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Introduction to hire purchase

Meaning and definition



Importance of hire purchase

Legal position/aspects

Banks & hire purchase business

Banks credit business

How is business going of the hire purchase outside India


Hire purchase v/s installment credit system

Case study

Hire purchase is a mode of financing the price of the goods
to be sold on a future date. In a hire purchase transaction,
the goods are let on hire, the purchase price is to be paid in
installments and hirer is allowed an option to purchase the
goods by paying all the installments. Hire purchase is a
method of selling goods. In a hire purchase transaction the
goods are let out on hire by a finance company (creditor) to
the hire purchase customer (hirer). The buyer is required to
pay an agreed amount in periodical installments during a
given period. The ownership of the property remains with
creditor and passes on to hirer on the payment of the last
installment. A hire purchase agreement is defined in the Hire
Purchase Act, 1972 as peculiar kind of transaction in which
the goods are let on hire with an option to the hirer to
purchase them, with the following stipulations: a. Payments
to be made in installments over a specified period. b. The
possession is delivered to the hirer at the time of entering
into the contract. c. The property in goods passes to the
hirer on payment of the last installment. d. Each installment
is treated as hire charges so that if default is made in
payment of any installment, the seller becomes entitled to


A method of buying goods through making
installment payments over time. The term
hire purchase originated in the U.K., and is
similar to what are called "rent-to-own"
arrangements in the United States. Under a
hire purchase contract, the buyer is leasing
the goods and does not obtain ownership
until the full amount of the contract is paid.


(1) Convenience in Payment:
The buyer is greatly benefited as he has to make the payment in installments. This
system is greatly advantageous to the people having limited income.
(2) Increased Volume Of Sales:
This system attracts more customers as the payment is to be made in easy
installments. This leads to increased volume of sales.
(3) Increased Profits:
Large volume of sales ensures increased profits to the seller.
(4) Encourages Savings:
It encourages thrift among the buyers who are forced to save some portion of their
income for the payment of the installments. This inculcates the habit to save among
the people.
(5) Helpful For Small Traders:
This system is a blessing for the small manufacturers and traders. They can
purchase machinery and other equipment on installment basis and in turn sell to the
buyer charging full price.
(6) Earning Of Interest:
The seller gets the installment which includes original price and interest. The
interest is calculated in advance and added in total installments to be paid by the
(7) Lesser Risk:
From the point of view of seller this system is greatly beneficial as he knows that if
the buyer fails to pay one installment, he can get the article back.

Disadvantages of hire

1) Higher Price:
A buyer has to pay higher price for the article purchased which includes cost plus
interest. The rate of interest is quite high.
(2) Artificial Demand:
Hire purchase system creates artificial demand for the product. The buyer is
tempted to purchase the products, even if he does not need or afford to buy the
(3) Heavy Risk:
The seller runs a heavy risk under such system, though he has the right to take
back the articles from the defaulting customers. The second hand goods fetch little
(4) Difficulties in Recovery of Installments:
It has been observed that the sellers do not get the installments from the
purchasers on time. They may choose wrong buyers which may put them in trouble.
They have to waste time and incur extra expenditure for the recovery of the
installments. This sometimes led to serious conflicts between the buyers and the
(5) Break Up Of Families:
The system puts a great financial burden on the families which cannot afford to buy
costly and luxurious items. Recent studies in western countries have revealed that
thousands of happy homes and families have been broken by hire purchase

Under hire purchase system, the buyer takes possession of
goods immediately and agrees to pay the total hire purchase
Each installment is treated as hire charges.
The ownership of the goods passes from the seller to the
buyer on the payment of the last installment.
In case the buyer makes any default in the payment of any
installment the seller has right to repossess the goods from
the buyer and forfeit the amount already received treating it
as hire charges.
The hirer has the right to terminate the agreement any time
before the property passes. That is, he has the option to return
the goods in which case he need not pay installments falling
due thereafter. However, he cannot recover the sums already
paid as such sums legally represent hire charges on the goods
in question. price in installments.


A Hire-Purchase transaction in which the goods are let out on hire with the option to the hirer to purchase
them, with following stipulations: A. Payment to be made in instalment over a specified period.
B. The possession is delivered to the hirer at the time of entering into the contract;

C. The property in the goods passes to the hirer on payment of the last instalment;

D. Each instalment is treated as hire charges so that if default is made in payment of any instalment, the
seller becomes entitled to take away the goods; and
E. The hirer is free to return the goods without being required to pay any further instalments falling due
after the return.

Aspects of hire purchase agreement A hire-purchase agreement has two aspects: Firstly, an aspect of
bailment of goods subject to hire-purchase agreement, and secondly, an element of sale which fructifies
when the option to purchase is exercised by the intending purchaser. Though the option to purchase is
allowed in the beginning, it can be exercised only at the end of the agreement.

Instalment Sale & its Payment In an Instalment sale, the contract of sale is entered into, the goods are
delivered and the ownership is transferred to the buyer but the price of the goods is paid in specified
instalments over a definite period. In instalment sale the ownership in the goods passed on to the
purchaser simultaneously with the payment of the initial/first instalment.

Aspects of ownership & depreciation The ownership of the asset passes on the user (hirer) in case of
hire-purchase finance on the payment of the last instalment. However, before the payment of the last
instalment, the ownership of the asset vests in the finance company/intermediary (seller). Hirer is entitled
to take the availing of benefit of depreciation.

Size of cost of acquisition, and margin money Usually the cost of acquisition under hirepurchase is not of
very high value. In a hire-purchase transaction a margin money equal to 20 to 25 per cent of the cost of
the asset is required to be paid by the hirer.

Legal Framework

There is no exclusive legislation dealing with hire purchase

transactions in India.

The Hire-Purchase Act was passed in 1972. A bill was introduced in

1989 to amend some of the provisions of the Act.
However, the Act has not been enforced so far. In the absence of any
specific law, the hire-purchase transactions are governed by the
general laws. The hire-purchase transaction has to aspects: (i) an
aspect of bailment of goods

which is covered by the Indian Contract Act, (ii) an element of sale

when the option to purchase is exercised by the hirer which is
covered by the Indian Sales of Goods Act.
The hire-purchase agreements also contain provisions for the
regulation of hire-purchase deals.

Taxation Aspects
There are three aspects of taxation of hire-purchase deals: (i) income-tax, (ii) sales tax and, (iii)
interest tax.
Though the hirer is not the owner of the asset, he is entitled to claim depreciation as a deduction
on the entire purchase price.
He can also claim deduction on account of consideration for hire, that is, finance charge.
The amount of finance charge to be deducted each year is to be spread evenly over the term of
the agreement on the basis of a method chosen from amongst the alternatives: SOYD, ERI, SLM.

The consideration is viewed as a rental charge rather than interest and no deduction of tax at
source is made.
The hire-purchase transaction can be used as a tax planning device in two ways: (i) by inflating
the net income (finance income interest on borrowings by the finance company) at the rearend of the deal and (ii) by using hire-purchase as a bridge between the lessor and the lessee, that
is, introduction of an sales, are liable to sales tax.

However, hire-purchase transaction structured by finance companies (which are not hirevendors), being essentially a financing arrangement, do not attract sales tax.
An interest tax has to be paid on the interest earned less bad debts. The tax is treated as a taxdeductible expense for the purpose of computing the taxable income under the Income-Tax Act.




How is business going of hire purchase

outside india

Difference between
Hire purchase system

Installment credit

Nature Of Contract

It is anagreement of sale.

Ownership of thegoods passes to the

buyer just signing theagreement.

The buyer can sell, destroy or mortgage

or transfer as his/her wish.

Hire PurchaseSystem:It is a

Hire PurchaseSystem:Ownership ofgoodsis

transferred afterthe paymentof
Hire PurchaseSystem:The buyer can not
sell, destroy or transfer thegoods.
Hire PurchaseSystem:All the risks are borne
by the vendor beforethe paymentof
Right Of Return
Hire PurchaseSystem:The buyer can return
thegoodsbefore making the finalin
Repair And Maintenance
Hire PurchaseSystem:The liability ofrepair
and maintenancelies with the seller
provided that the buyer takes the utmost
good care.
Forfeiture OfInstallmentPaid
Hire PurchaseSystem:In case of default in
payment ofinstallment, paidinstallmentwill
be forfeited and treated ashirecharges.

All the risks are to be borne by the buyer

from the date ofagreement.

The buyer can not return thegoodsto

the seller.

The buyer is responsible forrepair and


The act of forfeiture can not be



Case study