Applicability of Service Tax on lease/ hire purchase transaction

In a recent decision of the Madras High Court ruling of Madras Hire Purchase Association vs.
Union of India (judgment dated 9th June, 2009), constitutional validity of service tax on leasing
and hire purchase of moveable goods was discussed. The question before the court was whether
such transactions evolve an element of service where such transactions were expressly made
chargeable to VAT.

The Petitioners argued that they being NBFCs have been carrying out leasing and hire purchase
transactions and under Article 366 (29A) inserted in the 46th amendment of the Constitution of
India, and that the said transactions were included in the ambit of transaction constituting sale of
goods, hence chargeable to sales tax/ VAT. Also the Petitioners argued on the basis on the
invoices that there was no service involved in these transactions.

The Appellants relied on several judgments of Supreme Court including Bharat Sanchar Nigam
Limited vs. Union of India (judgment dated 2nd March, 2006), wherein it was held that a
particular lease/ hire purchase transaction would be charged to either goods tax or service tax
depending upon the substance of the transaction – the ‘dominant nature test.’ Further in Imagic
Creative (P) Ltd. vs. Commissioner of Commercial Tax, 2008 (2) SCC 614, it was held that the
goods tax and service tax operated in mutually exclusive domains. Also in a Delhi High Court
case of Home Solution Retail India Ltd vs. Union of India service tax on rentals pertaining to
letting out of immoveable property on lease was set aside.

The said argument was opposed by relying on the previous judgments of Supreme Court in
Tamil Nadu Kalyana Mandapam Association vs. Union of India, (judgment dated 30th April,
2001) and in Gujarat Ambuja Cements Ltd. vs Union of India, wherein it was held that the
definition of ‘financial services’ included equipment leasing and hire purchase hence levy of
service tax on the lease/ hire purchase transactions was constitutionally valid. In the Tamil Nadu
Kalyana Mandapam Association vs. Union of India, case the government had granted a
deduction of 90% from the installment amount and only 10% was chargeable to sales tax/ VAT.

In the present case the appellants had admitted that they had charged a service tax of 1% on the
documentation and incidental activities relating to hire purchase/ leasing, but this however was
not the principal transaction in question.

The Madras High Court held that the hire purchase and leasing transactions admittedly included
the concept of rendering of services; consequently charging of service tax on such transactions
was constitutionally valid. The Court further held that since the banking companies were paying
tax on similar transactions, there was no basis for arguing that NBFCs should not pay service tax.
The high Court had held that whether or not lease/ hire purchase transactions were chargeable to
VAT, service tax would be applicable on such transactions, even if it amount to double taxation
of the said transaction under VAT and service tax.