Tax Planning Hire Purchase
The hire purchase transaction can be used as a tax planning device in two ways:
First, the net income (finance income less interest on borrowings by the hire vendor) can be inflated at the rear end of the transaction and thereby defer tax liability. This is permissible by distributing the finance charge income over the period of hire agreement as the interest on his borrowings, which as a major item of expense is larger in the early years and declines as the hire installments are received, whereas the finance income remains constant. The hire can similarly postpone his tax liability by allocating a finance charge on the basis of a actuarial rate of return method that implies a higher deduction in the early years.
Secondly, another possible area of tax planning is to use hire purchase as a bridge between the lessor and the lessee. In other words, instead of direct lease an intermediate financier is introduced. Suppose, X wants to lease an asset to Z. Instead of going for a direct lease, they adopt a different strategy, wherein Y steps in as an intermediary, Y takes the asset on hire purchase from X and gives the same asset to Z on lease. There is no prohibition of such arrangement, unless the hire purchase agreement prohibits the sub lease. Under this strategy, Y gets me dual advantage of depreciation and finance charge against his income from lease rentals, thereby postponing his taxes. This strategy can be very useful in case Y is a high tax paying entity. Y in consideration for reduction in his tax liability will pass off some income to X in the fonn of high hire charges and to Z by way of lease rentals. Even if the intermediary Y derives no financial gains, substantial tax savings can be reaped by distributing the income and tax benefits.
Sales Tax Aspect
The salient features of sales tax, pertaining to hire purchase transactions, after the Constitution (Forty sixth Amendment) Act, 1982, are as detailed below: