GST council throws cold water on financial lease transactions

By Abhirup Ghosh( & Anita Baid(


The basic nature of levy under the GST laws (Goods and Service Tax) in India is that it is pervasive. Section 9 of the CGST Act, 2017, is the charging section which imposes tax on any “supply”. Here, exclusions are items like non-taxable supplies, exempt supplies and supplies which are zero-rated. Further, section 7(1) of the CGST Act, defines the ambit of the word “supply”, which consists of all forms of supply of goods and services:

“supply” includes “all forms of supply of goods or services or both such as sale, transfer, barter, exchange, license, rental, lease or disposal made or agreed to be made for a consideration by a person in the course or furtherance of business.”

However, activities as specified Schedule III of the said Act are not be considered as “supply”. Since the scope is fundamentally related to the words “goods” and “services”, hence it is necessary to examine the meaning of these terms:

“Goods” are defined in section 2(52) as

“(52) “goods” means every kind of movable property other than money and securities but includes actionable claim, growing crops, grass and things attached to or forming part of the land which are agreed to be severed before supply or under a contract of supply;”

“Services” are defined in section 2(102), as –

““services” means anything other than goods, money and securities but includes activities relating to the use of money or its conversion by cash or by any other mode, from one form, currency or denomination, to another form, currency or denomination for which a separate consideration is charged;”

Leases under GST

As per Schedule II, any transfer of right in goods amounts to supply of services. In case of both, operating leases and financial leases, there is a transfer of right to use to the goods from the Lessor to the Lessee. Therefore, under the GST law, both will be treated in similar way, unless otherwise provided in future.

However, here it is important to understand that the nature of a financial lease is admittedly a financial assistance and is akin to loan transactions. There have been several judicial pronouncements where it has been substantiated that financial leases are akin to loan. In the case of Association of Leasing and Financial Services Company v. Union of India, paragraphs 20 and 21 of the judgment clearly brings out the fact that financial leasing and hire purchase transactions are a mode of long term funding. In case of Asea Brown Boveri Ltd v. Industrial Finance Corporation of India[1], the judgment brings fore the fact that financial lease is nothing but loans in disguise.[2]

The banking and financial services in common parlance have always included activities like lending, depositing, issuing of pay order, demand draft, cheque, letter of credit and bill of exchange, financial leasing services including equipment leasing and hire-purchase, etc. under its ambit. The reason being financial leasing and hire purchase transactions in substance partakes the character of loans and advances as these involve grant of assets to lessors / hire purchasers on credit terms and at predetermined rentals. While in case of leasing transactions, lessor transfers the right to use the assets to the lessee for fixed periodic rentals. The lease rentals can be construed as interest inclusive instalment for the leased assets. Therefore, the leasing transactions assumes the character of loan and interest payments.

Currently, loan transactions, being for money transactions, are outside the purview of taxable supply (since neither “goods” nor “services” include money). By that argument, since a financial lease is admittedly a monetary transaction, it stands to logic that the interest inherent in financial lease should be exempt. However, currently, the reality is far from the idealistic situation and financial leases are being taxed as supply of services or supply of goods based on the actual terms of the transaction.

Further, there is apparently no difference between financial lease and operating leases under the GST regime.

Here it is important to note that some cases of financial leases involve transfer of title of the asset at the end of the tenure; such cases will be treated as supply of goods, because Schedule II of the CGST Act states any transfer of title in goods under an agreement which stipulates that property in goods shall pass at a future date upon payment of full consideration as agreed, is a supply of goods.

Clarification from Department

In order to address the ambiguities in various segments of the economy, the GST Council framed sector specific FAQs to resolve the issues. One set of such FAQs are meant for financial services sector and it is these FAQs that has opened up whole lot of complexities.

Question 47 of the FAQs state the following:

  1. Whether interest on a finance lease transaction is taxable under GST?

A finance lease is a method of borrowing against the asset. The interest represents the time value of the money expended by the Bank in financing the asset. Services by way of extending deposits, loans or advances in so far as the consideration is represented by way of interest or discount (other than interest involved in credit card services) is exempt. But, in a financial lease the ownership of the asset is with the bank. In essence, it is a ‘purchase the asset and lend it further’ transaction for bank. Therefore, neither the services are purely in the nature of extending loans nor the consideration for a financial lease is purely in the nature of interest. Thus, interest on finance lease transactions will be taxable under GST.

Whether financial lease is at par with loan transactions?

First of all, while the whole country was waiting for a clarification in favour of financial leases, the GST Council has re-iterated the old position saying financial lease, though a method of borrowing against asset, is not in the nature of extending loans or advances, as the ownership is retained by the lessor. The nature of the transaction has been called as “purchase the asset and lend it further”.

However, the Council has disregarded one of the most important feature of financial lease transactions in India. The financial lease transactions in India are mostly full payout leases and the legal title of the asset is retained as a security against the payment obligations. Therefore, the financial lessor’s interest in a leased asset is more of a security interest than an ownership interest. In fact, both the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interests Act, 2002 and the Insolvency and Bankruptcy Code, 2016 recognise interest of a financial lessor in the leased asset as security interest rather than ownership interest. All these have not been sufficient to convince the Council members to treat financial leases at par with loan transactions.

The reason why that might have been thought of the GST council is the legacy of service tax. In the case of Association of leasing and financial services company v/s Union of India[3], paragraph 20 and 21 of the judgment clearly brings out the fact that financial leasing and hire purchase transactions are a mode of long term funding. The honorable Supreme Court said that financial lease has both elements- The bailment which underlies finance leasing is only a device to provide the finance company with a security interest. GST Council is perhaps seized of the service element in financial lease and not the loan element.

Is Interest taxable?

Secondly, the question talks about the chargeability of GST on the interest component of a financial lease transaction. While currently, GST is charged on the entire lease rentals, however, the Council has dealt with only the interest component of the finance lease receivables. They might therefore be seriously meaning to say it is only interest which is taxable.

This gives us a very intriguing thought. Even under the earlier regime, sales tax was charged on the entire lease receivable, in addition to it, service tax was charged on 10% of the interest component. However, there is no similar abatement available on the finance lease transactions under CGST.

If one were to assume that the GST will be charged on the interest component of the lease rentals, let us understand the impact of the same with the help of an example –

Cost of asset  ₹     100.00
GST 18%  ₹       18.00
Total Cost  ₹     118.00
Lease tenure 3 years
IRR 12%
RV 0% [Assuming full payout transaction]
Rental ₹ 41.63 [paid annually]
Where GST is charged on the entire rental   Where GST is charged on the interest component only
Cashflow GST ITC c/f Cashflow Interest GST ITC c/f
0  ₹ -100.00  ₹  -18.00 0  ₹ -100.00  ₹  -18.00
1 ₹ 41.63 ₹ 7.49  ₹     10.51 1  ₹     41.63  ₹   12.00  ₹      2.16  ₹  15.84
2 ₹ 41.63 ₹ 7.49  ₹        3.01 2  ₹     41.63  ₹   8.44  ₹      1.52  ₹  14.32
3 ₹ 41.63 ₹ 7.49  ₹         – 4.48 3  ₹     41.63  ₹   4.46  ₹      0.80  ₹  13.52


In this case, we have taken an example of full payout transaction where GST is paid on the cost of the asset at 18% and GST is charged on the output at the same rate. We have considered two cases, first, where GST in charged on the entire lease rentals and second, where GST is charged only on the interest component of the lease rentals.

If interest is taxable, what about the ITC?

Input GST is paid on the entire principal component so the available amount of ITC is Rs. 18. In the first case, output GST is charged on the entire rentals, that is, even on the principal component of the transaction, the entire amount of ITC is being used up and total amount of GST payable to the government is on the value addition on the transaction, that is, on the interest component.

On the other hand, in the second case, GST is charged only on the interest component of the lease rentals. The total recovery of GST from the transaction is much less than the available amount of ITC. Therefore, in the second option, substantial amount of input tax would remain unutilized.

The first option leads to accelerated utilization of the input tax credit, whereas, the second one leads to under-utilization of the input tax credit. Further, it has to be noted that under the current GST law, the lessor will not be able to claim refund of the excess of ITC[4]. Therefore, there will be an unnecessary blockage of funds in the second case leading to loss of interest, which is economically not a viable option.

Though the FAQs have opened up new questions on the base of taxation in case of financial lease transactions, but economically the second one does not make any sense.


In the past several industry bodies have represented to the government for treating financial lease transactions at par with loan transactions for the purpose of the indirect taxation purposes[5], however, the FAQs has thrown water on all the hopes of the industry. Moreover, it has unsettled the otherwise settled view on the base of taxation of financial leases. Sure enough we will see a lot of questions being raised and a lot of representations being made to the Council to settle this issue.


[2] According to Lease Financing & Hire Purchase by Vinod Kothari (2nd Edn., 1986 at pp. 6 & 7), a finance lease, also called a capital lease, is nothing but a loan in disguise. It is only an exchange of money and does not result in creation of economic services other than that of intermediation.


[4] Refund is available only where the goods or services are exported out of India or where there is an accumulation of ITC due to the rate of GST on outputs being lower than the rate of GST on inputs.


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