The taxation aspects of hire purchase transaction can be divided into three parts (a) Income Tax, (b) Sales Tax and (c) Interest Tax.
Income Tax Aspect:
Hire purchase, as a financing alternative, offers tax benefits both to the hire-vendor (hire purchase finance company) and the hirer.
Income tax assessment of the Hire purchase or hirer: The hirer is entitled to (i) The tax shield on depreciation calculated with reference to the cash purchase price and (ii) the tax shield on the finance charges. Even though the hirer is not the owner he gets the benefit of depreciation on the cash price of the asset/equipment. Also he can claim finance charges (difference of hire purchase price and cash price) as expenses. If the agreement provides for the option of purchasing the goods as any time or of returning the same before the total amount is paid, no deduction of tax at source is to be made from the consideration of hire paid to the owner.
Income tax assessment of the Owner or financer: The consideration for hire/hire charges / income received by the hire vendor / financer is liable to tax under the head profits and gains of business and profession where hire purchase constitute the business (mainstream activity) of the assessee, otherwise as income from other sources. The hire income from house property is generally taxed as income from house property. Normal deduction (except depreciation) are allowed while computing the taxable income.
Sales Tax Aspect:
The salient features of sales tax pertaining to hire purchase transactions after the Constitution (Forty Sixth Amendment) Act, 1982, are as discussed in following points:
Hire purchase as Sale: Hire purchase, though not sale in the true sense, is deemed to be sale. Such transactions as per se are liable to sales tax. Full tax is payable irrespective of whether the owner gets the full price of the goods or not.
Delivery v/s Transfer of property: A hire purchase deal is regarded as a sale immediately the goods are delivered and not on the transfer of the title to the goods. The quantum of sales tax is the sales price, thus the sales tax is charged on the whole amount payable by the hirer to the owner. The sales tax on a hire purchase sale is levied in the state where the hire purchase agreement is executed
Rate of tax: The rate of sales tax on hire purchase deals vary from state to There is, as a matter of fact, no uniformity even regarding the goods to be taxed. If the rates undergo a change during the currency of a hire purchase agreement, the rate in force on the date of the delivery of the goods to the hirer is applicable. Interest Tax:
The hire purchase finance companies, like other credit / finance companies, have to pay interest tax under the Interest Tax Act, 1974. According to this Act, interest tax is payable on the total amount of interest earned less bad debts in the previous year at a rate of 2 percent. The tax is treated as a tax deductible expense for the purpose of computing the taxable income under the Income Tax.