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One of the most controversial issues in Sri Lanka today, the Goods and Services Tax Act was made effective only on 1^st April 1998.

The intent of the law is to enact a system of comprehensive value-added taxation in line with the UK value-added tax.

Towards this end, the Act imposes a Goods and Services Tax (GST) on supply of all goods, and rendering of all services, except those listed in the Schedule. At the same time, the Act provides for relief on account of GST paid by the tax payer. Thus, the tax is only on value-added.

The charging section 2 provides for payment of GST on "every taxable supply of goods or services made by a registered person, in a taxable period, in the course of carrying out a taxable activity".

The general definition of "taxable activity" covers all activity carried on as a business, and there is a specific mention to include "hiring or leasing of any movable property": therefore, both lease and hire-purchase transactions are covered as "taxable activity".

Having determined the scope of taxable income, it is important to understand whether a lease or hire-purchase is covered by "supply of goods" or by "supply of services".

Sec. 76 of the Act importantly defines "supply of goods" to mean the transfer of the right to dispose as owner of movable or immovable properties. This is a very important definition from the point of view of lease and hire-purchase transactions. Unfailingly, this definition conveys that neither lease nor hire-purchase can be taken as supply of goods:

• An essential element for a supply of goods is transfer of right of disposal - that is, the transferee should be given the right to dispose the goods;
• In a lease, the lessee is not given a right of disposal;
• In case of hire-purchase also, the hirer is not given the right of disposal - the right of assignment is not a right of disposal.
• Therefore, both lease and hire-purchase transactions are not to be treated as "supply of goods".
• "Supply of services" means all suppliers other than supply of goods - therefore, both lease and hire-purchase activities will be covered by "supply of services".

Since a lease is taken as a supply of service, it comes under sec. 4 (2) for determination of the tax liability. Sec. 4, it may be noted, fixes the liability based on the time when the supply is deemed to take place, which is the basis of the liability under sec. 2.

Accordingly, in case of a lease, under sec. 2, a supply shall be deemed to have taken place at the earliest of the following:

1. Expiry of a lease period, say, a month;
2. Receipt of a lease rental or future lease rentals;
3. Accrual of lease rentals;
4. Raising of an invoice in respect of lease rentals.

It may be noted that even future lease rentals received will be liable to be taxed: however, if an amount is received and held as a liability or a deposit with the lessor, such deposit will not be taxed.

Thus, the taxable amount of receipts of a lessor is the aggregate of the lease rentals received by him.

Coming now to sec. 22 (2), a registered person is entitled to credit for so much of the "input tax" as is allowable to him. Input tax is the tax paid on the supply of goods "used by the person" for carrying on his business. Undoubtedly, the assets given on lease are the assets acquired by the lessor for the purpose of leasing business, and therefore, the entire input tax paid thereon shall be deductible. Though there should be no dispute on the deductibility of the input tax on purchase of assets, on analogous provisions, in a UK appeal case named Royscot Leasing Ltd v Customs & Excise, decided on 10^th May 1996, there is a ruling to affirm this view.

What this means in sum is that the entire lease rentals accruing within a period, less the total amount of GST paid on purchase of lease assets.

There is obviously no proportionality between the rentals in a period, and the purchase of lease assets in a period. These two are unrelated; yet the law requires a set-off of the latter against the former. This may result into a lessor paying tax on the net income earned by him over a long term; but over short term, it might mean a significant refund claim by lessors.

In view of this, one wonders why should there by an opposition by the leasing industry against the GST enactment.

The leasing industry was also worried about the residual value practices: since the established practice of the industry seems to be transfer of leased goods at nominal values to lessees, whether there will be questions on the value at which such transfers have been effected. There is an important provision in sec. 5 (1) of the Act that in case of any supply of goods or services, the value of the supply shall be the market value of the goods or the supply, subject to exceptions made in the section. In case of leases, unfortunately, the sale of goods to the lessee is never at the market value of such goods.

This worry was answered by the Amendment made on 31.3.1998 by inserting another exception to the market value rule in sec. 5 : sub-section (12) now provides that where the leased goods are transferred at the expiry of the lease to the lessee at a price not exceeding 10% of the total consideration of the lease agreement, such consideration shall be treated as a part of the lease consideration. In other words, the market value rule will not apply. However, the very narrow wording of sec. 5 (12) restricts the scope of this exception only on satisfaction of all the following conditions:

• Transfer at the expiry of the lease, not before or after;
• Transfer only to lessee, not to any one else;
• Transfer at a value upto 10% of total consideration.

We have noted earlier that the essential and the only distinction between a lease and a hire-purchase transaction is the existence, in the latter, of an option to buy. It is also evident that the conduct of the parties may also point to the intention or the option to buy. Thus, if the lessor makes a sale of the leased asset to the lessee, immediately upon expiry of the lease term, at a price which is substantially less than the market value of the property, there is every possibility that such lease will be treated as a hire-purchase transaction, with all the attending consequences.

Therefore, in the opinion of the author, lessors in Sri Lanka will continue to be caught in a catch-22: if they indeed sell the asset to the lessee at a ridiculous or bargain price, it avoids the GST problem, but then it leads to an imputation that the lease was in substance a hire-purchase transaction. On the other hand, if the lessor transfers the asset to a person other than the lessee, at such substantially reduced prices, the GST market value rule certainly applies.

The other grey area is with regard to continuing rentals from leases done in the past: this as a transient problem remains unanswered.

Though a hire-purchase is a supply of service and not goods as noted above, there is a deeming provision in sec. 4 (3) (b): the supply in case of hire-purchase is deemed to take place at the time when the agreement is entered into.

There is also a provision, supporting the above, in sec. 5 (8): the value of goods in case of hire-purchase shall be the cash price of the goods.

Therefore, the tax payable by a hire-vendor is on the cash price of the goods, and obviously, the input tax will also have been paid on such cash price: leading to a NIL liability of the finance company.

As a matter of fact, the provisions of sections 4 (3) (b) and 5 (8) do not even seem to be applicable to a finance company: in the Schedule to the Act [Item (xvi) (h)], there is an exemption for financial services which includes a hire-purchase transaction. Understandably, if the hire-purchase activity is carried on by a finance company, the tax is not applicable; if carried on by a dealer in goods, the tax is applicable.

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