Right To Use –Tax Applicability & Tax Planning

Hiring / leasing of equipments, machineries and other movable assets are a common feature. It is an economical option to have the asset available to get the work executed rather than an outright purchase.  Further, a proper tax planning of these transactions from an indirect tax perspective can lead to optimization of tax expense on such transactions and an attempt is made to discuss the basic provisions of the same, in the article below.

Hiring/ Leasing of an asset and transfer of Right to use

“Right to Use” has not been either defined in Sales tax or in Service tax. But is referred as the legal right to operate or put the assets to use to reap benefits arising of the same. These rights are transferred by the owner of the assets to the customer via an agreement or a contract with or without transfer of an effective control on the same. These contracts does not pass on the ownership of the assets at any point of time, wether before or during the period of contract or at the end of the term, distinguishing it from a Hire purchase or normal sale contract.

Right to use- wether exigible to Sales tax/ Service Tax?

Transfer of Right to use is a taxable event in the eye of law. A thin line of demarcation has been made as to when the activity will be covered under the provisions of Sales Tax law and when the same will be qualified as a service. To getting a clear understanding of the same, the provisions laid down are discussed here forth.

 Definition of Sales (Clause (g) of Section 2 of Central Sales Tax act) as amended by Finance Act,2002 w.e.f 11.05.2002 was expanded and Clause ‘d ‘of Article 366(29A) of the Constitution was included which defines Right to use as the Deemed Sale. The context is as below…

… “transfer of the right to use any goods for any purpose (whether or not for a specified period) for cash, deferred payment or other valuable consideration”

The transactions where hiring of movable property is taking place with an effective transfer of control and possession of the asset, was covered in the scope of deemed sale and made exigible to Sales Tax/ Vat.

The same was settled via decision of the Hon’ble Andhra Pradesh High Court in the case of Rashtriya Ispat Nigam Ltd. Vs. CTO 1990 77 STC 182  (further confirmed by the Hon’ble Supreme Court vide decision no. [2002] 126 STC 0114 pronounced on 6th March 2002).

“The agreement has to be read as a whole, to determine the nature of the transaction. From a close reading of all the clauses in the agreement, it appears to us that the contractor is entitled to make use of the machinery for purposes of execution of the work of the petitioner and there is no transfer of right to use as such in favour of the contractor. We have reached this conclusion because the effective control of the machinery even while the machinery is in the use of the contractor is that of the petitioner-company (lender). The contractor is not free to make use of the same for other works or move it out during the period the machinery is in his use. The condition that he will be responsible for the custody of the machinery while the machinery is on the site does not militate against the petitioners’ possession and control of the machinery. For these reasons, we are of the opinion that the transaction does not involve transfer of the right to use the machinery in favour of the contractor.”

But, where the assets are being taken on hire without transfer of custody, control and possession, the same will not qualify as Deemed sale. Such an event was being brought in the net of Service Tax. Initially, “Right to use of tangible goods service” was introduced by the Finance Act, 2008, w.e.f 16-05-2008 vide notification No. 18/2008-ST, dated 10-05-2008.whereby taxable service was defined u/s 65(105)(zzzzj) of Finance Act, 1994 to mean as .

“any services provided or to be provided, to any person, by any other person in relation to supply of tangible goods including machinery, equipment and appliances for use, without transferring right of possession and effective control of such machinery, equipment and appliances”.

With introduction of Negative list regime under service tax, w.e.f 1^st July 2012 this transaction has been brought under the category of Declared Service under Section 66E confirming the applicability of service tax on it. The provision is as below….

…. “transfer of goods by way of hiring, leasing, licensing or in any such manner without transfer of right to use such goods.”

Hence, the guiding factor in determination of applicability of Sales Tax or Service tax on the event of supplying an asset for utilizing the same is to correctly assess the status of the transfer of RIGHT TO USE of the asset along with the transfer of an effective control and possession.

 When will it be considered that there has been transfer of effective control and possession?

On the basis of the above discussion, it becomes necessary to identify as to when to consider that the transfer of effective control and possession of the asset have taken place.

 In a recent case law “S G S Lamba & Sons Vs State Of Andhra Pradesh [2012-TIOL-49-HC-AP-CT]”  after analyzing the settled decisions of higher judiciary, the Hon’ble High Court summarized the essential requirements of a transaction for ‘transfer of right to use goods’ as follows:

“ (iii) In the transaction for the transfer of the right to use goods, delivery of goods is not a condition precedent, but the delivery of goods may be one of the elements of the transaction;

(iv) The effective or general control does not mean always physical control and, even if the manner, method, modalities and the time of the use of goods is decided by the lessee or the customer, it would be under the effective or general control over the goods; and

(v) The approvals, concessions, licences and permits in relation to goods would also be available to the user of goods, even if such licences or permits are in the name of owner (transferor) of the goods, and

(vi) During the period of contract, exclusive right to use goods along with permits, licenses etc, vests in the lessee.”

Hence, while executing an agreement of hiring of an asset, we should clearly identify as to how the transaction is being framed and executed. In scenario, where the assets are being hired out along with their licenses, permissions and exclusive right to use, as and when required, on the instructions of the lessee, will be construed that the effective control on the assets is being passed on.

Let us assess an illustration in accordance to it.

Company ‘A’ has 5 Road Rollers available for Hiring out.

Case 1: For first 3, the hiring contracts have been framed where the Road rollers were placed at the site of the Customer, all the licenses and road permits available for operating are passed on for the exclusive use of the Customer. The Operators of those road rollers were to be paid by the Company A, but they were to operate as per the time schedule and instruction of the Customer.

Case2: For the next 2 road rollers, the Company A has a set of customers, who place their request for making the road rollers available to them. Company A, according to the requirement of the customers, frame the time schedule for these road rollers, and pass on the instructions to operators to carry out operation accordingly at the customer’s site.

On assessing of both the situation, we can distinguish that in case 1, the road rollers were hired out with transfer of effective control and possession along with its right to use. Thus will qualify as deemed sale and taxable in the net of VAT. On the other hand in hiring of road rollers in case2, there has been no transfer of effective control to the customers and hence the same will qualify as Declared Service u/s 66E and service tax will be applicable on it.

Deemed Sale- Weather Local or Central Sale

One more dimension, which needs to be ascertained in case of the above deemed sale is to distinguish such an event as a local sale or a central sale.

Section 3, clause (a) of the Central Sales Tax Act, 1956, states that “A sale or purchase of goods shall be deemed to take place in the course of Inter-State Trade or Commerce if the sale or purchase occasions the movement of goods from one state to another”

Hence, if the assets in pursuance to the agreement moved from one state to another will qualify as a Central Sale. On the same, ‘C’ form may be available and hence may be taxable @2%.

Input Credit or Cenvat Credit on tax paid on Hire Charges

To move a step further, after being able to judge the tax applicable on the event of hiring of asset, we need to conduct the tax planning of the transaction in order to optimize the tax cost. Optimisation of the tax is dependent to the Output tax liability against which the credit of the tax paid on the hiring of the assets is available to set off against the output liability.

A.      Input Credit mechanism under Sales Tax/CST

Input credit mechanism is an essential element of the VAT Regime which permits to set off the VAT paid earlier, by the registered dealer against the amount of the output vat liability. VAT payable on the inputs and capital goods which has been used for the purpose of manufacture or processing or packing of taxable goods qualifies for the input credit (Note: Though there are some specific exclusions made in different states vat act).

On similar lines, VAT paid on hire charges on procuring of assets may be available for input credit in case the assets taken on hire is being used for the purpose of manufacture or processing or packing of taxable goods.

B.      Cenvat Credit Under Service tax

Cenvat credit Rules, 2004 (CCR, 2004) states that the provider of a taxable output service can claim the cenvat credit of the service tax paid in respect of Input service.

Rule 2(1) of CCR, 2004 defines input service as…….

…. “(i) used by a provider of output service for providing an output service;”……..

(The definition of input service has specific exclusions, but hiring charges is not one of them.)

Thus, if you have taken an asset on hire for providing the taxable output service, you can avail the cenvat credit of the service tax paid on hiring or leasing.

TAX PLANNING ILLUSTRATION

With regard to discussion made above, we can identify the tax applicable on the Hire charges under different situation and ascertain the credit mechanism applicability according to the use for which asset has been put to and the output tax liability relating to it. An analysis is further done below to check on the Net Hire charges for an organisation under different circumstances.

Two situations with different terms of the agreement are being discussed below :

In the table below, under Segment A various conditions of an agreement of transfer of right to use of an asset are laid down, and in accordance to the applicability of the same, their tax applicability have been identified under Column 1 to 5.  The gross hire charge is computed under each situation (considering Rs.100 is being paid as hire charges and the tax applicable accordingly). Following two cases are discussed for each such circumstance:

• Case 1: VAT as output tax liability

   Conditions:

          i.            An asset has been taken on hire and put to use for processing or manufacturing of taxable good.

        ii.            The organization has an output tax liability under VAT.

Under this scenario, an organisation can avail the input credit on the Vat amount paid where the same has qualified as local deemed sale against the output vat liability. Whereas if service tax has been paid then the same will not be available as cenvat credit and the tax paid will be an additional expense on the hire charges, increasing the effective cost. In case of Central sale, the same can be advantageous against the option of service tax payable, provided C form has been permitted by Sales tax authorities of the relevant state.

• Case 2: Service tax as output tax liability

Conditions:

        i.            An asset has been taken on hire and put to use for rendering a taxable service

      ii.            The organisation has an output service tax liability

Under this scenario, an organisation can avail the cenvat credit on the Service tax amount paid. The Tax expense will mitigate irrespective of the location from where the assets are being brought in to.  Where as in case the same has qualified as local deemed sale, tax paid will be an additional expense against the output vat liability on the hire charges, increasing the effective cost. In case of Central sale it may be noted that ‘C’ form will not be available.

Transfer Of Right To Use Of An Asset With Different Conditions In Agreement:-Identification Of Tax Applicable And The Effective Cost Under Vat And Service Tax

NA refers to “Not applicable”

To conclude, one should prudently plan out an activity of hiring of equipments; assess the indirect tax applicable and the credit of the same available against the output category in which one is taxable.

CA Ekta Gupta

Manager (C&C Constructions limited)

[email protected]

Disclaimer: These are my personal interpretation and the reader may draw inferences/make judgments on their case with respect to the applicable statute of their state and circumstances.