As the county moves to GST, we are offering extensive research, trainings, workshops and services to help our clients transition to the new regime.
We anticipate clients in the financial services industry to expect a bouquet of services to enable a smooth transition to the GST. Some of the services we are providing are:
-Impact study of GST: includes studying implications of GST on organizational cash flows
-Assisting in identifying the different benefits that can be availed by the company
-Preparation of detailed checklists for GST administration
-Organizing intermediate and advanced training programs for groups of employees based on specific organizational needs
-Reviewing the existing documentation to ensure that they are aligned with the law
Write to us at gst@vinodkothari.com if you wish to know further details with respect to the above.
For our workshops and training click here
Please drop an email to events@vinodkothari.com to register your interest.
Applicability of GST on penal charges
By Yutika Lohia (yutika@vinodkothari.com), (finserv@vinodkothari.com)
Introduction
The Goods & Services Tax (GST) has been the biggest tax reform in India founded on the notion of ‘one nation, one market, one tax’. It has and will further affect the entire economy including core industries such as agriculture, manufacturing, finance, service, infrastructure etc. The tax reform has been touted to create a significant positive impact on the economy in the long run. Unfortunately however, GST has not been exception to the fact that any big transition faces short term pains. The GST council has been receiving numerous queries and doubts from the myriad industries and trading associations regarding its applicability and nuances on the supply of various goods and services. One such concern had been on the issue of its applicability on additional/penal interest.
Recently the Council came up with a circular on “Clarification regarding applicability of GST on additional / penal interest” on 28th June, 2019[1] to address the issue.
The word “penal”
Black’s law dictionary defines penalty as ‘punishment imposed by statute as a consequence of the commission of a certain specified offense.” Subsequently as such the word “penal” is something relating to or containing a penalty. To put it in perspective, any default in payment of a loan transaction or in the supply of goods or services is liable for a penalty, which may be fixed or variable and thus may be in the name of additional interest or penalty interest, or overdue interest.
In a financial transaction, when there is a delay in the payment of EMI by the customer/borrower, the lender collects penal /default interest as additional interest for the period of delay, determined in days, months or years as per the agreed terms between the two.
Chargeability of GST
Penal charge is levied when there is delayed payment in a money-to-money transaction or when there is a supply of goods or services.
First let us understand whether the penal interest will be included in the value of supply.
As per section 15(2)(d) of the CGST Act, value of supply includes “interest or late fee or penalty for delayed payment of any consideration for any supply.”
Therefore, any interest or penalty paid for delayed payment in the supply of goods or service or a loan transaction shall be included in the value of supply i.e. the consideration amount.
Further, penal charges will not be covered under Schedule II- Activities to be treated as a supply of goods or services in clause 5(e), where supply of services include “agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act”
The expression “to tolerate an act” used in the above clause, should be understood to cover instances where the consideration is being charged by one person in order to allow another person to undertake any particular activity. Therefore it is very clear that at the very inception of the transaction, the intention of one party is to undertake an activity and the other party shall allow the same without any deterrent. To say, the contract is entered to allow the other person to carry out an activity, and not as a penalty or limit the person for carrying out such act in future.
Furthermore, the word “obligation” used in the clause 5(e) of Schedule II where the service recipient requests the service provider to tolerate an act/situation and the service provider obliges to tolerate for a consideration, then such a contractual relationship shall be covered in the above mentioned clause. Therefore it can be said that there is a consensus ad idem between the contracting parties.
Contrary to the above, penal interest/charges are collected only when an event occurs i.e. when there is a default in a payment of a loan transaction or supply of goods/services. The intention of the parties entering into a contract is either to avail the services in way of loan or supply of goods. Penal charges are to be paid if there is a breach in the contract and therefore it does not mean that the parties have entered into a contract for the penal interest.
Therefore penal charges does not fall under the deemed supply list given in Schedule II of the CGST Act.
As penal interest satisfies the definition of “interest” given in the notification, penal interest charged by parties who enter into a contract of giving loans will be covered under serial no. 27 of the notification dated 28th June, 2017.
Ergo, penal charges levied by the lender in a money to money transaction will have no GST implications.
Services by way of extending deposits, loans or advances in so far as the consideration is represented by way of interest or discount is an exempt service and penal charges levied by the vendor on delayed payment in case of supply of goods and services shall be under the purview of GST.
Various clarifications by the GST Council on additional/ penal interest taxability
The GST department’s explanations regarding the applicability of GST of additional / penal interest are listed below:
1. FAQs on financial sector
The Central Board of Indirect Taxes and Customs (CBIC) came up with a frequently asked questions document (FAQs documents) on financial sector[2] where taxability of additional interest in GST was discussed in serial no 45 of the document.
Any additional interest charged on default in payment of instalment in respect of any supply which is subject to GST, will be included in the value of supply and therefore will be liable to GST.
2. Notification No. 12/2017-Central Tax (Rate) dated 28th June 2017[3]
The department exempts services by way of extending deposits, loans or advances in so far that the consideration is represented by way of interest or discount (other than interest involved in credit card services).
Also the notification defines the word “interest” which means “interest payable in any manner in respect of any moneys borrowed or debt incurred (including a deposit, claim or other similar right or obligation) but does not include any service fee or other charge in respect of the moneys borrowed or debt incurred or in respect of any credit facility which has not been utilised.”
Further there was a ruling passed by the Advance Ruling Authority on the applicability of GST on penal interest when there is a delayed in repayment of loan.
3. The case of Bajaj Finance Limited
In case of Bajaj Finance Limited [4](BFL), an advance ruling was passed on 6th August 2018, where it was concluded that penal charges collected by the BFL shall attract GST.
Here it was said that in case of default of payment of EMI by the customer, the applicant tolerated such an act of default or a situation and the defaulting party i.e. the customer was required to compensate the applicant by way of payment of extra amounts in addition to principal and interest. Also, the additional interest is not in the nature of interest but penal charges.
Therefore, the charges levied for any default in repayment of loan will be covered under clause 5(e) of Schedule II of the CGST Act. Also, the same is not an exempt service and will be liable to tax under GST.
4. Circular no 102/21/2019-GST dated 28th June 2019
Given the numerous queries, the department finally released clarification on the matter. Penal interest charged on delayed payment for supply of goods and services will be included in the value of supply and will stand liable for GST. Whereas penal interest charged on the delayed payment of loan repayment will be exempt under GST.
The clarification given under the notification is discussed at length below.
The various clarifications by the GST Council on additional/ penal interest taxability is represented below in a tabular form:
|
FAQs on financial sector
|
Notification No. 12/2017-Central Tax (Rate) dated 28th June 2017 |
Case of Bajaj Finance Limited |
Circular no 102/21/2019-GST dated 28th June 2019
|
| Additional interest in case of default payment of instalment in respect of supply, which is subject to GST will be included in the value of supply and therefore liable to GST | Consideration by way of interest or discount on deposits loans and advances are considered as exempt service. | Charges levied for any default in repayment of loan will be liable to tax under GST. | Penal interest charged on delayed payment for supply of goods and services will be included in the value of supply and will stand liable for GST. Whereas penal interest charged on the delayed payment of loan repayment will be exempt under GST |
Implication of GST on penal charges
Accordingly, there are different GST implications, which are discussed by way of examples. Financing to a borrower may be done in the following ways:
- Situation 1: ABC Co (lender/shopkeeper) sells a car to Mr A (borrower) where the selling price of the car is ₹6,00,000. However ABC Co gives Mr A an option to pay the selling price of the car in 24 months (24 instalments) i.e. ₹ 26,250 (Repayment of principal ₹ 25000 + Interest @5% i.e. ₹ 1250). The instalment shall be paid every 10th of the month, and any delay on such payment shall be liable for a penal interest of ₹ 500 per day for delay in payment.
Here the transaction between ABC Co and Mr A is that of supply of taxable goods and not a money to money transaction. The shopkeeper has broken down the payment into tranches referred to as the EMI facility. The said EMI includes interest component as well which is subjected to GST. Also a penal interest is charged on the delayed payment. Accordingly, the interest and penal charges paid on the delayed payments shall be included in the value of supply and as a consequence, it will be under the ambit of GST.
Also this situation will not be covered under clause 5(e) of the Schedule II of the CGST Act. The expression to tolerate an act cannot be said to include a situation wherein penal charges are imposed on the erring party for delayed or non-payment.
Since the above is not covered under serial no 27 of the notification[5], the same is not exempt and taxable under GST.
- Situation 2: ABC Co sells a car to Mr. A where the selling price of the car is ₹6,00,000. Mr A has an option to avail a car loan at an interest of 12% per annum for purchasing the car from XYZ Co. The term of the loan from XYZ Co allows A, a period of 24 months to repay the loan and an additional /penal interest @1% per annum for every day of delay in payment.
Here the transaction between XYZ co and Mr. A is that of money to money transaction. The penal interest charged will be covered under serial no 27 of notification no 12/2017 Central Tax (Rate) dated the 28.06.2017 “services by way of (a) 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 exempted.
Accordingly, in this case, the “penal interest” charged thereon on transaction between XYZ Co and Mr. A would not be subject to GST. The value of supply by ABC Co to Mr. A would be ₹ 6,00,000 for the purpose of GST. Whereas there will be no GST charged on the interest and additional/ penal interest charged by the XYZ Co (lender) as the same is considered as an exempt supply.
Therefore, the vendor has the following option to sell the car to the customer:
- Provide a deferred payment facility by the vendor himself on account of purchase of the car, or
- Provide a loan facility to purchase the asset through the vendor’s captive lending unit, or
- Provide a loan facility to purchase the asset through any bank/NBFC
In all the three cases mentioned above, GST taxability will be different. In case the deferred payment facility is provided by the vendor and there is a delay in payment of EMI by the borrower, GST shall be charged on the additional interest due to such delay in payment. However, in case a loan facility has been provided by the vendor’s captive lending unit or by an independent bank or an NBFC, the additional interest charged on the delayed repayment will not be taxable under GST.
Conclusion
The circular by the government came up as a clarification in regard to GST implications on penal charges. This clarification brings ease to various NBFCs who were levying penal charges as per the agreement on the delayed payment of loan instalment. Also, the circular overrides the advance ruling in the case of Bajaj Finance Limited.
To summarise the above discussed concept:
- Penal charges in case of delayed payment of instalment of supply of goods and services shall be included in the value of supply as per section 15(2) (d) of the CGST Act. The same shall be liable to tax under GST
- Penal charges in case of delayed payment of instalment of a money to money transaction will be included in the value of supply as per section 15(2) (d) of the CGST Act. The same shall be exempt through serial no 27 of the notification No. 12/2017-Central Tax (Rate) dated 28th June 2017. Therefore penal charges in this case shall not be taxable under GST.
[1] http://www.cbic.gov.in/resources//htdocs-cbec/gst/circular-cgst-102.pdf;jsessionid=4085899A448EFF7FCF1762E53BC68D3F
[2][2] http://gstcouncil.gov.in/sites/default/files/faq/27122018-UPDATED_FAQs-ON-BANKING-INSURANCE-STOCK-BROKERS.pdf
[3] http://www.cbic.gov.in/resources//htdocs-cbec/gst/Notification12-CGST.pdf;jsessionid=3D2C63EDD8A1183AEB262F41985CB224
[4] https://mahagst.gov.in/sites/default/files/ddq/GST%20ARA%20ORDER-22.%20BAJAJ%20FINANCE%20LTD.pdf
[5] [5] http://www.cbic.gov.in/resources//htdocs-cbec/gst/Notification12-CGST.pdf;jsessionid=3D2C63EDD8A1183AEB262F41985CB224
Car Leasing In India: ‘Breaking the Stereotypical Definition Of Luxury’
Julie Mehta (julie@vinodkothari.com)
Introduction
Who thought hiring was even an option to enjoy the luxury of having to use a car. But with the world undergoing a paradigm shift, it untapped its energies into providing and establishing better services for its customers, leasing has paved its way into existence. Most of the industries have adopted this concept and structured their services accordingly in order to provide the best they can to their customers, but that requires huge understanding of their needs. A commoner would always be awed by the immensely developing technology and the environment around them but limited resources makes them take a step back from the thought of availing such services. The market had its solution as hiring and renting came into picture. This has ensured dreams do come true.
Car has always been a luxury at least in most parts of India because of the fact that India still in its developing stage and there still remains a big gap between the rich and the poor and the middle income families fall nowhere. Indians have been developed with the mind state that not everyone can afford everything and thus one should limit their demands keeping in mind their pocket potential. The concept of hiring and renting is not only limited to houses and properties but with the advent of MNC’s and startup companies, they have widened the scope of bringing in the concept of hiring even furniture, vehicles, electronic equipment’s, etc.
Earlier, the concept of car leasing was only limited to corporate senior executives that was earlier known as ‘corporate leasing’ and was common for the luxury car brands. But slowly it has trickled down and become accessible to commoners and middle income families. Companies like Mahindra & Mahindra made some of its models available for leasing. Following this concept, several other car brands like Hyundai, TATA group and luxury brands like BMW, Mercedes etc. have also opened their doors to providing the lease facilities.
Car leasing and rental is one of the most lucrative and fast growing segment of the automobile sector in India even though it currently represents only 4-5% of the market in terms of absolute number of vehicles, but its future prospects are strong enough.
Factors like increasing popularity of app-cab providers like Ola, Uber, Zoom car cab booking facilities, rapid urbanization, relocation of rural population into cities, adds on to the potential of car leasing in India.
[1]The growth of the market in India is to ensure manifold growth in its CAGR by 15-20% in the coming ten years and further on making hiring of cars simpler eventually with current worth of Rs. 1500 crores. Most car making companies are making 40% of its business from leasing cars. This has largely helped change the mentality of customers and imbibed the fact that ‘why buy when you can lease it’.
Yellow number plates or white number plates?
People remain apprehensive about the color of the number plate they use in the car. While a yellow number plates denotes commercial use, white number represents personal use. People taking cars on lease will of course want white number plates on their cars.
The current legal framework for registration of motor vehicles allow cars taken on lease for personal use to bear white number plates.
In case of a car taken on lease, the lessee is the person having possession of the vehicle and hence, the ‘owner’ as per the Motor Vehicles Act, 1988. Further, since it is the lessee who is actually using the car and the same has not been given on hire or used for any other commercial purpose, the car shall have a white number plate.
Global Status of Car Leasing
Globally, car leasing and hiring has been prevalent and growing for many years now. The analysts have forecasted that in the coming years, the global leasing market is to grow at a CAGR of 13-15%. This is gaining momentum due to the development of new mobility concepts by car leasing companies. For example, telematics was introduced in leased vehicles to monitor their usage on the job, another technological development was the installation of navigation in the leased vehicles making it more convenient for the lessor. People want change and with such facilities where there is an added benefit of not burning the pockets of customers, the lease scheme always works to hire cars on lease and cancel the contract anytime to shift on to better and advanced models of cars.[2]
The new trends dominating the global markets are the introduction of electric vehicle leasing and environment friendly cars that lead to sustainable development in the car manufacturing industries as well in the overall environmental situation. Such facilities encourage people to be more socially responsible and to do their bit towards the betterment of the society and also getting the leasing benefit out of it. Governments across the world are offering subsidies and tax benefits to encourage and boost the penetration of electric vehicles in their fleet. They have also introduced the concept of leasing old cars which helps reduce wastage as well as optimum usage. It is offered at a highly considerate premium and is attractive for low income customers. The global leasing market is fast moving with efficient strategies that ensures further growth too.
[3]Why has Leasing gained popularity in recent times?
GST introduction has come out to be a source of relief in time of distress for the Indian markets and consumers due to the stiff tax system of the country resulting in poor market functioning. With the introduction of ‘Goods and Services Tax’ on July 1, 2017, times have changed for the consumers, dealers as well as manufactures and has helped bring stability and balance in the economy by considering every person and their transaction at par, with the motive to bridge the gap between rich and poor in the long run. Evaluating their benefits below taking into consideration automobile industry:
- To the consumers: The new tax regime has resulted in significant reduction in the tax rates imposed on the end consumers in comparison to the previous tax system.
- To the dealers: The benefit of claiming the tax paid earlier benefits the dealers with the introduction of GST provides an added advantage to the dealers.
- To the manufacturers: In recent times, car manufacturing companies have marked a fall in their sales which has led to dwindling profits. With the increasing exposure to car leasing, manufacturers have found their resort to stabilise their performance. This option induces customers to opt for leasing, thereby ensuring good business to the car manufacturers.
| CAR TYPE | GST RATES | COMPENSATION CESS | TOTAL |
| Small Cars | 28% | 1% or 3% (depending on capacity) | 29% or 31% |
| Mid-segment Cars | 28% | 15% | 43% |
| Large Cars | 28% | 17% | 45% |
| Sports Utility Vehicles (SUV’s) | 28% | 22% | 50% |
| Electric Cars | 12% | N.A. | 12% |
Numerical Comparison
To understand the calculation of Loan EMIs and Lease rentals, we structure an example with the concept of residual model to distinguish the calculations of both the alternatives.
Any loan transaction requires an initial down payment to the seller after which installments follow on monthly/quarterly/annually basis. The down payment creates an extra outflow on part of the buyer on loan along with additional installments. While no down payment is required in case of a lease that makes its overall outflow on the lower side in comparison to a loan.
Plus, in case of a lease transaction, the lessor takes an exposure on the residual value of the asset, this brings down the lease rentals per month.
In the example below, with the assumption of different rates of residual value, we understand that with the every increase in the percentage of residual value, the lease rentals of the operating lease borne by lessee comes down. This implies lower the term of the lease contract, lesser value of the asset is used, and thus lesser are thee lease rentals.
| Details of the Vehicle | |
| Unit Cost | 1000000.00 |
| GST rate | 28% |
| Compensation Cess | 17% |
| Rate of GST | 45% |
| GST | 450000.00 |
| Total | 1450000.90 |
When Residual Value is considered to be 20%
| Operating lease arrangement | ||
| Basic price | 1000000.00 | |
| Add GST on purchase (ITC eligible) | 450000.00 | |
| Funding Amount | 1450000.00 | |
| Processing fees | 3.80% | 55100.00 |
| Expected Residual Value | 20% | 200000.00 |
| Tenure | 48 | |
| IRR | 18% | |
| Lease Rentals (RV not factored) | ₹ 42,593.75 | |
| Lease Rentals (before passing GST benefit) | ₹ 39,718.75 | |
| Input tax credit percentage | 100% | |
| Less: GST benefit | ₹ 9,375.00 | |
| Lease Rentals (after passing GST benefit) | ₹ 30,343.75 | |
| Add: GST on rentals | ₹ 13,654.69 | |
| Total inflow | ₹ 43,998.44 |
| Loan arrangement | ||
| Loan amount | 1450000.90 | |
| Processing fees | 3.80% | 55100.0342 |
| Expected Residual Value | 0% | 0 |
| Tenure | 48 | |
| IRR | 18% | |
| EMI | ₹ 42,593.78 |
When Residual Value is considered to be 25%
| Loan arrangement | ||
| Loan amount | 1450000.90 | |
| Processing fees | 3.80% | 55100.0342 |
| Expected Residual Value | 0% | 0 |
| Tenure | 48 | |
| IRR | 18% | |
| EMI | ₹ 42,593.78 |
| Operating lease arrangement | ||
| Basic price | 1000000.00 | |
| Add GST on purchase (ITC eligible) | 450000.00 | |
| Funding Amount | 1450000.00 | |
| Processing fees | 3.80% | 55100.00 |
| Expected Residual Value | 25% | 250000.00 |
| Tenure | 48 | |
| IRR | 18% | |
| Lease Rentals (RV not factored) | ₹ 42,593.75 | |
| Lease Rentals (before passing GST benefit) | ₹ 39,000.00 | |
| Input tax credit percentage | 100% | |
| Less: GST benefit | ₹ 9,375.00 | |
| Lease Rentals (after passing GST benefit) | ₹ 29,625.00 | |
| Add: GST on rentals | ₹ 13,331.25 | |
| Total inflow | ₹ 42,956.25 |
When the Residual Value is considered to be 30%
| Loan arrangement | ||
| Loan amount | 1450000.90 | |
| Processing fees | 3.80% | 55100.0342 |
| Expected Residual Value | 0% | 0 |
| Tenure | 48 | |
| IRR | 18% | |
| EMI | ₹ 42,593.78 |
| Operating lease arrangement | ||
| Basic price | 1000000.00 | |
| Add GST on purchase (ITC eligible) | 450000.00 | |
| Funding Amount | 1450000.00 | |
| Processing fees | 3.80% | 55100.00 |
| Expected Residual Value | 30% | 300000.00 |
| Tenure | 48 | |
| IRR | 18% | |
| Lease Rentals (RV not factored) | ₹ 42,593.75 | |
| Lease Rentals (before passing GST benefit) | ₹ 38,281.25 | |
| Input tax credit percentage | 100% | |
| Less: GST benefit | ₹ 9,375.00 | |
| Lease Rentals (after passing GST benefit) | ₹ 28,906.25 | |
| Add: GST on rentals | ₹ 13,007.81 | |
| Total inflow | ₹ 41,914.06 |
Conclusion
The major differentiating factors between a lease and a loan is that the former gives the right to use the asset without any upfront down payment, however, in case of the latter, there is an upfront down payment. Leasing works better when the lessor takes exposure on a handsome amount of residual value. Otherwise, it will turn out to be costlier than loan.
In the coming years, the car leasing market in India will be prospering as most car brands have now started to expand their services to even leasing now, which wasn’t prevalent until the last 4-5 years. With this competitive spirit, many more well developed brands would undertake this strategy to enhance customer base. The statistics of no: of cars being sold is going through a falling spree currently and is expected to fall further. But the leasing market will be flourishing on the other hand. It provides the ‘Best of Both Worlds’ to the customers as well as benefits the owner who still retain the ownership of the cars and gain benefit out of it.
[1] http://www.businessworld.in/article/-India-s-Car-Leasing-Market-Is-Worth-Rs-1-5K-Cr-Poised-For-15-20-CAGR-/27-05-2017-119041/
[3]http://www.cbic.gov.in/resources//htdocs-cbec/gst/notification05-compensation-cess-rate.pdf;jsessionid=B47A84DD8CE463AF356CD17117E2316B
[4]https://www.statista.com/outlook/270/119/car-rentals/india#market-arpu