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C. Shivkumar

The banks aim to use depreciation on the lease assets as a tax shield. The primary leasing market is virtually dead as a result of the liquidity overhang.

BANGALORE, Jan. 18

MANY public sector banks have pitched for taking out the lease assets of Indian Railway Finance Corporation (IRFC), the lease financing arm of the Ministry of Railways.

Taking out IRFC assets is identical to securitisation of lease receivables. In the process, the asset ownership would pass on to the public sector banks, along with the attendant benefit of depreciation shelter. The lease rental payments would also accrue to the banks instead of IRFC.

Banking sources said that the banks' objective was to use the depreciation on the lease assets as a tax shield. The approach was being pushed forward since the primary leasing market is virtually dead as a result of the liquidity overhang. Besides, almost all the banks, including some of the laggards, are expected to be in the black during the current fiscal. The large profits of the banks are expected to translate into an escalation in corporate tax liabilities. Corporate income tax on profits currently stands at 30 per cent.

The sources said that none of the banks have a tax shelter against this large tax liability. In the past, this shelter was available by way of depreciation provisions, especially on securities marked-to-market and available for sale categories.

This year, this shelter will not be available because the yield-to-maturity benchmark for securities valuation is likely to be fixed in the 7.8-8 per cent range. Besides, the sources said, the Central Board of Direct Taxes (CBDT) had so far not been very responsive on tax exemption for creation of reserve out of the profits earned from value appreciation of securities.

The banks had approached the CBDT in this regard after last week's notification by RBI for the creation of an investment fluctuation reserve (IFR). According to the sources, given the CBDT's reluctance to provide any exemption on the IFR, the best course of action was to take out some of the lease assets of IRFC.

IRFC currently has more lease portfolio than is required for its tax shelter. Besides, taking out lease assets of IRFC would also obviate the need for IRFC to borrow from the bond markets, they added. IRFC's lease assets comprise mostly rolling stock - locomotives and wagons. On these assets, the depreciation available is 25 per cent on a written-down value basis. The sources said that the critical issue for such transactions would be valuation. Year-end valuation of lease assets tends to be high in view of the tax hedging potential. Besides, some of IRFC's assets have internal rates of return of about 10.5 per cent, with a residual tenor of at least five years. Currently, yield-to-maturity (YTM) on five-year securities is about 7.2 per cent.

Consequently, IRFC is expected to push for the lowest discounting rates based on the current market yields. Such a valuation would translate into hefty premium pricing for the banks intending to take out the lease assets.

However, the sources said, despite the hefty premium, the resultant tax savings would bring down the weighted average cost of working funds for the banks through greater retention of funds. This, in turn, would impact future profits.

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