INTRODUCTION
The implementation of the Goods and Services Tax (GST) in India represented a major transformation in the country’s indirect tax framework. Taxes serve as a key revenue source for the government, supporting various public welfare programs and development initiatives, and are essential for the nation’s economic advancement. The GST, established with unanimous consent by the Parliament and formalized in the GST Bill of 2016, signifies a crucial chapter in India’s economic evolution. Its adoption has had significant effects on the functioning of industries throughout the country, particularly the banking and financial services sector. [1]
As a crucial component of the economy, the banking and financial services sector underwent considerable changes in its operations, compliance obligations, and cost structures as a result of GST. One of the most notable impacts was the rise in tax rates for banking services when compared to the pre-GST period, which could result in increased expenses for banking and financial services. The service sector, which includes banks and non-banking financial companies (NBFCs), is anticipated to face stronger effects from GST than the manufacturing or trading sectors.[2] This is attributed to the nature and scope of their operations, which encompass lease agreements, hire purchase contracts, fund-based and fee-based services, insurance, and actionable claims.
Considering the intricate range of services offered by banks and NBFCs, the implementation of GST compliance has proven to be a daunting challenge. This document investigates the primary effects of GST on the banking sector, concentrating on legal ramifications, compliance demands, and operational obstacles. The transition to GST has required a period of adjustment for the sector to conform to new taxation and compliance regulations, influencing their strategic and operational approaches.
TRANSITION FROM SERVICE TAX TO GST
Prior to GST, the tax framework for financial institutions was fragmented, with banks functioning under the service tax system at a rate of 15%. Centralized registration enabled streamlined compliance, and certain services, such as interest on loans and deposits, were exempt from taxes. However, services like commissions, brokerage, portfolio management, and credit/debit card charges were taxable. The CENVAT credit system allowed banks to offset input taxes against their liabilities, which supported their financial strategies. With the advent of GST, the tax structure underwent significant changes, introducing a consolidated framework that combined multiple state and central taxes into a standard rate of 18% for most banking services.[3] While this streamlined the tax regime, it also increased the tax burden, potentially raising the cost of banking services for consumers. For instance, transaction fees, such as those for ATM withdrawals exceeding free limits, saw a hike, increasing costs from ₹23 under the service tax regime to ₹23.60 under GST.
The compliance landscape also shifted under GST. The centralized registration system was replaced by a decentralized approach, requiring banks to register in every state where they operated, as per Section 22 of the CGST Act.[4] Although a single registration was permitted for all branches within a state, the administrative workload and complexity increased significantly for banks with nationwide operations. This transition added resource-intensive processes, impacting operational efficiency.
The input tax credit system introduced under GST further affected the financial strategies of banks. Unlike the service tax regime, which allowed the utilization of CENVAT credit with fewer restrictions, GST mandated the reversal of 50% of input tax credits on inputs, input services, and capital goods. This reduced credit availability raised capital costs for financial institutions, influencing their profitability and investment decisions.
GST’s extensive definition of “services” under Section 2(102) of the CGST Act brought additional concerns. The term encompasses everything apart from goods, raising questions about the taxation of interest income, which was previously exempt under the service tax regime. Although Schedule III of the CGST Act specifies activities that do not constitute a supply of goods or services, the lack of precise distinctions has created ambiguity, especially regarding interest taxation.
Exemptions that were available under the previous tax regime for certain banking activities have been removed under GST, further complicating compliance. For instance, inter-bank sales or purchases of foreign currency and services offered by the Reserve Bank of India (RBI) were exempt from service tax but are now taxable under GST.[5] These changes have increased compliance challenges for financial institutions.
The “place of supply” rules under GST introduced new operational complexities. Since GST operates as a destination-based tax, financial institutions must accurately determine the place of supply for each transaction to ensure proper tax payments. This requirement necessitates advanced tracking systems and modifications in IT infrastructure, increasing operational burdens and costs.[6]
Assessment and adjudication processes have also become more cumbersome under GST. Banks and non-banking financial companies (NBFCs) are now subject to assessments by state regulators based on the location of their registered branches. Each branch must substantiate its tax chargeability and justify the use of input tax credits across states. This decentralized adjudication process has led to inconsistencies, as multiple authorities can interpret the same issue differently, potentially extending the resolution timeline.[7] Addressing these discrepancies poses a significant challenge for financial institutions navigating the GST regime.
ISSUES RELATED TO REVENUE RECOGNITION UNDER GST
1. Account Linked Financial Services: The location of the recipient of services, according to the records of the service provider, determines the place of supply. In the centralized and digitized context in India, pinpointing the state where the service recipient is located can be quite challenging. This is especially true in situations where service recipients, such as professionals, manufacturers, traders, and other workers, frequently move in search of better prospects, leading the service provider to have various addresses like a permanent address, current address, communication address, and KYC address.[8]
2. Non-Account Linked Financial Services: In this case, the place of supply of service would be the location of the service provider. This can adversely affect companies that have a widespread presence in remote areas but transact from a back office situated in a different state.
3. Actionable Claims: Under the current regime, actionable claims are not recognized as a service under Service Tax, and consequently, no tax is levied. However, under GST, actionable claims are now considered part of the supply of goods. Services related to bills discounted to securitization will now face taxation as both B2C and B2B transactions primarily.[9]
BENEFITS TO BANKING INDUSTRY:
The implementation of GST brought several advantages to the banking and financial services sector, fundamentally altering their approach to taxation and compliance:
i. Enhanced Input Tax Credit Utilization: One of the key advantages of the GST framework is that banks can now balance their GST obligations with the credits obtained from purchasing goods and services.[10] This represents a significant shift from the previous service tax system, where banks faced limitations in claiming input tax credits, particularly concerning state VAT.
ii. Broader Scope for Tax Credits: In the past, banks were unable to claim input tax credits for the state VAT incurred on purchased goods. With the implementation of GST, which consolidates indirect taxes, banks are now able to claim credits on GST paid during procurement, thereby alleviating their overall tax liability and enhancing cash flow management.
iii. Simplification of Tax Structure: The amalgamation of different indirect taxes into a single, comprehensive GST has simplified the tax environment, making it easier for banks to handle their tax responsibilities. This simplification helps reduce confusion and fosters more transparent financial practices.[11]
iv. Potential for Growth and Digital Transactions: GST encourages a business-friendly ecosystem by deterring tax evasion and promoting digital transactions. As the process of conducting business becomes more straightforward, it supports growth across various sectors, ultimately leading to an increased demand for banking services. The rise in digital transactions boosts the volume of financial activities, resulting in higher revenues for banks.[12]
DIFFICULTIES FACED BY THE BANKING INDUSTRY:
However, the benefits of GST come with their share of challenges. The banking sector has had to navigate a complex compliance landscape, marked by significant operational hurdles:
i. Decentralized Registration Requirements: A significant challenge under GST is that banks are required to register individually in each state where they operate. In contrast to the previous centralized service tax system, this creates an extra administrative burden, forcing banks to handle multiple state-level registrations and compliance filings. Large banks with a national presence face heightened complexity when it comes to managing regulatory adherence.[13]
ii. Maintenance of Comprehensive Records: In order to effectively manage input tax credit, banks are required to keep distinct records of both utilized and unused credits. This detailed tracking adds a level of complexity to their accounting systems, necessitating considerable investments in technology and personnel.
iii. Increased Compliance Costs: The transition to a decentralized framework has increased compliance costs as well. Banks must ensure compliance with various state-level regulations, which often have differing interpretations of GST rules. Additionally, adhering to processes like reverse charge and partial reverse charge has made tax administration even more complicated.[14]
iv. Operational Complexity with Place of Supply Rules: Under GST, it is essential to identify the place of supply for transactions to apply the correct tax rates. This requirement has created considerable operational difficulties for banks, which conduct numerous transactions across different states and countries. Updating IT systems and ensuring accurate compliance for each type of transaction has raised both workload and operational costs.
LEGAL IMPLICATIONS OF GST ON BANKING
i. Definition of Taxable Supply – The GST framework has expanded the definition of ‘taxable supply’ to include a broader range of banking services. This redefinition has had a considerable effect on how banks evaluate their offerings, resulting in an enlarged tax base and an increase in taxable services. The banking sector, which was previously accustomed to certain service tax exemptions, found it necessary to reassess which services now fall under GST’s jurisdiction. For example, loan processing fees, fund transfer fees, and specific commission types, which may have been interpreted differently in the past, are now clearly included within GST’s scope.[15] This shift required significant updates to billing systems and staff training to ensure that all relevant services were accurately identified and taxed.
ii. Challenges with Input Tax Credit (ITC) – The transition to GST has also brought about considerable difficulties concerning the management and claiming of Input Tax Credit (ITC). Although GST aimed to simplify tax credits and minimize cascading taxes, the situation for banks has become more intricate. Financial institutions, which often deal with both taxable and exempt supplies (such as interest on loans, which remains exempt), have encountered challenges with the proportional allocation of ITC. Banks are now obligated to precisely compute and distribute ITC in accordance with the output services rendered, complying with the detailed ITC regulations set forth by GST laws. This accurate proportional allocation is essential to avoid penalties or compliance complications, prompting a need for improved accounting systems and increased administrative monitoring. Moreover, the rule requiring a 50% reversal of ITC on various inputs, input services, and capital goods has further constrained the credit accessible to banks.[16] This reversal provision, which is meant to equilibrate credit claims across mixed supplies, has effectively raised operational costs, placing strain on the profitability and financial management of the sector.
iii. Inter-branch Transactions – The handling of inter-branch transactions under GST represented a notable shift from prior practices. Under the former service tax system, transactions between a bank’s branches were typically not deemed taxable. However, GST has classified these interactions as taxable if the branches are located in different states, designating them as “distinct persons.” Consequently, banks needed to regard inter-branch services as taxable supplies, which required thorough documentation, tax invoices, and compliance verification. The obligation to ascertain the value of these inter-branch services and employ the correct “place of supply” rules added further administrative and logistical challenges. Banks had to enhance their IT systems and internal processes to accurately monitor and report these transactions, ensuring compliance and avoiding penalties. This transformation has been particularly challenging for banks with extensive branch networks across numerous states, where inter-branch interactions occur frequently and require significant coordination.[17]
COMPLIANCE REQUIREMENTS OF GST ON BANKING
i. Registration and Reporting: The implementation of GST required banks to register individually in each state where they operated. This stipulation, though intended to ensure tax compliance and proper revenue allocation to the respective states, added considerable complexity to the operational frameworks of financial institutions. Unlike the period before GST, when banks could manage a centralized registration, they were now compelled to navigate state-specific compliance measures. This transition resulted in a rise in administrative burdens and necessitated the deployment of resources to handle these registrations and adhere to varied state regulations. The procedure involved not just registering in each state but also submitting monthly, quarterly, and annual GST returns specific to those locations. This alteration created a noteworthy strain, particularly for banks with extensive branch networks nationwide.[18]
ii. Documentation and Record-Keeping: With GST in place, the demand for thorough record maintenance for numerous services grew. Banks were required to adapt to more rigorous documentation standards to guarantee compliance and avoid penalties. Each transaction, whether exempt, zero-rated, or taxable, necessitated meticulous record-keeping to support the allocation of input tax credit (ITC) and substantiate claims presented in GST returns. This thorough documentation became essential for facilitating audits and demonstrating compliance with GST regulations. Inaccurate record maintenance could result in disputes, penalties, and potential reputational harm.
iii. Reconciliation Challenges: Aligning GST returns with the bank’s financial accounting records posed a continuous challenge. Inconsistencies between the figures reported in GST returns and actual transactions could lead to audits or penalties. Banks required robust technological solutions that could automate the reconciliation process to reduce errors and boost accuracy.[19] This necessity often entailed investing in specialized software and enhancing existing accounting systems to guarantee smooth integration with GST-compliant practices.
OPERATIONAL CHALLENGES OF GST ON BANKING
i. Increased Costs: The transition to the GST framework led to a surge in operational expenses for banks. Compliance demanded system enhancements to meet new tax calculation and reporting requirements, as well as specialized training for employees to familiarize them with GST standards. Many banks also sought external consultancy services to help navigate the complexities of GST compliance, further adding to operational costs. These supplementary expenses, while essential for compliance, affected the profitability margins of banking institutions and imposed additional financial pressure, particularly on smaller banks and financial services providers.
ii. Customer Experience: The introduction of GST on banking services resulted in higher fees for customers. Charges related to services such as debit card issuance, ATM withdrawals exceeding the allowable free limit, loan processing, and fund transfers saw increases due to the additional GST rate of 18%. This rise, although consistent with the comprehensive tax structure, had the potential to influence customer behavior, possibly leading to decreased demand for certain non-essential banking services. Banks had to manage customer expectations and address any dissatisfaction stemming from the increased costs. [20]
iii. Complex IT Solutions: The banking sector was required to revamp its IT infrastructure to implement comprehensive systems capable of accurately tracking, calculating, and reporting GST-compliant data. This integration was crucial not only for compliance but also to ensure seamless reporting across various state-specific registrations. Challenges such as determining the place of supply for different transactions and accurately allocating input tax credits demanded advanced IT solutions. Banks that invested in these technological upgrades were better positioned to tackle the multifaceted challenges of GST compliance, while others struggled to maintain operational efficiency.[21]
IMPACT ON RETAIL AND CORPORATE BANKING
The retail banking sector experienced noticeable changes with the introduction of GST. Services frequently used by individual customers, such as issuing debit cards, fund transfers, and ATM transactions, became subject to additional GST charges, leading to slight cost increases for consumers. To address this, banks adjusted their service fees to reflect the new tax regime. However, implementing these changes required effective communication with customers to explain the reasons behind the price adjustments. Clear and transparent messaging was crucial to mitigate any negative perceptions, maintain trust, and ensure continued customer loyalty.
Corporate banking felt an even greater impact due to the complexity and scale of its operations. Large institutions handling significant volumes of domestic and international transactions faced heightened compliance challenges under the GST framework. Cross-border transactions, in particular, required careful tax treatment to align with Indian GST laws and international tax regulations.[22] Compliance responsibilities increased significantly, with banks needing to maintain meticulous records for input tax credit claims, manage export services under zero-rated supply provisions, and handle reverse charge mechanisms where applicable. These demands expanded the workload for corporate tax teams, necessitating more frequent consultations with tax advisors to ensure complete adherence to GST regulations.
CONCLUSION
The framework of GST marked a significant turning point for the banking and financial sector in India. Although GST was designed to simplify and restructure the complicated indirect tax system, its initial implementation presented substantial challenges across various industries, including banking. Financial institutions encountered a range of obstacles, from compliance and operational transformations to the requirement for improved IT infrastructure capable of capturing GST-compliant data on both the front and back end. Despite these challenges, GST provides clear advantages, such as a unified taxation system and simplified input tax credit mechanisms, which could potentially enhance efficiencies previously hampered by the fragmented tax framework. The transition from service tax to GST raised the tax rate on financial services, affecting consumer costs and altering business dynamics. However, this new system also opened up avenues for streamlining processes and adapting to a more transparent and unified tax environment.
In conclusion, while the banking sector faced initial disruptions and increased service tax rates that led to customer dissatisfaction, the GST framework ultimately possesses the potential for long-term growth and efficiency. By balancing compliance demands, operational adjustments, and customer expectations, financial institutions have had to quickly adapt, highlighting GST’s significant, albeit intricate, contribution to promoting the growth and advancement of the nation’s economy.
[1] M. Govinda Rao, Goods and Services Tax in India: Progress, Performance & Prospects, https://indianeconomy.columbia.edu/sites/default/files/content/201902-Govinda%20Rao%20-%20GST.pdf.
[2]Anuradha Shukla, Clarification likely on GST on NBFC co-lending, https://economictimes.indiatimes.com/news/economy/policy/clarification-likely-on-gst-on-nbfc-co-lending/articleshow/110281351.cms?from=mdr.
[3] Ernst & Young, GST Transformation, https://assets.ey.com/content/dam/ey-sites/ey-com/en_in/topics/tax/gst-compliance-technology/ey-gst-transformation-the-road-ahead.pdf.
[4] GST Council, Registration under GST Law, https://gstcouncil.gov.in/sites/default/files/e-version-gst-flyers/Registration_under_GST_Law_new.pdf.
[5] Standard chartered, Goods and Services Tax on Forex Transactions, https://www.sc.com/in/important-information/service-tax-on-forex-transactions/#:~:text=All%20foreign%20currency%20conversion%20transactions,GST%20%4018%25%20is%20applicable.
[6] Santosh Dalvi, Model GST Law : Place of supply rules – How it rings in for the telecom sector, https://idt.taxsutra.com/experts/column?sid=256.
[7]Cleartax, Impact of GST on Banks and NBFCs, https://cleartax.in/s/impact-gst-banks-nbfcs.
[8]BCAS, Place of Supply of Services — Critical Analysis, https://www.bcasonline.org/Referencer2018-19/part4/place-of-supply-of-services-critical-analysis.html.
[9]Tax2win, Actionable Claim Under GST – All You Need to Know, https://tax2win.in/guide/actionable-claim-under-gst#:~:text=GST%20on%20Actionable%20Claims,-Under%20the%20CGST&text=This%20is%20because%20actionable%20claims,or%20disposed%20of%20for%20consideration.
[10] Annapurna, ITC Under GST, https://cleartax.in/s/gst-input-tax-credit.
[11] Ernst & Young, GST Transformation, https://assets.ey.com/content/dam/ey-sites/ey-com/en_in/topics/tax/gst-compliance-technology/ey-gst-transformation-the-road-ahead.pdf.
[12] Jerome Joseph, Digital Payments and GST Revenue: An Empirical Analysis, https://nipfp.org.in/media/medialibrary/2022/12/JJ.pdf.pdf.
[13] Cleartax, Impact of GST on Banks and NBFCs, https://cleartax.in/s/impact-gst-banks-nbfcs.
[14] Cleartax, All about RCM under GST, https://cleartax.in/s/reverse-charge-gst.
[15] BCAS, Place of Supply of Services — Critical Analysis, https://www.bcasonline.org/Referencer2018-19/part4/place-of-supply-of-services-critical-analysis.html.
[16] Annapurna, ITC Under GST, https://cleartax.in/s/gst-input-tax-credit.
[17] Adv. Lavanya P.R, CA Vikram Katariya, VALUATION FOR INTER-BRANCH TRANSACTIONS UNDER GST, https://hnallp.com/a/valuation-for-interbranch-transactions-under-gst.
[18] ET Bureau, Government rules out centralised registration for banks under GST, https://economictimes.indiatimes.com/news/economy/policy/government-rules-out-centralised-registration-for-banks-under-gst/articleshow/59112238.cms?from=mdr.
[19]GST Reconciliation and Matching: Importance and Procedure, https://cleartax.in/s/gst-reconciliation.
[20] M. Govinda Rao, Goods and Services Tax in India: Progress, Performance & Prospects, https://indianeconomy.columbia.edu/sites/default/files/content/201902-Govinda%20Rao%20-%20GST.pdf.
[21] Anuradha Shukla, Clarification likely on GST on NBFC co-lending, https://economictimes.indiatimes.com/news/economy/policy/clarification-likely-on-gst-on-nbfc-co-lending/articleshow/110281351.cms?from=mdr.
[22] GST Council, Registration under GST Law, https://gstcouncil.gov.in/sites/default/files/e-version-gst-flyers/Registration_under_GST_Law_new.pdf.
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