Ita/230/2002 Of Commissioner Of Income Tax v. Muthoot Leasing & Finance

IN THE HIGH COURT OF KERALA AT ERNAKULAM PRESENT : THE HONOURABLE MR. JUSTICE C.N.RAMACHANDRAN NAIR & THE HONOURABLE MR. JUSTICE T.R.RAMACHANDRAN NAIR MONDAY, THE 10TH MARCH 2008 / 20TH PHALGUNA 1929 ITA.No. 230 of 2002() --------------------- INT. TA.13/CO/2000 of I.T.A.TRIBUNAL,COCHIN BENCH .................... APPELLANT/RESPONDENT: ------------------------------------- THE COMMISSIONER OF INCOMETAX, COCHIN. BY ADV. SRI.GEORGE K. GEORGE, SC FOR IT SRI.P.K.R.MENON RESPONDENTS: APPELLANT ---------------------- M/S.MUTHOOT LEASING & FINANCE LTD., OPP.SARITHA THEATRE, BANERJEE ROAD, COCHIN-18. BY ADV. SRI.P.BALACHANDRAN (SR.) THIS INCOME TAX APPEAL HAVING BEEN FINALLY HEARD ON 10/03/2008, ALONG WITH ITA NO.237/2002 & CONN.CASES, THE COURT ON THE SAME DAY DELIVERED THE FOLLOWING: C.N.RAMACHANDRAN NAIR &T.R.RAMACHANDRAN NAIR, JJ. .................................................................... I.T. Appeal Nos.230, 237, 264, 220, 312, 314,& 269 of 2002, 93, 99, 101, 105, 107 & 111 of 2007,& O.P. 10041 of 1996 .................................................................... Dated this the 10th day of March, 2008. JUDGMENT C.N.Ramachandran Nair, J. The only question arising in the connected appeals filed by theRevenue against the order of the Income Tax Appellate Tribunal iswhether the "finance charges" collected by respondent-companiesunder hire purchase agreements attract tax under the Interest Tax Act,1974 as amended by Finance (No.2) Act of 1991. According to theRevenue, "finance charges" collected by the respondents for vehiclefinancing is nothing but "interest" at flat rate loaded along with loanamount and collected in instalments and therefore, the same isassesseable under the Act. The case of the respondents on the otherhand is that hire purchase transactions are outside the scope of theInterest Tax Act and so much so, finance charges collected cannot beassessed as interest. We have heard Senior counsel Sri.P.K.R.Menonappearing for the appellant and Senior counsel Sri.P.Balachandran and other counsel appearing for the respondents. 2. Admittedly respondents being hire purchase finance companies are specifically covered by the definition "credit institution" which areliable to pay interst tax on interest covered by Section 2(7) of the Act.In fact, atleast some of the respondents have paid tax on certain otherreceipts of interest and consequently have no dispute that they are notassesseable under the Act. The short question arising for considerationis whether "finance charges" recovered by them from motor vehiclefinancing business is interest as defined under Section 2(7) of the Act.For easy reference, "interest" as defined under Section 2(7) is extractedhereunder: "S.2(7): "Inerest" means interest on loans andadvances made in India and includes-- (a) commitment charges on unutilised portion of anycredit sanctioned for being availed of in India; and (b) discount on promissory notes and bills ofexchange drawn or made in India, but does not include-- (i) interest referred to in sub-section (IB) of Section 42 of the Reserve Bank of India Act, 1934 (2) of 1934); (ii) discount on treasury bills." "S.2(7): "Inerest" means interest on loans andadvances made in India and includes-- (a) commitment charges on unutilised portion of anycredit sanctioned for being availed of in India; and (b) discount on promissory notes and bills ofexchange drawn or made in India, but does not include-- (i) interest referred to in sub-section (IB) of Section 42 of the Reserve Bank of India Act, 1934 (2) of 1934); (ii) discount on treasury bills." vehicle financing business. Along with "finance charges" recovered inthe vehicle financing business, respondents have also claimedexemption on "service charges" recovered in the same business. TheAssessing Officer examined the nature of the two receipts and thoughgranted exemption on service charges received, found that the amountreceived and accounted as "finance charges" is nothing but interestcollected at flat rate and threrefore, he levied tax on the same. In otherwords, the finding of the Assessing Officer is that vehicle financingunder the so-called hire purchsae arrangement is nothing but "loan oradvance" made by the respondents and interest accounted under thename finance charges is assesseable under the Act. The nature oftransaction which is same for all assessees as found by the AssessingOfficer in the assessment of the respondent in I.T.A. 230/2002 is asfollows: "The sanction letter (copy of letter dt.23.10.98addressed to Shri.Peter Paul filed as specimen) showsthat the hirer has given application to the assesseerequesting for hire purchase finance of the amountspecified therein. The hire purchase agreement(agreement dtd.23.10.98 in the case of Shri.Peter Paulfiled as specimen) also shows that the hirer hadrequested the assessee (owner) for finance for purchaseof a new vehicle and the assessee has agreed to financefor the purchase on the terms and conditions stipulatedin the hire purchase agreement. It is evident from theabove that the assessee has advanced money to the hirer for the purcahse of the vehicle in response to a specificrequest made by him for finance and the transaction isessentially in the nature of financing transaction. Iftransactions of this type will not fall within the categoryof financing transaction it is difficult to coneive whichtransaction will fall within this category." "The methods of fixation of the initial payment,i.e., margin money, determination of finance charges anddetermination of hire purchase price followed by theassessee also clearly show that the hire purchasetransactions entered in to by it are in substance financialtransactions. The margin money is the cost of the assetas reduced by the hire purchase finance sanctioned to thehirer at his request. It has no relation to the cost of theasset. If a hirer seeks 90% of the cost of the asset as hirepurchase finance, margin money will be the balance10% only. For the same asset if a hirer is sanctioned75% of the cost as hire purchase finance the marginmoney will be 25% only. This shows that the hirepurchase advance is a loan, pure and simple granted bythe assessee according to the needs of the hirer.Similarly finance charges are also calculated at a flat rateof 11% per annum on the net amount financed and thisis nothing but calculation of interest @ 11% p.a. at flatrate for the period of hire purchase. The hire purchaseprice is also fixed by adding the finance charges to thenet amount financed. The hire purchase price so fixed ispayable in equal monthly instalments over a number ofyears. It is clear from the above that the finance chargescollected by the assessee actually represents interest onthe amount advanced by it to the so-called hirer." (emphasis supplied) From the above it is clear that though the transaction is styled as hire purchase agreement, it is actually financing for purchase of a vehicle.The crucial difference between hire purchase agreement and (emphasis supplied) From the above it is clear that though the transaction is styled as hire purchase agreement, it is actually financing for purchase of a vehicle.The crucial difference between hire purchase agreement and arrangement in these cases is that while in the hire purchasearrangement the financier remains the owner of the goods and the hirerhas only an option to purchase the goods after payment of the hirepurchase instalments, in these cases the borrower is the purchaser andregistered owner of the vehicle and the respondents-companies haveonly a licence to repossess the vehicle on default. Even though none ofthe authorities including the Tribunal has not considered the provisionsof the Motor Vehicles Act, 1988 pertaining to financing of vehiclepurchase, we feel it would be useful to refer to the provisions of thesaid Act for understanding the nature of transaction between therespondents and the vehicle owners. Section 51(1) of the MotorVehicles Act mandates that the registering authority shall enter in thecertificate of registration of the vehicle, about the hire purchaseagreement. Clause (3) provides for cancellation of the hire purcahseliability entered in the certificate of registration on production of proofof termination of the agreement. Similarly, clause (4) provides fortransfer of ownership of the vehicle subject to hire purchase agreementonly with the consent of the finance company. Ultimately, clause (5)authorises the finance company to take over possession of the vehiclesubject to hire purchase agreement and thereafter they can apply for change of registration in their name. Therefore, the business of therespondents reflected in the order of the Assessing Officer is consistentwith the above statutory provision of the Motor Vehicles Act whichonly provide for endorsement of hypothecation in the RC book andregistration of the vehicle is in the name of the borrower. Now thequestion to be considered is whether on these facts, the transactionbetween the respondents and the borrowers is a case of loan or a hirepurchase agreement. The Assessing Officer has already found andrespondents cannot controvert the fact that flat rate of interest for thewhole loan period is loaded to the loan amount and the hire chargescollected in instalments include such interest loaded to the loan amountadvanced by the finance company. Besides enodrsement ofhypothecation in the RC book of the vehicle, the respondents takepromissory notes, cheques etc., from the borrowers towards security.The Supreme Court has considered the distinction between hirepurchase arrangement and loan transaction in the following words inthe decision in SUNDARAM FINANCE LTD. V. STATE OFKERALA reported in AIR 1966 SC 1178: "...... If there is a bona fide and completed sale ofgoods, evidenced by documents, anterior to andindependent of a subsequent and distinct hiring to the "...... If there is a bona fide and completed sale ofgoods, evidenced by documents, anterior to andindependent of a subsequent and distinct hiring to the vendor, the transaction may not be regarded as a loantransaction, even though the reason for which it wasentered into was to raise money. If the real transactionis a loan of money secured by a right of seizure of thegoods, the property ostensibly passes under thedocuments embodying the transaction, but subject tothe terms of the hiring agreement, which become opartof the buyer's title, and confer a licence to the seize.When a person desiring to purchase goods and is nothaving sufficient money on hand borrows the amountneeded from a third person and pays it over to thevendor, the transaction between the customer and thelender will unquestionably be a loan transaction. Thereal character of the transaction would not be altered ifthe lender himself is the owner of the goods and theowner accept the promise of the purchaser to pay theprice or the balance remaining due against delivery ofthe goods. But a hire-purchase agreement is a morecomplex transaction. The owner under the hire-purchase agreement enters into a transaction of hiringout goods on the terms and conditions set out in theagreement, and the option to purchase exercisable bythe customer on payment of all the instalments of hirearises when the instalments are paid and nsot before.In such a hire-purchase agreement there is noagreement to buy goods, the hirer being under no legalobligation to buy, has an option either to return thegoods or to become its owner by payment in full of thestipulated hire and the price for exercising the option.-This class of hirepurchase agreement must bedistinguished from transaction in which the customer isthe owner of the goods and with a view to finance hispurchase he enters into an agreement which is in the-form of a hirepurchase agreement with the financier,but in substance evidence a loan transaction, subject tohiring agreement under which the lender is given the".licence to seize the goods (emphasis supplied) Now what is to be considered is whether the transaction between therespondents and the applicants who purchased the vehicles with thefinance given by the respondents is really a hire purchase under theAct. The Tribunal heavily relied on the provisions of the Hire PurchaseAct 1972 and took the view that transaction of hire purchase is not"loan or advance" as defined under Section 2(7) of the Act. On goingthrough the Tribunal's orders, we find that what waighed with them isthe option under the hire purchase agreement to the borrowers topurchase the vehicle. However, we notice that option given to theborrower to purchase vehicle for rupee one in the hire purchaseagreement is an empty formality in this case because vehicle purchasedis registered in the name of the borrower and respondents have only alicence to repossess the vehicle on default. In order to get ownership,respondents have to apply for change of registration in their nameunder the provisions of the Motor Vehicles Act abovereferred. Besidesthis, we have already noticed the salient features of the so-called hirepurchase agreement, whereunder the loan amount is recovered ininstalments along with flat rate of interest charged for loan period andloaded to the instalments. Respondents have taken cheques,promissory notes, etc. towards security for the loan, in addition to hypothecation noticed in the RC book. It is clear from the terms oftransaction that the vehicle financing covered by so-called hirepurchase agreements is only in the nature of loan and contrary to hire-purchases conceived under the Hire Purchase Act, respondents haveonly a licence to repossess the vehicle and get the vehicle registered intheir name and that too under orders of Registering Authority under theMotor Vehicles Act after default is committed by the hire purchasers.We are of the view that the Tribunal mis-directed itself and reached awrong conclusion only because of their failure to appreciate the factspertaining to transaction properly and without reference to theprovisions of the Motor Vehicles Act which deal with ownership,hypothecation, etc. on vehicles. Respondents have heavily relied onCircular No. 760 dated 13.1.1998 issued by CBDT wherein they havestated that genuine hire purchase transactions are not covered by theInterest Tax Act. However, we notice that the very same CBDT incircular No. 738 dated 25.3.1996 have earlier clarified that interestrecovered under hire purchase agreement falls under Section 2(7) of theInterest Tax Act. Even in the circular relied on by the respondentswhat the CBDT has said is that each and every transaction should beconsidered on merits and exclusion is provided only on hire charges and not on interest. Applying the principle laid down by the SupremeCourt in SUNDARAM FINANCE LTD.s case, we already found thatthe transaction is a genuine loan transaction, though it is styled as a hirepurchase arrangement. Another instruction relied on by therespondents is instruction No. 1425 in E.No. 275/90/80 IT (B) dated18.11.1981 issued by the CBDT with reference to Section 194A of theI.T. Act which provides for deduction of tax at source on interestincome. What is stated in this is that no deduction should be made atthe time of payment of hire purchase instalment. We do not know howthis circular prohibiting deduction of tax at source on hire purchaseinstalment of which interest is only an element can apply to the facts ofthis case. Moreover, it is to be noted that hire purchase companies aresquarely covered by definition of "credit institutions" under the Act andare liable to pay tax on charge of interest on loans and advances. It isimmaterial whether a loan or advance is called hire purchase agreementor snot. On the other hand, what is to be considered is whether thetransaction involved is really a loan or advance and if the transaction isfound so, then the interest earned on the same is taxable under theInterest Tax Act. Besides the decision of the Supreme Court inSUNDARAM FINANCE LTD.'s case, the other decision relied on by the assessees is that of the Punjab and Haryana High Court in DEEPHIRE PURCHASE V. COMMR. OF INTEREST TAX, 274 I.T.R. 69.We notice that this is a case where Punjab and Haryana High Courthad only confirmed the order of the Tribunal remanding the matter tothe assessing officer with an observation that interest on financing onlyattracts tax under Section 2(7) of the Act. However, the questionwhether motor vehicle financing of the kind carried on by therespondents which is the issue in this case attract tax under the Act ornot was not raised or decided by that Court. Similarly another decisionrelied on by the respondent is that of the Madras High Court inCOMMR. OF INCOME TAX V. HARITA FINANCE LTD. 283 I.T.R.370 (Mad.) also does not deal with the nature of transaction involved inthis case. On the other hand, the Court has only held that Tribunal'sfindings on facts are binding and conclusive and there is no scope forinterference in Reference Case. However, in this case revenue hadspecifically canvassed against the findings of the Tribunal contrary tothe concurrent findings entered by the assessing authority and the firstappellate authority based on documents and with reference to specifichire purchase agreements entered into between the respondents andtheir parties. After going through the facts pertaining to transactions extracted above, we find no justification for the Tribunal to come to thefindings different from that of the two lower authorities. Besides thiswe have already noticed that the exercise of option provided in theagreement relied on by the Tribunal is contrary to the real deal andagainst the provisions of the Motor Vehicles Act because ofregistration of vehicles by the borrowers in their own names. TheTribunal's findings are based on wrong assumption of facts and theyhave decided the matter without even refering to the provisions of theMotor Vehicles Act which comprehensively deal with all transactionsin motor vehicles. We, therefore, allow the appeals by reversing theorder of the Tribunal and restoring the assessments confirmed in firstappeals. The O.P. No.10041/1996 stands dismissed. C.N.RAMACHANDRAN NAIRJudge T.R.RAMACHANDRAN NAIRJudgeJudge