With the recent roll-out of the Goods and Services Tax (GST) regime, many industry observers have expressed hope that this will mark the revival of the leasing industry in India. For long, lease, as a financial instrument, has not quite taken off in India despite being an empirically proven cost-effective tool for capital creation worldwide. The confusion amongst our policy makers on whether leasing involves the sale of a good or a service resulted in the imposition of multiple taxes on lease thereby virtually killing its efficacy. With the introduction of GST, we are probably headed towards a more transparent taxation regime for leasing. However, certain niggling issues still need to be sorted out. But before we come to that, it is important to understand why leasing is so relevant for India.
Today, thanks to a number of domestic and international factors, India is the world’s fastest growing major economy. Thus, investors from around the world are once again interested in India’s growth story and are exploring opportunities to invest in India. However, despite the decent growth rate, latest macroeconomic indicators reveal prominent signs of a slowdown in both consumption and investment, which are precursors to an impending slowdown in GDP growth. It is imperative to arrest this trend, or else the window of opportunity that has opened up for India will get closed soon.
What we need currently is a significant step up in investments in the infrastructure sector. Capacity creation in infrastructure is a must for any economy to sustain its growth momentum. India is no exception. While the government is doing its bit to increase its spending on infrastructure, to expedite the pace of infrastructure creation there is an urgent need to bring in private sector investments. India’s Public-Private Partnership (PPP) model of infrastructure creation is unique because, unlike most countries, we have successfully engaged the private sector in infrastructure creation. While it is usually the big project developers who bid for infrastructure projects, most of the actual implementation of project work is carried out by the numerous small and medium enterprises (SMEs) to whom the work gets sub-contracted. These SMEs, scattered throughout the country, carry out functions like construction, logistics and other ancillary services. While they require high-value assets (like earth-moving equipment, construction equipment, material handling equipment, etc.), keeping in mind the little capital they start off with it is very difficult for them to access such assets. What makes their job even more difficult is the fact that mainstream financing channels like banks usually do not find them loan-worthy.
This is where the Non-Banking Finance Companies (NBFCs) and leasing come into play. NBFCs fill in this financial void by catering to the credit needs of the SMEs. Thus, NBFCs are essentially promoting financial inclusion and contributing to the process of nation building. NBFCs help these SMEs to access these assets through leasing and renting as it works out to be a much more cost-effective solution vis-à-vis owning. Using the assets for limited periods works out to be more economical as such assets are prone to technological obsolescence.
Worldwide the penetration of leasing and equipment rental is quite high. Compared to countries like USA, Japan and China, India’s leasing and rental business is still at a nascent stage. And one reason for that has been the unfavourable tax treatment of leasing in India so far. With introduction of GST, the ambiguity on the tax front will hopefully get sorted out. Growth of the leasing and rental industry will definitely encourage original equipment manufacturers (OEMs) to explore opportunities in the Indian market and this will enable easier access to asset-related services like operations, repair and maintenance, availability of spare parts and skilling of personnel. The market will become more and more organized. Additionally, this will enable an orderly growth of the used equipment market which is very essential for a market like India where majority of the customers are cost-conscious and nearly 60% of the customers are first time users (FTUs). Another major advantage of GST will be the enhanced mobility of the asset. Inter-state movement of such equipment had been a headache for decades. With GST, movement of such assets will be seamless and it will be easier to re-deploy the asset at multiple locations on multiple projects thereby ensuring optimal utilization of the asset over its economic life.
Post GST niggles
The two usual modes of leasing are Finance Lease and Operating Lease. In a FL transaction, the lessor/NBFC buys the asset from an OEM and then makes it available to the user/lessee for an agreed price and time period. FL is treated like a loan and the risks and rewards associated with the asset are transferred to the lessee and the asset remains on the lessee’s balance sheet. In the present tax structure, FL transactions include both VAT and service tax. In an OL, all risks and rewards associated with the asset remain with the lessor.
Here the lease payments are shown as operational fees paid by the lessee and the asset appears on the lessor’s balance sheet. VAT is charged on the rental income, but there is no service tax component. Financially, OL works out to be slightly cheaper than FL. Also, OL is a preferred mode
for the lessor as in case of a payment default it is easier to repossess the asset.
Pre-GST, the VAT paid on procurement of equipment for leasing is entirely available for set-off with the output VAT liability. However, the GST framework proposes that the input credit on inputs, capital goods and input services to be reduced to 50% for NBFCs and banks who are engaged in extending finances through the process of lease of equipment. This is bound to create a considerable cash flow impact on the lessors and they will ultimately recover the extra cost from the lessees. It can be empirically established that post-GST a lessee will need to pay out more. Capital-starved SME players will face major hardship due to this. This will effectively be a death blow to leasing even before it makes a comeback in India. More importantly, the pace of infrastructure creation will suffer a setback which, in turn, will slow down India’s growth momentum.
It is worth noting in this context that under the current service tax regime, 50% reversal is required only for input services, and not for capital goods. Post-GST, a FL will be treated as a supply of good and an OL will be treated as a service, both being subjected to GST. Thus, to keep the provisions at par in the GST regime too, 100% input credit should be allowed for capital goods. That way, at least the FL will work out to be economical in the post-GST scenario.
Even if capital good sale is allowed 100% input credit, post-GST, OL will lose its cost-competitiveness vis-à-vis FL. With OL counted as a service post-GST, it will involve 50% reversal of input credit. Not only will it be more expensive than a FL post-GST, an OL post-GST will work out to be costlier than the same OL pre-GST. This will be disadvantageous for the NBFCs as such as their preferred mode is always OL.
Presently, the import of assets, which are then leased out, does not attract VAT. Post-GST, Integrated GST (IGST) will be levied on procurement of such assets, but such assets will also be allowed 50% input credit, thus hurting its cost-competitiveness. Ideally, 100% input credit should also be allowed for imported assets.
Infrastructure creation is our national priority and leasing is yet to develop in this country. Thus, it would be in the best interest of the nation to allow 100% input tax credit for both capital goods and services post-GST (and for both domestically produced and imported equipment). This would certainly provide a fillip to leasing in India. In addition, the GST rate for most capital goods has been fixed at 28%. It is ultimately the lessee who, last in the GST chain, pays this tax. Keeping in mind the huge multiplier impact that use of capital goods creates in an economy and the fact that majority of the lessees or customers are in the SME category, the government should actively consider not bracketing the capital goods in the same GST bracket as luxury goods and sin goods. A lower GST rate at 5% or at the most 12% for capital goods can reap rich dividends for the economy in the long run.
GST has been the ‘Brahmastra’ which we have been waiting for so many years. It will unite India as a common market and that can open up huge opportunities for entrepreneurship. Leasing, as a financial tool, will not only be instrumental in facilitating infrastructure creation, but it can also have a huge impact on other sectors like agriculture, healthcare, logistics, IT and many more. We must ensure that all the concern areas regarding the post-GST tax treatment of leasing get ironed out quickly so that leasing can unleash its potential and propel India into a higher growth trajectory.