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ARTICLE 13
CAPITAL GAINS
(1) Gains derived by a resident of a Contracting State from the
alienation of immovable property referred to in Article 6 and situated in the other
Contracting State may be taxed in that other State.
(2) Gains from the alienation of movable property forming part of the business property of
a permanent establishment which an enterprise of a Contracting State has in the other
Contracting State or of movable property pertaining to a fixed base available to a
resident of a Contracting State in the other Contracting State for the purpose of
performing independent personal services, including such gains from the alienation of such
a permanent establishment (alone or with the whole enterprise) or of such fixed base, may
be taxed in that other State.
(3) Gains from the alienation of ships or aircraft operated in international traffic,
boats engaged in inland waterways transport or movable property pertaining to the
operation of such ships, aircraft or boats, shall be taxable only in the Contracting State
in which the place of effective management of the enterprise is situated.
(4) Gains from the alienation of shares of the capital stock of a company the property of
which consists directly or indirectly principally of immovable property situated in a
Contracting State may be taxed in that State.
(5) Gains from the alienation of shares other than those mentioned in paragraph (4)
representing a participation of .... per cent (the percentage is to be established through
bilateral negotiations) in a company which. is a resident of a Contracting State may be
taxed in that State.
(6) Gains from the alienation of any property other than that referred to in paragraphs
(1), (2), (3), (4) and (5) shall be taxable only in the Contracting State of which the
alienator is a resident.
73. Scope
This Article deals with the alienation of the following:
1. Immovable property.
2. Movable property forming part of the business property.
3. Ships or aircraft.
4. Shares of the capital stock of the company, the property of which consists principally
of immovable property.
5. Shares of other companies representing a participation of.....per cent in a company
which is resident of a Contracting State.
6. Any other assets gains in respect of (1), (2) and (4) may be taxed by the Contracting
State where the immovable property or the permanent establishment or the fixed base is
situated; in respect of (3), by the State in which the place of effective management of
the enterprise operating ships or aircraft exists, and in respect of (5) and (6) by the
State of which the company and the alienator is resident respectively.
Article 13 does not give right to the State to tax capital gains if according to its
domestic laws no capital gains are chargeable. Where there is a transfer without there
being any profit arising on transfer, there is no profit liable to capital gains tax. The
Ordinance specifies certain transactions which do not constitute-transfer or even if these
be so taken, they are to be ignored for the purpose of capital gains, e.g., section
27(2)(b), (i) distribution of assets by companies (ii) transfer under a will or gift).
Section 27(2)(b) of Income Tax Ordinance, 1979 reads as under ·
"Sec. 27(2)(b) "transfer" includes the sale, disposition, exchange
or relinquishment of the asset, or the extinguishment of any rights therein, but does not
include -
(i) any transfer by reason of the compulsory acquisition of any capital asset under any
law for the time being in force;
(ii) any transfer of a capital asset under a gift, bequest or will or an irrevocable
trust;
(iii) any distribution of the assets of a company to its shareholders on its liquidation;
and
(iv) any distribution of capital assets on the dissolution of a firm or other association
of persons or the partition of a Hindu undivided family."
The right to tax capital gains on the alienation of the property has been given to the
country where such property is situated, both by the OECD and UN Models. The OECD Model
Convention grants to the source country the right to tax capital gains from the alienation
of immovable property and from the movable property that is ~ part of a permanent
establishment or which pertains to e~ fixed base for performing independent personal
service. There is a close similarity between the business profit and the capital gains in
respect of movable property inasmuch as both are taxable in the source country only if
permanent establishment exists. No distinction is therefore made between capital gains and
commercial profits. It, however, reserves to the residence country the right to tax gains
on other forms of alienable property. The right to 'tax the gains on alienation of ships
or aircraft or boats is given to the State in which the effective management of the
enterprise is situated. The residuary para 4 of Article 13 of the OECD and 6 of the UN
Model Convention provide that the gains from the alienation of any property other than
that referred to in the preceding paragraphs are taxable in the Contracting State of which
the alienator is a resident. However, the developing countries advocated the right of the
Contracting State in which such gains arise according to its laws, which is equivalent to
saying that either or both States may tax according to their own laws with the belief that
the State of residence will eliminate double taxation under Article 23. The UN Model,
however, retained para 4 of the OECD Model Convention and renumbered it as para 6.
Thus under all tax agreements the right to tax capital gains has been conferred on the
State of which the alienator is the resident, except in cases of immovable properties or
of movable properties forming part of business property of the permanent establishment or
pertaining to a fixed base where the right to tax it belongs to the State where such
property is situated. This Article is intended to apply only if there is alienation, and
not when there is appreciation in value of the asset on account of appreciation in
currency in terms of the currency of situs country or on any other account. It does not
apply to prizes in a lottery or to premiums and prizes attaching to bonds or debentures.
The Article does not give a detailed definition of capital gains. The words 'alienation of
property' are used to cover in particular capital gains resulting from the sale or
exchange, transfer or relinquishment of property and also from a partial alienation, the
expropriation, the transfer to a company in exchange for stock, the sale of a right,
paragraph (2) deals with the alienation of movable property of a permanent establishment
or pertaining to a fixed base available to a resident of one Contracting State in the
other State for the purpose of performing professional services. The capital gain is
chargeable by the State where such property is situated. This paragraph applies when the
property is alienated, and also when the permanent establishment or fixed base as such is
transferred. If the whole enterprise is transferred, only the gains which are referable to
the movable property forming part of the business property of the permanent establishment
becomes taxable as capital gains. The rules of Article 7 would then apply mutatis mutandis
without express reference thereto.
74. Alienation of property
In a general sense the expression 'alienation of property' connotes the passing of
rights in property from one person to another. In one case, there may be passing of the
entire bundle of rights from the transferor to the transferee. In another case, the
transfer may consist of one of the estates only out of the estates comprising the totality
of rights in the property. In a third case, there may be a reduction of the exclusive
interest in the totality of rights of the original owner into a joint or shared interest
with other persons. An exclusive. interest in property is a larger interest than a share
in that property. To the extent to which the exclusive interest is reduced to a shared
interest, it would seem that there is a transfer of interest. Thus, for example, when a partner brings in his personal asset into
the capital of the partnership firm as his contribution to its capital, he reduces his
exclusive rights in the asset to the shared rights in it with the other partners of the
firm. While he does not lose his rights in the asset altogether what he enjoys now is an
abridged right which cannot be identified With fullness of the right which he enjoyed in
the asset before it entered the partnership capital. This cannot be read for holding that
the position in law as on the dissolution of and as on the retirement of a partner from
the firm is the same.
The word 'alienation' is not normally defined in the tax agreement and, therefore, its
meaning may be gathered from the domestic law.
Relinquishment or extinguishment of rights in the property has been found missing in many
agreements, as also the reference to the compulsory acquisition of property. Such absence,
however, does not mean compulsory acquisition may not be taken ‘transfer’ of
asset. In the absence of a distinct genus or category no presumption can arise that the
word ‘alienation’ must be construed in the sense of a voluntary act of transfer
since 'sale', 'exchange' or 'relinquishment' are in the normal acceptation of those terms
of voluntary acts. The words sale, exchange, relinquishment and transfer must be given
their plain and natural meaning and there is no justification for restricting the wide
comprehension of the word 'transfer' to voluntary transfers by the application of the
ejusdem generis rule. If it is intended that voluntary transfers alone should fall within
the meaning of the Article, it is unnecessary to use the word, ‘alienation, an
expression acknowledged in law as having a wide connotation and amplitude. If an existing
title in a capital asset is extinguished and new one created, there is a transfer of
capital asset. The fact that the divestiture of title takes place under a law relating to
compulsory acquisition of property would make no difference.
The word 'alienation' is, therefore, used to mean extinguishment or relinquishment of
rights in the capital assets. Since the transfer as contemplated is one as a result
whereof consideration has passed to the assessee or has accrued to him, extinguishment or
relinquishment of rights must relate to that 'capital asset' corporeal or incorporeal. It
is, therefore, obvious that a transfer of a capital asset in order to attract liability to
tax under the head 'Capital gains' must be a 'transfer' as a result whereof some
consideration is received by or accrues to the assessee. If the transfer does not yield
any consideration, there can be no question of capital gains. If the transfer takes effect
on extinguishment of a right in the capital asset, there must be receipt of consideration
for such extinguishment to attract liability to tax.
The word ‘transfer’ also covers cases which result in the destruction,
annihilation, extinction, termination, cessation or cancellation, by satisfaction or
otherwise, of all o any of the bundle of rights -which a person has in the capital assets.
74.1. Sale, meaning of- Ordinary meaning of the word 'sale' is
a transaction entered into voluntarily between two persons known as buyer and the seller
by which the buyer acquires the property for an agreed consideration known as price.
Eric L. Kohler in A Dictionary for Accountants, 1978 Edition, defines 'sale' in the
following words:
"A business transaction involving the delivery (i.e., the giving) of a commodity, an
item of merchandise or property a right, or a service, in exchange for (the receipt of)
cash, a promise to pay, or money equivalent, or for any combination of these items. It is
recorded and reported in terms of the amount of such cash, promise to pay, or money
equivalent. A sale is sometimes distinguished from an exchange (1), Particularly in the
phrase 'sale or exchange', where the latter is confined to transactions involving no cash
or an incidental amount of cash, thus being used in the sense of barter; but except for
such use or where specifically qualified, the term extends to any transaction where
something is parted with and as compensation therefor something is received. A sale dif
for which there is no consideration, from a bailment, which involves no transfer of title,
and from a chattel mortgage, under which a transfer can occur only in case of default on
the obligation it secures.
the aggregate of such recorded and reported amounts during any given accounting period,
appearing on books of account as a credit. On an income statement unless otherwise
qualified, sales are net, i.e., gross less returns, allowances, discounts and (rarely)
provisions for uncollectible accounts."
According to the Sales Tax Act, 1990 of Pakistan, 'sale price' means the amount payable to
a dealer as consideration for the sale of any goods, less any sum allowed such as discount
according to the practice normally prevailing in the trade, but inclusive of any sum
charged for anything done by the dealer in respect of the goods at the time of or before
the delivery thereof other than the cost of freight or delivery or the cost of
installation in cases where such cost is separately charged.
'Sale', according to its ordinary meaning, is a transfer of property for a price. 'Sale' according to section 54 of the Transfer of
Property Act, 1882 is a transfer of ownership in exchange for a price paid or promised or
part paid or part promised. There is, however, no definition of 'price' in the said Act.
But it is well settled that the word 'price' is used in the same sense as in Sale of Goods
Act, 1930. Section 2(10) of the said Act defines 'price' as meaning the money
consideration for a sale of goods. According to section 4 of the Sale of Goods Act, there
should be a transfer on sale of goods or property in goods by the seller to the buyer for
a price. No doubt the contract of sale of goods may be one entered into between one part
of the owner and another on the part of buyer. It may also be absolute or conditional.
However, the crux of the matter is that there should be a transfer of property by the
vendor called the seller and the vendee, the purchaser, for a price. Unless these
ingredients of a valid sale are satisfied or established, it cannot be said that the
transaction in question would amount to a sale.
A sale comprises of the following essential elements :
- There must be parties competent to contract
- There must be mutual contract
- There must be a thing which is transferred from the seller to the buyer
- There must be price in money paid or promised
74.1-1 Compelled sale - A contract for sale thus postulates
exercise of volition on the part of the contracting parties. As held by the Indian Supreme
Court in New India Sugar Mills Ltd. v. CST unless
there is an exercise of volition on the part of the contracting parties, the mere use of
the word 'sale' will not make it a sale. The manufacturer of sugar was directed by the
orders of the Sugar Controller to despatch sugar to various States. There was no consensus
or contract between the manufacturer and the State to which the goods were consigned.
However, as pointed out by the Indian Supreme Court in State of Rajasthan v. Karam Chand
Thappar & Bros., there could be free consent
of parties to a sale, in spite of certain statutory compulsions. The consent under the law
of contract need not be express but could be implied. A sale could also take place by
operation of law rather than by mutual agreement, express or implied. Although there might
be compulsion both in selling and buying, a compelled sale is nevertheless a sale and it
cannot be said that there is no sale because the freedom to offer and accept is wanting.
A compelled sale under a statutory obligation is sale in the sense that there is a
privity of contract between the seller and the purchaser for the transfer of goods, for a
consideration, which passes from the latter to the former. But where the Government
acquires a property and pays compensation to its owner, the transfer cannot be taken sale.
The essential ingredients of sale are lacking. The 'price' is only a compensation for the
compulsory passing off the property in goods to which the order of acquisition relates, at
an amount fixed by the authority, though the compensation is determined on some generally
fixed principle.
In Calcutta Electric Supply Corpn. Ltd v. CIT an
electric generator was acquired compulsorily under the Defence of India Rules in spite of
owner's protest and it was held that the transaction or transfer thus brought about did
not amount to sale. If, however, the purchase by the Government of an asset was the result
of a contract, such a transaction amounts to sale.
In John Hudson & Co. Ltd. v. Kirkhess (H.M Inspector of Taxes) certain wagons were requisitioned and these were acquired by the
Government. A contention was raised that the acquisition amounted to a transfer for a
price and therefore, it was a sale. This contention was rejected by a majority of the
House of Lords. The Madhya Pradesh High Court in CIT v. Shrikrishan Chandmal held that though compulsory acquisition by the Government may not
constitute a sale, it would still be a transfer. So was held by the Indian Supreme Court in James Anderson v. CIT and other High Courts.
The word 'transfer' is comprehensive and is regarded generally as comprehending within its
scope transfers both voluntary and involuntary, that in the absence of a distinct genus or
category, no presumption can arise that the word transfer in section 27 must be construed
in the sense of a voluntary transfer, because the words 'sale', 'exchange' and
'relinquishment' are in the normal acceptation of those terms as voluntary acts, and that,
therefore, if an existing title of a capital asset is extinguished and a new one created,
there is within the meaning of section 27 a 'transfer' of capital asset, and that the fact
that the divestiture of title takes place under a law relating to compulsory acquisition
of property would make no difference. The compulsory acquisition of capital asset may be a
'transfer' within the meaning of section 27, but is not sale and, therefore, lightly
excluded under section 27(2)(b)(i) of the Income Tax Ordinance, 1979. These expressions
are not synonymous conveying the same meaning. Had this been so, and also the expression
'sale' as embracing within its scope 'compulsory acquisition' of an asset, there would
have been no need to refer to both these expressions in the inclusive definition of
'transfer' in section 27. One of the purposes of the inclusive definition is to expand the
concept defined. The meaning of the expression 'transfer' was extended to cover the
compulsory acquisition of an asset, along with sale, exchange, relinquishment of an asset,
or extinguishment of any right therein. However, for the purpose of chargeability the
transfer by compulsory acquisition under any law of the land has specifically been
excluded.
74.1-2 When sale of immovable property is said to be complete -
In order to decide whether the sale transaction is complete, the question of vital
importance is not whether the title in the property has passed but is whether the
significant risks and rewards of asset would have been transferred. The tests to decide
whether significant risks and rewards of ownership have been transferred are: (i) whether
the seller retains any effective control over assets transferred to an extent normally
exercised by an owner; and (ii) whether any significant acts of performance remain to be
completed. Thus, where a builder constructs fiats with the money of others and after
completion of their construction transfers possession and interest in these fiats to those
others, registration of the fiats in the names of the respective owners for whom the fiats
were constructed may not be necessary for the completion of the transaction of sale. True,
in the absence of an execution of sale deed and its registration in the case of fiats, the
ownership, strictly speaking, does not pass. But where the vendees, under the terms and
conditions of the agreement, acquire an absolute right of enjoyment and possession of the
fiats allotted to them, they become absolute owners of the usufructs of and the income
from the said fiats. The fact that the vendor is burdened with some common obligations
would not make it owner; nor does the retention by him of non-significant risk of
ownership, i.e, the retention of the title over the land and other traits of ownership for
the purpose of effective and efficient use of the building for the common benefit of all
the fiat owners. Such retention of insignificant risk of ownership is essential in the
context of present day living in multi-storeyed flats. The concept of ownership has
undergone a change. It is now understood in the light of rights of a person in possession
in regard to a particular property.
The Indian Supreme Court in R. B. Jodha Mal Kuthiala v. CIT posed the question about who the owner is for the purposes of the Indian
Income-tax Act: Is it the person in whom the property vests or is it he who is entitled to
some beneficial interest in the property? The Indian Supreme Court observed that a
property cannot be owned by two persons, each one having independent and exclusive right
over it. Hence, the owner must be that person who can exercise the rights of the owner not
on behalf of the owner but in his own right. The word 'owner' has different meanings in
different contexts. Under certain circumstances, a lessee may be considered as the owner
of the property leased to him. In CITv. Modern Flats (P.) Ltd. the builder had sold whatever right, title and interest it had to the
individual fiat owners who were called the purchasers under the document and what is more
the purchaser was given the right in his turn to sell or assign the rights given to him by
the document and the builder,' except for the purposes of the management of the entire
property, had no other right, title or interest in the building as such after the transfer
of the rights to the individual fiat owners. In such circumstances, the purchasers were
considered owners. In CIT v. Fazalbhoy Investment Co. (P.) Ltd. the fiat owners, who had contributed to the construction of flats and had
actually got possession of their respective portions after construction was over, were
considered owners. In the case of Smt. Kala Rani v. CIT and Addl. CIT v. Sahay Properties & Investment Co.
(P.) Ltd. also, the vendee was regarded as owner of the entire
usufruct of the property, though the formality of registration under the Indian
Registration Act was not completed. But these decisions are no longer valid. The various High Courts and the Indian Supreme Court are of the
view that unless a document for the transaction of sale is not registered, sale cannot be
said to be complete.
74.1-3 When sale of building constructed by a building contractor
is said to be complete - In the case of building contract, a question arises whether
the property in the material used by the contractor in its construction passes only when
the building is complete and handed over to the contractee or it passes from brick to
brick because as soon as it is used in the construction it becomes part of the structure
embedded to the land which belongs to the contractee where what passes ultimately is the
building composed of materials used by the contractor, the question arises is whether the
contractor is the owner of the building in the sense that he is the owner of the material
which has been utilised in its construction which has ultimately assumed the shape of
superstructure. The question could be resolved on the basis of the terms of the contract.
In a contract for sale the main object is the transfer of property in and delivery of
possession of an article or thing to the buyer. When an arrangement is a contract for sale
of an article to be produced, the finished product will have an individual existence as
the sole property of the party who produces it, at sometime before its delivery. To
constitute a sale, there must be an agreement' express or implied relating to sale of
article or thing and completion of that agreement by passing of the title in the very
article or thing created to be transferred. A contract for works can be said to involve
sale of article or thing if there is an independent term in the said contract for the sale
of any specific materials by one party to another for money consideration and not merely
an incidental transfer of title to some .materials as ancillary to the performance of the work. The primary' question for consideration, in
a case of transaction which is neither pure contract of sale nor pure works contract but
which is of mixed nature, is whether the transaction is entire or indivisible or whether
it is severable into more than one distinct contract. This depends upon the intention of
the parties. Transaction may contain more than
one contract, viz., sale of materials, as well as for work and labour to be done, contract
for work involving transfer of contractor's goods.
Where not only work is to be done but the execution of such work requires materials to be
used, it may take one of the following three forms:
- The contract may be of or the work to be done for remuneration and for supply of
materials used in the execution of work for a price.
- it may be a contract for the work in which the use of the material is necessary or
incidental to the execution of the work.
- It may be a contract for the supply of goods where some work is to be done as incidental
to sale.
Where the contract is of first type, it is a composite contract consisting of essentially
of two contracts, one for the sale of goods and the other for work and labour. The second
type of contract is clearly a contract of work and labour and not involving sale of goods.
The third type is a contract for sale where goods are sold as chattels and some work is
undoubtedly done, but it is done only as incidental to sale. No difficulty arises where
the contract is of the first type because it is divisible and the contract for sale can be
separated from the contract for work and labour. The amount payable under the composite
contract can be apportioned between the two. But when the contract is indivisible, the
sale would be complete when the subject-matter of the contract is handed over
substantially completed; as for instance, in a building contract. Under the building
contract property in materials passes to the owner of the land not by virtue of delivery
of materials as goods under the agreement of sale which stipulate the price of materials,
but because materials are affixed to buildings in pursuance of contract, and that when the
entire property passes to the owner then and only then, and not before then the property
in materials which are fixed to the building, are passed to the owner. Building materials used by the contractor in the construction of building
could be sold by him to the owner of the building.
The question is when the contractee becomes the owner of the building; whether when the
building is complete or substantially complete and is handed over to the contractee or as
soon as any accretion is made to the land and he becomes the owner of Such accretion.
Pakistani and Indian law on the subject does not adopt the general maxim in English law
that whatever is affixed to the soil belongs to the soil. In Mammunhi
v. Kunhibi the Kerala High Court was concerned with a question as to
whether a construction put up by husband on a plot belonging to his wife should be treated
as the property of the wife by the application of the above doctrine. Answering the
question in the negative, the court held that when the construction was effected with the
consent of wife, the husband upon divorce was entitled to remove the materials if the wife
was not prepared to give compensation for the same. Thus, the husband was the owner of the
superstructure. Similarly, a contractor is the owner of the superstructure and of the
materials used in its construction, till he hands it over to the contractee. In another
case, Saiffuddin v. CIT a person purchased a
land and the expenses for the construction of superstructure were paid by him and his two
brothers. There was no written agreement regarding the construction, no mutation, nor was
a sale deed executed in favor of his brother. The Rajasthan High Court held that income
from such property assessable in the hands of each should be at the rate of one-third. The
court, therefore, recognised each as the owner of income and so the property to the extent
of one-third in the absence of a conveyance deed. The import of this decision appears to
be this: If a person constructs a building on the land of another with the consent of that
another without there being any registered document conveying transfer of any interest in
the land in favour of that person, the person is still the owner of the superstructure.
Similarly, the contractor who undertakes construction on the land of some person with the
latter's consent and approval and to hand over to him the building after its construction
is complete, the contractor would still be the owner of the building as the material used
therein belongs to him. In that situation, if the terms of agreement between the
contractor and contractee holds the former as the owner of the materials or for that
matter the building, transfer of building takes place when it is handed over to the
contractee.
74.1-4 Hire-purchase transaction, whether sale - In a
contract of sale the seller transfers or agrees to transfer the property to the buyer for
a price. Hire-purchase agreement is a contract for the hire of an asset which contains a
provision giving the biter an option to acquire legal title to the asset upon the
fulfillment of certain conditions stated in the contract. It is the nature of a contract
of bailment with an element of sale added to it. A hire-purchase agreement has two
elements: (1) element of bailment, and (2) element of sale, in the sense that it
contemplates an eventual sale. The element of sale fructifies when the option is exercised
by the intending purchaser after fulfilling the terms of agreement. When all the terms of
the agreement are satisfied and the option is exercised a sale takes place of the goods
which till then have been hired. In a sale where
price is payable by instalments, property nonetheless passes on the date of the contract,
while in a hire-purchase agreement it passes when the option is finally exercised by the
intending purchaser after complying with all the terms of the agreement.
The Allahabad High Court in Shyam Kumar Verma v. S.P. Misra held that the test to know if an agreement is by way of hire-purchase
agreement is whether the hirer has an option to terminate the bailment at any time he
likes, and secondly, whether, on default of any payment by the biter, the owner of the
article has reserved . the right to terminate the agreement and to resume the possession
of the article. It is only when either of the elements is present, the agreement can be
taken as a hire-purchase agreement. According to Halsbury's Laws of England, the term
‘hire-purchase’ properly applies only to contracts of hire conferring an option
to purchase, but it is often used to describe contracts which are in reality agreements to
purchase chattels by instalments, subject to a condition that the property in them is not
to pass until the instalments have been paid.
The hire-purchase contract predetermines the total amount payable by the
hire-cum-purchaser which exceeds the original price of the asset by an amount which may be
called hire .charges. If on entering into a hire-purchase agreement a clear distinction is
made between the price for which the asset is sold and the hire charges which are' payable
only if the price for the asset is not paid at the time of the transfer of property, then
it would be arguable that the hire charges should not be regarded as a part of the price
of the asset. This argument would gather force if an option were to be given to the
hirer-cum-purchaser to pay the full price of the asset without hire charges at the time of
the transfer of the goods or to exempt from paying the proportionate hire charges if
before the expiry of the hire-purchase period he were to pay the full price. The hire
charges are for the actual period of delay in paying the full price, but they should not
be payable when he exercises the option earlier than the whole stipulated period of the
hire-purchase contract. On the other hand, if the whole of the amount payable by the
hire-purchaser is consolidated and instalments are made payable without giving any right
to the hirer-cum-purchaser to buy the asset at the original price without paying the hire
charges or earlier than the expiry of the whole period of the hire-purchase after paying
the proportionate hire charges for that part of the hire-purchase period which is vet to
expire, then no distinction can be made. between the price and the hire charges because
the whole of the amount is the consideration. for the hire-purchase and hence for the
transfer of the goods in hire-purchase.
The hire-purchase consideration has to be split up into two parts, namely, the. amount
paid as consideration for the use of the asset so long as it is the property of the owner
and the payment for the option on a future date to purchase the asset at a nominal price.
The former would represent the hire charges and the latter sale price. To sum up, whether
a transaction is an outright sale on deferred payment or is a hire-purchase, depends on
the terms of the agreement governing the transaction. In case it is the former, sale is
said to be complete. when the vendee has secured the possession of goods, and in the
latter when the hirer-cum-purchaser has paid all the instalments. The consideration agreed
upon in the former case represents sale proceeds and in the latter case it is to be paid
in instalments which consists of the price of the goods and the hire charges. An exercise
has, therefore, to be made to find out how much amount represents price and how much hire
charges, depending on facts of each case. The amount which is referable to price is sale
proceeds.
74.1-5 Leasing transaction, whether sale - A lease is a
contract between a lessor and lessee for the hire of a specific asset. The lessor retains
the ownership of the asset but conveys the right to use it to the lessee for an agreed
period of time in return for the payment of specified rentals. A lease consists of a right
to the possession and-use of the property owned by some other person. It is an outcome of
the separation of ownership and possession. Thus,
the basic characteristic of the concept of leasing is the divorce between 'ownership' and
'use' of the. asset.
A finance lease is a lease that transfers substance all the risks and rewards incident to
ownership of an asset. Title may or may not pass. Finance lease normally cannot be
cancelled. It ensures the lessor the recovery of his capital outlay plus a return for the
funds invested by him. If the lease does not transfer substantially all the risks and
rewards of ownership (other than legal rifle) to the lessee, the lease is not a finance
lease but an operating lease. Under an operating lease, the risks and rewards incident to
ownership of an asset remain with the lessor. Therefore, the asset is treated by the
lessor as a depreciable asset and the rental receivable are included in income over the
lease period. A manufacturer or dealer lessor does not recognise any selling profit on
entering into an operating ]ease because it is not equivalent to sale. The finance lease
has characteristics of a hire-purchase contract and should be treated similarly. Under the
finance lease rights of possession and enjoyment are transferred to the lessee and only
the formality of transferring the legal ownership remains to be completed on the expiry of
the lease period. The rentals receivable are usually treated by the lessor as repayments
of principal and finance income to reimburse and reward for his investment. The total
amount receivable over the period of lease might represent the sale price as in
hire-purchase contract similar to the one in the case of CIT v. Madras Autorickshaw Drivers Co-operative Society Ltd. or in the case of
Sundararn Finance Ltd. v. State of Kerala.
In the case of hire-purchase contract, the Indian Supreme Court in KL
Johar & Co. v. Dy. CT held that the sales tax authorities may
split up the hire in two parts, namely, the amount paid as consideration for the use of
the asset so long as it was the property of the owner, and the payment for the option on a
future date to purchase the asset at a nominal price. If the first part is determined the
rest would be towards the payment of price. The first may be determined after finding out
the proper amount to be paid as hire in the market for the asset of the type concerned, or
in such other manner as may be available with the authorities. The second method may be to
take the original price fixed in the hire-purchase agreement and to calculate the
depreciation and all other factors that may be relevant in arriving at the price when the
second sale takes place to the hirer, including the condition of the asset at the time of
second sale. Similarly, in the case of finance lease, the lease has to be split into two
parts; namely, (a) the amount representing the fair value of the asset (that is price at
which an asset could be sold or exchanged in the open market between a willing purchaser
and willing seller) at the inception of the lease, which would represent its sale price;
and (b) amount reflecting periodic rate of return on lessor's net cash investment in the
lease in each period. However, through a fiction of law the entire amount of lease rentals
is deemed to be income of the lessor as per section 12(19) of the Income Tax Ordinance,
1979 which read as under;
"Sec. 12(19) Where an assessee, being a scheduled bank, a financial
institution, or such modaraba or leasing company as is approved by the Central Board of
Revenue for the purposes of the Third Schedule, has leased out, on or after the first day
of July, 1985, any asset, whether owned by it or not, to another person, any amount paid
or payable by the said person in connection with the lease of the said asset shall be
deemed to be the income of the said assessee."
74.2 Lease - A lease of a property is a transfer of a right to
enjoy such property made for a certain time, express or implied, or in perpetuity, in
consideration for a price paid or promised, or of money, a share of crops, service or any
other thing of value, to be rendered periodically or On specified occasions to the
transferor by transferee who accepts the transfer on such terms [section 105 of the
Transfer of Property Act]. A lease consists of a right to the possession and use of the
property owned' by some other person. It is' an outcome of the separation of ownership and
possession. Lessor of land is one who owns and possesses it, but has transferred the
possession to another. But mere occupation is
not a possession although every physical possession is occupation. Possession is a legal
concept and one of the ingredients which is essential to it is the specification of actual
period of time when act of possession as possession commences and not merely as an act of occupation. A lease is not a mere
contract but it is a transfer of interest in land and creates a right in rem. Even in case
where a lease in perpetuity is granted interest still remains in the lessor which is
called reversion. 'The stipulation relating to renewal could not be regarded as
transferring property or any right therein.
Normally, a mere right to renew a lease does not create a contract between the
parties, whether such right is burdened with conditions or not. It is only when the said
right is exercised by the lessee that a contract is created' between the parties resulting
in interest in the property. A lease is
heritable and transferable. If the lease is for a fixed period with one option to renewal
whether of the tenant or the lessor, it does not affect the duration of the term, the
reason being that the option until exercised creates no interest in the leased property.
In case, however, a lessee continues possessing the property after determination of the
lease, with the lessor's consent, the tenant is said to be a tenant holding over. When the
tenant continues without the consent of the landlord, he is called tenant by sufferance.
The assent may be expressed by acceptance of rent by the lessor or otherwise assenting to
his possession. If there is no evidence to show that the lessor tried to evict the tenant,
who had continued the peaceful possession and enjoyment of the properties all along, such
an act may lead one to infer that the lease is for a period longer than what it is made to
appear.
74.2-1 Lease and licence - There is a marked distinction
between lease and licence. The following propositions may be taken well established:
- To ascertain whether a document creates a licence or lease, the substance of the
document must be preferred to the form.
- The real test is the intention of the parties whether they intend to create a lease or
licence.
- If the document creates an interest in the property, it is a lease; but if it only
permits other to make use of the property on which the legal possession continues with the
owner, it is licence.
- If under a document a party gains exclusive possession of the property, prima facie, he
is considered to be a tenant; but circumstances may be established which negative the
intention to create a lease.
