'Leasing' signify a very widespread way of doing business today. It is very commonly employed by businesses who cannot afford to make huge investment in assets in one go, particularly during start up or even otherwise as well. Such are called Lessees. On the other side - the Lessors find out investors for their assets who pays them value for their assets over an agreed time period (called as lease term), and usually an enhanced value inclusive of an interest. Thereby, enhancing purchasing power of consumers and increasing thy customer base. At the end of lease term, both parties decide the future course of action - whether to extend the lease, take the asset back, transfer the asset to Lessee only or any other. Through leasing, big assets or projects requiring huge capex investment can be easily funded and operationalized.
We find various types of Lessors doing business as such - could be strategic investors or professional asset leasing companies having love for particular assets or purely financial investors such as Banks who are only interested in generating returns from the whole set up. There are Lessees who take the assets on lease and operate such assets as per terms of lease and agreed structure between the parties.
Thus, we have seen that Leasing can be quite a complicated business which can have complex structures, terms of agreement, financing, the way it is accounted for in books (following the prescribed Accounting Standards); and yes, quite a big taxation impact!
Under the Indian tax laws, Leasing can have several tax implications from both Direct and Indirect tax sides. Interestingly, under the Indian tax laws, particularly Income tax, the lawmakers have been paying attention to leasing concept from olden days itself and we can see some clarifications emerging from the year 1943 as well. Under the Indirect tax laws also, we can see clearly prescribed implications arising on leasing under VAT and Service tax laws. Consequently, there has been a lot of litigation around the subject.
Let's firstly see the different types of structures that can emerge under this business, as the implications can vary significantly depending upon the structure that we have in place. Leases can be classified into Operating and Finance lease. The chief difference between the two is that in case of Finance Lease, substantial risks and rewards are transferred by lessor to lessee - just like Banks finances a Car purchase under a lease structure. Typically, Finance lease term cover the entire life of the asset and the lessee virtually gains all rights of the owner and becomes the economic owner of the asset. Operating lease on the other hand is exactly opposite and akin to a normal lease structure that we can see in different forms in our routine lives. Thus, the presence / absence of certain vital factors in any arrangement would determine whether it is in the nature of Operating Lease or Finance Lease.
Within the principal categories of lease as seen above, there can be Dry lease or Wet lease. Whereas, Dry lease signify providing only the asset on lease, Wet lease signify providing the asset on lease as well as the personnel to operationalise such asset. Something like providing a Ship along with the crew and staff as a complete package. Thus, Wet lease can be very close to becoming a 'Service' in real terms.
There are several structures such as Hire Purchase, installment systems, sale and leaseback transactions etc that possess very close proximity with Lease, of course with its underlying differences as well. Such transactions would be governed by their respective governing a laws. Now, let's see the tax impact on leases.
Under the Income tax, the lease payment can trigger the tax withholding implications straight. Providing asset on rent under dry lease or in a wet lease as a transaction much akin to service, it can clearly invoke tax withholding requirements. Even in international transactions, tax withholding requirement would emerge as payment of lease rental would partake the character of royalty and subject to tax as such. There are few tax treaties that provide specific exemptions / benefits. Such as Ireland which exempts lease of Aircraft or Israel which does not tax royalty paid on 'Equipment'. Wet leases as seen earlier can partake the character of service and become taxable or exempt accordingly.
Another vital aspect of leasing in Income tax is the tax impact of payments of lease rent, which the Lessee would make, particularly in Finance lease. In operating lease, it could be a simple deduction for renting of asset or leasehold rights.
In Finance lease, lease rent typically comprise of principal repayment (of loan) and also the interest. The question arise on the deductibility of principal component. Since the Lessee acquire ownership rights in the asset by virtue of making such payments, the lessee would like to capitalize the value of asset in its books and claim depreciation thereon. But, the legal owner of such asset remain the Lessor, hence the Taxmen may not allow depreciation to the Lessee. Also, it can be argued that such principal payment is in the nature of capital payments, therefore it cannot be allowed even otherwise. So Lessee has generally to substantiate that it is the owner of asset and can claim depreciation. Thus arise the litigation.
Whereas, the law provides depreciation in case of Hire Purchase to the Purchaser, it does not clearly provide for the Leasing. Basis a few case - laws (including the ones decided by Hon'ble Supreme Court), a position can be taken that in finance lease, lessee can claim the depreciation, but it is not very clear and settled. Though in the draft Direct Tax Code or the DTC, there was a provision that in case of Finance Lease, depreciation will be allowed to Lessee. Thus, it is left to the facts and circumstances to ultimately decide who will claim the benefit. Hence a matter of taking a position.
Talking about the Indirect taxes, Hire Purchase transactions and 'transfer of right to use the goods' are clearly included in definition of 'Sale' and thus subject to VAT or sales tax. What constitutes transfer of right to use the goods is also defined by certain case laws. Thus, if there is transfer of such right, it could have VAT, if not, it may be subject to Service tax. Thus, lessor has to charge such taxes at the time of invoicing the lessee and the lessee can claim input credit of the same, if eligible. In case of Financial leasing services and hire purchase, service tax shall be levied on the 10% component of the interest part included in the lease rent.
As we have seen the tax impact on leasing transactions can vary significantly depending on its nature, one has to look at the underlying structure, the intention of parties, the accounting aspect, tax impact and the cash flows to define the terms of lease agreement and arrive at a most suitable structure. The tax implications would arise thereon accordingly.
It is imperative that amid evolving laws, accounting practices and tax jurisprudence, Leasing is governed by several legal and other attributes and thereby, holds a substantial exposure arising from tax and other fronts. Therefore, the business must consciously an proactively make efforts towards reckoning the issues that can arise on account of the above and try to find out ways to resolve the same amicably.
