By TIOL News Service

MUMBAI, JUNE 20, 2018: THREE demand notices were issued to the appellant for recovery of service tax for the period 2003-04 to 2009-10, the first covering the extended period and the other two for the normal period of limitation.

The CST, Mumbai-I by order dated 24.12.2013 confirmed a service tax demand of Rs.62.81croresagainst the first demand of Rs.76.78croresand limited the confirmation in the other two to Rs.5.38 Lakhs and Rs.4.33 Lakhs respectively along with penalties and interest.

The adjudicating authority placed reliance on the CBEC clarification F No. B.11/1/2001-TRU dated 09.07.2001 and the decision of the Supreme Court in Association of Leasing and Financial Service Companies - 2010-TIOL-87-SC-ST-LB to hold that service tax liability arises on the finance/interest charge component of the equated monthly instalment paid by lessee/hire-purchaser. Apparently, after extending the benefit of notification no. 4/2006-ST dated 01.03.2006, the confirmed demand was scaled down from the proposal in the show cause notices.

The TRU letter dated 09.07.2001 had clarified –

2.1.2 In the case of leasing or hire purchase, it is understood that the general business practice is as follows: The service provider enters into a leasing or hire-purchase agreement with the lessee or hire-purchaser. At the time of entering into the agreement, they collect a charge called lease management fee or processing fee or documentation charges or by any other name, which is usually a percentage of the transaction value. The lease rental or hire purchase amount is recovered in equated monthly instalments (EMI) over the period of lease or hire-purchase as indicated in the agreement through post dated cheques and no separate bills are raised for the monthly recovery. Every agreement bears a unique number.

2.1.3 The EMIs consist of recovery of principal amount (towards the original cost of the equipment) and finance /interest charges. The allocation between the principal and the finance/interest charges are known to and agreed upon by both the parties. The customer repayment schedule contains the details of the EMIs with the break up for the principal and the interest. In respect of leasing and hire-purchase, the amount recovered as principal is not the consideration for services rendered but is credited to the capital account of the lessor/hire purchase service provider. The interest/finance charges is the revenue or income and is credited to the revenue account. Such interest or finance charges together with the lease management fee/ processing fee/documentation charges is the consideration for the services rendered and, therefore, they constitute the value of taxable service and service tax is payable on this value. Accordingly it is clarified that service tax in the case of financial leasing including equipment leasing and hire purchase will be leviable only on the lease management fee/processing fee/documentation charges (recovered at the time of entering into the agreement) and on the finance/interest charges (recovered in equated monthly installments) and not on the principal amount.

In the matter of the stay application filed, the CESTAT had while waiving pre-deposit of the adjudged dues and granting stay observed –

6. After considering the submissions made by both sides, on perusal of the decision of the Hon'ble Apex Court in the case of Association of Leasing & Financial Service Companies Vs. Union of India (supra), various provisions of Finance Act, and Service Tax Rules. Prima facie we do agree with the contention of the Ld. Counsel for the applicant that applicant is engaged in the activity of giving loan for earning interest through leasing the vehicles under financial leasing services. As per explanation to Section 67 of the Finance Act, 1994. interest on loan is exempted from service tax is not to be included in the taxable service and same has been followed by Rule 6 (2)(iv) of the Service Tax Valuation Rules, 2006. In these circumstances, prima facie we find that applicants have made out a case for complete waiver of pre-deposit. Therefore, we waive the requirement of pre-deposit of entire amount of service tax, interest and penalty and stay recovery thereof during the pendency of the appeals.

We had reported this order as 2014-TIOL-2223-CESTAT-MUM.

The appeal was heard in February and an order was passed recently.

In an elaborate judgment replete with (archaic) terms ‘similitude', ‘betwixt' and interesting lines as the ones mentioned below -

++ There is a tax and a path to that tax; as long as the taxing authority has arrived at the destination from the point of origin, his meanderings and jaywalking are not of material concern.

++ The world of taxation is one of hard-boiled reality which suffers the consequence of frailty of expression both in promulgating intent and in articulation of logical thought – the one by the sovereign legislature and the other by the tax collector.

++ Siblings may bicker, they may ignore one another but they cannot wish away the existence of the other.

++ Those are the horns of dilemma that confronts the tax authority in this peculiar situation and there are only two ways out of a dilemma; take hold of the horns or pass betwixt them.

++ With a judgment of the Hon'ble Supreme Court providing us with firm limbs, the crutch of a decision of the Tribunal is but an unwanted burden.

the Member (Technical) writing for the bench further observed –

+ It is now well settled in law that hire purchase is but a loan: that the hirer obtains goods from a seller and the banking and financial institution finances the purchase of goods with the title firmly resting with the hirer and the institution vested with right to acquire possession of the goods, through judicial intervention, in the event of non-payment of contracted amount. This differs substantially from operating lease. Therefore, the taxability of the service is not in question.

+ There is no doubt that interest earned on loans is not chargeable to service tax; this is the law in section 67 of Finance Act, 1994 and Service Tax (Determination of Value) Rules, 2006. Consequently, any income that is in the nature of interest earned by a bank or financial institution cannot be collected.

+ However, in computing the value of taxable service mandated by section 67 of Finance Act 1994, the law provides exclusion either by Explanation or by Rules; it is that exclusion that has been claimed by appellant as their statutory right. And it is that claim which is in dispute before us.

+ The issue is whether that statutory exclusion can be denied. We hold that no statutory exclusion can be denied. However, we take note that with the inclusion of financial and equipment leasing in the definition of the activity in relation to which taxability arises, it was the decision of the Hon'ble Supreme Court in re Association of Leasing and Financial Services Companies that settled the transactions, such as that of the appellant, within the scope of coverage as loans instead.

+ The consideration for the taxable service rendered by appellant is received as equated monthly instalment which is then assigned by appellant as principal and interest. It has been held by the Hon'ble Supreme Court that there are three components that make up consideration for hire purchase - principal, processing/management charges and interest -with taxability devolving on the latter two. Decisions of the Tribunal have excluded the scope of collection from the last. It is, therefore, clear that only processing/management fees can be subjected to tax.

+ However, while conferring the mantle of lending on hire purchase and leases, other than operating leases, the Hon'ble Supreme Court in re Association of Leasing and Financial Services added another factor of income, viz., processing or management fee, to interest and principal and held it liable to tax. The judgement also distinguished these loans from normal bank loans by reference to banking companies undertaking such leases or hire-purchase through subsidiaries and by the categorization of non-banking financial companies, in accordance with instructions of Reserve Bank of India, as leasing or hire-purchase entities on the basis of prescribed parameters. There is, therefore, a distinction between the interest earned by a bank and the disaggregation of equated monthly instalments earned by a financial institution engaged in financial leasing and hire-purchase.

+ A banking institution has the wherewithal to deploy funds from deposits placed with it and with the latitude afforded by the reserve ratios prescribed by the Reserve Bank of India. On the other hand, a non-banking company deploys resources whose costs do not. The equated monthly instalment contains within it the interest cost, the principal recovered and other administrative costs attributable to each hire-purchase or financial lease transaction. The tax liability on the recovery of administrative costs through the equated monthly instalment is not extinguished by the exclusion from assessable value. It is only the interest component that is extinguished and the principal component that is not taxable. That justifies the abatement of nine-tenth of the interest income from the computation of taxability in notification no. 4/2006-ST.

+ Therein lies the answer to the dilemma. Interest income is exempt if such is entirely attributable to the business of lending from deposits. If income is to be attributed to lending from borrowings there is an interest cost that is abated in computation of assessable value to give effect to exclusion of interest. Interestingly, it is only after Service Tax (Determination of Value) Rules, 2006 was enacted that this disaggregation of interest was acknowledged by the abatement notification.

+ It is, therefore, concludable that income from financial lease or hire-purchase is taxable under Finance Act, 1994 as lending activity, that income attributable to interest on lending is not to be included in assessable value, that it was only from 1 st March 2006 that ten percent of the income described as interest was attributed to income other than borrowing and, hence, includible in assessable value of the financial institutions where the Hon'ble Supreme Court has acknowledged receipt other than that of principal amount and an income other than interest in the equated monthly instalment.

+ The decisions of the Tribunal that have held otherwise did not have the benefit of wisdom of the judgement of the Hon'ble Supreme Court in re Association of Leasing and Financial Service Company and are, therefore, per incuriam .

Conclusion:

++ The recovery of tax on interest for the period prior to 01 st March 2006 is without authority of law as there is a presumption of attributing the entire amount to interest in the absence of any mechanism to isolate the processing or management cost even if that were collected in the equated monthly instalment or any determination of such in the notice issued to the appellant. The recovery by application of the rate of tax on one-tenth of the interest component of the equated monthly instalment is within the sanction of law.

++ The demand for the period prior to 01 st March 2006 is set aside and the demand for the period thereafter, not suffering from the handicap of invoking the extended period is sustained with consequent penalty under section 76 of Finance Act, 1994.

The appeal was disposed of.

Quick reference: Notfn. 4/2006-ST dated March 01, 2006 -

… exempts the taxable service, specified in sub-clause (zm) of clause (105) of section 65 of the Finance Act, that is to say the financial leasing services including equipment leasing and hire-purchase as defined in item (i) of sub-clause (a) of clause (12) of section 65 of the Finance Act, provided or to be provided to any person, from so much of the service tax leviable thereon under section 66 of the said Finance Act, as is equivalent to the service tax calculated on ninety per cent. of an amount, forming or representing as interest, i.e. the difference between the installment paid towards repayment of the lease amount and the principal amount contained in such installment paid.

Explanation. - This exemption shall not apply to any amount, other than an amount forming or representing as interest, charged by the service provider such as lease management fee, processing fee, documentation charges and administration fee.

Also note: Notfn. 4/2006-ST was rescinded by notification 34/2012-ST dated 20.06.2012 w.e.f 01.07.2012 and the ST Valuation Rules, 2006 came into being by notification 12/2006-ST dated 19.04.2006.

(See 2018-TIOL-1905-CESTAT-MUM)