HIRE PURCHASE

Definition
“It is defined as a contractual agreement in
which the owner gives his goods on hire to the
hirer and gives the option to the hirer to
purchase the goods as per the terms of the
contract”
• According to hire purchase act of 1972.An
agreement under which goods are let on hire
under which the hirer has an option to purchase
them in accordance with the terms of agreement
and include an agreement under which;
1. Possession of goods is delivered by the owner
thereof to a person on the condition that such
person pays the amount in periodic payments
2. The Ownership of the goods is to pass to such a
person on the payment of the last installment.
3. Such a person has a right to terminate the
agreement any time before the property so
passes.
 Salient features of Hire-Purchase System
1. Hire-Purchase System is governed by Hire-
Purchase Act 1972
2. It is an agreement of hiring
3. It is an agreement between Hirer and Hire
Vendor
4. Terms and conditions between the parties are
entered and recorded in a document called Hire-
Purchase Agreement.
5. Cash price of goods is paid in installment on
agreed terms.
6. Goods (possession) is transferred immediately
after getting down payment
7. The title (ownership) to goods passes on last
payment
8. The Hire Vendor (Seller) can take possession of
goods if Hirer fails to pay installment and treat
paid amount as hire charged
9. Installment include interest and principal amount
10. Vendor charges interest on flat (constant) rate
11. The Hirer is not responsible for risk of loss of
goods, till the ownership is transferred.
12. The Hirer cannot mortgage, hire or sell or
pledge the goods
13. The Hirer has got a right to terminate the
agreement at any time before the property so
passes.
 Advantages
1. Facility of buying
People with small income can buy expensive articles such
as car, house, furniture, etc. They can make payment
in easy installments and thereby improve their
standard of living. The buyer can return the goods if
he is not satisfied with their quality or is unable to pay
further installments.
2. Easy Possession
Buyer get the possession of goods immediately after
giving the down payment
3. Thrift and savings
Hire purchase system encourages people to reduce
expenses and save money to pay installments at
regular intervals.
4. Higher sales
Hire purchase system helps to widen market for
costly goods. People who cannot buy such goods
otherwise are tempted to purchase them on
installments. The seller can take back the goods
if buyer makes default in payment.
5. Boon to small producers
Small scale units and farmers can buy machinery
and equipment and pay installments out of
earnings.
6. Growth of Economy
By increase in sales, leads to increase it.
 Disadvantages
1. Extravagance: (Lavishness)
Hire purchase system induces middle class people to buy
luxury goods which they cannot otherwise afford. They
are tempted to pledge their future income. They may
not be able to pay installments in time. They suffer
heavy loss when the seller takes back the goods on
default of payment.
2. Higher prices:
The buyer has to pay much higher prices than that payable
on cash purchase. The seller adds a margin to cover
interest and risk. The seller may pass on goods of
doubtful quality by offering easy credit terms. The
buyer does not get ownership of goods until last
installment paid. He cannot sell the goods before final
payment.
3. Risk of bad debts:
When the buyer fails to pay installments, the seller
may suffer loss. He may have to spend money and
time to recover goods from the buyer. There is
risk of loss of goods lying with the buyer.
4. Large investment:
The hire purchase seller has to invest large funds
because payments are received from buyers over a
long period of time.
Difference between Leasing and Hire Purchasing
1. Ownership of the Asset: In lease, ownership lies
with the lessor. The lessee has the right to use the
equipment and does not have an option to
purchase.
Whereas in hire purchase, the hirer has the option to
purchase. The hirer becomes the owner of the
asset/equipment immediately after the last
installment is paid.
2. Depreciation: In lease financing, the depreciation
is claimed as an expense in the books of lessor.
On the other hand, the depreciation claim is allowed
to the hirer in case of hire purchase transaction.
3. Rental Payments: The lease rentals cover the
cost of using an asset. Normally, it is derived
with the cost of an asset over the asset life.
In case of hire purchase, installment is inclusive
of the principal amount and the interest for
the time period the asset is utilized.
4. Duration: Generally lease agreements are
done for longer duration and for bigger assets
like land, property etc.
Hire Purchase agreements are done mostly for
shorter duration and cheaper assets like hiring
a car, machinery etc.
5. Tax Impact: In lease agreement, the total
lease rentals are shown as expenditure by the
lessee.
In hire purchase, the hirer claims the
depreciation of asset as an expense.
6. Repairs and Maintenance: Repairs and
maintenance of the asset in financial lease is
the responsibility of the lessee but in
operating lease, it is the responsibility of the
lessor.
In hire purchase, the responsibility lies with the
hirer.
7. Down pyment: In Lease financing no down
payments are required
but in case of hire purchase, the normally 20 to
25 % money is required to be paid as down
payment
8. Capiatlization:
Leasing-Done in the books of lessor
Hire purchasing-done in the books of hirer
9. Benefit of Salvage Value:
leasing:- no one can claim it
Hire purchasing-hirer can claim
10.Nature of asset:
Leasing-considered as fixed asset of the lessor
Hire- vendor considered as stock in trade or as
receivables
11. Income:
Leasing-rentals changing periodically
Hire-installment amount equal
 The Hirer's Rights
1. To buy the goods at any time by giving notice to
the owner and paying the balance of the HP price
2. To return the goods to the owner — this is
subject to the payment of a penalty to reflect the
owner's loss of profit
3. With the consent of the owner, to assign both the
benefit and the burden of the contract to a third
person. The owner cannot unreasonably refuse
consent where the nominated third party has
good credit rating
4. Where the owner wrongfully repossesses the
goods, the hirer can either to recover the goods
plus damages for loss of quiet possession
 The Hirer's Obligations
1. To pay the hire installments
2. To take reasonable care of the goods (if the
hirer damages the goods by using them in a
non-standard way, he or she must continue to
pay the installments and, if appropriate,
compensate the owner for any loss in asset
value)
3. To inform the owner where the goods will be
kept.
4. A hirer can sell the products if, and only if, he
has purchased the goods finally or else not to
any other third party.
 The Owner's Rights
The owner usually has the right to terminate the
agreement where the hirer defaults in paying the
installments or breaches any of the other terms in
the agreement.
1. This entitles the owner to forfeit the deposit
2. To retain the installments already paid and
recover the balance due
3. To repossess the goods (which may have to be by
application to a Court depending on the nature of
the goods and the percentage of the total price
paid)
4. To claim damages for any loss suffered.
 Legal Frame Work
Follow Hire purchase Act 1972; provisions of
the Act contains;
I. Contents or format of the hire purchase
agreement
II. Warrants and conditions
III. Ceiling (top limit) on hire purchase charges
IV. Rights and obligations of the hirer and the
owner
Also Follow Indian contract Act and sale of
goods act
 I. Contents of Hire purchase agreement
1. Nature of Agreement:
Stating the nature, term and commencement of the
agreement.
2. Delivery of Equipment:
The place and time of delivery and the hirer’s
liability to bear delivery charges.
3. Location:
The place where the equipment shall be kept during
the period of hire.
4. Inspection:
That the hirer has examined the equipment and is
satisfied with it.
5. Repairs:
The hirer to obtain at his cost, insurance on the
equipment and to hand over the insurance policies
to the owner.
6. Alteration:
The hirer not to make any alterations, additions and
so on to the equipment, without prior consent of
the owner.
7. Termination:
The events or acts of hirer that would constitute a
default eligible to terminate the agreement.
8. Risk:
Risk of loss and damages to be borne by the hirer.
9. Registration and fees:
The hirer to comply with the relevant laws, obtain
registration and bear all requisite fees.
10. Indemnity clause:
The clause as per Contract Act, to indemnify the
vender.
11. Stamp duty:
Clause specifying the stamp duty liability to be
borne by the hirer.
12. Schedule:
Schedule of equipments forming subject matter
of agreement.
13. Schedule of hire charges.
The agreement is usually accompanied by a
promissory note
Signed by the hirer for the full amount payable
under the agreement including the interest and
finance charges.
 II. Warrants and conditions
1. The hirer will be enjoy quiet possession of
goods, no one interfere
2. Owner will be able to pass ownership, when
contract requires
3. Goods are in quality and fit
4. Supply of goods with description and sample
Taxation Aspects
The taxation aspects of hire purchase transaction
can be divided into three parts (a) Income Tax, (b)
Sales Tax and (c) Interest Tax.
1. 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 Hire vendor or
financer:
The consideration for hire/hire charges / income
received by the hire vendor 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.
2. 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:
a. Hire purchase as Sale: Hire purchase, though
not sale in the true sense, is deemed to be sale.
Such transactions as per sales tax are liable to
sales tax. Full tax is payable irrespective of
whether the owner gets the full price of the
goods or not.
b. 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
c. Rate of tax: The rate of sales tax on hire
purchase deals vary from state to state. 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.
3. 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 %. The
interest tax is treated as a tax deductible
expense for the purpose of computing the
taxable income under the Income Tax.