In Tamil Nadu, value-added tax (VAT) became operational from January 1.

It is imperative that a legislation like VAT is understood in the context of each industry rather than in a purely macro or generic sense. The effect of VAT on leasing (an industry which has lost a lot of its sheen) is interesting as it has thrown up new issues and challenges.

VAT Act and rules

The definition of sale in the VAT Act contained in Section 2(33) includes `transfer of right to use any goods for any purpose'. This definition has been incorporated from the erstwhile TNGST Act. The earlier dispensation provided for seconds sales exemption for locally-purchased goods leased out in Tamil Nadu. In the VAT regime, this is no longer valid.

Similarly, there is a specific definition for turnover and taxable turnover. In determining the taxable turnover, the specified deductions, as laid out in rules, has to be reduced from the total turnover. In a typical financial leasing transaction, there is an interest component embedded in the lease rentals. The question for consideration is whether this component of interest can be reduced in arriving at taxable turnover?

Rule 8(1) of the draft Tamil Nadu Value Added Tax Rules 2006 mandates a deduction from turnover, various items to determine VAT liability. Sub-clause (c) of sub-section (1) 8 reads thus: "All amounts charged separately as interest on the unpaid amount payable or finance charges in the case of hire purchases or any such system of payment by instalments."

It is to be noted that in reducing from turnover, the interest element relatable to hire purchase is allowed as a deduction, but this is not specifically stated and, hence, there is ambiguity. While it may be that the deduction interest component in leasing is covered under the expression `any such system of payment by instalments', it is better that this position is spelt out explicitly for the sake of clarity.

Transitionary provisions

Any leasing transaction originates on a particular date and concludes in accordance with the agreement, which may be for three or five years. With VAT becoming operational in Tamil Nadu from January 1, leasing contracts entered before this date would have been covered by the erstwhile TNGST Act which conferred seconds sale exemption for locally-procured goods.

However, the turnover was liable for resale tax at 1 per cent. What would be the position on these already executed contracts where rentals are forthcoming after January 1? Will they be covered by the earlier law, which means the said rentals would continue to suffer 1 per cent resale tax.

The question of already-executed contracts coming under the new VAT regime would pose problems in determining the credit for input tax and determining the VAT liability at 12.5 per cent on lease rentals. There is also uncertainty of whether the interest element is to be included for VAT calculation.

Ideally, the position taken by Maharashtra Government can be incorporated. The Maharashtra law has provided clarity on the transitionary phase and spelt out that the old law would apply for the already executed contracts. This needs to be incorporated in the Tamil Nadu VAT Act.

R. Anand
(The author is a Chennai-based chartered accountant.)