GST council throws cold water on financial lease transactions

By Abhirup Ghosh(abhirup@vinodkothari.com) & Anita Baid(anita@vinodkothari.com)

Introduction

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.

Conclusion

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.


[1] https://indiankanoon.org/doc/1163314/

[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.

[3] https://indiankanoon.org/doc/1531013/

[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.

[5] http://www.assetfinanceindia.com/wp-content/uploads/2017/04/Representation-Financial-Leases-to-be-treated-as-Loan.pdf

Investment by FPIs in securitised debt instruments

By Anita Baid,(anita@vinodkothari.com)(finserv@vinodkothari.com)

Investments by Foreign Portfolio Investors (FPIs) in unlisted debentures and securitised debt instruments (SDIs) issued by Indian companies was allowed pursuant to SEBI notification dated 27th February, 2017[1]. Earlier in November, 2016, Reserve Bank of India (RBI) had also permitted investment by FPIs in unlisted non-convertible debentures and securitised debt instruments issued by Indian companies[2]. The said amendments by the securities market regulator and financial services regulator were the final push which was needed to encourage more FPI investments in India.

Previously, FPIs could invest only in debt securities of companies engaged in infrastructure sector. This was a clear indication that the government aimed to develop the infrastructure sector in India. But eventually, it seemed that the government did not want to restrict this to infrastructure only and wanted to reap all the benefits for developing a dynamic and facilitating bond market in the country.

Economic development and smooth flow of funds into the economy are the twin sides of the same coin and the government of India has very well taken this into account while amending the FPI regulation. Allowing FPI investments in unlisted debt instruments of Indian companies, was a step by the government to relax the burden which the companies had to bear, while raising funds in form of equity. The regulation  in turn blocked the companies from taping into fresh funds and listing of debt instruments, which called for additional burden of complying with a host of other regulations.

Companies are now able to raise debt funding from foreign sources in form of unlisted debt, i.e., without listing the instrument.

Apart from unlisted debt instruments, FPI investments in SDIs has also gained a lot of popularity. SDI has been defined under SEBI (Public Offer and Listing of Securitised Debt Instruments) Regulations, 2008 as –

“securitised debt instrument” means any certificate or instrument, by whatever name called, of the nature referred to in sub-clause (ie) of clause (h) of section 2 of the Act issued by a special purpose distinct entity

Further, section 2(h) (ie) of the Securities Contracts (Regulation) Act, 1956 defines the term ‘securities’ to include-

(ie) any  certificate  or  instrument  (by  whatever  name  called),  issued  to an  investor  by  any issuer  being  a  special  purpose  distinct  entity which  possesses  any  debt  or  receivable,  including  mortgage  debt, assigned  to  such entity,  and  acknowledging  beneficial  interest of such investor in such debt or receivable, including mortgage debt, as the case may be;

However, SDIs which are eligible for FPI investments have to be –

  1. any certificate or instrument issued by a special purpose vehicle (SPV) set up for securitisation of asset/s where banks, FIs or NBFCs are originators; and/or
  2. any certificate or instrument issued and listed in terms of the SEBI Regulations on Public Offer and Listing of Securitised Debt Instruments, 2008.

Accordingly, instruments issued by other than the ones listed above will neither be regulated by the central bank of the country nor the securities market regulator.

Recently, RBI has further relaxed the regulations for investments by FPI, which has been welcomed by the industry at large. At the same time it has also tighten investor-wise exposure limits.

The major changes proposed by RBI’s circular dated 27th April, 2018 are specified herein below:

Ø  Investment by any FPI, including investments by related FPIs, shall not exceed 50% of any issue of a corporate bond.

Ø  In case an FPI, including related FPIs, has invested in more than 50% of any single issue, it shall not make further investments in that issue until this stipulation is met.

Ø  As per A.P. (DIR Series) Circular No. 26 dated May 1, 2018 the term “related FPIs” refers to all FPIs registered by a non-resident entity.

Ø  No FPI shall have an exposure of more than 20% of its corporate bond portfolio on a single corporate.

The RBI vide its notification dated 27th April, 2018[3], amended on 1st May, 2018[4] has relaxed their terms of investments in corporate bonds by FPIs. The intent behind these changes are to accelerate the demand for shorter maturity papers that matures within the span of twelve months. Treasury bills, commercial papers and certificate of deposits are few ubiquitous short-term maturity instruments.

Further, exposure limits on FPI investment in corporate bonds have also been introduced. The relevant extract of the circular is reproduced herein below:

“(e) Single/Group investor-wise limit in corporate bonds

FPI investment in corporate bonds shall be subject to the following requirements:

(i) Investment by any FPI, including investments by related FPIs, shall not exceed 50% of any issue of a corporate bond. In case an FPI, including related FPIs, has invested in more than 50% of any single issue, it shall not make further investments in that issue until this stipulation is met.

(ii) No FPI shall have an exposure of more than 20% of its corporate bond portfolio to a single corporate (including exposure to entities related to the corporate). In case an FPI has exposure in excess of 20% to any corporate (including exposure to entities related to the corporate), it shall not make further investments in that corporate until this stipulation is met. A newly registered FPI shall be required to adhere to this stipulation starting no later than 6 months from the commencement of its investments.”

Prior to change, FPIs were only permitted to invest in corporate bonds with minimum residual maturity of three years or above. Pursuant to the recent amendment, FPIs are permitted to invest in corporate bonds with minimum residual maturity of above one year. Further, investments by an FPI in corporate bonds with residual maturity below one year shall not exceed, at any point in time, 20% of the total investment of that FPI in corporate bonds. Also, on a whole, the investment by an FPI including related FPIs cannot be more than 50% of any issue of corporate bonds.The major issues that need to be specifically emphasized on are –

  1. whether pass through certificates (PTCs) issued by special purpose trust (SPV), under a securitization transaction, would qualify to be a corporate bond,
  2. whether, residual maturity norms shall apply in case of SDIs, and
  3. whether investment made in the PTCs issued by the SPV be treated as an exposure on the originator and will it fall under the aforesaid concentration limits.

Firstly, it is pertinent to note that the concentration limits are for issuance of corporate bonds. In case securities are issued by an SPV, the same does not fall under the category of corporate bond. Para 21(1) of the SEBI (Foreign Portfolio Investors) Regulations, 2014[5] provides a list of instruments in which FPIs can invest. The list originally included corporate securities like non-convertible debentures/bonds, shares, securities etc. issued by an Indian company. However, subsequently the regulations were amended to include securitised debt instruments issued by SPVs. It can be argued, the very intention of including the SDIs was because the instruments were not originally covered under items provided therein. Therefore, it can be safely concluded that SDIs cannot be considered as corporate bonds.

Since, SDIs are not considered as corporate bonds itself, the residual maturity limit shall also not be applicable. Hence, investment by FPIs in securitised debt instruments shall not be subjected to the minimum residual maturity requirement.

Secondly, in securitization transactions, the originator sells the receivables to the SPV on true sale and non-recourse basis. The SPV issues PTCs on a private placement basis, backed by the receivables owned by the SPV and the investors subscribes to the PTCs. The exposure of the investor is on the SPV and ultimately on the underlying receivables and not on the originator, save and except for any credit enhancement provided for the transaction which puts an obligation on the originator.

Moreover, the priority sector lending (PSL) requirements of commercial banks are also fulfilled by investing in PTCs, wherein there is a see-through approach. The regulators do not look at the PTC as a security of the issuer, but consider it based on a see-through approach for complying with the PSL requirements. Therefore, investments made in PTCs cannot be considered as exposure on the originator.

 

 


 

[1] https://www.sebi.gov.in/sebi_data/attachdocs/1488197031529.pdf

[2] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=10718&Mode

[3] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11266&Mode=0

[4] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11268&Mode=0

[5] https://www.sebi.gov.in/legal/regulations/apr-2017/sebi-foreign-portfolio-investors-regulations-2014-last-amended-on-march-6-2017-_34690.html

Indian Valuation Standards: Standardizing the rules of valuation in India

Property Share Business Models in India

By Vishes Kothari (vishes@vinodkothri.com)

Real estate suffers from the paradox of being a much sought after mode of investment which is at the same time illiquid, has high investment threshold and is difficult to adminster and manage. However technology can provide newer and more efficient ways of investing smaller amounts into co-ownership of property.

Property sharing is a concept which has caught in various developed economies and is now beginning to gain traction in Indian markets. The startup sets up a portal where individuals can get together to buy a property, enjoy the rentals it generates and finally be able to sell their share when they want, thus enjoying capital gains. The management of the property has to be done by the startup itself.

Various models can be constructed to devise a method whereby a group of individuals collectively owns a property, divides the rental revenues among its members and nominates a single entity to manage and adminster the property on it’s behalf.

Of course, there already are vehicles which have been envisaged for shared property investment- namely Real Estate Investment Trusts (REITs). However REITs are suited towards large scale investments in commercial real estate.. REITs must be publicly listed.The minimum issue size for a REIT is 500 crores. Thus REITs are not suitable for shared investment in say, a small office or a 2 BHK. Hence a business model using an alternative instrument must be devised.

What must be the features of such a business model?

The nomination of another entity to manage and adminster the property is a sensitive issue legally. The model must be so devised that only the management and adminstration of the property is handed over to the entity. The moment the management of moneys is handed over to the entity and/or a certain rate of return on this money is promised, it would classify as investment activity. Any such entity which is taking on investment activity on behalf of others would fall under the regulatory purview of SEBI and would require prior registration as Alternative Investment Fund (AIF) or a Collective Investment Scheme (CIS).  These are defined by SEBI as follows:

“Alternative Investment Fund or AIF means any fund established or incorporated in India which is a privately pooled investment vehicle which collects funds from sophisticated investors, whether Indian or foreign, for investing it in accordance with a defined investment policy for the benefit of its investors.”

“Any scheme or arrangement made or offered by any company under which the contributions, or payments made by the investors, are pooled and utilised with a view to receive profits, income, produce or property, and is managed on behalf of the investors is a CIS.“

Thus the three critical features of an AIF are: (a) pooling of money; (b) entrustment of money to someone such that the investors are not the ones who are managing their own money; and (c) Contribution by investors with a view to receive profits[1].  A CIS is, in addition, publicly offered.

A possible business model could be as follows:

  • A particular property is listed, say for, Rs. 1 crore on a portal.
  • 10 buyers are required, each paying Rs. 10 lakh.
  • Once 10 such buyers indicate their willingness to invest on the portal, they together form an LLP/ Company with each buyer holding equal stake/partnership interest in the entity. Let us call this entity E. The incorporation process has to be facilitated by the portal itself.
  • E now acquires the property.
  • E must hand over the management and administration of the property to the portal, via, say a Power of Attorney arrangement.
  • The portal now manages the property on behalf of E, rentals flow upstream to E and are divided equally among its stakeholders.
  • If at any point of time any of the stakeholders wishes to sell his stake and is able to find a potential buyer for his stake at a mutually agreeable price; then the equity/partnership interest gets transferred to the new buyer.

The questions arises- does the portal fall under the definition of an AIF/CIS ? We now analyse each of the 3 conditions to qualify as an AIF separately:

  1. Pooling of Money:  AIF involves pooling of money by the investors for a particular property collectively owned by the investors themselves. In the present situation, entity E owns the property, while the Portal manages/administers the property. Hence the Portal does not hold the funds itself during any part of the process.
  2. Distancing of ownership and management of the funds: The Portal is being appointed with the sole intention of managing the apartments in the interests of the shareholders of the entity E, and is not involved with the making of any investment decisions or administration of investor funds. The investment decision has already been made by the owners when they decide to invest in the property.
  3. No guaranteed profit or rate of return: There is no guaranteed profit or rate of return. Revenues come from rentals as well as from sale of apartments. Both these revenue streams are market dependent and the portal will not make any promise or advertisement concerning rates of return.

Thus the portal is not going to fall under the definition of an AIF. While the portal is a publicly accessible website, since at no point does the portal take control of the funds, it would not qualify as a CIS.

The notion that property ownership can flow from holding equity/partnership interest in a company/LLP finds validation in the Hill Properties Ltd vs Union Bank of India (1975) ruling pronounced by the Supreme Court, if the Articles of Association of the Company provide for this. Moreover, this right can be sold, hypothecated or mortgaged. Thus, it follows that owners of equity/partnership interest in the Company/LLP will become fractional owners of the property. Moreover they can resell their share, hypothecate it or mortgage it.

Stamp duty Issues

  1. Stamp duty is applicable when the property is bought by E.
  2. If the property owners’ interest is regarded as fractional ownership interest in the property, then the fractional interest itself amounts to immovable property. Note that the definition of immovable property as given in Stamp Act includes any interest in immovable property as well. On the contrary, if E is a body corporate, and the fractional owner is transferring the shares/ownership interest in the body corporate, there is no question of any stamp duty as applicable to immovable property. At best the stamp duty applicable on sale of shares/ownership interest may be applicable, which also may be avoided if the shares are in demat format.
  3. Should the entity E decide to sell the property in its entirety, then stamp duty will be applicable.

 

Transitory liberalisation of asset classification norms for MSMEs

by Yutika Lohia and Anita Baid (finserv@vinodkothari.com)

With the advent of GST in the Indian economy, all three sectors i.e. Agriculture, Industry and Service, have been facing several challenges. Majority of small entities in the country have been impacted in some way or the other, irrespective of whether they required registration under GST or not. MSMEs requiring registration faced difficulties due to disruption of their business for ensuring compliance with the new regime. Even unregistered MSMEs faced complications as they were dealing with businesses which were directly disrupted due to GST implementation eventually effecting their cash flows to honour financial obligations. In response to the worries of small enterprise, the government has introduced several relaxation so as to enable them to adopt themselves with the revolutionary change of indirect taxation scheme being implemented in the country. Certainly the cash flows of the micro, small, medium enterprises (MSMEs) sector has been adversely affected with this new GST regime and such entities whether registered or not under GST, who have taken financial assistance are definitely facing problems to pay off their debts. Read more

GST on assignment of receivables: Wrong path to the right destination

Team Vinod Kothari Consultants P. Ltd

 

There has been a lot of uncertainty on the issue of exigibility of direct assignments and securitisation transactions to goods and services tax (GST). While on one hand, there have been opinions that assignments of secured debts may be taxable being covered by the circuitous definition of “actionable claims”, there are other views holding such assignments of debts (secured or unsecured) to be non-taxable since an obligation to pay money is nothing but money, and hence, not  “goods” under the GST law[1]. The uncertainty was costing the market heavily[2].

In order to put diverging views to rest, the GST Council came out with a set of Frequently Asked Questions on Financial Services Sector[3], trying to clarify the position of some arguable issues pertaining to transactions undertaken in the financial sector. These FAQs include three separate (and interestingly, mutually unclear) questions on – (a) assignment or sale of secured or secured debts [Q.40], (b) whether assignment of secured debts constitutes a transaction in money [Q.41], and (c) securitisation transactions undertaken by banks [Q.65].

The end-result arising out of these questions is that there will be no GST on securitisation transactions. However, the GST Council has relied on some very intriguing arguments to come to this conclusion – seemingly lost between the meaning of “derivatives”, “securities”, and “actionable claims”. If one does not care about why we reached here, the conclusion is most welcome. However, the FAQs also reflect the serious lack of understanding of financial instruments with the Council, which may potentially create issues in the long run.

In this note[4] we intend to discuss the outcome of the FAQs, but before that let us first understand what the situation of the issue was before this clarification.

Situation before the clarification

  1. GST is chargeable on supply of goods or services or both. Goods have been defined in section 2(52) of the CGST Act in the following manner:

“(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 have been defined in section 2(102) of the CGST Act oin in the following manner:

““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;”

Money, is therefore, excludible from the scope of “goods” as well as “services”.

Section 7 details the scope of the expression “supply”. According to the section, “supply” includes “all forms of supply of goods or services or both such as sale, transfer, barter, exchange, licence, 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 in Schedule III of the said Act shall not be considered as “supply”.

It may be noted here that “Actionable claims, other than lottery, betting and gambling” are enlisted in entry 6 of Schedule III of the said Act; therefore are not exigible to GST.

  1. There is no doubt that a “receivable” is a movable property. “Receivable” denotes something which one is entitled to receive. Receivable is therefore, a mirror image for “debt”. If a sum of money is receivable for A, the same sum of money must be a debt for B. A debt is an obligation to pay, a receivable is the corresponding right to receive.

Coming to the definition of “money”, it has been defined under section 2(75) as follows –

““money” means the Indian legal tender or any foreign currency, cheque, promissory note, bill of exchange, letter of credit, draft, pay order, traveller cheque, money order, postal or electronic remittance or any other instrument recognised by the Reserve Bank of India when used as a consideration to settle an obligation or exchange with Indian legal tender of another denomination but shall not include any currency that is held for its numismatic value.”

The definition above enlists all such instruments which have a “value-in-exchange”, so as to represent money. A debt also represents a sum of money and the form in which it can be paid can be any of these forms as enlisted above.

So, in effect, a receivable is also a sum of “money”. As such, receivables shall not be considered as “goods” or “services” for the purpose of GST law.

  1. As mentioned earlier, “actionable claims” have been included in the definition of “goods” under the CGST Act, however, any transfer (i.e. supply) of actionable claim is explicitly excluded from being treated as a supply of either goods or services for the purpose of levy of GST.

Section 2(1) of the CGST Act defines “actionable claim” so as to assign it the same meaning as in section 3 of the Transfer of Property Act, 1882, which in turn, defines “actionable claim” as –

“actionable claim” means a claim to any debt, other than a debt secured by mortgage of immovable property or by hypothecation or pledge of movable property, or to any beneficial interest in movable property not in the possession, either actual or constructive, of the claimant, which the civil courts recognise as affording grounds for relief, whether such debt or beneficial interest be existent, accruing, conditional or contingent;”

It may be noted that the inclusion of “actionable claim” is still subject to the exclusion of “money” from the definition of “goods”. The definition of actionable claim travels beyond “claim to a debt” and covers “claim to any beneficial interest in movable property”. Therefore, an actionable claim is definitely more than a “receivable”. Hence, if the actionable claim represents property that is money, it can be held that such form of the actionable claim shall be excluded from the ambit of “goods”.

There were views in the industry which, on the basis of the definition above, distinguish between — (a) a debt secured by mortgage of immovable property, and a debt secured by hypothecation/pledge of movable property on one hand (which are excluded from the definition of actionable claim); and (b) an unsecured debt on the other hand. However, others opined that a debt, whether secured or unsecured, is after all a “debt”, i.e. a property in money; and thus can never be classified as “goods”. Therefore, the entire exercise of making a distinction between secured and unsecured debt may not be relevant at all.

In case it is argued that a receivable which is secured (i.e. a secured debt) shall come within the definition of “goods”, it must be noted that a security granted against a debt is merely a back-up, a collateral against default in repayment of debt.

  1. In one of the background materials on GST published by the Institute of Chartered Accountants of India[5], it has been emphasised that a transaction where a person merely slips into the shoes of another person, the same cannot be termed as supply. As such, unrestricted expansion of the expression “supply” should not be encouraged:

“. . . supply is not a boundless word of uncertain meaning. The inclusive part of the opening words in this clause may be understood to include everything that supply is generally understood to be PLUS the ones that are enlisted. It must be admitted that the general understanding of the world supply is but an amalgam of these 8 forms of supply. Any attempt at expanding this list of 8 forms of supply must be attempted with great caution. Attempting to find other forms of supply has not yielded results however, transactions that do not want to supply have been discovered. Transactions of assignment where one person steps into the shoes of another appears to slip away from the scope of supply as well as transactions where goods are destroyed without a transfer of any kind taking place.”

Also, as already stated, where the object is neither goods nor services, there is no question of being a supply thereof.

  1. Therefore, there was one school of thought which treated as assignment of secured receivables as a supply under the GST regime and another school of thought promoted a view which was contrary to the other one. To clarify the position, representations were made by some of the leading bankers and the Indian Securitisation Foundation.

Situation after the clarification

  1. The GST Council has discussed the issue of assignment and securitisation of receivables through different question, extracts have been reproduced below:

 

  1. Whether assignment or sale of secured or unsecured debts is liable to GST?

Section 2(52) of the CGST Act, 2017 defines ‘goods’ to mean every kind of movable property other than money and securities but includes actionable claim. Schedule III of the CGST Act, 2017 lists activities or transactions which shall be treated neither as a supply of goods nor a supply of services and actionable claims other than lottery, betting and gambling are included in the said Schedule. Thus, only actionable claims in respect of lottery, betting and gambling would be taxable under GST. Further, where sale, transfer or assignment of debts falls within the purview of actionable claims, the same would not be subject to GST.

Further, any charges collected in the course of transfer or assignment of a debt would be chargeable to GST, being in the nature of consideration for supply of services.

  1. Would sale, purchase, acquisition or assignment of a secured debt constitute a transaction in money?

Sale, purchase, acquisition or assignment of a secured debt does not constitute a transaction in money; it is in the nature of a derivative and hence a security.

  1. What is the leviability of GST on securitization transactions undertaken by banks?

Securitized assets are in the nature of securities and hence not liable to GST. However, if some service charges or service fees or documentation fees or broking charges or such like fees or charges are charged, the same would be a consideration for provision of services related to securitization and chargeable to GST.

 

  1. The fallacy starts with two sequential and separate questions: one dealing with securitisation and the other on assignment transactions. There was absolutely no need for incorporating separate questions for the two, since all securitisation transactions involve an assignment of debt.

 

  1. Next, the department in Question 40 has clarified that the assignment of actionable claims, other than lottery, betting and gambling forms a part of the list of exclusion under Schedule III of the CGST Act, therefore, are not subject to GST. This was apparent from the reading of law, therefore, there is nothing new in this.

 

However, the second part of the answer needs further discussion. The second part of the answer states that – any charges collected in the course of transfer or assignment of a debt would be chargeable to GST, being in the nature of consideration for supply of services.

There are multiple charges or fees associated in an assignment or securitisation transaction – such as  servicing fees or excess spread. While it is very clear that the GST will be chargeable on servicing fees charged by the servicer, there is still a confusion on whether GST will be charged on the excess spread or not. Typically, transactions are devised to give residuary sweep to the originator after servicing the PTCs. Therefore, there could be a challenge that sweep right is also a component of servicing fees or consideration for acting as a servicing agent. The meaning of consideration[6] under the CGST Act is consideration in any form and the nomenclature supports the intent of the transaction.

Since, the originator gets the excess spread, question may arise, if excess spread is in the nature of interest.  This indicates the need for proper structuring of transactions, to ensure that either the sweep right is structured as a security, or the same is structured as a right to interest. One commonly followed international structure is credit-enhancing IO strip. The IO strip has not been tried in Indian transactions, and recommendably this structure may alleviate concerns about GST being applied on the excess spread.

  1. Till now, whatever has been discussed was more or less settled before the clarification, question 41 settles the dispute on the contentious question of whether GST will be charged on assigned of secured debt. The answer to question 41 has compared sale, purchase, acquisition or assignment of secured debt with a derivative. The answer has rejected the view, held by the authors, that any right to a payment in money is money itself. The GST Council holds the view that the receivables are in the nature of derivatives, the transaction qualifies to be a security and therefore, exempt from the purview of supply of goods or supply of services.

While the intent of the GST Council is coming out very clear, but this view is lacking supporting logic. Neither the question discusses why assignments of secured receivables are not transactions in money, nor does it state why it is being treated as derivative.

Our humble submission in this regard is that assignment of secured receivables may not be treated as derivatives. The meaning of the term “derivatives” have been drawn from section 2(ac) of the Securities Contracts (Regulation) Act, 1956, which includes the following –

(A) a security derived from a debt instrument, share, loan, whether secured or unsecured, risk instrument or contract for differences or any other form of security;

(B) a contract which derives its value from the prices, or index of prices, of underlying securities.

In the present case, assignment of receivables do not represent any security nor does it derive its value from anything else. The receivables themselves have an inherent value, which get assigned, the fact that it is backed a collateral security does not make any difference as the value of the receivables also factor the value of the underlying.

Even though the logic is not coming out clear, the intent of the Council is coming out clearly and the efforts made by the Council to clear out the ambiguities is really commendable.

 


[1] Refer: GST on Securitisation Transactions, by Nidhi Bothra, and Sikha Bansal, at  http://vinodkothari.com/blog/gst-on-securitisation-transactions-2/; pg. last visited on 06.06.2018

[2] At the recently concluded Seventh Securitisation Summit on 25th May, 2018, one leading originator confirmed that his company had kept transactions on hold in view of the GST uncertainty. It was widely believed that the dip in volumes in FY 2017-18 was primarily due to GST uncertainty.

[3] http://www.cbic.gov.in/resources//htdocs-cbec/gst/FAQs_on_Financial_Services_Sector.pdf

[4] Portions of this note have been adopted from the article – GST on Securitisation Transactions, by Nidhi Bothra and Sikha Bansal.

[5] http://idtc-icai.s3.amazonaws.com/download/pdf18/Volume-I(BGM-idtc).pdf; pg. last visited on 19.05.2018

[6] (31) “consideration” in relation to the supply of goods or services or both includes––

(a) any payment made or to be made, whether in money or otherwise, in respect of, in response to, or for the inducement of, the supply of goods or services or both, whether by the recipient or by any other person but shall not include any subsidy given by the Central Government or a State Government;

(b) the monetary value of any act or forbearance, in respect of, in response to, or for the inducement of, the supply of goods or services or both, whether by the recipient or by any other person but shall not include any subsidy given by the Central Government or a State Government:

Provided that a deposit given in respect of the supply of goods or services or both shall not be considered as payment made for such supply unless the supplier applies such deposit as consideration for the said supply;

Governmment NBFCs to stand on equal footing

 

Anita Baid, Senior Manager (anita@vinodkothari.com)
Rajeev Jhawar, Executive (finserv@vinodkothari.com)

 

Section 2(45) of the Companies Act, 2013 defines a Government Company as –

“any company in which not less than fifty-one per cent of the paid-up share capital is held by the Central Government, or by any State Government or Governments, or partly by the Central Government and partly by one or more State Governments, and includes a company which is a subsidiary company of such a Government company.”

A Government Company registered with the Reserve Bank of India (RBI) as a Non-Banking Finance Company (NBFC) is referred to as Government-owned NBFC or Government NBFC. As on March 2017, the count of Government NBFCs-NDSI was around 15 with an asset size of Rs.6280 billions and there were 2 deposit accepting NBFCs with an asset size of Rs.273 billion[1]. These Government NBFCs were earlier exempted from various regulatory and statutory provisions issued by the RBI for NBFCs.

In view of a regulatory regime for the financial sector, it has been a long drawn proposal of RBI to bring all deposit taking and systemically important government owned companies under the provisions of the same guidelines. Considering the same the RBI has eliminated regulatory exemptions for government-owned NBFCs vide its notification no. DNBR (PD) CC.No.092/03.10.001/2017-18 dated May 31, 2018[2]. The RBI has specified a roadmap, extending till 2021-22, for the Government NBFCs to meet the norms on capital adequacy, provisioning and corporate governance at par with the other NBFCs. The NBFC regulations shall be applicable to Government NBFCs as per the timeline indicated in the notification.

Previously, Government NBFCs were advised vide DNBS.PD/CC.No. 86/03.02.089/2006-07 dated December 12, 2006 to submit to the Reserve Bank [Department of Non-Banking Supervision – (DNBS)] a road map for compliance with the various elements of the NBFC regulations, in consultation with the Government. Hence, the current notification provides that Government NBFCs that are already complying with the prudential regulation as per the road map submitted by them shall continue to follow the same.

We have tried to list down the major provisions and the applicability on Government NBFCs post the withdrawal of exemption:

Relevant provision With exemption Without exemption
Reserve Bank of India Act, 1934
Sections 45-IB

Maintenance of percentage of assets – 15% of the outstanding deposits

Not required Government NBFCs will be required to maintain a percentage of asset as investment in unencumbered approved securities as per the following timeline:

 

March 31, 2019 – 5% of outstanding deposits

March 31, 2020 – 10% of outstanding deposits

March 31, 2021 – 12% of outstanding deposits

March 31, 2022 – 15% of outstanding deposits

 

Section 45-IC

Every non-banking financial company shall create a reserve fund and transfer therein a sum not less than twenty per cent of its net profit every year as disclosed in the profit and loss account and before any dividend is declared.

Not required By March 31, 2019, the Government NBFCs shall be required to transfer at least 20% of its net profit to the statutory reserve fund
Master Direction – Non-Banking Financial Company – Systemically Important Non-Deposit taking Company and Deposit taking Company (Reserve Bank) Directions, 2016
Income Recognition

The income recognition shall be based on recognized accounting principles. The income recognition shall be based on recognized accounting principles. Income including interest/ discount/ hire charges/ lease rentals or any other charges on NPA shall be recognized only when it is actually realized. Any such income recognized before the asset became non-performing and remaining unrealized shall be reversed.

Not Required Government NBFC-SI and deposit taking, will be required to recognize income in accordance with accounting principles for FY ending March 31, 2019.
Asset Classification

An asset, in respect of which, interest has remained overdue for a period of 90 days or more shall be classified as NPA.

Not Required Government NBFC-SI and deposit taking shall classify an asset as a NPA if the interest has remained overdue for a period of

1.       120 days or more for the financial year ending March 31, 2019

2.       90 days or more for the financial year ending March 31, 2020 and thereafter.

 

Provisioning Requirement

Every applicable NBFC shall make provisions for

·         standard assets at 0.40 per cent by the end of March 2018 and thereafter of the outstanding, which shall not be reckoned for arriving at net NPAs.

·         loss asset: the entire asset shall be written off.

·         sub-standard assets: A general provision of 10 percent of total outstanding shall be made.

·         doubtful asset: 100% provision to the extent to which the advance is not covered by the realizable value of the security to which the applicable NBFC has a valid recourse shall be made. The realizable value is to be estimated on a realistic basis and also

Period for which the asset has been considered as doubtful
Up to one year 20%
One to three years 30%
More than three years 50%

 

 

Not Required Government NBFC-SI and deposit taking, will be required to comply with the prescribed requirement in totality for the financial year ending March 31, 2019 and thereafter.
Capital Adequacy

The NBFC shall maintain CRAR of 15 percent (with a minimum Tier I capital of 10 percent)

Not Required Government NBFC-SI and deposit taking will have to comply with capital adequacy ratio as mentioned in the table below:

CRAR of 10% (min Tier I – 7%;  March 31, 2019
CRAR of 12% (min Tier I – 8%) March 31, 2020
CRAR of 13% (min Tier I – 9%) March 31, 2021
CRAR of 15% (min Tier I – 10%) March 31, 2022

 

 

Concentration of Credit Investment

No applicable NBFC shall,

(i) lend to

(a) any single borrower exceeding fifteen per cent of its owned fund; and

(b) any single group of borrowers exceeding twenty-five per cent of its owned fund;

(ii) invest in

(a) the shares of another company exceeding fifteen per cent of its owned fund; and

(b) the shares of a single group of companies exceeding twenty-five per cent of its owned fund; (iii) lend and invest

(loans/investments taken together) exceeding (a) twenty five per cent of its owned fund to a single party; and (b) forty per cent of its owned fund to a single group of parties.

 Not Required Government NBFCs, set up to serve specific sectors may approach the RBI for exemptions, if any.

 

For other NBFC-SI and deposit taking, the timeline for ensuring the compliance is FY March 31, 2022

Corporate Governance

All applicable NBFCs shall adhere to following requirements in order to ensure good corporate governance

·         Formation of various committees

·         Fit and proper criteria for directors

·         Disclosure and Transparency

·         Rotation of partners of the Statutory Auditors Audit Firm

·         Framing of Internal Guidelines

Not required Government NBFC-SI and deposit taking, are required to adhere to corporate governance guidelines for the financial year March 31, 2019 and thereafter.
Conduct of Business Regulations (Fair Practices Code) Not required Government NBFC-SI and deposit taking, are required to adhere to fair practices code for the financial year March 31, 2019 and thereafter.
Master Direction – Non-Banking Financial Company – Non-Systemically Important Non-Deposit taking Company (Reserve Bank) Directions, 2016
Income Recognition

The income recognition shall be based on recognized accounting principles. Income including interest/ discount/ hire charges/ lease rentals or any other charges on NPA shall be recognized only when it is actually realized. Any such income recognized before the asset became non-performing and remaining unrealized shall be reversed.

Not Required Government NBFC-NSI will be required to recognize income in accordance with accounting principles dated March 31,2019
Asset Classification

An asset, in respect of which, interest has remained overdue for a period of 180 days or more shall be classified as NPA.

Not Required Government NBFC-NSI shall classify an asset as a NPA if the interest has remained overdue for a period of

1.       180 days or more for the financial year ending March 31, 2019 and thereafter.

 

Leverage Ratio

The leverage ratio of an applicable NBFC shall not be more than 7 at any point of time, with effect from March 31, 2015.

Not Required A roadmap for adherence by March 31, 2022 to be prepared by the Government NBFC-NSI.
Master Direction – Non-Banking Financial Companies Acceptance of Public Deposits (Reserve Bank) Directions, 2016
Minimum Credit Rating

To get rated by approved Credit Rating Agencies

Not Required Government NBFC-D shall obtain Investment Grade Credit rating for acceptance of public deposits- March 31, 2019.

 

A Government NBFC-D having investment grade credit rating can accept deposits only up to 1.5 times of its NOF. Government NBFCs holding deposits in excess of the limit shall not access fresh deposits or renew existing ones till they conform to the limit, the existing deposits will be allowed to run off till maturity.

Other Deposit Directions Not required All other directions shall apply from Balance Sheet dated March 31, 2019.

 

The removal of exemption benefits for Government NBFCs shall ensure that both types of NBFCs stand at par in terms of compliance with specific RBI regulations. This would also result in intensifying the competition between the two types of ownership structures.


[1] RBI Annual Publication- Trend and Progress of Banking in India

[2] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11283&Mode=0

Sudden prohibition for CA Valuers

By Yutika Lohia, (yutika@vinodkothari.com) (finserv@vinodkothari.com)

Introduction

The income tax laws of our country have witnessed a lot vicissitudes over the years. Responding to the changing reforms as well as practices, the law makers have always tried to pace up with the dynamic economy. Chartered Accountants, in India, are widely accepted as tax professionals and in that capacity they play a very important role in the comprehending the income tax laws for the commoners. But a recent change by the IT Department would certainly not please the CA fraternity in the country. Read more

GST on Securitisation Transactions

Nidhi Bothra

Sikha Bansal

finserv@vinodkothari.com

Transitioning into GST, assessing its impact on business and taking appropriate measures to bring about tax neutrality/ efficiency are the prime concern for all and sundry. GST also has an impact on the securitisation transactions in India which now happens to be Rs. 84,000 crores odd industry. In this Chapter we are broadly trying to deal with GST impact on securitisation of standard as well as non-performing assets and its various facets.

In India, securitisation is undertaken through the PTC route (issuance of pass-through certificates or direct assignments. The distinction is not relevant when we talk about securitisation of non-performing assets through asset reconstruction companies.

A.  GST implications on PTC transactions

The implications of GST will have to be mulled over at each stage of the securitisation  transaction. A securitisation transaction will have the following facets:

  1. Assignment of receivables by the originator to an SPV
  2. SPV acquiring receivables on discount
  3. SPV issuing PTCs to investors and servicing PTCs over the term
  4. Originator receives servicing fees for collections/ recovery of receivables
  5. Originator receives excess interest spread (EIS) in the transaction after servicing of the investors with the receivables collected.

There is one more issue of whether the SPV will be considered as a related person as defined under the CGST Act.

Below is a detailed analysis.

i.          Requisites of Taxability under GST

Section 9 of the CGST Act provides for levy and collection of CGST on all intra-State supplies of goods or services or both.

Hence, there must be “goods” or “services” or “both”, and the same shall be supplied.

“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;”

Money, is therefore, excludible from the scope of “goods” as well as “services”.

Section 7 details the scope of the expression “supply”. According to the section, “supply” includes “all forms of supply of goods or services or both such as sale, transfer, barter, exchange, licence, 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 in Schedule III of the said Act shall not be considered as “supply”.

It may be noted here that “Actionable claims, other than lottery, betting and gambling” are enlisted in entry 6 of Schedule III of the said Act; therefore are not exigible to GST.

The discussion below studies the nature of “receivables” and seeks to determine whether assignment of receivables will be treated as a supply of goods or services within the purview of the GST law.

Nature of “Receivables”

There is no doubt that a “receivable” is a movable property. “Receivable” denotes something which one is entitled to receive. Receivable is therefore, a mirror image for “debt”. If a sum of money is receivable for A, the same sum of money must be a debt for B. A debt is an obligation to pay, a receivable is the corresponding right to receive.

A “debt” is a sum of money which is now payable or will become payable in the future by reason of a present obligation, depitum in praesenti, solvendum in future.  See, Web v. Stendon, (1883) 11 Q.B.D. 518, 572; Kesoram Industries and Cotton Mills Ltd. v. CWT, 1966 AIR 1370 : 1966 SCR (2) 688.

Coming to the definition of “money”, it has been defined under section 2(75) as follows –

“money” means the Indian legal tender or any foreign currency, cheque, promissory note, bill of exchange, letter of credit, draft, pay order, traveller cheque, money order, postal or electronic remittance or any other instrument recognised by the Reserve Bank of India when used as a consideration to settle an obligation or exchange with Indian legal tender of another denomination but shall not include any currency that is held for its numismatic value.”

The definition above enlists all such instruments which have a “value-in-exchange”, so as to represent money. A debt also represents a sum of money and the form in which it can be paid can be any of these forms as enlisted above.

So, in effect, a receivable is also a sum of “money”. As such, receivables shall not be considered as “goods” or “services” for the purpose of GST law.

ii.  Receivables vis-à-vis Actionable Claims

As mentioned earlier, “actionable claims” have been included in the definition of “goods” under the CGST Act, however, any transfer (i.e. supply) of actionable claim is explicitly excluded from being treated as a supply of either goods or services for the purpose of levy of GST.

Section 2(1) of the CGST Act defines “actionable claim” so as to assign it the same meaning as in section 3 of the Transfer of Property Act, 1882, which in turn, defines “actionable claim” as –

“actionable claim” means a claim to any debt, other than a debt secured by mortgage of immovable property or by hypothecation or pledge of movable property, or to any beneficial interest in movable property not in the possession, either actual or constructive, of the claimant, which the civil courts recognise as affording grounds for relief, whether such debt or beneficial interest be existent, accruing, conditional or contingent;”

It may be noted that the inclusion of “actionable claim” is still subject to the exclusion of “money” from the definition of “goods”. The definition of actionable claim travels beyond “claim to a debt” and covers “claim to any beneficial interest in movable property”. Therefore, an actionable claim is definitely more than a “receivable”. Hence, if the actionable claim represents property that is money, it can be held that such form of the actionable claim shall be excluded from the ambit of “goods”.

There are views which, on the basis of the definition above, distinguish between — (a) a debt secured by mortgage of immovable property, and a debt secured by hypothecation/pledge of movable property on one hand (which are excluded from the definition of actionable claim); and (b) an unsecured debt on the other hand. However, the author opines that a debt, whether secured or unsecured, is after all a “debt”, i.e. a property in money; and thus can never be classified as “goods”. Therefore, the entire exercise of making a distinction between secured and unsecured debt may not be relevant at all.

In case it is argued that a receivable which is secured (i.e. a secured debt) shall come within the definition of “goods”, it must be noted that a security granted against a debt is merely a back-up, a collateral against default in repayment of debt.

iii.   Assignment of receivables as “Supply”

Though, the fact that a debt is merely a representation of “money” and therefore there is no question of any “supply” under the GST law, yet it is important to study the scope of the word “supply” in this context.

In one of the background materials on GST published by the Institute of Chartered Accountants of India[1], it has been emphasised that a transaction where a person merely slips into the shoes of another person, the same cannot be termed as supply. As such, unrestricted expansion of the expression “supply” should not be encouraged:

“. . . supply is not a boundless word of uncertain meaning. The inclusive part of the opening words in this clause may be understood to include everything that supply is generally understood to be PLUS the ones that are enlisted. It must be admitted that the general understanding of the world supply is but an amalgam of these 8 forms of supply. Any attempt at expanding this list of 8 forms of supply must be attempted with great caution. Attempting to find other forms of supply has not yielded results however, transactions that do not want to supply have been discovered. Transactions of assignment where one person steps into the shoes of another appears to slip away from the scope of supply as well as transactions where goods are destroyed without a transfer of any kind taking place.”

A simple example of assignment of receivable is – A sells goods to B. B owes a certain sum of money to A. This sum of money is “receivable” in the hands of A. A has the right to get that sum from B. A decides to pass that right to C. He therefore, assigns the receivable to C, for a certain consideration. Therefore, A is actually passing on the benefits under the contract with B, to C. C is merely stepping into the shoes of A. There is no separate supply as such.

Also, as already stated, where the object is neither goods nor services, there is no question of being a supply thereof.

iv.     Servicing Fees

Typical to a securitisation transaction is that the originator continues to do the collection of receivables from the obligors for and on behalf of the SPV. The originator, therefore acts as a servicing agent and charges a servicing fees.

Under the current tax regime, servicing fees was subject to 15% service tax, charged by the originator to the SPV. The SPV would typically not be able to claim set off and this would be a sunk cost.

This cost under the GST regime goes up to 18%. Therefore if the servicing fee is 50 basis points, the increase in cost is 9 basis points. Since SPV cannot claim the set off, the GST is a dead loss.

In India, the typical servicing fee charged is 25 basis points. Whether or not the consideration for taxable supply of service is reasonable would depend upon the type of a pool. For instance, if the pool is a microfinance pool or a granular pool, it may not seem reasonable to charge a servicing of 25 bps as against a car loan pool. Therefore, where the servicing fee does not seem at arm’s-length, it may be challenged that servicing fees is not adequate consideration or the only consideration for collection of receivables.

Further, if it was to be contested that the SPV is a related person to the originator as defined under the CGST Act, then the servicing fees charged could be subject to valuation rules which will subject the servicing fees to reasonable determination of value of such supply of service by the assessing officer.

v.   SPV a related person?

One of the issues during securitisation transaction structuring is to ensure that an SPV is a distinct entity from legal and accounting perspective. It would be relevant to have independence established of the SPV from tax perspective as well.

The definition of related persons under CGST is as follows:

For the purposes of this Act,––

(a) persons shall be deemed to be “related persons” if––

(i) such persons are officers or directors of one another’s businesses;

(ii) such persons are legally recognised partners in business;

(iii) such persons are employer and employee;

(iv) any person directly or indirectly owns, controls or holds twenty-five per cent. or more of the outstanding voting stock or shares of both of them;

(v) one of them directly or indirectly controls the other;

(vi) both of them are directly or indirectly controlled by a third person;

(vii) together they directly or indirectly control a third person; or

(viii) they are members of the same family;

(b) the term “person” also includes legal persons;

(c) persons who are associated in the business of one another in that one is the sole agent or sole distributor or sole concessionaire, howsoever described, of the other, shall be deemed to be related

One of the ways of establishing that the SPV and the originator are related persons, is by establishing control by the originator. The term control has not been defined under CGST and therefore, one may have to rely on accounting tests for control.

As per the accounting standards, if the originator is controlling the SPV, it would lead to consolidation thereby frustrating the purpose of doing securitisation itself.

So, to avoid consolidation it is pertinent to avoid control by the originator over the SPV. If there is no control, the other parameters for falling into related person definition could be meandered.

However, if the transaction structure was such that control could be established then the transaction is subject to arm’s-length test and valuation rules.

vi. Treatment of EIS component

Another critical issue in structuring securitisation transactions is how the excess interest spread or EIS will be swept by the originator from the transaction. Typically, transactions are devised to give residuary sweep to the originator after servicing the PTCs. Therefore there could be a challenge that EIS is also a component of servicing fees or consideration for acting as a servicing agent. The meaning of consideration[2] under the CGST Act is consideration in any form and the nomenclature supports the intent of the transaction.

Since, the originator gets excess spread, question may arise, if excess spread is in the nature of interest. Therefore it is important to structure excess spread as IO strip.

Going forward it would be rather recommendable that the sweep of excess spread is structured as IO strip. Since it is interest only.

vii.  Servicing of PTCs

Another facet of securitisation transaction that needs attention from GST perspective, is taxability of servicing of coupon and repayment of PTCs. PTCs being securities, servicing of securities is exempt from applicability of GST.

viii.   GST on Securitisation – Global Overview

Since the Indian GST law is largely inspired by EU VAT laws, it would be quite relevant to go through UK and EU precedents pertaining to securitization and factoring transactions. It is important to understand that in every loan sale, securitization, factoring or assignment of receivables, the common thread is the assignment of receivables. Hence, if the assignment of receivables is taken as a “supply”, then, in each of these cases, there would be a question of applying VAT on the entire turnover, that is, the entire consideration involved in the supply of receivables.

In UK, a distinction is drawn between “sale of debt” and “assignment of debt”. The sale of a debt is a financial transaction, whereby the purchaser acquires ownership of debts from a creditor, at a nominal sum to the face value of the debts. The purchaser assumes all the rights and obligations of the original creditor and all legal and beneficial or equitable interest passes to the buyer to whom full title and risk is transferred. However, in an assignment only the equitable interest is passed to the assignee and the assignor retains the legal interest in the debt and any liability to obligations arising from the original contract. Often it will not be possible for the assignee to sell that which has been assigned.

The distinction is akin to the distinction between “assignment of a contract” and “assignment of benefits under contract” as pointed out in the article titled, “Law of Assignment of Receivables”, Vinod Kothari[3].

The sale of a debt is exempt from VAT under the VAT Act 1994, Schedule 9, Group 5, item 1. And, the assignment or re-assignment of a debt is not a supply for VAT purposes[4].

In Finanzamt Gross Gerau v. MKG Kraftfahrzeuge Factory GmbH[5], the European Court of Justice had to examine whether, in case of factoring transaction, VAT was applicable on the entire turnover of receivables, or was it applicable only on the commission charged by the factor for the assumption of the risk of default or other services of the factor. In this ruling, the ECJ held factoring to be an economic activity, by way of exploitation of the debts to earn an income by providing a service to the factor’s clients; however, it is not the debt itself which is a supply, but the commission charged by the factor.

In MBNA Europe Bank v. Revenue and Customs Commissioners[6], (2006) All ER (D) 104 (Sep); [2006] EWHC 2326 (Ch) , the Chancery Court discussed whether a credit card securitization amounts to a taxable supply for VAT purposes.  After elaborate discussion on the nature of securitization, and referring to findings of lower authorities that securitization is nothing but a sophisticated form of borrowing, the Chancery Court held that the assignment of receivables in a securitization was not a supply at all.

The position thus held by Courts is well accepted by the administration itself. UK HMRC’s Internal Manual clearly puts the tax position on securitization as follows:

The assignment of the assets by the originator

The assignment of the receivables by the originator to the SPV is not a supply for VAT purposes. It is simply the fulfilment of a pre- condition so that the SPV can provide its ‘securitisation’ service.

The issue of securities to fund the purchase of the assets

The issue of a security for the purposes of raising capital is not a supply for VAT purposes (see VATFIN4250).

The administration of the assets

The servicer is the entity that deals with the receivables on a day to day basis, administering and collecting them and transferring the funds to the SPV, normally whilst maintaining the original contract with the underlying debtors.  The servicer will receive a fee for this service from the SPV which is generally set at a percentage of the aggregate balance of the loans/receivables or the funds collected. The servicer services are supplies to the SPV in the course of an economic activity and the servicer fee is consideration for that supply.

B.  GST implications on Direct Assignment transactions

In case of direct assignment, as in case of PTCs transaction, the assignment of receivables will be tax exempt (going by the same rationale, as in case of securitisation transactions).

The servicing fees charged to the buyer, would be subject to GST. The only reprieve here being that the buyer would be a bank or an NBFC and would be able to claim set off on the GST levied.

C.  GST implications on sale of Non-Performing Loans (NPLs)

In case of sale of NPLs to an asset reconstruction company (ARC), the receivables are acquired by a trust floated by an ARC. The receivables usually are not on the books of the ARC directly.

In case of ARCs, it would be a very strong contention that the trust of the ARC is a related person to the ARC and therefore the management fees, the carry amount etc charged by the managers would be subject to valuation rules.

With regard to the security receipts (SRs) issued by the ARCs, the taxability of such SRs would be the same as in case of PTCs, as both are securities and therefore not falling under taxable supply.

D. Conclusion

It is established that the GST regime requires mollification in the existing transaction structures such that tax inefficiency in the change of regime can be avoided.

It is important that we understand these nuances to avoid tax litigations at a later stage.

The securitisation industry as gone through several rounds of regulatory changes – some favourable and some not. From change in the regulatory guidelines of RBI to distribution tax applicability and subsequent roll-over. There have been several seasons of changes to come to some momentum as on date.

Therefore it is important to take cognizance of the changes and make the appropriate stitch now to save the nine later!

 

[1] http://idtc-icai.s3.amazonaws.com/download/pdf18/Volume-I(BGM-idtc).pdf; pg. last visited on 19.05.2018

[2] (31) “consideration” in relation to the supply of goods or services or both includes––

(a) any payment made or to be made, whether in money or otherwise, in respect of, in response to, or for the inducement of, the supply of goods or services or both, whether by the recipient or by any other person but shall not include any subsidy given by the Central Government or a State Government;

(b) the monetary value of any act or forbearance, in respect of, in response to, or for the inducement of, the supply of goods or services or both, whether by the recipient or by any other person but shall not include any subsidy given by the Central Government or a State Government:

Provided that a deposit given in respect of the supply of goods or services or both shall not be considered as payment made for such supply unless the supplier applies such deposit as consideration for the said supply;

[3] http://vinodkothari.com/wp-content/uploads/2013/12/Law-of-Assignment-of-Receivables-Vinod-Kothari.pdf; pg. last visited on 19.05.2018

[4] https://www.gov.uk/hmrc-internal-manuals/vat-finance-manual/vatfin3215; pg. last visited on 19.05.2018

[5]http://www.bailii.org/eu/cases/EUECJ/2003/C30501.html; pg. last visited on 19.05.2018

[6] http://www.bailii.org/cgi-bin/markup.cgi?doc=ew/cases/EWHC/Ch/2006/2326.html; pg. last visited on 19.05.2018