Interest Imbalance: Will the disproportionate interest Split in Loan Transfers be liable to withholding tax?

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ITAT Ruling Clarifies Taxation on Disproportionate Interest share in Loan Transfers

– Dayita Kanodia | Finserv@vinodkothari.com

Direct Assignment of a loan or transfer of loan exposures refers to the process where financial institutions, such as banks, purchase a pool of loans or assets from other entities, typically NBFCs, without the involvement of a third-party intermediary. In this arrangement, the buying institution directly acquires the ownership of the loans or assets and the associated rights, including the right to receive future payments from the borrowers. This method allows the selling NBFC to offload its loans, thereby freeing up capital, while the purchasing institution gains the opportunity to enhance its loan portfolio and earn interest income from the acquired loans. This Direct Assignment is essentially what is popularly known as the transfer of loan exposure.

The RBI issued the transfer of loan exposures directions in 2021 regulating all transactions among regulated entities involving transfer of loan exposures.

Interest sharing and servicing after the transfer

Pursuant to a transfer of loan, it is not necessary that the future interest income arising from the loans would be shared in the same proportion as that of the transfer. For instance, if an NBFC assigns 90% of the loan portfolio to a bank, there is no mandate that all interest income received in the future would be shared in the same proportion of 90:10. Generally, the borrower is not made aware of the transfer and therefore it is important that the NBFC continues to service the loan. In such cases it is only fair that the NBFC gets a higher proportion of interest. Accordingly, it is quite common in direct assignment transactions to have a disproportionate interest share. 

The question which now arises is whether this excess interest income retained by the NBFC would be taxable under the provisions of the income tax act. 

ITAT Ruling and taxation on disproportionate interest share in loan transfers

A recent ITAT ruling of May 7, 2024 clarifies the taxation treatment for disproportionate interest share in case of loan transfers. In this case, NBFC assigned 90% of the loan portfolio to a bank via the direct assignment route. However, the bank was not receiving the entire interest on the 90% loan assigned but was only entitled to a fixed percentage of share while the NBFC retained the excess interest. Accordingly, the revenue department was of the view that the assessee was responsible to deduct TDS on the excess interest allowed to be retained by the NBFC under section 194A of the Income Tax Act. 

The revenue department further raised the question on deduction of TDS under SEction 194J and 194H of the Income Tax Act. 

Interest Retained not a result of money borrowed or debt incurred by the transferee

For the deciding the fate of the NBFC under section 194A of the Income Tax Act, the following was observed by the ITAT:

  1. For TDS to be deducted under section 194A of the Income Tax Act, the crucial aspect to be satisfied was whether the part interest allowed to be retained by the originating NBFC by the bank is payment in the nature of interest to the NBFC for any money borrowed or debt incurred by the bank.
  1. It was acknowledged that the 90% of the loan portfolio was assigned to the bank and consequently any default among the assigned loans would result in loss to the bank. 
  1. Any amount collected from the borrowers was initially getting deposited in an escrow account and was subsequently distributed between the NBFC and the bank in accordance with the agreement entered into by the entities. 
  1. It could not be shown that the interest allowed to be retained with the NBFC was a result of any money borrowed or debt incurred by the bank from the NBFC. 
  2. Accordingly, the assessee was under no obligation to deduct TDS on the excess interest retained by the NBFC under section 194A. 

Interest retained not in the nature of fees for any professional / technical services rendered by the transferor

The next issue which was adjudicated in the case was whether the interest allowed to be retained with the NBFC was a consideration for rendering professional / technical services by the transferor NBFC to the transferee bank. 

As per section 194J of the Act, any person, not being an individual or HUF, who is responsible for paying to a resident any sum, inter alia, by way of fees for professional services or fees for technical services shall at the time of credit of such sum to the account of payee deduct tax at source.

For this purpose the ITAT observed the following:

  1. The NBFC and the Bank entered into a tripartite service agreement pursuant to which the originating NBFC was appointed as servicer for the loans. The NBFC was therefore responsible for managing, collecting and receiving payment of the receivable and depositing the same in the ‘Collection and Payout Account’ to enable the distribution of the payout therefrom and providing certain other services.
  1. As per the service agreement, a one time service fee of Rs.1 Lakh was agreed to be payable by the bank to the NBFC as consideration for the services rendered.
  1. The ITAT brushed aside the contention of the revenue department that service fee of Rs 1L was inadequate and the excess interest allowed to be retained by the NBFC should in fact be considered as fee for rendering the services by the transferor NBFC. 
  1. There was a separate tripartite Deed of Assignment of receivables entered into by the parties according to which the bank paid the entire principal amount equivalent to 90% of the entire pool to the NBFC upfront. However, it was observed that the transfer being an independent commercial transaction cannot be on a cost to cost basis without there being any markup.
  1. Accordingly, the bank opted to pay the consideration for the loans assigned partially by way of an upfront payment equivalent to the principal amount of the loan assigned to it and partly by agreeing to earn a lower rate of interest on its portion of assigned loans and allowing the NBFC to retain the part interest received from the borrower.
  1. Therefore the liability under section 194J of the Income Tax Act was only for the service fee of Rs.1 L and cannot be extended to the excess interest share retained by the NBFC.
  1. Accordingly, the assessee was under no obligation to deduct TDS on the excess interest share retained by the NBFC under section 194J of the Income Tax Act. 

Interest retained not in the nature of commission / brokerage

The last issue in this case to be decided before the ITAT was whether the retained interest would fall in the category of commission or brokerage and was liable to TDS under section 194H of the Income Tax Act. 

As per section 194H of the Act, any person, not being an individual or HUF, who is responsible for paying to a resident, any income by way of commission or brokerage, shall at the time of credit of such income to the account of the payee deduct tax.

For determining the tax treatment under this section, the ITAT observed the following:

  1. It could not be said that the loans originated by the NBFC were on behalf of the bank.
  1. For the services rendered by the NBFC, it was observed that the same was pursuant to a separate service agreement which provides for payment of separate service fees in lieu of such services.
  1. Accordingly, it cannot be contended that the transferor NBFC was acting as an agent of the transferee bank.
  1. Accordingly, the liability to deduct TDS on the excess interest retained by the NBFC under section 194H of the Income Tax Act does not arise. 

Concluding Remarks 

In conclusion, the recent ITAT ruling has provided significant clarity on the taxation treatment of disproportionate interest shares in loan transfers, particularly in the context of Direct Assignment transactions. 

In this case, the ITAT emphasized that the interest retained by the NBFC was not a result of any money borrowed or debt incurred by the bank. Additionally, it was clarified that the interest retained did not constitute fees for professional or technical services rendered by the transferor NBFC, nor did it fall within the ambit of commission or brokerage.

As the financial landscape continues to evolve, such judicial pronouncements play a crucial role in fostering transparency, compliance, and fairness in taxation.

The iSAFE option to start up funding: Legality and taxation

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Mahak Agarwal | corplaw@vinodkothari.com

Navigating the world of fundraising for startups is no easy feat. This becomes all the more challenging for a pre-revenue start-up which cannot have a valuation. Amongst the several fundraising options available to a start-up, one of the budding and lesser-known sources happens to be iSAFE.

Origin

iSAFE, short for, India Simple Agreement for Future Equity, was first introduced in India by 100X.VC, an early-stage investment firm. This move was inspired by US’s ‘Simple Agreement for Future Equity (‘SAFE’)’, an alternative to convertible debt and the brainchild of an American start-up incubator. SAFE is a financing contract between a startup and an investor that grants the investor the right to acquire equity in the firm subject to specific activating events, such as a future equity fundraising.[1]

So far as the success of SAFE in India is concerned, being neither debt (since they do not accrue interest), nor equity (since they do not carry any dividend or shareholders’ rights) or any other instrument, it could not carve its place in India and was cornered as a mere contingent contract with low reliability and security. On the contrary, iSAFE happened to be the game changer in the Indian context, being a significantly modified version of SAFE.

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Securing the Beat: Tuning into Music Royalty Securitization

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Dayita Kanodia | finserv@vinodkothari.com

“Music can change the world”

–Ludwig van Beethoven

This quote by Beethoven remains relevant today, not only within the music industry but also in the realm of finance. In the continually evolving landscape of finance, innovative strategies emerge to monetize various assets. One such groundbreaking concept gaining traction in recent years is music royalty securitization. This financial mechanism offers investors a unique opportunity to access the lucrative world of music royalties while providing artists and rights holders with upfront capital.

The roots of this innovative financing technique can be traced back to the 1990s when musician David Bowie made history by becoming the first artist to securitize his future earnings through what became known as ‘Bowie Bonds’. This move not only garnered attention but also paved the way for other artists to follow suit. Bowie Bonds marked a significant shift in how music royalties are bought, sold, and traded.

As per the S&P Global Ratings[1], the issuance of securities backed by music royalties totaled nearly $3 billion over the two-year span 2021-22. The graph below shows a recent surge in issuance of securities backed by music royalties.

Data showing the growth of Music Royalty Securitization

This article discusses music royalty securitization, its mechanics, benefits, challenges along with implications for the music industry.

Understanding Music Royalties:

Before exploring music royalty securitization, it’s essential to understand the concept of music royalties. In the music industry, artists and rights holders earn royalties whenever their music is played, streamed, downloaded, or licensed for use. These royalties are generated through various channels, including digital platforms, radio, TV broadcasts, live performances, and synchronization licenses for commercials, movies, and TV shows. However, it’s important to note that artists only earn royalties when their music is utilized, whether through sales, streaming, broadcasting, or live performances.

As a result, the cash flows from these royalties being uncertain are received over time and continue to be received for an extended period. Consequently, artists experience a delay in receiving substantial amounts from these royalties, sometimes waiting for several years before seeing significant income.

The Birth of Music Royalty Securitization:

Securitization involves pooling and repackaging financial assets into securities, which are then sold to investors. The idea is to transform illiquid assets, such as mortgage loans or in our case, music royalties, into tradable securities. Music royalty securitization follows a similar principle, where the future income generated from music royalties is bundled together and sold to investors in the form of bonds or other financial instruments.

Future Flows Securitization:

Music royalty securitization is a constituent of future flows securitization and therefore before discussing the constituent, it is important to discuss the broader concept of future flows securitization.

Future flows securitization involves the securitization of future cash flows derived from specific revenue-generating assets or income streams. These assets can encompass a wide range of future revenue sources, including export receivables, toll revenues, franchise fees, and other contractual payments, even future sales. By bundling these future cash flows into tradable securities, issuers can raise capital upfront, effectively monetizing their future income. Future flows securitization differs from the traditional asset backed securitization by their very nature as while the latter relates to assets that exist, the former relates to assets that are expected to exist. There is a source, a business or infrastructure which already exists and which will have to be worked upon to generate the income. Thus, in future flows securitization the income has not been originated at the time of securitization. The same can be summed up as: In future flow securitization, the asset being transferred by the originator is not an existing claim against existing obligors, but a future claim against future obligors.

Mechanics of Music Royalty Securitization:

Music royalty securitization involves packaging the future income streams generated by music royalties into tradable financial instruments. The process begins with the identification of income-generating assets, which are then bundled into a special purpose vehicle (SPV). The SPV issues securities backed by these assets, which are sold to investors. The revenue generated from the underlying music royalties serves as collateral for the securities, providing investors with a stream of income over a specified period.

The process of music royalty securitization typically involves several key steps:

Asset Identification: Rights holders, such as artists, record labels, or music publishers, identify their future royalty streams eligible for securitization.

Valuation: A valuation is conducted to estimate the present value of the anticipated royalty income streams. Factors such as historical performance, market trends, and artist popularity are taken into account.

Selling the future flows: The future flows from royalties are then sold off to the Special Purpose Vehicle (SPV) to make them bankruptcy remote. The sale entitles the trust to all the revenues that are generated by the assets throughout the term of the transaction, thus protecting against credit risk and sovereign risk as discussed later in this article.

Structuring the Securities: These future cash flows are then structured into securities. This may involve creating different tranches with varying levels of risk and return.

Issuance: The securities are then issued and sold to investors through public offerings or private placements. The proceeds from the sale provide upfront capital to the rights holders.

Revenue Collection and Distribution: The entity responsible for managing the securitized royalties collects the revenue from various sources which is then distributed to the investors according to the terms of the securities.

Importance of Over-collateralization:

Over-collateralization is an important element in music royalty securitization. In music royalty securitization and in all future flows transactions in general, the extent of over-collateralization as compared to asset backed transactions is much higher. The same is to protect the investors against performance risk, that is the risk of not generating sufficient royalty incomes. Over-collateralization becomes even more important since subordination structures generally do not work for future flow securitizations. This is because the rating here will generally be capped at the entity rating of the originator.

Why go for securitization ?

Now the question may arise as to why an artist or a right holder of a royalty has to go for securitization of his music royalties in order to secure funding. Why cant he simply opt for a traditional source of funding ? The answer to this question is two folds: 

Firstly, the originator in the present case generally has no collateral to leverage and hardly there will be a lender willing to advance a loan based on assets that are yet to exist. 

Secondly even if they are able to obtain funding it will be at a very high cost due to high risk the lender perceives with the lending. 

Music royalty securitization, could be his chance to borrow at a lower cost. The cost of borrowing is related to the risks associated with the transaction, that is, the risk the lender takes on the borrower. Now, this risk includes performance risk, that is the risk that the work of the originator does not generate enough cash flows. While this risk holds good in case of securitization as well, it however takes away two major risks – credit risk and sovereign risk. 

Credit risk, as divested from the performance risk would basically mean that the originator has sufficient cash flows but does not pay it to the lender. This risk can be removed in case of a securitization by giving the SPV a legal right over the cash flow. 

Sovereign risk on the other hand emanates only in case of cross-border lending. This risk arises when an external lender gives a loan to a borrower whose sovereign later on in the event of an exchange crises either imposes a moratorium on payments to external lenders or may redirect foreign exchange earnings. This problem is again solved by giving the SPV a legal right over the cash flows from the royalties arising in countries other than the originator’s, therefore trapping cash flow before it comes under the control of the sovereign. 

The lack of these two types of risks might reduce the cost of borrowing for the originator; thus making music royalty securitization a lucrative option.   

Accounting Treatment:

As discussed, there is no existing asset in a music royalty transaction. In terms Ind AS 39, an entity may derecognize an asset only when either the contractual rights to the cash flows from the financial asset have expired or if it transfers the financial asset. However, here asset means an existing asset and a future right to receive does not qualify as an asset in terms of the definition under Ind AS 32.

Accordingly, the funding obtained through the securitization of music royalties should be shown as a liability in books as the same cannot qualify as an off-balance sheet funding.               

Regulatory Framework in India:

It is crucial to discuss the applicable regulatory framework on securitization currently prevalent in India and whether music royalty securitization would fall under any of these:

  1. Master Direction – Reserve Bank of India (Securitization of Standard Assets) Directions, 2021(‘SSA Master Directions)
  2. SEBI (Issue and Listing of Securitised Debt Instruments and Security Receipts) Regulations, 2008 (SDI Framework)    
  3. Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002  

While the SSA Master Directions primarily pertain to financial sector entities, and will not directly apply to this domain; however, there exists a possibility that the securitization of music royalties could fall under the purview of SEBI’s SDI Framework.

The same has been discussed in detail in the artcile- The Promise of Predictability: Regulation and Taxation of Future Flow Securitization                                                                                                                                                           

Benefits of Music Royalty Securitization:

Music royalty securitization offers a range of benefits for both investors and rights holders:

Diversification: Investors gain exposure to a diversified portfolio of music royalties, potentially reducing risk compared to investing in individual songs or artists.

Steady Income Stream: Music royalties often provide a stable and predictable income stream, making them attractive to income-oriented investors, such as pension funds and insurance companies.

Liquidity: By securitizing music royalties, rights holders can access immediate capital without having to wait for future royalty payments, providing liquidity for new projects or business expansion.

Risk Mitigation: Securitization allows rights holders to transfer the risk of fluctuating royalty income to investors, providing a hedge against market uncertainties and industry disruptions.

Challenges and Considerations:

While music royalty securitization presents compelling opportunities, it also poses certain challenges and considerations:

Market Volatility: The music industry is subject to shifts in consumer preferences, technological disruptions, and regulatory changes, which can impact the value of music royalties.

Due Diligence: Thorough due diligence is essential to assess the quality and value of music assets, including considerations such as copyright ownership, market demand, and revenue potential.

Potential Risks:

  • Market Risk: Changes in consumer behavior, technological advancements, or regulatory developments could impact the value of music royalties.
  • Legal Risk: Disputes over ownership rights, copyright infringement, or licensing agreements could lead to litigation and financial losses.
  • Concentration Risk: Investing in a single music catalog or genre exposes investors to concentration risk if the popularity of that catalog or genre declines.
  • Cash Flow Variability: While music royalties can provide steady income, fluctuations in streaming revenues or changes in licensing agreements may affect cash flow stability.
  • Reputation Risk: The success of music royalty securitization depends on the ongoing popularity and commercial success of the underlying music assets. Negative publicity, controversies, or declining relevance can adversely affect investor confidence and returns.

Implications for the Music Industry:

While music royalty securitization presents exciting opportunities, it also raises certain considerations for the music industry:

Artist Empowerment: Securitization can empower artists by providing them with alternative financing options and greater control over their financial destiny.

Industry Evolution: The emergence of music royalty securitization could reshape the traditional music business model, fostering innovation and collaboration between artists, labels, and investors.

Way Forward

Music royalty securitization offers a compelling investment opportunity for investors seeking exposure to the lucrative music industry. By securitizing future royalty streams, music rights owners can unlock liquidity while providing investors with access to a diversified portfolio of music assets.

As the music industry continues to evolve, music royalty securitization is likely to play an increasingly prominent role in the financial landscape, providing new avenues for capital deployment and revenue generation. It has the potential to transform the rhythm of creativity into the melody of investment opportunity.

See also our article on:

  1. Securitization of future flows
  2. Bowie Bonds: A leap into future by a 20th century singer

[1] https://www.spglobal.com/ratings/en/research/articles/240220-abs-frontiers-music-royalty-securitizations-are-getting-the-band-back-together-13003585

[2] https://incometaxindia.gov.in/Pages/acts/income-tax-act.aspx

[3] https://www.rbi.org.in/scripts/bs_viewmasdirections.aspx?id=12165

[4] https://www.sebi.gov.in/sebiweb/home/HomeAction.do?doListingAll=yes&search=Securitised%20Debt%20Instruments

[5] https://www.indiacode.nic.in/bitstream/123456789/2006/1/A2002-54.pdf

Finance Ministry to modernize the Indian Stamp Act

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Archana Kejriwal | corplaw@vinodkothari.com

The Ministry of Finance, Government of India, through its Department of Revenue, has issued a draft Indian Stamp Bill, 2023[1] on 17th January, 2024 inviting public comments and suggestions within 30 days, with an intent to align it with the modern stamp duty regime. Once enacted, the Bill seeks to replace the Indian Stamp Act, 1899[2].

The Indian Stamp Act, 1899 is a fiscal legislation enacted for the purpose of generating revenue to the Government. Being enacted during the British era, the Act has undergone several amendments from time to time, however, most of the provisions still stand redundant, for instance, proviso under section 8(2) of the Act provides for the treatment of stamp duty on bonds, debentures or other securities issued by the local authority prior to 26th March, 1897, the Act at several places uses denomination of money in ‘anna’ which has no role in the present. Such transitional provisions hold no stand anymore, thus may be removed. Therefore, it has been proposed to modernise the legislation to enable it to deal with the present realities and objectives.

 In this article, we have made an attempt to analyse the changes proposed.

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Shorn of tax benefit, MLDs now face tax deduction on payouts

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Dayita Kanodia | Executive

finserv@vinodkothari.com

Background

The Finance Bill, 2023[1], has quite nearly caused the demise of the so-called “Market-Linked Debentures” (MLDs)[2]. The changes made pursuant to the Finance Bill, 2023, took away what seemed to be a strong reason for popularity of MLDs, i.e., the tax arbitrage.

Prior to the change, listed MLDs had the advantage of being exempt from the withholding tax under section 193 of the Income Tax Act, 1961, as well as being taxed at 10% as Long Term Capital Gains (LTCG) tax, if held for at least 12 months.

Finance Bill, 2023 inserts a new section 50AA to the Income Tax Act, 1961, which makes MLDs to be taxed at slab rates as a short term capital asset in all cases at the time of  transfer or redemption on maturity, irrespective of the period of holding, therefore losing out on the earlier lower LTCG rate of 10%.

In addition, the earlier exemption from withholding tax on listed debentures has now been removed pursuant to an amendment in section 193, which means that interest paid on listed debentures would now be subject to withholding tax with effect from April 01, 2023[3].

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Taxation in Securitisation: A judicial overview

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-Anirudh Grover, Executive | finserv@vinodkothari.com

Introduction

Securitization transactions in India post the pandemic has seen significant improvement with volumes growing by 70% to Rs. 73000 crores in FY 2023 compared to Rs. 43000 crores in FY 2022.[1] This growth was also highlighted in one of our recent write up wherein it can be seen from the data laid down that despite the global slowdown in the world economy on account of the pandemic, the volume of securitization transactions in India gained a lot of popularity. Given the impetus of this fundraising mode, it is important to have a vibrant securitization market. This can be only achieved if the governing framework with respect to taxation does not impose an additional taxation burden on the parties. Through this article, the writer will be reviewing the stance of various courts by highlighting the principles with respect to the taxation of the parties involved in a securitization framework i.e. Originator, Special Purpose Vehicle(‘SPV’), and the Investors. For a better understanding of the framework of securitization, the readers can also refer to our Article on Securitization: A Primer.

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Market-linked debentures: Is it the end of the market for them?

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– Aanchal Kaur Nagpal, Manager | finserv@vinodkothari.com

Tax proposal to tax gains on MLDs as short-term capital gains

The Budget proposes that the capital gains on market linked debentures (MLDs) will be taxed as short term capital gain.

Presently, MLDs are mostly listed, and as listed securities they have 2 advantages:

  • First , there are exempt from withholding tax. This is one of the carve-outs in sec. 193
  • Secondly, the holding period for capital gain purposes is 12 months,  as opposed to 36 months in case of normal capital assets. This comes from sec. 2 (42A) of the Act. Therefore, if a listed security is held for at least 12 months, and transferred or redeemed thereafter, the gain will be taxed as long term capital gain, with a rate as low as 10%.

Market linked debentures is a concept that prevails world-over, with different names such as equity-linked bonds, index-linked bonds, etc. However, in India, the issuance of MLDs was being exploited as a regulatory and tax arbitrage device.

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Financial entities in IFSC: A primer

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– Parth Ved, Executive | parth@vinodkothari.com

Table of contents

BackgroundApplicability of Domestic Regulatory framework Regulatory framework in IFSC
What is IFSC?Companies Act, 2013IFSCA (Finance Company) Regulations, 2021
Purpose of setting up an IFSC Foreign Exchange Management Act, 1999Specific Frameworks for Aircraft Leasing and Ship Leasing
Who regulates IFSC?Income tax act, 1961IFSCA (Fund Management) Regulations, 2022
Is IFSC and GIFT City the same? Goods and Services TaxIFSCA (Banking) Regulations, 2020
Permission for setting up an entity in IFSCStamp dutyClosing remarks
Securities lawRelevant Links
Banking law

Background

Flow of funds, just like a river, not only enriches its destination but also benefits all the stops it passes through. Having a financial hub, a stopover which enables routing billions and billions of global funds on a daily basis can definitely prove resourceful. London, New York, Singapore are some of the globally recognised financial centres, and needless to say these locations are at the forefront of financial development. India too has tried to tap into this with the setting up of GIFT-IFSC in Gujarat, and has tried to position itself as the next big global hub for financial transactions.

Through this write-up, the author tries to explain the concept of International Financial Services Centre and the applicability of domestic regulatory framework on entities set up therein.

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Secondment contract as ‘services’: Supreme Court held under Indian taxation regime

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– Neha Sinha, Assitant Legal Advisor | neha.sinha@vinodkothari.com 

Background

Secondment of employees have become increasingly popular amongst corporate entities which enter into secondment arrangements to leverage the expert knowledge and specific skill sets. The seconded employees work on a deputation basis in the seconded companies they are seconded to which require their technical expertise on certain matters. Since the seconded employee works for the seconded company during the secondment period, a pertinent question arises on whether the seconded employee becomes an employee of the seconded company. If yes, then what are the likely implications in the context of service tax. 

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Financial Leases getting a new lease of life?

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– Kanakprabha Jethani, Senior Manager | kanak@vinodkothari.com

Background

Leasing industry in India started and grew, as in several other countries, with financial leasing. However, over last several years, it seemed as if financial leases had lost their relevance, for reasons discussed below. While activity in the leasing space was not very brisk, but whatever activity was there was seen mostly in operating leases. Operating leases were sold on the strength of either off-balance sheet treatment, or with lower monthly rentals, or residual value management etc. In case of financial leases, on the other hand, there seemed very little motivation.

Some recent developments seem to be rekindling the interest in financial leases, and if the tax ruling by the ITAT Chennai either goes unchallenged or is affirmed on further appeal, there may be just a new lease of life for financial leases. Coupled with other benefits such as bankruptcy remoteness etc., there may be strong reasons for looking at financial leases, both by lessors and lessees.

In financial year 2021-22, the volume of financial leasing reached to around 7% of the total leasing volumes in the country, compared to 20% in the financial year 16-17[1]. Considering the legal and regulatory construct in India, the reducing volumes of financial leasing make complete sense. However, the recent rulings on taxation of leases may reverse the long known reasons for not doing financial leases.

In this article, the author discusses the reasons why financial leases do not appeal to lessors and lessees and how the recent developments on the taxation aspects of leasing may seem to be bringing financial leases back to life.

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