the Tribunal has expressly dissented from the ruling of the AP High Court in ITC Classic.
There were several other rulings laid down by the Tribunal in the same decision, briefly as follows:
1. In case of letting out of hoardings, the Tribunal adopted the reasoning of the West Bengal Taxation Tribunal in Selvel Advertising to hold the hoarding was not an immovable property, and that the facts as to whether possession or control over the asset has been passed on to the lessee were to be examined during assessment proceedings.
2. In case of hiring of lorries, where the driver was not provided by the hire-vendor, the Tribunal adopted the reasoning of the Orissa High Court in Krushna Chandra Behera and held that the substance of the transaction was transfer of right to use goods.
3. Lease of software : the Tribunal saw no impediment to a tax being levied on software licensing charges.
There was some vague remark by the Tribunal about the levy of tax being limited to the value of the goods as at the time of the initial transaction. How is this going to be practical remains to be seen.
Almost every notable name in Tamil Nadu sales-tax legal circles was involved in this case involving several petitioners.
Sales-tax changes on leases in West Bengal
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West Bengal in its Budget for year 1999-2000 has taken the initiative to make certain favourable changes in sales-tax on lease transactions. See the detailed report appended in a separate page. Click here for the full report.
AP Tribunal holds sales-tax inapplicable on
inter-state leases
Are you still paying sales-tax on inter-state leases?
This author has been contending, for over 10 years now, that sales-tax cannot be charged on inter-State lease transactions as they are outside the Constitutional powers of the States.
Read below for a history of legal developments relating to this matter.
Now the AP Tribunal in the case of Wimco Limited v. State of Andhra Pradesh 25 APSTJ 222 has held that the Constitution does not empower the State govt. to levy tax on inter-State leases, and where goods had moved from one State to another in pursuance of a lease agreement, the State cannot levy a tax.
The AP High Court has given a ruling in this matter earlier in the matter of ITC Classic. Subsequent thereto, the legislature moved an amendment in the Act inserting a retrospective provision to the effect that if the goods are being used in the State, the lease will be taxable in the State.
According to the Tribunal, this was violative of Article 228 of the Constitution, and therefore, had to be read down.
Lease-tax applicable on franchising agreements
This ruling will prove to be a landmark in time to come. If States make full use of this ruling, it will have major impact on trade and industry. Letting out trade marks is a very common way of doing business. A number of MNCs have let out their trade names to Indian companies. Likewise, a number of reputed brands have appointed franchisees. If all the royalties for transfer of right to use trade marks are to be taxed under sales-tax laws, there will be a substantial tax liability which was never apprehended by trade and industry. The ruling, when implemented, will be a shocking surprise.
After the Constitution (46th Amendment) Act of 1982, a transfer of right to use goods is treated as a sale by most States. "Goods" in sales-tax parlance includes intangible assets such as trade marks. Now, the Bombay High Court has ruled in Commissioner of Sales-tax v. Duke and Sons (P) Ltd. 112 STC 370 that agreements which convey a right to use trade marks, in other words, franchising agreements, are also within the purview of sales-tax on transfer of right to use goods.
The High Court drew a distinction between "assignment" and "transfer" of trade marks. Assignment would mean divestation of the rights of the original owner. If, however, without divesting his own rights over it, the owner of a trade mark permits someone to use it, it is a case of transfer of right to use it, and therefore, falls under the purview of the taxing clause which taxes transfer of right to use goods.
In other words, for the purpose of sales-tax, franchising agreements stand at par with leases - both are treated as transfer of right to use goods, and both would therefore attract tax.
On purely technical grounds, a counter argument possible is that the transfer of right to use that the Constitution envisaged for sales-tax purposes was one where the transferor's own right in what he was transferring stood divested -that is exactly what the Court has termed as "assignment of trade marks". It is quite possible, therefore, that the ruling would end up being contested in the Supreme Court.
The actual applicability of the tax and the rate of tax would depend upon the State law. Some States have listed down the goods on which there will a "transfer of right to use" tax. For example, in Karnataka, Gujarat, Rajasthan, UP and MP, the franchising tax cannot be imposed till the respective taxing schedules are amended. However, in States like West Bengal, Tamil Nadu, Bihar, Orissa, etc. which either do not have a specific taxing schedule, or State like Maharashtra where trade marks are specifically included already, the tax will be applicable not only in future but also in the history - as many years up the road as the tax officer is permitted to go.
Thus, huge liability by way of sales-tax awaits most industrial houses where the group trade mark is centrally owned, consumer goods franchisees, soft drinks franchisees, sweets franchisees - the list goes on.
Sales-tax on inter-State leases not payable
This is yet another ruling on the matter : that no State has any right to tax an inter-State lease or import lease transaction.
Earlier, we have provided our clients/readers/members of leasing Associations with the rulings of the AP High Court in ITC Classic's case and UP Taxation Tribunal in Amrita Bazar Patrika's case. Before we come to the latest ruling from the Karnataka High Court, let us put the facts on record once again:
You will all be pleased to note that a single Judge of the Karnataka High Court in India Equipment Leasing v. Deputy Commissioner of Commercial Taxes, ruling dated 29th June 1998, held that the State has no right to charge tax on inter-State leases. The Court has quashed assessments of about 30 leasing companies in the State and sent them back for re-examination.
The ruling of the Court is based on whether the movement of goods and the transfer of right to use are results of separate agreements, or single agreement. In a usual lease transaction, there will never be a separate agreement for movement of goods and for the lease, in which case, as per the Court's ruling, the lease will held to be inter-State lease and beyond the taxing competence of the State govt.
However, it might so happen that the goods might have been brought into the State for some other purpose, and thereafter, a lease is done. In that case, the lease will be intra-State. This, in the context of leasing companies, may be possible if goods are repossessed and given on lease, or goods are brought for one lease and leased to another lessee.
RBI proposes deferred tax accounting for finance companies
A recent recommendation of a task force of the Reserve Bank of India attempts doing what the Institute of Chartered Accountants of India has been sleeping over, for almost a decade now - it seeks to make deferred tax accounting obligatory for non-banking finance companies.
A recent report in The Times London [Sept 2, 1999] put it as follows: "Put the words 'deferred' and 'taxation' into the same sentence and you can guarantee the sound that follows. It is the sound of a forehead hitting a desk just before the onset of rhythmic snoring. However, no matter how boring the subject may be, it is nonetheless important."
Deferred tax accounting may be boring elsewhere in the world, but for Indian accountants, it will be a major challenge since most Indian accountants do not even understand what deferred tax accounting is all about. It is something that is a permanent fixture in accounting conferences, but neither the speakers nor the audience seem to have a clear idea of what is tax effect accounting or deferred tax accounting.
The concept, apparently very simple, is extremely difficult in practice. What it means is as follows: if a company earns a profit before tax of Rs 1 crore, and shelters its taxes by leasing (ignore MAT for a minute), the company has a Nil tax liability and therefore, does not make any provision for tax. It reports a Profit after tax of Rs 1 crore. Under accounting theory, the deferment of tax on Rs. 1 crore, say Rs. 35 lacs (35 % tax rate) is only a timing advantage, as it arises due to a difference between book depreciation and tax depreciation, which will be reversed over a period of time. Therefore, the tax advantage in the current year is only a temporary gain, and a provision in accounts should be made for the full deferred tax liability. In other words, in the current year, though the company is not liable to pay tax as such, it should still make full provision for the tax effect of income, that is, Rs. 35 lacs should be provided for.
International accounting standards have enforced deferred tax accounting for over a decade now - IAS 12 is the standard in issue. There are similar standards by almost every standard setting body in the World. However, for some strange reason, ICAI issued a note on tax effect accounting sometime in 1991, but gave a short shrift to the deferred tax accounting issue saying the time is not ripe for its introduction.
The RBI now proposes to make deferred tax accounting obligatory for finance companies. This is likely to have major consequences on NBFC reporting. It is a known fact that most NBFCs defer taxes by resorting to leasing transactions. The tax deferred is reported as profit available for distribution. This leads to a higher distributable profit or retained earning. Either way, deferred tax allows companies to increase their leverage or share prices. If companies were required to prepare accounts on deferred tax basis, there is no doubt that companies will be healthier in the long run, but there will be an immediate drop in profitability by about 25% - the difference between full tax effect provisioning and the current MAT payable.
Pakistan, it may be noted, has made deferred tax accounting applicable for all companies, but provided a specific exemption to leasing companies realising that deferral of taxes is the source of sustenance for many leasing companies. On the other hand, in India, deferred tax accounting will be applicable to only leasing companies, and not non-financial companies. Internationally, such standard is applicable for both financial and non-financial companies.
Procedure in case of import and lease of duty-free/concessional duty items
Vide Notification Circular no. 44/98 - Cus. Dated 26th June, 1998, the Govt of India has clarified that in case of imports by leasing companies for lease of items which are eligible for duty free imports or imports at concessional rates, the import will be allowed on satisfaction of the following conditions:
The bill of entry shall be made in the following fashion:
M/s ------------------------- (lessee)
Financed by --------------------------------------- (Lessor) under leasing arrangement.