Three Tax Positions in One Board Note: GST on Leasing, TDS Characterisation and the 115BAA Election
IRFC's tax team is finalising the FY 2025-26 position. The company has leased rolling stock to Indian Railways on a finance-lease basis; the annual lease rental is ₹1,020 crore plus GST at 18%. The lessee deducts tax at source under section 194I at 2%, treating the whole rental as rent for plant and machinery. IRFC's consultants argue that in substance the rentals are debt servicing and that TDS should instead be under section 194A at 10% on the interest component, which they estimate at 72% of the rental. Separately, the CFO must choose between the normal regime and section 115BAA (22%) for the next five years. Profit before tax is expected to be ₹4,000 crore, available deductions are ₹250 crore, and unutilised MAT credit is ₹600 crore. The company also pays ₹95 crore of GST on common input services, while earning interest income of ₹3,200 crore on loans classified as exempt.
1. Confirm the GST treatment of the lease rentals and compute the input tax credit that IRFC can actually retain for the year.
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Character of the supply. Leasing of rolling stock is a supply of service under SAC 9973 (leasing or rental of other machinery and equipment) at 18%, in the forward charge - the lessee does not discharge GST under reverse charge for this supply. Where the wagons are located in a state different from IRFC's registration state, IGST applies. The full rental, not merely the interest element, is the value of supply; the label 'finance lease' does not convert it into an exempt financial service.
Watch the boundary. If the contract transfers title at the end for a nominal consideration, the transaction may be characterised in substance as a supply of goods, and rolling stock attracts a lower rate under the goods tariff. The agreement wording determines this: confirm whether title passes, and document the conclusion in a tax position paper.
ITC computation (Rule 42/43). IRFC has both taxable turnover (lease rentals ₹1,020 crore) and exempt turnover (interest income ₹3,200 crore). Interest on loans is exempt under Entry 27 of Notification 12/2017, so common input tax credit must be apportioned.
- Total turnover = 1,020 + 3,200 = ₹4,220 crore.
- Exempt proportion = 3,200 ÷ 4,220 = 75.8%.
- Reversal = 95 × 0.758 = ₹72.0 crore.
- Retained ITC = 95 − 72.0 = ₹23.0 crore.
Practical point. Input credit on inputs exclusively used for the taxable leasing activity (for example, custody or advisory fees on the lease book) is fully available without apportionment; only common credits are reversed. Reconcile GSTR-2B, the credit ledger and the Rule 42 working quarterly - a mismatch is a routine audit observation.
2. Advise on the TDS characterisation (194I at 2% versus 194A at 10%) and quantify the cash-flow difference.
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The tests. Section 194I applies to 'rent', defined to include any payment under a lease, sub-lease or tenancy for the use of land, building, plant or machinery. Section 194A applies to interest other than interest on securities. The characterisation therefore turns on whether the payer has obtained use of an asset (rent) or has borrowed money (interest).
194I route. TDS = 2% × ₹1,020 crore = ₹20.4 crore a year. This is the position the lessee has adopted.
194A route. Interest component = 72% × ₹1,020 crore = ₹734.4 crore. TDS = 10% × 734.4 = ₹73.4 crore a year.
Cash-flow gap. ₹53.0 crore a year is locked in TDS until IRFC claims a refund or sets it off against its advance tax. For a leveraged NBFC, that is a real working-capital cost - roughly ₹4 crore a year at an 8% funding cost.
Judgement. A finance lease does not automatically become a loan for TDS purposes. Where the lessee is the economic owner, claims depreciation and the rentals are demonstrably a repayment of principal plus interest, the interest element is properly 194A. Initiate either an advance ruling under section 245 or a written confirmation from the lessee, and align the TDS position with the accounting and income-tax treatment. Until that is resolved, keep the 194I deduction (lower cash outflow, consistent with the current Form 26AS) and disclose the exposure. Do not allow the two parties to take inconsistent positions - that is what triggers a 201(1) default notice.
3. Should IRFC elect section 115BAA? Support the answer with a five-year comparison.
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Normal regime (year 1). Taxable income = 4,000 − 250 = ₹3,750 crore.
- Tax at 30% = ₹1,125 crore
- Surcharge at 12% (income above ₹10 crore) = ₹135 crore; subtotal ₹1,260 crore
- Cess at 4% = ₹50.4 crore; total ₹1,310.4 crore
- Less MAT credit utilised (₹600 crore available): net cash tax = ₹710.4 crore in year 1.
Section 115BAA (year 1). Tax at 22% × 4,000 = ₹880 crore; surcharge at 10% = ₹88 crore; subtotal ₹968 crore; cess at 4% = ₹38.72 crore; total ₹1,006.72 crore. No MAT credit, no deductions.
Break-even. Annual saving = 1,310.4 − 1,006.72 = ₹303.68 crore. The ₹600 crore MAT credit is exhausted in 600 ÷ 303.68 ≈ 2 years.
Five-year view. Normal regime = 5 × 1,310.4 − 600 = ₹5,952 crore. 115BAA = 5 × 1,006.72 = ₹5,033.6 crore. 115BAA saves about ₹918 crore over five years, and the margin widens thereafter because there is no further MAT credit to burn.
Risks to flag. The 115BAA option is irrevocable, forfeits the MAT credit balance, and disallows the ₹250 crore of deductions permanently. It also bars additional depreciation. If a large deduction (for example, a bad-debt allowance or a specific exemption) is expected in the near term, the arithmetic changes. On the facts given, and with stable profitability, elect 115BAA; record the irrevocability and the forfeiture of MAT credit in the board note.