NOVEMBER 21, 2017

By Nivedita Agarwal, CA

SALE and leaseback transactions are financing transactions structured in two legs. In the first leg of the transaction,the asset is sold to a buyer for cash wherein there is transfer of title from the seller to the buyer. In the second leg of the transaction, the same asset is taken back on lease by the seller of the asset. Thus, effectively, the sale of the assets in the first leg does not involve any movement in asmuch as it remains in the possession of the seller which he continues to use under the lease arrangement.

In case of operating lease, the asset continues to remain in the books of the lessor. However, in case of financial lease transactions, the asset is transferred to the books of the lessee. These transactions are often used as a methodology to free up funds blocked in high value assets which may be needed by the company to meet its short term working capital obligations or for other operational purposes. Such transactions are commonly seen in the aircraft industry,heavy machinery and equipment financing in India.

The legal and regulatory impact on the sale and leaseback transactions have recently undergone a sea change in light of the Goods and Services Tax implemented in India from 01.07.2017 and the implementation of IND-AS 17.

This article has made an attempt to analyse the implications of GST on sale and leaseback transactions and the structural changes that may have to be carried out in a sale and leaseback transaction due to GST.

Implications under the GST scenario

Sale of the asset to the lessor

The first leg of the sale and leaseback transaction involves a sale of the asset to the lessor who thereafter leases it back. The sale of the asset to the lessor will fall under the scope of supply of goods under Section 9 of the Central Goods and Services Tax Act, 2017 (CGST Act) and will be chargeable to GST.In this context, it is pertinent to analyse whether the sale transaction will be leviable to CGST/SGST or IGST.

The place of supply of goods is one of the determining factors in this regard. As per Section 10(1)(c) of the IGST Act, the place of supply of goods where the supply does not involve movement of the said goods whether by the supplier or the recipient shall be the location of such goods at the time of delivery to the recipient. In the case of such sale, there is no physical movement of the asset from the premises of the lessee to the premises of the lessor. As per Sale of Goods Act, 1930 a delivery is constructive when it is affected without any change in the actual possession of the goods when delivery is made by attornment or symbolic delivery. Borrowing the definition of constructive delivery from the Sale of Goods Act, it can be inferred that constructive delivery has taken place in the first leg. Hence, the place of supply in this case will be same as the location of the supplier. Accordingly, the sale of the asset will be considered as an intra-state supply as per Section 8 of the IGST Act and will be subjected to CGST + SGST.

Leaseback of the asset by the lessor to the seller

In the second leg of the transaction, the buyer immediately contracts to lease the asset either on operating lease or financial lease basis to the original owner.

In a typical case of a financial lease transaction, the right to use the goods are passed on by the lessor to the lessee wherein the lessor retains ownership of the asset. Clause 5(f) of Schedule II of the CGST Act, 2017 provides that transfer of right to use any goods for any purpose, for cash, deferred payment or other valuable consideration is a supply of services. In view of the same, a finance lease will be a transfer of right to use goods under 5(f) of Schedule II and will be taxed as a supply of service.

An operating lease is in the nature of a rental agreement for an asset and will also qualify as a supply of service under GST.

Open Issues

Whether the lessor is eligible to claim ITC of GST paid on the sale of asset in the first leg?

Whilst on the issue, it is to be noted that the lessor may not be in a position to avail the input tax credit of the GST paid on purchase of asset in the first leg in view of the following reasons:

- Section 16 of the CGST Act provides that ITC can be availed only after the goods or services have been received by the recipient of the supply. In sale and leaseback transactions, the asset is not physically received by the buyer at all which will deprive him of the ITC which should otherwise be available.

- Even if in the first situation the asset is deemed to have been received in view of the constructive delivery, the transaction of sale of the asset will be subject to CGST + SGST. In situations where the lessor is situated in a State different from that of the lessee, he will not be in a position to avail the ITC of the SGSTpaid as he would not have a registration in that State. The availment of CGST credit also, though legally permissible, may be disputed by the department. In case where the seller and buyer are located in the same state, anomaly on this account will not arise.

Whether the lessee is eligible to claim ITC of GST paid on the lease of asset in the second leg?

- ITC of GST on lease rentals will generally be eligible as credit to the lessee. However, practically it may happen that the lessor has a contractual agreement with the head office of the lessee where the invoices for the lease is being issued whereas the assets on lease are located at a worksite in a different state.

In such cases, there may be a hindrance in availment of credit in terms of Section 16 of the CGST Act as the actual receipt of services are taking place at the worksite in a different state.

The contracts may be modified and GST invoices be raised to the worksite where the asset is located to satisfy the condition of receipt of assets for availment of credit.

Alternatively, the lessor may continue to raise the invoice on the head office who will have either taken ISD registration to distribute the credit to the worksite or may raise a GST invoice on its branch office in another State which is a distinct person for the purpose of GST Act.

Final Thoughts

The implementation of GST remains bumpy even after four months of its rollout with the industry grappling to implement the new-tax reform. Sectoral specific issues have been emerging and suitable representations are being filed before the Government. The sale and leaseback industry may also have to re-structure the way it does its business so that credit can continue to be availed even in the GST regime for such transactions. Hopefully, the CBEC would examine the matter closely and comeout with a solution before the issue snowballs into a major controversy.

(The author is Associate, M/s. Lakshmikumaran & Sridharan, Kolkata and the views expressed are strictly personal.)