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GST on Corporate Guarantees: Understanding the new regime

–  Payal Agarwal, Associate | corplaw@vinodkothari.com


The debate around levy of GST on corporate guarantee extended without or with inadequate consideration has been settled with the insertion of sub-rule (2) to Rule 28 of the Determination of Value of Supply Rules (“Valuation Rules”), effective from 26th October, 2023. Sub-rule (2) of Rule 28 specifies a deemed value for provisions of corporate guarantee to a related person subject to certain conditions. Now, vide another notification dated 10th July, 2024, amendments have been made to the said sub-rule, to ease out the provisions with respect to value of corporate guarantee given to a related person.


Effective date of the amendment


Sub-rule (2) of Rule 28 has been notified and made applicable w.e.f. 26th October, 2023. The amendments made under sub-rule (2), vide the July 2024 notification, has also been made applicable retrospectively, i.e., w.e.f. 26th October, 2023. Hence, sub-rule (2) of rule 28 applies to a corporate guarantee issued or renewed on or after 26th October, 2023.


Understanding the terminology


In usual financial parlance, the guarantor provides a guarantee to a lender (or other person to whom certain obligations or performance is owed), in favour of a borrower (or obligant, owing performance obligations). The guarantor is the giver of the guarantee, the lender is the receiver of the guarantee and the person for whom the guarantee is given is the beneficiary of the guarantee.


However, in GST parlance, it is important to understand that the language is from the viewpoint of “supply of services”. Hence, the guarantor is the supplier of the service, the borrower or beneficiary is the recipient of the service, and the lender is actually not a party to the supply, but has a relevance as the rules relate to who the guarantee is given.


Hence, importantly, the receiver of the supply in GST parlance is not the lender, but the borrower.


Value of supply of corporate guarantee for related persons


With the amendments coming into force, there are three ways the value of supply of service, i.e., issue of corporate guarantee, is to be determined, based on the nature of the recipient and the lender:


  • As per the deemed value of the supply

  • As per invoice value of the supply

  • As per determination by the tax officer

The below chart summarises the same:


(a)   Value of corporate guarantee as per deemed value under rule 28(2)


Rule 28 prescribes the value for supply of goods and services between distinct persons or related persons. In view of the common practice among related persons to provide corporate guarantee at nil consideration, sub-rule (2) was inserted under rule 28 to explicitly provide for a deemed value of consideration in case of supply of corporate guarantee. The same has been further amended vide the July amendment.


Sub-rule (2), as amended, reads as below:


Notwithstanding anything contained in sub-rule (1), the value of supply of services by a supplier to a recipient  who  is  a  related  personlocated in India, by  way  of  providing  corporate  guarantee  to  any  banking  company  or financial institution on behalf of the said recipient, shall be deemed to be one per cent of the amount of such guarantee offered per annum, or the actual consideration, whichever is higher.”


The deemed value provided under the said rule is 1% p.a. of the amount of guarantee offered, where no consideration is charged, or the actual consideration is lower than the aforesaid threshold. However, the said deemed value is applicable only where the following conditions are met:



  • Recipient of the service (i.e., the borrower) is a related person of the supplier (i.e., the guarantor),

  • Recipient of the service is located in India (since GST is not levied on export of services),

  • Recipient of the service is not eligible for full ITC, and

  • Corporate guarantee has been provided to a banking company or financial institution[1]


(b)  Value of corporate guarantee as per declared value in the invoice


A new proviso has also been inserted to sub-rule (2) of rule 28 vide the July amendment to ease out the GST implications on corporate guarantees. Pursuant to the said amendment, the deemed value of corporate guarantee will not apply, and the declared value in the invoice is taken as the value of the corporate guarantee, where the recipient of the service, i.e., the borrower is eligible for full ITC.


A similar proviso exists under sub-rule (1) of rule 28 as well. However, sub-rule (2) begins with a non-obstante clause, and thus, sub-rule (1) becomes non-existent for corporate guarantees between related persons to the banks/ financial institutions.


Hence, prior to the present amendment, for corporate guarantee between related persons, the relief with respect to invoice value was not available, and hence, GST was leviable on the basis of the deemed value. However, the amendments being applicable retrospectively, for recipients eligible for full ITC, benefit of invoice value will be available for corporate guarantees issued or renewed on or after 26th October, 2023.


Persons eligible for full ITC

Section 16 of the CGST Act specifies the eligibility and conditions for availing ITC. Where a person is eligible for a claim of full ITC, the value of supply of corporate guarantee will be based on the invoice value instead of the deemed value.


Here, it is important to note that the proviso refers to “full ITC”, and hence, eligibility for availing ITC u/s 16 is not enough, the recipient should be eligible for “full ITC”. The meaning of eligibility for full ITC is controversial, with some advance rulings on the subject[2]. In view of the aforesaid, it appears that the benefit of the proviso may not be available for a banking company or financial institution availing the option of 50% ITC as per sub-section (4) of section 17 of the CGST Act, as well as other persons providing exempt supplies. In essence, if the borrower (note, borrower is the recipient of the service) is a bank or financial institution or an entity providing exempt supplies, for whose borrowings a guarantor, being a related person, has given a guarantee, the deemed value will be applicable.


(c)   Value of corporate guarantee determined by tax officers under rule 28(1)


Rule 28(2) being a specific provision for value of corporate guarantee between related persons, valuation as per sub-rule (1) will apply only in cases where sub-rule (2) is not applicable. Sub-rule (1) is a general provision, applicable to supply for any goods or services between distinct or related persons. Under the said sub-rule, the value of corporate guarantee will be based on the determination by the tax officer (refer our article on the same here).


Hence, the same will be applicable only in cases where value of supply as per (a) and (b) above does not apply.


Applicability of deemed value on FLDG arrangements


First Loss Default Guarantee or FLDGs[3] are arrangements that do not involve the borrower, the guarantee is usually given by the supplier (i.e., the DLG provider) to the lender. As such, unlike guarantee which is a tripartite contract between the guarantor, borrower and the lender, FLDG is more like an indemnity, involving only two parties – the indemnifier (i.e., the guarantor) and the indemnified (i.e., the lender). The borrower being out of the picture, the applicability of deemed value of corporate guarantee, if at all, would arise if the guarantor and the lender are related persons. However, going by the nature of FLDG – being an indemnity rather than a guarantee – sub-rule (2) of rule 28 does not seem to be applicable. However, if the transaction is between related persons, the recipient of the service being an NBFC, it is important to ensure that the terms of the service are based on arms’ length consideration.


Conclusion


With the recent amendments in the GST regime applicable on corporate guarantees to related persons, the deemed value of supply for levying GST on corporate guarantee does not apply, if consideration is being charged by the guarantor and the recipient is eligible to claim full ITC. Market valuation principles do not apply, and hence, one may further want to circumvent the provisions by charging guarantee commission at negligible value, thereby, avoiding a higher GST charge. However, that does not preclude the RPT consideration under corporate laws, that require at least companies to ensure that any related party transaction is undertaken at arm’s length terms including pricing, and hence, the guarantee commission charged from a related party should also be based on the same principle.


[1] The meaning of financial institution is to be taken from section 45-I(c) of RBI Act, 1934.


[2] See a few advance rulings on the subject by West Bengal AAR, Tamil Nadu AAR


Also see a few articles on the subject: https://www.livelaw.in/law-firms/law-firm-articles-/input-tax-credit-central-goods-services-tax-rules-cgst-act-itc-tlc-legal-243111


https://taxguru.in/goods-and-service-tax/meaning-full-input-tax-credit-2nd-proviso-rule-28.html


[3]Structured Default Guarantees – https://vinodkothari.com/2022/09/structured-default-guarantees/


See our FAQs on default loss guarantee here – https://vinodkothari.com/2023/06/faqs-on-default-loss-guarantee-in-digital-lending/

Taxability of Corporate Guarantees under GST

– Dayita Kanodia, Executive | finserv@vinodkothari.com

A person who can’t pay gets another person who can’t pay, to guarantee that he can pay.

Charles Dickens

Background

It is a common practice for companies to issue guarantees for loans taken by their group companies. When transactions happen between related parties, there is always a likelihood of them being not at arm’s length. 

Accordingly, this has led to questions that whether such corporate guarantees given without any consideration shall be liable to GST. A Supreme Court ruling issued earlier this year has clarified that corporate guarantees issued without any consideration shall not be liable to service tax. 

Therefore while the situation in case of levy of service tax has been clarified by the ruling, the same has led to a lot of ambiguities and questions for the levy of GST on such guarantees. This article aims to clarify the same.   

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Loan Penal Charges: Accounting and GST implications

Abhirup Ghosh, Qasim Saif & Aanchal Kaur Nagpal  | finserv@vinodkothari.com

Background

Levying of penal charges or late payment charges are claimed as ‘just’, owing to the underlying breach of contract under the Contract Act, 1972. A breach or a non-performance by one party entitles the other party to receive compensation for any loss or damage suffered due to such breach. Penalties may not only be compensatory; they also have a deterrent element.

In order to ensure compliant behaviour, lenders  charge penalties to their borrowers for various ‘events of default’; the predominant ones being penalty for delayed payments (in the form of charges or interest) and prepayment penalties. However, such charges stopped being ‘just’ and ‘reasonable’ when lenders started maneuvering such penalties as revenue enhancement tools, rather than as a deterrent measure and compensation for a breach. Such unreasonable penalties coupled with non-disclosures, compounding of penal interest, etc. were highly prejudicial to consumer interest and accordingly, caught the eye of the regulator. 

The RBI introduced guidelines to the lenders to ensure reasonableness and transparency in the disclosure of penal interest vide its Circular on ‘Fair Lending Practice – Penal Charges in Loan Accounts’(RBI Guidelines on penal charges’)  dated August 18, 2023. Our article and FAQs[1] on the same may be read here[2].Our YouTube video discussing the guidelines may be viewed here.

However, charging penal interest also raises several practical questions for lenders, mainly indirect taxation and accounting of penal charges, which will be discussed in detail in this article.

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A Critical Analysis on Corporate Guarantees under Service Tax and GST

Dayita Kanodia, Executive | finserv@vinodkothari.com

“The Supreme Court’s only armour is the cloak of public trust; its sole ammunition, the collective hopes of our society.” – Irving R. Kaufman

Background

The Supreme Court has ruled that service tax will not be levied on corporate guarantees by a parent company to its subsidiaries where there is no consideration involved.

This article discusses the impact of this ruling on companies which issue corporate guarantees without consideration.

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Can companies avail GST benefits on CSR spending?

– By Harsh Juneja | Executive (corplaw@vinodkothari.com)

(Updated as on February 03, 2023 by Lovish Jain | Executive)

Background

Section 135(5) of the Companies Act, 2013 (‘the Act’) requires every eligible company [as per section 135(1)] to spend at least 2% of the average of net profits of immediately preceding 3 financial years towards Corporate Social Responsibilities(‘CSR’) activities. The CSR spending may sometimes include contributions made to NGOs or other beneficiaries, or money paid to implementing agencies. However, quite often, the expense may relate to procurement of goods or services which are applied to one or more CSR activities. This procurement of goods or services comes with the tax cost, viz., GST. So the question is, does this GST paid, while acquiring goods or services, give rise to an input tax credit, such that the same may be claimed as a set off? A related, and more important question is, whether CSR expense for the purpose of sec. 135 (5) be the amount net of the ITC, if the ITC is claimable, or the gross amount paid?

Input Tax Credit

Eligibility

Section 16(1) of the Central Goods and Service Tax (‘CGST Act, 2017’) prescribes the eligibility criteria for taking Input Tax Credit. It states that “Every registered person shall, subject to such conditions and restrictions as may be prescribed and in the manner specified in section 49, be entitled to take credit of input tax charged on any supply of goods or services or both to him which are used or intended to be used in the course or furtherance of his business and the said amount shall be credited to the electronic credit ledger of such person.”

Until the Budget 2023 announcement, there was no explicit provision clarifying the position whether input tax credit would be available for acquiring goods or services for carrying out CSR activities. In the Finance Bill, 2023, a proposal has been made for amendment in section 17 of the CGST Act, 2017 to disallow the availability of input tax credit for expenditure made towards CSR activities. Please refer to our article on the same

There have been rulings by Appellate Tribunal and Advance Rulings under GST w.r.t. the same.

Hon’ble CESTAT Mumbai, in the case of M/s Essel Propack Ltd. vs Commissioner of CGST, Bhiwandi, gave a view that the CSR gives a company an economically, socially and environment sustainability in the society in the long run, as a company can not operate without providing benefits to its stakeholders. Therefore, it held that if companies are unable to claim input services in respect of activities relating to business, production and sustainability of the companies themselves would be at stake.

Hon’ble High Court of Karnataka, in its judgement, in the case of M/s Commissioner of Central Excise, Bangalore vs. Millipore India (P) Ltd., also was of view that CSR Expenses are mandatorily incurred by employers towards benefit of the society and “to maintain their factory premises in an eco-friendly manner”. Therefore, the tax paid on such services shall form part of the costs of the final products and thus, the company can claim these taxes paid as input services.

Uttar Pradesh Authority for Advance Ruling (‘AAR’) in the matter of M/s Dwarikesh Sugar Industries Ltd held that a company is mandatorily required to undertake CSR activities and thus, forms a core part of its business process. Hence, the CSR activities are to be treated as incurred in “the course of business”.

Telangana State AAR in the matter of M/s. Bambino Pasta Food Industries Private Limited has clearly held that expenditure made towards CSR, is an expenditure made in the furtherance of the business. Hence the tax paid on purchases made to meet the obligations under CSR will be eligible for ITC. 

Section 135(7) is a penal provision under the Act which deals with penalty on non-compliance of section 135(5)  and (6). It was observed by the AAR that a Company fulfilling eligibility criteria under section 135(1) of the Act is required to mandatorily spend towards CSR and thus, must comply with these provisions to ensure smooth run of business.

Thus, Uttar Pradesh AAR held that the expenses incurred by the Company in order to comply with requirements of CSR under the Act qualify as being incurred in the course of business and are eligible for ITC in terms of the Section 16 of the CGST Act, 2017.

Contrary ruling: Free Supply of Goods

Section 17(5)(h) of the CGST Act excludes “goods lost, stolen, destroyed, written off or disposed of by way of gift or free samples” for the purpose of availing ITC on payment of GST. The term ‘gift’ is not defined anywhere in the CGST Act. However, in layman’s language, gift means a thing given willingly to someone without payment.

In the matter of M/s. Polycab Wires Private Limited, Kerala AAR held that distribution of necessaries to calamity affected people under CSR expenses shall be treated as is if they are given on free basis and without collecting any money. Hence, for these transactions, it was held that ITC shall not be available as per section 17(5)(h).

However, a contrast has been drawn in the Uttar Pradesh AAR Ruling towards goods given as ‘gift’ and given as a part of CSR activities. Gifts are voluntary and occasional in nature whereas CSR expenses are obligatory and regular in nature. AAR held that since CSR expenses are not incurred voluntarily and have to be incurred regularly, they are not to be treated as ‘gift’ and thus, should not be restricted under section 17(5)(h) for claiming ITC.

One may also refer to explanation 2 to Section 37(1) of Income Tax Act, 1961, as also cited by Hon’ble High Court of Delhi in the matter of Pr. Commissioner of Income Tax vs. M/s Steel Authority of India Ltd which provides that, any expenditure incurred by an assessee on the activities relating to CSR referred to in section 135 of the Companies Act, 2013 shall not be deemed to be an expenditure incurred for the purposes of the business or profession.

Availing Benefit through Beneficiary

A company contributes a sum towards a beneficial organisation such as NGOs, Charitable Trusts and Section 8 Companies (‘implementing agencies’) towards fulfillment of CSR activities. However, these implementing agencies also need to hire services of vendors to complete these activities. These vendors charge GST on the services rendered by them. Since these implementing agencies often do not generate any output, the question raises can these organizations also claim ITC on the services rendered by them?

There is a concept of ‘pure agent’ in GST. Explanation to Rule 33 of CGST Rules, 2017 prescribes that a pure agent means a person who –

The implementing agencies fulfill this eligibility criteria of being a ‘pure agent’. Rule 33 also contains some conditions on the fulfilment of which, expenses incurred by the supplier as a pure agent of the recipient of the supplier of goods or services, are excluded from the value of supply-

In our case, if an implementing agency avails any goods or services from a vendor to fulfil the CSR activities for a company, then the payment of any such amount to the vendor shall be treated as a supply made as a pure agent by the implementing agency on behalf of recipient of supply, i.e., the company. Thus, these expenses incurred by the implementing agencies shall be excluded from the value of supply and therefore, are not liable for payment of GST.

CSR Contribution: Pre-GST or Post-GST?

The Act does not clarify that the amount to be contributed towards CSR activities should be inclusive or exclusive of taxes. However, it seems that since GST is charged on supply of goods and services, irrespective of the intention of social benefit, the amount contributed towards CSR can be both inclusive and exclusive of GST. Having said that, the question still pertains on the inclusivity of the amount of GST paid towards the amount of CSR expenditure for the purpose of section 135(5) of the Companies Act, 2013.

Conclusion

While the rational view would be, expenses incurred on GST for fulfilment of CSR activities should be eligible for claiming input tax credit, however, the Finance Bill, 2023 proposes otherwise. The effective date of the amendment will be 1st April 2023. Hence, once the Budget proposals are passed, any acquisition of goods or services for CSR purposes will be denied the benefit of GST set off. So the next question is whether the CSR expenditure would be inclusive of GST. We deal with the same citing illustrations in our article.

GST on consideration paid to a director

Demarcation of salary and fees makes the difference

-Kanakprabha Jethani and Qasim Saif

(finserv@vinodkothari.com)

Introduction

The Goods and Services Tax laws (GST) introduced in 2017, also brought with itself, a concept of Reverse Charge Mechanism (RCM). GST is a tax on supply, however, under the concept of RCM, the liability to pay tax is on the recipient of supply of goods and services instead of the supplier of such goods or services.

Section 9(3) and 9(4) of the Central Goods and Services Tax Act, 2017 (CGST Act) provide two scenarios in which tax shall be chargeable on RCM basis:

  1. Supplies notified by Government u/s 9(3)
  2. Taxable Supplies by unregistered person to registered person

The government, pursuant to section 9(3) notified that any services supplied by a director of a company to the said company shall be taxed on RCM basis.  

While it is clear that as per section 7(2) and schedule III of the CGST Act keep the services provided by an employee to its employer outside the purview of GST. This raised concerns on differential treatment between services of an executive director and an employee of a company.

The recent ruling of Rajasthan Authority of Advance Ruling (AAR) has provided a landmark decision that would be guiding the tax treatment of services provided by the directors. The following write-up intends to provide a basic understanding of RCM and critically analyse the ruling of Rajasthan AAR.

Understanding RCM

RCM can be understood as a method of levying GST under which the liability to pay tax is upon the recipient of services rather than on supplier. Following figure explains taxation on RCM basis:

For further understanding of taxability on RCM basis- read our detailed FAQs here- http://vinodkothari.com/2017/08/faqs-on-gst-on-directors-remuneration/#_ftn3

Levy of GST on Director’s Remuneration

As discussed above, the focal point of issued in GST on director’s remuneration is that GST is not chargeable on services provided by employees but is chargeable of services of directors. Hence, the key question for determination of GST liability will be determining the nature of the employment of a person.

Can director be an employee?

Principally yes. Going by the principles of the Companies Act, 2013 (CA), there is no bar on a director handling operations of a company like any other employee. In fact, the CA has a concept of executive and non-executive directors. Rule 2 (k) of the Companies (Specification of Definitions Details) Rules, 2014 defines executive director as-

“Executive Director” means a whole time director as defined in clause (94) of section 2 of the Act;

Further, whole-time director is defines in the CA as-

“whole-time director” includes a director in the whole-time employment of the company

From the above, it is clear that a director can also be an employee of a company.

Taxability on services of ‘Director + Employee’

The above discussion clarifies that a person can be both employee as well as director of a company. The question in this case will be the whether services provided by such person would be taxable under GST law? Would an executive director be treated as an employee of a company both under CA and CGST Act?

This issue was raised in the matter of Clay Craft India Private Limited[1] (‘Company’), where advance ruling was sought on whether GST would be payable on RCM basis on the salary paid to directors, given that-

  • directors are compensated by way of regular salary and other allowances as per the employment contract;
  • the Company is deducting TDS on salary and also PF norms are being complied;
  • the income of directors is shown as “income from salary” by the directors in their ITRs;
  • the Company deducts EPF contribution from the salary of directors as it does for its other employees;
  • the Company pays GST on commission paid to the directors but not on the salary paid to them.

The AAR, considering the above facts, provided the following observations:

  • GST law does not recognise payment of salary to directors. It only recognises ‘consideration’ paid to directors- which shall mean any payment made or to be made, whether in money or otherwise, in respect of, in response to or for inducement of, the supply of goods or services or both.
  • Consideration paid to directors is specifically recognised through notification[2] issued under section 9(3).

Based on the above observations, the AAR held that any consideration paid to directors shall be taxable on RCM basis.

Analysis of the Ruling

The above discussed ruling failed to consider the existence of relationship of master and servant which is present in the employer-employee relationship.

Also, the AAR did not consider that the definition of whole time director under section 2(94) of the CA. The contention that director cannot be an employee does not hold good at all times.

It is pertinent to note that the outcome of an advance ruling is applicable only on the assessee who was involved in the case. However, the rulings provide guidance on the stand of revenue authorities.

Clarification issued by the CBIC

The CBIC issued a circular on June 10, 2020[3], which clearly demarcated between services provided by an independent director and a whole-time director.

Consideration for services of Independent Director

The circular clarifies that an independent director cannot be an employee of the company as definition of Independent director under section 149(6) of companies Act, 2013 state that a person being employee of Company, or its holding, subsidiary or its associate cannot be an independent director.

Hence, GST will be levied on his remuneration and the company shall be liable to pay the same on reverse charge basis.

Consideration for services of a Whole-time Director

The circular also clarified that the employer-employee relationship of a director in a company may be established on following grounds:

  • Existence of “contract of service”;
  • Remuneration paid to such director being disclosed as salaries in the accounts of company;
  • TDS being deducted under section 192 of Income Tax Act on the consideration paid to such director;

Where the above grounds are satisfied, the services provided by director in such cases shall be exempt under Schedule III of CGST Act, 2017.

However, if the remuneration is declared as any expense other than salary say professional fees, and TDS is deducted under section 192J of IT Act (Fees for professional or technical services) it shall be treated as consideration for providing service and tax on such consideration shall be paid by the company on RCM basis.

Conclusion

A person may provide his/her services to a company as an employee or a director or both. If the consideration paid is recorded as income from salary, the same is not chargeable under GST. If it is not shown as salary income under IT Act, GST on the same will be chargeable on RCM basis. Obviously, where part of consideration is shown as salary income and part is shown as other income, the GST shall be charged on the part other than salary.

The AAR ruling failed to recognise the principles of the CA that differentiate between executive and non-executive directors. However, the clarification issued by CBIC recognises those principles and provides guidance on taxability in both cases.

[1] http://www.gstcouncil.gov.in/sites/default/files/ruling-new/RAJ_AAR_33_2019-20_20.02.2020_CCIPL.pdf

[2] https://www.cbic.gov.in/resources//htdocs-cbec/gst/Notification13-CGST.pdf

[3] https://www.cbic.gov.in/resources/htdocs-cbec/gst/Circular_Refund_140_10_2020.pdf

Companies under IBC-quarantine, get GST-rebirth

-Vinod Kothari 

[vinod@vinodkothari.com]

Resolution is not a re-birth of an entity – it is simply like nursing a sick entity back to health. It is almost akin to putting the company under a quarantine – immune from onslaught of creditor actions, while the debtor and/or the creditors prepare a revival plan. The objective is that the entity revives – in which case, it is out of the isolation, and is back as a healthy entity once again.

This process is not unknown in insolvency laws world-over. However, in India, revival under insolvency framework has taken a completely unique trajectory. First was section 29A, cutting the company from its promoter-lineage for all time to come. The next was section 32A – redeeming the company from the past burden of civil as well as criminal wrongs, thereby giving it a new avatar, with a new management.

Now, the initiation of a CIRP proceeding will be akin to a new birth to the company, at least for GST purposes. Therefore, irrespective of whether the revival process succeeds or not, at least for GST purposes, the entity becomes clean-slate entity. This is the result of the new GST rule announced on 21st March, 2020. However, the new rules do not seem to have envisaged several eventualities, and we opine the intent of giving an immunity from past liabilities might have better been carried out by appropriate administrative instructions, rather than the new registration process.

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Car Leasing In India: ‘Breaking the Stereotypical Definition Of Luxury’

Julie Mehta (julie@vinodkothari.com)

Introduction

Who thought hiring was even an option to enjoy the luxury of having to use a car. But with the world undergoing a paradigm shift, it untapped its energies into providing and establishing better services for its customers, leasing has paved its way into existence. Most of the industries have adopted this concept and structured their services accordingly in order to provide the best they can to their customers, but that requires huge understanding of their needs. A commoner would always be awed by the immensely developing technology and the environment around them but limited resources makes them take a step back from the thought of availing such services. The market had its solution as hiring and renting came into picture. This has ensured dreams do come true.

Car has always been a luxury at least in most parts of India because of the fact that India still in its developing stage and there still remains a big gap between the rich and the poor and the middle income families fall nowhere. Indians have been developed with the mind state that not everyone can afford everything and thus one should limit their demands keeping in mind their pocket potential. The concept of hiring and renting is not only limited to houses and properties but with the advent of MNC’s and startup companies, they have widened the scope of bringing in the concept of hiring even furniture, vehicles, electronic equipment’s, etc.

Earlier, the concept of car leasing was only limited to corporate senior executives that was earlier known as ‘corporate leasing’ and was common for the luxury car brands. But slowly it has trickled down and become accessible to commoners and middle income families. Companies like Mahindra & Mahindra made some of its models available for leasing. Following this concept, several other car brands like Hyundai, TATA group and luxury brands like BMW, Mercedes etc. have also opened their doors to providing the lease facilities.

Car leasing and rental is one of the most lucrative and fast growing segment of the automobile sector in India even though it currently represents only 4-5% of the market in terms of absolute number of vehicles, but its future prospects are strong enough.

Factors like increasing popularity of app-cab providers like Ola, Uber, Zoom car cab booking facilities, rapid urbanization, relocation of rural population into cities, adds on to the potential of car leasing in India.

[1]The growth of the market in India is to ensure manifold growth in its CAGR by 15-20% in the coming ten years and further on making hiring of cars simpler eventually with current worth of Rs. 1500 crores. Most car making companies are making 40% of its business from leasing cars. This has largely helped change the mentality of customers and imbibed the fact that ‘why buy when you can lease it’.

 

Yellow number plates or white number plates?

People remain apprehensive about the color of the number plate they use in the car. While a yellow number plates denotes commercial use, white number represents personal use. People taking cars on lease will of course want white number plates on their cars.

The current legal framework for registration of motor vehicles allow cars taken on lease for personal use to bear white number plates.

In case of a car taken on lease, the lessee is the person having possession of the vehicle and hence, the ‘owner’ as per the Motor Vehicles Act, 1988. Further, since it is the lessee who is actually using the car and the same has not been given on hire or used for any other commercial purpose, the car shall have a white number plate.

 

Global Status of Car Leasing

Globally, car leasing and hiring has been prevalent and growing for many years now. The analysts have forecasted that in the coming years, the global leasing market is to grow at a CAGR of 13-15%. This is gaining momentum due to the development of new mobility concepts by car leasing companies. For example, telematics was introduced in leased vehicles to monitor their usage on the job, another technological development was the installation of navigation in the leased vehicles making it more convenient for the lessor. People want change and with such facilities where there is an added benefit of not burning the pockets of customers, the lease scheme always works to hire cars on lease and cancel the contract anytime to shift on to better and advanced models of cars.[2]

The new trends dominating the global markets are the introduction of electric vehicle leasing and environment friendly cars that lead to sustainable development in the car manufacturing industries as well in the overall environmental situation. Such facilities encourage people to be more socially responsible and to do their bit towards the betterment of the society and also getting the leasing benefit out of it. Governments across the world are offering subsidies and tax benefits to encourage and boost the penetration of electric vehicles in their fleet. They have also introduced the concept of leasing old cars which helps reduce wastage as well as optimum usage. It is offered at a highly considerate premium and is attractive for low income customers. The global leasing market is fast moving with efficient strategies that ensures further growth too.

 

[3]Why has Leasing gained popularity in recent times?

GST introduction has come out to be a source of relief in time of distress for the Indian markets and consumers due to the stiff tax system of the country resulting in poor market functioning. With the introduction of ‘Goods and Services Tax’ on July 1, 2017, times have changed for the consumers, dealers as well as manufactures and has helped bring stability and balance in the economy by considering every person and their transaction at par, with the motive to bridge the gap between rich and poor in the long run. Evaluating their benefits below taking into consideration automobile industry:

  • To the consumers: The new tax regime has resulted in significant reduction in the tax rates imposed on the end consumers in comparison to the previous tax system.
  • To the dealers: The benefit of claiming the tax paid earlier benefits the dealers with the introduction of GST provides an added advantage to the dealers.
  • To the manufacturers: In recent times, car manufacturing companies have marked a fall in their sales which has led to dwindling profits. With the increasing exposure to car leasing, manufacturers have found their resort to stabilise their performance. This option induces customers to opt for leasing, thereby ensuring good business to the car manufacturers.
 CAR TYPE GST RATES COMPENSATION CESS TOTAL
Small Cars 28% 1% or 3% (depending on capacity) 29% or 31%
Mid-segment Cars 28% 15% 43%
Large Cars 28% 17% 45%
Sports Utility Vehicles (SUV’s) 28% 22% 50%
Electric Cars 12% N.A. 12%

Numerical Comparison

To understand the calculation of Loan EMIs and Lease rentals, we structure an example with the concept of residual model to distinguish the calculations of both the alternatives.

Any loan transaction requires an initial down payment to the seller after which installments follow on monthly/quarterly/annually basis. The down payment creates an extra outflow on part of the buyer on loan along with additional installments. While no down payment is required in case of a lease that makes its overall outflow on the lower side in comparison to a loan.

Plus, in case of a lease transaction, the lessor takes an exposure on the residual value of the asset, this brings down the lease rentals per month.

In the example below, with the assumption of different rates of residual value, we understand that with the every increase in the percentage of residual value, the lease rentals of the operating lease borne by lessee comes down. This implies lower the term of the lease contract, lesser value of the asset is used, and thus lesser are thee lease rentals.

Details of the Vehicle  
Unit Cost 1000000.00
GST rate 28%
Compensation Cess 17%
Rate of GST 45%
GST 450000.00
Total 1450000.90
When Residual Value is considered to be 20%
Operating lease arrangement    
Basic price 1000000.00  
Add GST on purchase (ITC eligible) 450000.00  
Funding Amount 1450000.00  
Processing fees 3.80% 55100.00
Expected Residual Value 20% 200000.00
Tenure 48  
IRR 18%  
Lease Rentals (RV not factored) ₹ 42,593.75  
Lease Rentals (before passing GST benefit) ₹ 39,718.75  
Input tax credit percentage 100%  
Less: GST benefit ₹ 9,375.00  
Lease Rentals (after passing GST benefit) ₹ 30,343.75  
Add: GST on rentals ₹ 13,654.69  
Total inflow ₹ 43,998.44  
 
Loan arrangement    
Loan amount 1450000.90  
Processing fees 3.80% 55100.0342
Expected Residual Value 0% 0
Tenure 48  
IRR 18%  
EMI ₹ 42,593.78  

 

When Residual Value is considered to be 25%
Loan arrangement    
Loan amount 1450000.90  
Processing fees 3.80% 55100.0342
Expected Residual Value 0% 0
Tenure 48  
IRR 18%  
EMI ₹ 42,593.78  

 

Operating lease arrangement    
Basic price 1000000.00  
Add GST on purchase (ITC eligible) 450000.00  
Funding Amount 1450000.00  
Processing fees 3.80% 55100.00
Expected Residual Value 25% 250000.00
Tenure 48  
IRR 18%  
Lease Rentals (RV not factored) ₹ 42,593.75  
Lease Rentals (before passing GST benefit) ₹ 39,000.00  
Input tax credit percentage 100%  
Less: GST benefit ₹ 9,375.00  
Lease Rentals (after passing GST benefit) ₹ 29,625.00  
Add: GST on rentals ₹ 13,331.25  
Total inflow ₹ 42,956.25  
When the Residual Value is considered to be 30%
Loan arrangement    
Loan amount 1450000.90  
Processing fees 3.80% 55100.0342
Expected Residual Value 0% 0
Tenure 48  
IRR 18%  
EMI ₹ 42,593.78  

 

Operating lease arrangement    
Basic price 1000000.00  
Add GST on purchase (ITC eligible) 450000.00  
Funding Amount 1450000.00  
Processing fees 3.80% 55100.00
Expected Residual Value 30% 300000.00
Tenure 48  
IRR 18%  
Lease Rentals (RV not factored) ₹ 42,593.75  
Lease Rentals (before passing GST benefit) ₹ 38,281.25  
Input tax credit percentage 100%  
Less: GST benefit ₹ 9,375.00  
Lease Rentals (after passing GST benefit) ₹ 28,906.25  
Add: GST on rentals ₹ 13,007.81  
Total inflow ₹ 41,914.06  

 

Conclusion

The major differentiating factors between a lease and a loan is that the former gives the right to use the asset without any upfront down payment, however, in case of the latter, there is an upfront down payment. Leasing works better when the lessor takes exposure on a handsome amount of residual value. Otherwise, it will turn out to be costlier than loan.

In the coming years, the car leasing market in India will be prospering as most car brands have now started to expand their services to even leasing now, which wasn’t prevalent until the last 4-5 years. With this competitive spirit, many more well developed brands would undertake this strategy to enhance customer base. The statistics of no: of cars being sold is going through a falling spree currently and is expected to fall further. But the leasing market will be flourishing on the other hand. It provides the ‘Best of Both Worlds’ to the customers as well as benefits the owner who still retain the ownership of the cars and gain benefit out of it.

 

[1] http://www.businessworld.in/article/-India-s-Car-Leasing-Market-Is-Worth-Rs-1-5K-Cr-Poised-For-15-20-CAGR-/27-05-2017-119041/

[2] www.statista.com

[3]http://www.cbic.gov.in/resources//htdocs-cbec/gst/notification05-compensation-cess-rate.pdf;jsessionid=B47A84DD8CE463AF356CD17117E2316B

[4]https://www.statista.com/outlook/270/119/car-rentals/india#market-arpu