It has been two years since GST implementation but it seems that the industry needs clarity on various contentious issues to avoid litigation in the future. The Government has introduced a mechanism of Advance Ruling under GST law to provide facility to the tax payers where they can approach the tax authorities in advance to get the certainty regarding taxability of any transactions to be under taken by them. However it has been observed that rulings pronounced by Authority of Advance Ruling (AAR) are generally pro revenue which has created a dilemma before tax payers and advisors in opting for advance ruling under GST. Further the government is issuing large number of circulars to clarify the various issues arising out of poorly drafted GST law and contradictory Rulings by AAR. One of such issue is implication of GST on penal interest charges and late fees collected by the NBFCs and Banks from the borrower on account of delay in payment of equated monthly instalments (EMI). In this regards it is important to refer to the ruling of AAR Maharashtra in case of Bajaj Finance Ltd wherein it has been pronounced that the amount of penal interest collected from borrower on default of monthly instalments of loan is a service of tolerating an act of default and thus liable to GST. Recently the Central Board of Indirect tax And Customs (‘CBIC’) has come up with a circular on “Clarification regarding applicability of GST on additional / penal interest” on 28th June, 2019 to address the issue. The purpose of this article is to analyze the said clarification dated 28th June 2019 issued by the CBIC in light of the provisions of Central Goods And Services Act, 2017 (‘CGST Act’) and further it intends to analyze whether the circular has put an end to the anomaly created by the AAR.
♣ It is regular business practice to recover interest or some charges penal in nature for recovery of dues from the customer. This article covers GST implication on following type of transactions viz.,
a) Recovery of penal interest by NBFCs, Banks and other lenders from the borrower on account of default in payments of due instalments of loan.
b) Recovery of interest from customer on account of delay in making payment for the supplies of goods and services. Further the implication of GST if supplier also collects charges such as LC usance charges, discounting charges and interest on overdue hundies to extend the credit period beyond the regular credit period generally offered to the Customer.
3. LEGAL POSITION AND ANALYSIS
- In light of the issue in hand it is important to refer to the provisions of Section 15(2)(d) of the CGST Act which provides that the penal interest shall be included in the value of supply. Section 15(2)(d) of the CGST Act reads as under:
“value of supply includes “interest or late fee or penalty for delayed payment of any consideration for any supply.”
- In view of the above, any interest or penalty paid for delayed payment in the supply of goods or service or a loan transaction shall be included in the value of supply i.e. the consideration amount. Further any other cost incurred by the supplier for extending the credit period to the customer and if such charges are recovered from the customer, the same shall be included in the value of supply and shall be chargeable to GST.
- On a perusal of the hereinabove mentioned the provisions of Section 15(2)(d) a view may be taken that even penal interest or overdue interest (interest at higher rate) recovered by NBFCs and Bank on account of delay in payment of instalment, shall also be included in the value of supply i.e. the interest on instalments. It is important to note that services for providing loan where consideration is represented by of interest or discount is exempted from payment of GST vide notification no. 12/2017 dated 28.06.2019. It may be argued that the overdue interest or penal interest is nothing but merely a stepped up interest for the period for which the borrower has made breach of contractual terms of contract. Therefore a conclusion can be drawn that overdue interest is to be included in the value of original supply i.e. interest and will also be exempt from payment of GST.
- In reference to above it is important to refer to the recent ruling of Maharashtra AAR in case of Bajaj Finance Limited wherein it has been held that penal interest recovered from the borrower on account of delay in payment of instalments shall be classified as services and the said activity squarely falls under clause 5(e) of the Schedule II of GST Act, 201 and therefore such amounts received, would attract tax liabilities under GST. The Rationale behind the ruling is that there is service of tolerating an act of default of the borrower in lieu of default charges named as penal interest. Further FAQ on financial sector has also clarified that the additional Interest charged for default in payment of instalments in respect of any supply, which is subject to GST, will be includible in the value of such supply and therefore would be liable to GST.
- However in view of the above a contrary argument can be made that the additional interest or penal interest is nothing but a interest charged at higher rate in case of default made by the borrower and thus shall also be exempt from payment of GST. Further an argument can also be made that the penal interest cannot be considered as services of an agreeing to the obligation of tolerating an act of default by the borrower. Since there is no obligation between the parties to the contract to make default from the inception of the contract. On contrary penal interest is charged to complete the contract without any default by the borrower. Further the intention of the parties entering into the contract is to avail the services by way of loan or supply of goods. Penal charges are to be paid if there is a breach in the contract and therefore it does not mean that the parties have entered into a contract for the penal interest. Therefore penal charges does not fall under the deemed supply list given in Schedule II of the CGST Act.
- In view of the above a reference can be drawn that penal interest is also to be considered as a consideration received in respect of providing original services of extending loan or deposit and which shall be included in the value of original supply i.e. regular interest which is exempt from payment of GST.
- In response to the controversial ruling of the AAR and numerous queries, the CBIC vide Circular no 102/21/2019-GST dated 28th June 2019 has released a clarification on the matter. The circular by way of example has made a clear distinction between the implication of GST on interest including penal interest charged by a supplier of goods and services where the supplier has extended a credit facility to the buyer and the implication of GST on interest collected by a finance Company where the principal supply is supply of services of extending loan or deposit.
- It has been clarified that the interest as well as penal interest charged in relation to the supply of goods and services shall be included in the value of goods and services and will be liable to GST.
- Further it has been clarified that the additional interest or penal interest charged on the delay in payment of instalment of loan by the borrower will be covered under interest as defined under notification no. 12/2017 dated 28th June 2019. Thus the same shall be exempt from payment of GST.
- Further the above position has been explained by way of following examples in the circular:
- AMC Mart sells refrigerator to the customer XYZ having price INR 40,000/-. Further AMC Mart provides an option to XYZ to pay the amount for refrigerator under an instalment of INR 10000/- monthly over a period of 5 months. Further if XYZ make default in payment of instalment of loan then in such case an additional amount of penal charges amounting to INR 500/- pm shall also be collected from XYZ. Further AMC Mart will raise a separate invoice for recovery of interest amount as embedded in monthly instalments as well as for the amount of penal interest.
- As per the provisions of sub-clause (d) of sub-section (2) of section 15 of the CGST Act, the amount of penal interest is to be included in the value of supply. The transaction between AMC Mart and XYZ is for supply of taxable goods i.e. Refrigerator. Accordingly, the original amount of interest as well as penal interest would be taxable as it would be included in the value of the Refrigerator, irrespective of the manner of invoicing.
- If in the above case refrigerator is being sold by AMC Mart and XYZ has the option to avail the loan from AZB financers. XYZ shall repay the amount of loan in 5 monthly instalments of INR 5000 each. Further an additional amount of INR 500 as penal interest will be recovered from XYZ in case there is default in payment of due instalments.
- The additional / penal interest is charged for a transaction between XYZ and M/s AZB financers and the same is getting covered under Sl. No. 27 of notification No. 12/2017-Central Tax (Rate) dated 28.06.2017. Accordingly, in this case the ‘penal interest’ charged thereon on a transaction between XYZ and M/s AZB financers would not be subject to GST, as the same would be covered under notification No. 12/2017-Central Tax (Rate) dated 28.06.2017. The value of supply of refrigerator by AMC Mart to XYZ would be INR. 40,000/- for the purpose of levy of GST. It is also important to note that if AZB financers also collects some charges or fee form XYZ then such charges or fee for extending loan or deposit shall not be considered as interest under as defined in notification No. 12/2017- Central Tax (Rate) dated 28.06.2017, and accordingly will not be exempt.
♣ The said circular issued by the government has brought a big relief to the NBFCs charging additional or penal interest from the borrowers upon making default in payment of instalments of loan. Further the circular has nullified that ruling of AAR in case of Bajaj Finance Limited. Therefore to summarize the discussion above:
a) In cases where the supplier along with the supply goods and services has allowed a credit facility to the customer in such cases interest for extending loan as well as penal interest charged from the customer upon delay in payment of consideration for supply of goods and services shall be included in the value of supply of goods and services and shall be liable to GST. Further any other charges such as LC usance charges, discounting charges and interest on overdue hundies recovered from the customer to extend the credit period beyond the regular credit period generally offered to the Customer, shall also be included in the value of supply and shall be liable to GST.
b) In cases where the lending facility has been provided by the any finance company or bank where the principle supply is extension of loan in such cases the amount of interest for extending loan as well as penal interest for delay in payment of loan instalments shall be included in value of supply. Further such penal interest shall be covered under the definition of interest as provided under entry no. 27 of notification no. 12/2012 CTR dated 28.06.2017 and thus will be exempt from payment of GST.
Author of article CA. Ankit Karanpuria (Author Member of Team GSTCORNOR) can be reached at email@example.com and whatsapp at 8770063848