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In today’s time, leasing has become an indispensable element of businesses – Any and every asset movable or immovable, equipment or software can be taken on lease. Colloquially, lease refers to an arrangement where a property owned by one is given for use by another, against regular rentals. In India, there are two types of lease transactions-financial lease and operating lease. Typically, a financial lease is a disguised financial transaction whereas operating lease is akin to rental contracts.
While leasing has gained much importance and relevance over the years, its feasibility and viability depends a major deal on its tax implications – they could easily make or break the deal. The technical aspects with respect to taxation on implementation makes it all the more significant. Issues like depreciation, lease rentals, tax deduction at source and exposure to GST are key concerns. Further, though leases are classified as finance or operating, it is important to note that such distinction is essentially from an accounting perspective – the Income Tax Act, 1961, however, does not distinguish between the two.
A rather significant but overlooked aspect of leasing is the ‘tax deduction at source’ (‘TDS’). As is known TDS is a key element of the Indian taxation framework which aims to collect tax at the source of generation of income. In case of a lease transaction, the lessee is required to deduct tax under 194-I of the Income Tax Act at the time of payment of lease rentals to the lessor.
While there are several judicial precedents dealing with TDS vis-à-vis lease transactions, the Hon’ble High Court of Karnataka in a recent order, in the case of Commissioner of Income Tax vs. Texas Instruments India Pvt Ltd (2021), concluded that in case of a financial lease, the lease financing company did not provide any particular service as a driver or otherwise for the purpose of usage of the car. The only transaction entered between the assessee and the lease financing company was to make payments of the amount due to the company. To say there was a mere financing arrangement and therefore section 194-I of the IT Act shall not be applicable in case of a financial lease transaction.
In this article we shall discuss the above stated ruling in detail.
The Assessee, Texas Instruments India Pvt Ltd being in the business of manufacture and export of computer software had taken motor vehicle on finance lease for its employees. It considered the lease rentals as business expenditure and claimed deduction of the same under the head income from business and profession. TDS was not deducted on the finance lease rentals as the assessee contested that the same did not fall under the provision of section 194-I or 194-C of the IT Act.
However, the Assessing Officer disallowed the claimed expenditure on the grounds that the lease rentals were being paid to the vendor under the contract and therefore the payment/ expenses would be attracting the provisions of section 194-C.
Aggrieved by the order of the A.O., the Assessee preferred an appeal before to the CIT(A). Upon such appeal, the CIT(A) overturned the A.O’s order and held that the payments made by assessee were not in the nature of service rendered by the leasing company for the carriage of goods or passengers. The CIT(A) also held that the assets were in the disposition of the Assessee.
Following such order, the matter was appealed before the Income tax Appellate Tribunal (ITAT) where it was held that provisions of Section 194-C will not be applicable on lease rentals.
Once again, the matter was taken for appeal before the Hon’ble Karnataka High Court where it was held that the leasing financing company did not provide any particular service as a driver or otherwise for the purpose of usage of car. The maintenance was carried by the employees of the assessee. The only transaction entered between the assessee and the leasing company was to make payments of the amount due to the company. Since no services were being provided by the leasing company and is a mere financing agreement, provisions of section 194-C and 194-I shall not be applicable.
Section 194-I of the IT Act 1961 governs tax deduction at source in case of lease rentals. As already mentioned, Income Tax Act does not draw any line of distinction between financial lease and operating lease, let us understand whether TDS needs to deducted on lease rentals in case of both financial lease and operating lease.
Section 194-I of the IT Act explains rent as follows:
“rent” means any payment, by whatever name called, under any lease, sub-lease, tenancy or any other agreement or arrangement for the use of (either separately or together) any
(a) land; or
(b) building (including factory building); or
(c) land appurtenant to a building (including factory building); or
(d) machinery; or
(e) plant; or
(f) equipment; or
(g) furniture; or
whether or not any or all of the above are owned by the payee;
Rent has been broadly defined under section 194-I and shall be applicable when asset is given for use for any payment under lease, sub lease, tenancy, or any other arrangement or agreement.
(1) Any person responsible for paying any sum to any resident (hereafter in this section referred to as the contractor) for carrying out any work (including supply of labour for carrying out any work) in pursuance of a contract between the contractor and a specified person shall, at the time of credit of such sum to the account of the contractor or at the time of payment thereof in cash or by issue of a cheque or draft or by any other mode, whichever is earlier, deduct an amount equal to—
(i) one per cent where the payment is being made or credit is being given to an individual or a Hindu undivided family;
(ii) two per cent where the payment is being made or credit is being given to a person other than an individual or a Hindu undivided family,
of such sum as income-tax on income comprised therein.
The judgement highlights that by virtue of the fact that no services were provided by the leasing company and that it was a mere financing agreement, section 194-C and 194-I would not be applicable in the given case.
Therefore, it seeks attention on the fact whether TDS has to be deducted on financial lease rentals.
Also, one must contemplate whether TDS should have been deducted under section 194-A of the IT Act as the lease transaction was considered as a mere finance agreement. This remains unanswered.
A Sale and Leaseback (SLB) is a special case of application of leasing technique. Lease is a preferred mode of using the asset without having to own it. In case of leases, the lessee does not own the asset but acquires the right to use the asset for a specified period of time and pays for the usage.
SLB is a simple financial transaction which allows selling an asset and then taking it back on lease. The transaction thus allows a seller to be able to use the asset and not own it, at the same time releasing the capital blocked by the asset.
SLB allows the lessee to detach itself with legal ownership yet continuing to use the asset as well. In effect there is no movement of asset however on paper there is a change in the title of the asset.
Sale and Leaseback transactions are globally common in the Real estate investment trusts (REITs) and Aviation industry.
As is evident from the mechanics of SLB above, SLB results in taking the asset off the books of the lessee and results in upfront cash which could be used for paying off existing liabilities. Hence this does not impact the existing lines of credit the lessee may be availing.
SLB can help entities raise finance for an amount equal to fair market value of the asset which may be significantly higher than its book value. Though there might be taxation challenges attached to it in Indian context. Nevertheless, SLB may bring about a financial advantage as well wherein a high-cost debt can be substituted with a low-cost lease liability.
Most of the assets considered for SLB have been used by the lessee for a substantial period of time and the value of the physical assets may be insignificant. Hence SLB is sometimes referred to as junk financing.
SLB may sometimes lead to tax benefits as well (we shall see this in detail in the sections below). This has been one of the major drivers of SLB transactions in India and has its own downsides as well. One of the major pitfalls to SLB is the danger of excess leveraging; the lessee may tend to overvalue the asset. Considering that SLB is a mode of asset-backed lending but the asset has may not have much value and the lessee may exercise discretion on the application of funds poses threat of misuse of the product.
The legal validity of SLB was discussed by the U.S Supreme Court in the landmark ruling of Frank Lyon and Company. In Frank Lyon’s case the bank took the building on SLB. Under the lease terms the bank was liable to pay rentals periodically and had the option to purchase the building at various times at a consideration based on its outstanding balance. The bank took possession of the building in the year it was completed and the lessor claimed deductions on depreciation, interest on construction loan, expenses related to sale and lease back and accrued the rent from the bank.
The Commissioner of Internal Revenue denied the claims of the petitioner on the grounds that the petitioner was not the owner of the building and the sale and leaseback was a mere financing transaction. The Hon’ble Court held that –
Where, as here, there is a genuine multiple-party transaction with economic substance that is compelled or encouraged by business or regulatory realities, that is imbued with tax-independent considerations, and that is not shaped solely by tax-avoidance features to which meaningless labels are attached, the Government should honor the allocation of rights and duties effectuated by the parties; so long as the lessor retains significant and genuine attributes of the traditional lessor status, the form of the transaction adopted by the parties governs for tax purposes.
The fundamental principle is that the Court should be concerned with the real substance of the transaction rather than the form of the same. If there are reasons to believe that the form of the transaction and its real substance are not aligned, the Court must not be simply concerned by the form of the transaction nor by the nomenclature that the parties have given to it.
In India too, the legality of SLB transactions have been questioned in several cases; sometimes the transactions have come out clean while in some cases, SLBs were considered an accounting gimmick.
The legality of SLB transactions and analysis of various judicial pronouncements on the same, have been discussed in detail in our write up “Understanding Sale and leaseback”
Tax aspects specifically direct tax acts as a major motivation behind such transactions, SLB provides a creative playground for finance professionals to structure transactions in a manner that can lead to substantial benefit to the entity, and taxation acts as a major tool at their disposal.
Though tax benefits have been a motivator for SLB transaction, the same has also been the reason for near wipe-out of SLB from Indian markets.
During the 1996-98 period one of the most infamous cases was the sale and leaseback of electric meters by state electricity boards (SEBs). For SEBs it made perfect sense as it amounted to cheap borrowing by the cash starved SEBs who had practically no other source of borrowing.
For leasing companies and others looking for a tax break, it was a perfect deal as there was 100% write off in case of assets costing Rs 5000 or less. Thus, an electric meter will qualify for 100% deduction. Several SEBs had undertaken such transactions in those days. Obvious enough the sole motive was tax deduction no one would care about the value, quality, existence etc of the meters. In some cases, the asset was bought on 30th March to be used only for a day, assets revalued heavily at the time of sale to leasing companies etc. Lease of non-existing assets such as electric meters, computers, glass bottles, tools, etc, lure of depreciation allowances caused the tax authorities to come down hard on sale and leaseback transactions calling them tax evading transactions. The whole fiasco of such sham transactions resulted in leasing going off the market completely. The burns of the past continue to linger even after a decade and half since SLB transactions were completely written off.
The most significant consideration in lease transactions is the depreciation claim. For tax purposes, depreciation is calculated on the block of the assets and not on the written down value of each asset separately.
Section 2(11) of the Income Tax Act, 1961 (IT Act) defines block of assets to mean
“”block of assets” means a group of assets falling within a class of assets comprising—
(a) tangible assets, being buildings, machinery, plant or furniture;
(b) intangible assets, being know-how, patents, copyrights, trade-marks, licences, franchises or any other business or commercial rights of similar nature, in respect of which the same percentage of depreciation is prescribed.”
The sale proceeds of the assets sold are deducted from the written down value of the block. In case of SLB transaction, assets are sold at higher than written down value, and the gain made on such a sale results in reduction in depreciable value of the block of assets. The reduction in depreciation will be allowed over a number of years. Similar would be the case in case the asset was sold at less than written down value, sale consideration would be reduced from the block of the assets.
Once the asset is sold and taken off the books of the lessee, the lessee is able to account for an immediate accounting profit without having to pay tax on it instantly. As under the block concept of depreciation, when the lessee sells the capital assets, the sale proceeds including the profits on sale are allowed to be deducted from the block of assets and hence there is no immediate tax on the accounting profits.
Also, typically the asset is recorded on historical costs which may be lower than the intrinsic value of the asset. SLB sometimes allows the entities to unlock the appreciation in value. However, it is not always necessary that the asset would have appreciated value. In some cases, the asset may have become junk completely.
To avoid the same revenue has introduced following provisions in the IT act, in order to restrict undue benefits being passed by use of sham SLB transactions:
Section 43 (1) provides for treatment of sale and lease back transactions for tax purposes, the relevant extracts are reproduced below –
“Explanation 3.—Where, before the date of acquisition by the assessee, the assets were at any time used by any other person for the purposes of his business or profession and the Assessing Officer is satisfied that the main purpose of the transfer of such assets, directly or indirectly to the assessee, was the reduction of a liability to income-tax (by claiming depreciation with reference to an enhanced cost), the actual cost to the assessee shall be such an amount as the Assessing Officer may, with the previous approval of the Joint Commissioner, determine having regard to all the circumstances of the case.”
“Explanation 4A.—Where before the date of acquisition by the assessee (hereinafter referred to as the first mentioned person), the assets were at any time used by any other person (hereinafter referred to as the second mentioned person) for the purposes of his business or profession and depreciation allowance has been claimed in respect of such assets in the case of the second mentioned person and such person acquires on lease, hire or otherwise assets from the first mentioned person, then, notwithstanding anything contained in Explanation 3, the actual cost of the transferred assets, in the case of first mentioned person, shall be the same as the written down value of the said assets at the time of transfer thereof by the second mentioned person.
Explanation 3 and 4A of Section 43 (1) restricts the consideration at which the lessor purchases the assets to written down value of the asset as appearing in the books of the lessee before it was sold and taken back on lease. The explanation explicitly states that the sale value for such sale and lease back transactions will be ignored and depreciation will be allowed on the first seller’s depreciated value. Take, for instance, A purchased machinery for Rs. 10 crores from B, though the WDV in the books of B is Rs. 2 crores. A can claim depreciation on Rs. 2 crores and not on Rs. 10 crores.
The said provisions removes any motivation for the lessor to carryout transactions at inflated values. Hence preventing junk financing to enter into SLB transactions.
Pre-GST indirect taxation regime acted as a major road block in the development of leasing industry as a whole, the legal differentiation as well as non-availability of credit among central and state taxes made leasing transactions costly.
Introduction of GST is playing a key role in development of leasing industry, from a stage where it had nearly become extinct. We have further discussed GST implications on leasing.
The first leg of the transaction would involve sale of Assets by lessee to lessor.
In terms of section 7(1)(a) “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;”
The taxability under GST arises on the event of supply accordingly the sale of capital assets for a consideration would fall under the ambit of supply and accordingly GST shall be levied.
The second part of transaction would lease back that is when the asset is leased back from buyer -lessor to seller lessee. The leaseback would be subject to GST like any other lease transaction.
The term lease has not been defined anywhere in GST Act or Rules. To classify a lease transaction as either supply of goods or supply of service, we have to refer Schedule II of the CGST Act, 2017 where in clear guidelines for classification of a transaction as either “supply of goods” or “supply of services” has been enumerated, based on certain parameters: –
Undoubtedly, the SLBs do not involve movement of goods, the seller lessee continuous to be in possession of leased asset even after the sale. Hence, In the case of such sale, there is no physical movement of the asset from the premises of the lessee to the premises of the lessor. The ownership gets transferred in the premise of the lessee.
In terms of Section 10(1)(c) of the IGST Act, the place of supply of goods where the supply does not involve movement of the said goods whether by the supplier or the recipient shall be the location of such goods at the time of delivery to the recipient. Accordingly, the place of supply in this case will be same as the location of the supplier. Accordingly, the sale of the asset will be considered as an intra-state supply as per Section 8 of the IGST Act and will be subjected to CGST + SGST.
Applications of GST on disposal of capital assets is one of the major deterring factors of in SLBs. Section 18(6) of the CGST Act,2017 state that:
“In case of supply of capital goods or plant and machinery, on which input tax credit has been taken, the registered person shall pay an amount equal to the input tax credit taken on the said capital goods or plant and machinery reduced by such percentage points as may be prescribed or the tax on the transaction value of such capital goods or plant and machinery determined under section 15, whichever is higher:”
Entry no. (6) Of Rule 44 of CGST Rules, 2017: Manner of Reversal of ITC under Special Circumstances which reads as under: –
“The amount of input tax credit for the purposes of sub-section (6) of section 18 relating to capital goods shall be determined in the same manner as specified in clause (b) of sub-rule (1) and the amount shall be determined separately for input tax credit of central tax, State tax, Union territory tax and integrated tax:”
“……………..Clause (b) of sub rule 1 of same rules states that :
(b) for capital goods held in stock, the input tax credit involved in the remaining useful life in months shall be computed on pro-rata basis, taking the useful life as five years………….”
Generally, the lessor procures the capital Assets at WDV due to Income tax Act implication. In that case WDV as per Income tax act would be the transaction value.
Let’s consider a numerical example: an Entity A enters into SLB arrangement with an Entity B. A sells its machinery to B for Rs. 5,00,000/- as on 31st May 2021. The entity had purchased the asset for Rs. 6,00,000/- as on 31st March 2019.
B then leases back the asset to A for a yearly rental of Rs, 1,00,000/- for 3 years term with a purchase option at the end of 4th year at Rs. 2,50,000. (Assumed to be exercised)
(GST @ 18%)
On disposal asset, GST will be charged on the selling price of the asset. However, the amount to be deposited to the government with respect to this sale transaction shall be higher of the following:
Portion of ITC availed on the asset, attributable to the period during which the transferor used the asset:
6,00,000 * 18% * (5% * 8) = 43200
Remaining ITC = (6,00,000 * 18%) – 43200 = 64800
GST on the selling price = 500000 * 18% = 90000
Therefore, GST to be paid to the government is 90000, that is higher of the two amounts discussed above.
As mentioned above GST shall be chargeable to lease rental, at the rate similar to that charged on acquisition of leased asset. Accordingly, Entity B shall charge GST on rentals for an amount of Rs. 18,000/- (Rs. 1,00,000/- * 18%).
Further GST shall also be charged on sale of asset at the end of lease tenure for an amount of Rs. 45,000/-(2,50,000*18%).
IAS 17 covered the accounting for a sale and leaseback transaction in considerable detail but only from the perspective of the seller-lessee.
As Ind AS 116/IFRS 16 has withdrawn the concepts of operating leases and finance leases from lessee accounting, the accounting requirement that the seller-lessee must apply to a sale and leaseback is more straight forward.
The graphic below shows how SLB transactions should be accounted for:
IFRS 16/Ind AS 116 state that
“ An entity shall apply the requirements for determining when a performance obligation is satisfied in Ind AS 115 to determine whether the transfer of an asset is accounted for as a sale of that asset.”
Accordingly, when a seller-lessee has undertaken a sale and lease back transaction with a buyer-lessor, both the seller-lessee and the buyer-lessor must first determine whether the transfer qualifies as a sale. This determination is based on the requirements for satisfying a performance obligation in IFRS 15/Ind AS 115 – “Revenue from Contracts with Customers”.
The accounting treatment will vary depending on whether or not the transfer qualifies as a sale.
The para 38 of Ind AS 115/IFRS 15- Performance obligations satisfied at a point in time, provides ample guidance on determining whether the performance obligation is satisfied.
The para states that:
“If a performance obligation is not satisfied over time in accordance with paragraphs 35– 37, an entity satisfies the performance obligation at a point in time. To determine the point in time at which a customer obtains control of a promised asset and the entity satisfies a performance obligation, the entity shall consider the requirements for control in paragraphs 31–34. In addition, an entity shall consider indicators of the transfer of control, which include, but are not limited to, the following:
(a) The entity has a present right to payment for the asset—if a customer is presently obliged to pay for an asset, then that may indicate that the customer has obtained the ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset in exchange.
(b) The customer has legal title to the asset—legal title may indicate which party to a contract has the ability to direct the use of, and obtain substantially all of the remaining benefits from, an asset or to restrict the access of other entities to those benefits. Therefore, the transfer of legal title of an asset may indicate that the customer has obtained control of the asset. If an entity retains legal title solely as protection against the customer’s failure to pay, those rights of the entity would not preclude the customer from obtaining control of an asset.
(c) The entity has transferred physical possession of the asset—the customer’s physical possession of an asset may indicate that the customer has the ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset or to restrict the access of other entities to those benefits. However, physical possession may not coincide with control of an asset. For example, in some repurchase agreements and in some consignment arrangements, a customer or consignee may have physical possession of an asset that the entity controls. Conversely, in some bill-and-hold arrangements, the entity may have physical possession of an asset that the customer controls. Paragraphs B64–B76, B77–B78 and B79–B82 provide guidance on accounting for repurchase agreements, consignment arrangements and bill-and-hold arrangements, respectively.
(d) The customer has the significant risks and rewards of ownership of the asset—the transfer of the significant risks and rewards of ownership of an asset to the customer may indicate that the customer has obtained the ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset. However, when evaluating the risks and rewards of ownership of a promised asset, an entity shall exclude any risks that give rise to a separate performance obligation in addition to the performance obligation to transfer the asset. For example, an entity may have transferred control of an asset to a customer but not yet satisfied an additional performance obligation to provide maintenance services related to the transferred asset.
(e) The customer has accepted the asset—the customer’s acceptance of an asset may indicate that it has obtained the ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset. To evaluate the effect of a contractual customer acceptance clause on when control of an asset is transferred, an entity shall consider the guidance in paragraphs B83–B86.”
It shall be noted that no single criteria can be taken as a determining factor for concluding that sale has taken place. Each criterion should be individually assessed every case. Needless to say, substance of the transaction should be adjudge based on principles set.
The criteria set out in the para 38 specified above can be summarised as follows:
If the transfer does not qualify as a sale the parties account for it as a financing transaction. This means that:
Where the transfer qualifies as sale, there can be further two situations:
If the transfer qualifies as a sale and is on fair value basis the seller-lessee effectively splits the previous carrying amount of the underlying asset into:
The seller-lessee recognises a portion of the total gain or loss on the sale. The amount recognised is calculated by splitting the total gain or loss into:
The leaseback itself is then accounted for under the lessee accounting model.
The buyer-lessor accounts for the purchase in accordance with the applicable standards (eg IAS 16 ‘Property, Plant and Equipment’ if the asset is property, plant or equipment or IAS 40 ‘Investment Property’ if the property is investment property). The lease is then accounted for as either a finance lease or an operating lease using IFRS 16’s lessor accounting requirements.
The accounting methodology shall remain the same, However, Adjustments would be required to provide for the discounted or premium price.
These adjustments would be as follows:
A sample spreadsheet calculations for the below example can be accessed here
|Sale considerations||₹ 10,00,000.00|
|Carrying Amount||₹ 5,00,000.00|
|Fair Value of Building||₹ 9,00,000.00|
|Incremental borrowing rate||10%|
|PV of rentals||₹ 6,08,486.36|
|Additional Financing||₹ 1,00,000.00||Sale Consideration
– Fair Value
|Payments towards Lease Rentals||₹ 5,08,486.36||PV of Rentals
– Additional Financing
|Ratio of PV of rentals and
Payment towards lease Rentals
|Yearly payments towards Add. Financing||₹ 13,147.38||Rental X Ratio|
|Yearly payments towards Lease Rental||₹ 66,852.62||Rental – Payment toward Add. Fin.|
|ROU of Asset||₹ 2,82,492.42||Carrying Amount X
[Payments towards Lease Rentals/Fair Value of Building]
|Total Gain on sale||₹ 4,00,000.00||Fair Value – Carrying Amount|
|Gain recognised Upfront||₹ 1,74,006.06||Total Gain X [(Fair Value of Building-Payments towards Lease Rentals)
/Fair Value of Building]
|₹ 5,08,486.36||₹ 1,00,000.00|
|Year||Lease Rentals||Additional Financing|
|1||₹ 66,852.62||₹ 13,147.38|
|2||₹ 66,852.62||₹ 13,147.38|
|3||₹ 66,852.62||₹ 13,147.38|
|4||₹ 66,852.62||₹ 13,147.38|
|5||₹ 66,852.62||₹ 13,147.38|
|6||₹ 66,852.62||₹ 13,147.38|
|7||₹ 66,852.62||₹ 13,147.38|
|8||₹ 66,852.62||₹ 13,147.38|
|9||₹ 66,852.62||₹ 13,147.38|
|10||₹ 66,852.62||₹ 13,147.38|
|11||₹ 66,852.62||₹ 13,147.38|
|12||₹ 66,852.62||₹ 13,147.38|
|13||₹ 66,852.62||₹ 13,147.38|
|14||₹ 66,852.62||₹ 13,147.38|
|15||₹ 66,852.62||₹ 13,147.38|
|Financial Asset||₹ 1,00,000.00|
|*Lease accounted as per Finance or operating lease accounting|
|Financial Liability||₹ 6,08,486.36|
|Gains on Asset Transfer||₹ 1,74,006.06|
 435 U.S. 561 (1978)
By Rahul Maharshi (email@example.com), (firstname.lastname@example.org)
Employee share based payments (ESBPs) are an effective way of incentivising employees. ESBPs work as a two way growth strategy for both company as well as the employees. On one hand, it helps the employees to participate in the growth of the entity and in turn reap out the benefits from it, on the other hand it helps the entity to boost the growth rate and align the vision of the employees with that of the company. The ESBPs work as a catalyst for the employee growth as well as the growth of the company.
The theme of this article revolves around the taxation aspects of different types of ESBPs, but before we proceed further, let us have a quick understanding about the different types of ESBPs. Read more
Interest subvention income are earnings received from the third party i.e. person other than the borrower. This scheme work as a compensation to the seller who intends to penetrate the market. They arrange low cost finance for their customers (though not low cost because the part of it is compensated by its captive unit).Therefore the seller (lender) offers subsidized rate to the buyer (borrower) and the discounts are borne by the third party who is either a captive unit of the seller or also by Central or State Government who plans to provide financial aid through subvention.
In the case of Daimler Financial Services India Private Limited (DFSI), the advance authority passed a ruling where it was concluded that interest subvention is like “other miscellaneous services” which was received from Mercedes-Benz India Private Limited (MB India) by DFSI and will be chargeable to GST as a supply.
In the said case, DFSI is registered as an NBFC and is engaged in the business of leasing and financing. DFSI is a captive finance unit of MB India where the customers get a rebate in the interest component when DFSI acts as a financer and the car is purchased from one of the authorized dealers of MB India. MB India is engaged in the manufacture and sale of car which is usually done through its authorized dealer. The difference interest amount for each transaction is paid upfront by MB India to DFSI who raises an invoice against MB India. Payments made by MB India for the interest subvention was done after deducting TDS under section 194A of the IT Act.
The assessee contended that the interest subvention received is an interest and is an exempt supply. Also, the GST law and the Indian Contract Act 1872 recognize that consideration for a transaction can flow from anybody. The loan agreement with the customers also mentioned the applicable interest rate, the interest subsidy received from the MB India and the net interest payable by the customer.
Several reference of rulings were submitted by the assessee through which it contended that
The following points were put up by the department:
The department that DFSI had not borrowed money from MB India. Also interest income can be exempt when there is a direct supply. It was also put that the interest income exempt through notification is not valid for a payment made by third party. The whole structure was set up to promote the business of DFSI.
The department gave reference to section 15 of the CGST Act, where value of supply includes subsidies directly linked to price and the amount of subsidy will be included in the value of supply. Therefore “interest subvention” is an interest subsidy and hence chargeable to GST. Also it was noted that income booked by DFSI is shown under revenue from operations as subsidy income.
The ruling concluded that interest received by DFSI from MB India was to reduce the effective interest rate to the final customer is chargeable to GST as supply under SAC 999792 as other miscellaneous services, agreeing to do an act.
As per the exempted list of services, consideration represented by way of interest or discount on services by way of extending loans or advance is an exempt supply. As it is evident, that services exclude any transaction in money but includes activities relating to use of money i.e. processing fees falls within the meaning of activities relating to use of money and therefore charged to GST.
When there is an interest subsidy, there are two arrays of interest involved- “applicable fixed interest rate gross” and “Net applicable fixed interest rate”. The borrower is under no obligation to pay the lender interest on principal i.e. the applicable fixed interest rate gross. The lender pays at the net applicable fixed interest rate. The difference between the two arrays of interest is the interest subvention borne by the third party. Technically the consideration paid by the borrower is the subsidized rate of interest. The borrower indirectly pays the differential amount of interest through the third party. Therefore referring section 7 of the CGST Act, consideration paid by the borrower is in the course of business whereas consideration paid by the third party is for furtherance of business. The two considerations received are totally different as one is “interest” and the other is “interest subsidy”.
Further, referring to section 15 (2) (e) of the CGST Act, value of supply of includes subsidies directly linked to the price excluding subsidies provided by the Central and State Governments. The interest subvention received are directly linked to price i.e. the interest paid by the borrower to lender and should be considered as value of supply.
Also the definition of “interest” is defined by the council as – “interest” 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;
The interest paid on money borrowed is under the exempted category of services. Interest subvention disbursed by the captive unit of the lender is not paid on any money borrowed. It is a form of consideration paid so as to promote the business indirectly. They are like any other charges and therefore should not be considered as interest on money borrowed.
Since interest subvention is not interest on money, the same is not an exempt supply and therefore under the purview of GST.
The Advance Ruling Authority (AAR) interpreted the law and considered interest subvention to be taxable under GST. Further clarification is still required on its taxability as one may note that as per section 103 of the CGST Act, the rulings pronounced by the Authority is only binding on the applicant.
Therefore, whether interest subvention is taxable under GST or not requires further attention from the department.
By Yutika Lohia (email@example.com), (firstname.lastname@example.org)
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 to address the issue.
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.
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.
The GST department’s explanations regarding the applicability of GST of additional / penal interest are listed below:
The Central Board of Indirect Taxes and Customs (CBIC) came up with a frequently asked questions document (FAQs documents) on financial sector 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.
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.
In case of Bajaj Finance Limited (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.
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|
Accordingly, there are different GST implications, which are discussed by way of examples. Financing to a borrower may be done in the following ways:
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, the same is not exempt and taxable under GST.
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:
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.
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:
-Kanakprabha Jethani | Executive
Vinod Kothari Consultants Pvt. Ltd.
The Working Group on Developing Avenues for Aircraft Financing and Leasing Activities in India, constituted by Ministry of Civil Aviation submitted its report on measures for developing this industry in the country. The Working Group was formed to examine the regulatory framework relating to financing and leasing of aircrafts. The idea was derived from the Cape Town convention and it has also been proposed to enact a bill in order to fully implement the convention. This project is based on the theme “Flying for All”. The Indian civil aviation market has been exhibiting tremendous growth for past years. There is an overwhelming increase in demand for passenger transportation for which airlines in India have placed orders for more than 1000 aircrafts. Moreover, Indian airlines have been relying on other countries for financing acquisition of aircrafts on export credit, loan or lease basis. This hair-triggers the need for India to have in place its own systems for financing of such acquisitions.
One of the motivations of the project is to ensure that the dependence of Indian aviation industry on import leases is reduced. Currently more than 90% of the aircrafts operating in the country are on import lease basis, and there is a huge monthly outflow of foreign exchange by way of lease rentals, which is not reported as ECB, since it is an operating expense.
The key players in global aircraft financing and leasing market are Ireland and the US. Countries like China, Singapore, Hong Kong and Japan are emerging competitors in the market. The structures of aircraft financing, however, differ largely in all of these countries. The overall trends in the global arena can be evaluated on following bases:
Regional Outlook: through a research conducted for the Aviation Industry Leaders Report, it was concluded that North America is viewed as the most optimistic market player. Europe shows mixed signals due to market being strong and simultaneous slowing down of economy and other political issues. The Middle Eastern countries show a slow pace of growth and their models exhibit signs of stress. African airline market still has a lot of unrealised potential.
Financing Trends: sale and lease back transactions have become the most frequently used medium of aircraft finance over the world. Other forms of financing such as commercial bank debt, pre-delivering payment financing etc. have picked up pace. Also, traditional forms of financing such as export credit continue to be in operation but with reducing levels. Overall, the capital market remains very active and innovative in the aircraft finance sector.
Technology: new technology in aircrafts is being introduced frequently. However, implementation and commercialisation of the same continues to be a challenge. The Aviation Working Group’s Global Aircraft Trading System (GATS) proposed digitisation of transfer of lease deed ownership system which shall be expected to be activated by end of the year 2019.
In terms of growth and advancement, India is far behind other Asian economies such as China, Singapore and Hong Kong. However, the Indian Aviation market has shown exponential rise in the past few years with an annual growth rate of 18.86% in 2017-18 and overall growth of 16.08% in passenger traffic. From 74 operational airports in 2013, it has reached a height of 101 operational airports in 2016. Expectations of having 190-200 operational airports by the end of 2040 are pointed out through various studies.
Currently, India has large aircraft order books, virtually all of which are leased through leasing companies located offshore. Under the regional connectivity scheme Ude Desh ka Aam Nagrik (UDAN), the government has decide to lease out operations, maintenance, and development of certain airports under Public private Partnership (PPP) model.
Overall, India has immense potential for growth in aviation sector but little means to aid the growth. It is in need of systems that aid the growth in a cost-effective and sustainable manner.
In the view of increasing demand and non-availability of own sources of aircraft financing, it is essential for India to set up its own structures for the same. Moreover, civil aviation sector is an important sector for development of the economy. In the civil aviation industry, aircraft financing is the most profitable segment and there are no entities in the country exploring this line of business. All the benefits from this gap are being enjoyed by foreign entities.
For this structure, GIFT-CITY in Gujarat has been identified as preferred destination for initiation of operations in this industry as it offers a tax regime competitive to that of leasing companies all over the world.
The aforementioned structure will face following barriers:
The working group has proposed corresponding changes and amendments to be made to overcome these barriers. The response of relevant authorities is awaited.
|IFSC-GIFT CITY (proposed structure)||INDIA (not following the structure)|
|Corporate Tax Rate:||34.94|
o Year 1 to 5
o Year 6 to 10
o Year 11 onwards
|Minimum Alternate Tax||10.48||21.55|
|Capital gains on sale of aircraft||0.00||34.94|
o Operating lease rentals
o Interest payment (USD debt)
o Interest payment (INR debt)
o Other payments
|Dividend Distribution Tax||nil||20.56|
|GOODS AND SERVICES TAX|
|Purchase of aircraft||0.00||0.00|
|Operating lease rentals||0.00||5.00|
|Underfinance lease(interest portion)||0.00||5.00|
|Stamp duty on lease related documents||0.00||3.00|
Following table shows an analysis of indirect tax implications from the point of view of lessee and compares the proposed structure with the existing practice of financing as well as situation if financing is done outside the proposed structure but in India.
This table is based on following assumptions:
On the aforesaid assumptions, lease rental per annum would amount to Rs.306.63 crores
Amount (in Rs. crores)
|Tax expenditure||Ireland||IFSC-GIFT CITY||Rest of India|
|GST on lease rentals||15.3315||0.00||15.3315|
|GST on other services||0.00||nil||12.6|
|Overall indirect tax expenditure||15.3315||0.00||27.9315|
Recommendations have been made by the Working Group to various regulatory authorities in order to overcome various barriers that are a hindrance to establishment of India’s own structure of aircraft financing and leasing. Following table shows some of the major recommendations:
|RBI||Confirm that the term “equipment” includes aircrafts or notify aircraft financing and leasing as permitted activity for banks or subsidiaries of banks.|
|Amend IBU circular to include equipment leasing and investment in capital of leasing entities in scope of activities of banks|
|Confirm that equipment leasing entities shall be eligible to register as NBFC in IFSC|
|Issue specific directions in regard to investment in or by foreign entities engaged in aircraft financing and leasing activities.|
|Tax authorities||Capital gains on sale of leased aircrafts should be fully exempted.|
|GST on leasing aircraft should be made zero-rated.|
|Nil withholding tax should be specified for airline companies.|
|Transfer/novation of aircraft financing / leasing contracts to units in an IFSC should not be under the purview of GAAR, for both the lessee and lessor|
|SEBI||Amend SEBI (AIF) Regulations to create a separate category of AIFs for investment in aircraft financing/leasing activities or permit greater concentration of investment in aircraft financing/leasing entities.|
|Clarify whether 25% investment cap by AIFs applies on investment in equipment and grant additional relaxations to AIFs investing in aircraft financing activities.|
|Create separate category of mutual funds of investment in entities engaged in aircraft financing and leasing activities.|
|Clarify which institution can invest in entities registered in IFSC.|
|IRDAI||Amend IRDAI regulations permitting companies set up in IFSC to invest in entities engaged in aircraft financing and leasing activities.|
|Clarify whether investment of funds of policyholders’ in entities registered in IFSC be considered as funds invested in India only.|
|Others||Clarify under aircraft rules that aircrafts of lessors cannot be detained against any statutory or other outstanding dues.|
|Entities like pension funds, insurance companies, employee provident fund organisations be allowed to invest directly or indirectly in aircraft financing and leasing activities.|
|SARFAESI Act not be applicable to aircrafts.|
|Gujarat Stamp Act to exempt aircraft financing and leasing from its purview.|
|Permit airlines to set up branch in IFSC.|
It is absolutely evident that aircraft industry is on upsurge and will continue to be rising globally in the coming years. To meet the rising demand and expand the country’s hold in the aviation market the proposed structure provides a well-established groundwork through the proposed structure. All recommendations, if accepted and implemented in a proper manner, will enable India to pioneer a very profitable and growth-oriented aviation market.
-Million dollar question: Can the same be extended to Sec. 56(2)(x) ?
By Yutika Lohia (email@example.com)
The abolition of Gift Tax Act in the year 1998 paved way for one of the most dynamic sections of the Income Tax Act, 1961, – Section 56(2). Under this section all kinds of incomes and gains which were from sources other than the sources mentioned in the Act at that time was brought under the purview of Income Tax. Now, incomes and gains arising out of such transactions which were structured to pass on assets to some other party without any consideration or with inadequate consideration was subject to be taxed under this section.
While the Section 56(2) gave the authorities a tool to keep check on the transactions structured to merely launder unaccounted income, it also brought in many questions with itself. The CBDT has since been releasing clarification to address the questions as well as making changes to the section to cover all lose ends of laundering unaccounted incomes.
Recently Central Board of Direct Taxes (CBDT) in its circular dated 31st December, 2018 came up with a clarification to address the question –
Does the terms “receives” with regards to section 56 (2)(viia) include receiving shares of companies (where public are not substantially interested) by way of issues of shares by way of fresh issue/ bonus issue/ issue of rights shares/ transaction of similar nature?
Before we get to the clarification lets first analyse the sections – 56(2)(vii), 56(2)(viia) , 56(2)(viib) & 56(2)(x)
|Section 56(2)(vii)||Section 56(2)(viia)||Section 56(2)(viib)||Section
|Applicable to||Individual/ HUF||Firm/ Company (closely held)||Company (closely held)||Person as per section 2(31) of the IT Act, 1961|
|Applicable on||1. Money
2. Immovable Property
3.Property other Immovable Property
|Shares of closely held company||1.Issue of Shares||1. Money
2. Immovable Property
3.Property other Immovable Property
|Applicable date||From 1st October, 2009 to 31st March, 2017||From 1st June, 2010 to 31st March, 2017||From 1st April, 2013||From 1st April, 2017|
Section 56(2)(viia) of the IT Act, 1961 was inserted by Finance Act, 2010. Referring to the memorandum of Finance Act, 2010 clause (viia) was incorporated in section 56 to prevent the practice of transferring unlisted shares at a price which was different from the fair market value (i.e no or inadequate consideration) of the shares and also include within its ambit transactions undertaken in shares of the company (not being a company in which public are substantially interested) either for inadequate consideration or without consideration where recipient is a firm or a company (not being a company in which public are substantially interested).
In a layman’s term the act of receiving means to receive something which was already in existence and the act of creation of the that particular thing.
Similarly receipt of shares of shares by way of fresh issue/ bonus issue/ issue of rights shares/ transaction of similar nature is an act of creation of the securities and not transfer of the same. The CBDT in its circular dated 31st December, 2018has clarified the same. section 56(2)(viia) is applicable to transactions involving subsequent transfer of the shares form the initial receiver to some third party, and not time of issuance of such shares.
It is palpable that the shares would be treated as goods only when it comes into existence and issuance of shares is the act of bringing the shares into existence. The word “receives” with respect to section 56(2)(viia) would not include issuance of shares within its ambit.
The intent of insertion of clause (viia) to section 56 was to apply anti-abuse provision i.e transfer of shares for no or inadequate consideration, it is hereby clarified by the CBDT circular that section 56(2)(viia) of the Act shall apply in cases where a company (not being a company in which public are substantially interested) or a firm receives the shares of the company (not being a company in which public are substantially interested) through transfer for no or inadequate consideration. Hence section 56(2)(viia) of the Act shall not be applicable on fresh issue of shares by the specified company.
Taxation of fresh issue of shares comes under the purview of section 56(2)(viib).
Recently the Income Tax Appellate Tribunal (ITAT) in the case of The Assistant Commissioner of Income Tax Vs. Shri Subhodh Menon, order dated 7th December, 2018 held that a shareholder cannot be taxed under section 56(2)(vii)(c) of the IT Act, 1961 so long as the shares are allotted to the holder on a proportionate basis (right shares), even if such shares are allotted at a value lower than the fair market value.
Drawing from the above case law, right shares issued at a value below the fair market value to individual/ HUF where allotment is disproportionate will not be taxable under section 56(2)(vii)(c) of the IT Act, 1961. Shares issued higher than proportion offered (based on shareholding) shall attract tax provisions.
The Union Budget 2017 introduced the section 56(2)(x) of the IT Act, 1961 widening the scope of Income from other sources and also clubbing section 56(2)(vii) & section 56(2)(viia). Income Tax shall not be chargeable at normal rate for fresh issue of shares for closely held companies.
Since the offence that section 56(2)(viia) was trying to curb is the same as section 56(2)(x), the question still lies, whether the term “receives” clarified in the CBDT circular shall have the same analogy for Section 56(2)(x)? Simply put, whether section 56(2)(x) of the Act will also be limited to transfer of existing shares and not cover fresh issue of shares?
By Yutika Lohia (firstname.lastname@example.org)
India is en-route to turn itself into a 21st century super-economy fuelled by the unprecedented growth of its business enterprises. Business may grow in two ways – either in an organic way or inorganic. The former refers to the internal forces of the enterprises which are re-organised to bring in development and growth into the business, whereas, in case of inorganic growth, the company goes into corporate restructuring to re-align its external facade to fuel the planned development and growth. In today’s fast moving corporate environment, corporate restructuring happens to be the most ideal tool to win an advantage in this pursuit.
Business restructuring is a comprehensive process, be it financial or technological or market or organisational. Business can be re-arranged by way of mergers, demergers, disinvestments, takeovers, strategic alliance or slump sale.
This article focusses on implications of GST on slump sale.
The concept of slump sale comes from the Income Tax Act, 1961. The IT Act, in section 2(42C) defines “slump sale” as – “slump sale” means the transfer of one or more undertakings as a result of the sale for a lump sum consideration without values being assigned to the individual assets and liabilities in such sales.” Further as per explanation 1 to section 2(19AA), “undertaking” shall include any part of an undertaking or a business activity taken as whole, but does not include individual assets or liabilities or any combination thereof not constituting a business activity.
Therefore, slump sale contains the following conditions:
One of the major precondition of a slump sale transaction is that all assets and liabilities of the business undertaking must be transferred to the buyer.
As per Section 50B of IT Act, the cost of acquisition of such sale shall be the net worth (book value of assets and liabilities) of the undertaking.
Explanation 1 provides the method of computing the net worth of an undertaking or a division sold on slump sale basis. As per Explanation 1 “For the purposes of this section, “net worth” shall be the aggregate value of total assets of the undertaking or division as reduced by the value of liabilities of such undertaking or division as appearing in its books of account.” This definition is no different from the meaning of the expression ‘net worth’, as is commonly understood in the accounting parlance.
There are various judicial pronouncements where there is difference of opinion that it is not essential to transfer all assets and liabilities for a transaction to qualify for a slump sale. That is to say, that even if some assets are retained by the transferor and the undertaking after such transfer carries out its business activities without any obstruction, it shall still qualify to be a slump sale. The same has been substantiated by Bombay High Court in its ruling.
Since all assets and liabilities are to be transferred in a slump sale, it is important for one to understand the concept of going concern which is discussed at length below.
The terminology “going concern” is not precisely mentioned in the definition of slump sale. Transfer as a going concern means transfer of a business or a unit which is capable of being carried on by a purchaser as an independent business. To constitute a slump sale, it is not necessary that the business is ongoing at the time of its transfer.
Going Concern is a fundamental accounting assumption and Accounting Standard 1, Disclosure of Accounting Policies defines it as follows:
“The enterprise is normally viewed as a going concern, that is, as continuing in operation for the foreseeable future. It is assumed that the enterprise has neither the intention nor the necessity of liquidation or of curtailing materially the scale of the operations.”
To constitute a slump sale all the assets and liabilities of the undertaking are to be transferred. Therefore it can be said that companies whose operations are shut and is into liquidation may also opt for slump sale provided the conditions mentioned above are met. The intention of such condition is to ensure that the business will continue in the new hands with regularity and a nature of permanency.\
Further it is not necessary that the entity should be a profit making company. The only valid point to be considered for a transfer to constitute as a “going concern” to mean if it constitutes a business activity capable of being run independently for a foreseeable future. Such views were taken In the Matter of M/S. Indo Rama Textiles Ltd
The term “going concern” has no place in the GST Act. However one can refer to the pronouncement of the Advance Authority Ruling in case of Rajashri Foods Pvt Ltd for the same as mentioned below:\
A going concern is a concept of accounting and applies to the business of the company as a whole. Transfer of a going concern means transfer of a running business which is capable of being carried on by the purchaser as an independent business. Such transfer of business as a whole will comprise comprehensive transfer of immovable property, goods and transfer of unexecuted orders, employees, goodwill etc.
The transfer of business assets implies where the part of assets are transferred and not the whole business, i.e. the liabilities remain in the books of the transferor, whereas in transfer of business all assets and liabilities are transferred together. The concept of transfer of going concern comes handy when the business as a whole is transferred, however case laws and analysis do suggest the likelihood of transfer of assets as a going concern.
To understand the applicability of GST on a slump sale transaction, it is imperative to throw light on the word “supply” under the GST Act. It is explicitly discussed that for GST to be levied, there must be a case of “supply”. Therefore, we shall now refer the scope of supply as mentioned in Section 7 of the (Central Goods and Services Tax Act 2017 (CGST Act) which is as follows:
“(1) For the purposes of this Act, the expression “supply” includes––
Supply includes activities such as sale, transfer, barter etc for a consideration in the course or furtherance of business. From this we can infer that the activities shall take place in the course or furtherance of business. Coming to slump sale, the transaction is neither during the course of business nor in persistence of business. However since the word “includes” has been used in the definition in Section 7 (1) of the CGST Act, the scope of supply goes beyond the course or furtherance of business. Therefore the transfer as a going concern shall also be treated as “supply” under GST.
As slump sale is considered to be a supply under GST, we should now understand if the same constitutes to be goods or services.
The term goods has been defined under section 2(52) of the CGST Act 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;”
Further definition of “Service” as per section 2(102) of the CGST Act defines the term service as:
“(102)“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.”
Clause 4(c) of Schedule II of CGST Act states that
“(c) where any person ceases to be a taxable person, any goods forming part of the assets of any business carried on by him shall be deemed to be supplied by him in the course or furtherance of his business immediately before he ceases to be a taxable person, unless—
(i) the business is transferred as a going concern to another person; or
(ii) the business is carried on by a personal representative who is deemed to be a taxable person.”
Schedule II of the CGST Act talks about activities to be treated as a supply of good or supply of service wherein Clause 4, transfer of business assets has been considered as supply of goods. In Clause 4(c ) transfer of business as a going concern does not constitute as supply of goods.
As per the definition of services, anything other than goods is called a service. Business transferred as a going concern is excluded from the list of supply of goods. Since the schedule specifically excludes this activity, it becomes very obvious that transfer of business as a going concern is considered to be a supply of service.
Ministry of Finance vide its notification no 12/2017- Central Tax (Rate) dated 28th June 2017, came out with a list of supply of services and further brought clarity on “service by way of transfer of a going concern, as a whole or an independent part thereof” in serial no 2 of the said notification to constitute under supply of service. Further, activity of transfer of a going concern shall have “nil” rate of tax on such supply.
Since the notification talks about the activity of transfer of a going concern as a supply of service and the same is exempt from the purview of GST. Similarly Schedule II of the CSGT Act excludes transfer of business as a going concern as supply of goods, the same shall be considered as a supply of service and GST shall be levied.
It shall be inferred that transfer of a going concern as a whole or a part there or transfer of business as a going concern is tax-exempt under GST and transfer of business assets will have GST implications.
The above can be further justified by referring to the judgement passed by the Tax Authority of Advance Ruling in Karnataka in the case of Rajashri Foods Pvt Ltd where it was decided that subject to the condition that the unit being transferred is a going concern, it will be considered as a supply of service and the same shall be exempt from the payment of GST to the extent leviable under sub section (1) of Section (9) of the CGST Act, 2017.
In a slump sale, assets proposed to be transferred consist of both movable and immovable property i.e. land, building, stock, plant and machinery etc. Since these assets and liabilities are sold together for a lump sum consideration it does not tantamount to a “mixed supply” under GST.
Let us first understand the concept of mixed supply under GST
Section 2(74) of the CGST Act defines mixed supply as under:
“(74) “mixed supply” means two or more individual supplies of goods or services, or any combination thereof, made in conjunction with each other by a taxable person for a single price where such supply does not constitute a composite supply.”
To constitute a mixed supply, there has to be two or more supplies of goods or services and they have be in conjunction with each other. Therefore if the item in the bundle are neither goods nor services, it will not be considered a mixed supply under GST.
Let us understand the same with the help of an example. Suppose the assets being transferred to the buyer are plant & machinery, land and stock for a single price. Here there are more than one good transferred in the transaction. The bundle is not exclusively that of goods or services or both. The same will not qualify to be a mixed supply as land being transferred is excluded from the purview of GST (As per Schedule III of the GST Act which enumerates items which are neither supply of good nor supply of services).
Referring to the above example we may say that all legs of the definition should be satisfied for it to become a mixed supply. Merely because multiple items are sold for a single price should not, by the very fact render them as “mixed supply”. In so far as movable assets being concerned, it would be treated as supply of goods and is likely to attract GST.
Slump sale may be of an on-going business/unit or transfer of a stalled business/unit where the intent of the transferee is to run the entity. It can be said that that when there is a transfer of business and not of that of assets, in order to insulate from GST, it would require evaluation whether transfer is as a going concern or not.
The transaction of transfer of business as a whole of one of the units in the nature of going concern amounts to supply of service. The notification holds good, but subject to the condition that the unit is a going concern and therefore the same shall be free from the GST purview.
To summarise the above discussed concept
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