Athul Aravind*
This paper will analyse various types of loan agreements entered that are now being entered into, and the tax liability of these loans. It will focus specifically on interest subvention and how it should be categorised for tax purposes, with more focus on the automobile industry, given the recent judgements and jurisprudence.
WHAT IS INTEREST SUBVENTION?
Interest subvention is the reduction of interest rate, when granting a loan to a party. Traditionally, these subvention schemes have been offered by the Government to the Agricultural or Educational sector and can be categorized as a subsidy, and this can be also be called priority lending.
However, in recent times, interest subvention clauses are found in loan agreements between related parties or group companies. This has blurred the lines, in terms of how it should be categorized. For more clarity, an example of this arrangement will be brought out through the automobile industry.
Company A is engaged in the manufacture of vehicles and is a related entity of Company B who has a similar purpose. It has a loan agreement with Company C, which is a subsidiary of Company B, and whose purpose and function is finance. Company A relies on Company C to advertise the vehicles made by Company A, and sell it to the customers, for which it adds a subvention clause. This makes the offer more attractive as a reduced interest rate by 50% is offered to the customer by Company C. The other 50% is offered by Company A to Company C. This is a typical interest subvention arrangement that can be found in loan agreements.
CATEGORIZATION OF INTEREST SUBVENTION
The main dilemma that has arisen in the recent past, is whether this reduction in interest rate should be categorized as interest income and exempt from service tax or a consideration for a service, hence liable for service tax, or a commissionaire arrangement which has a different tax liability in itself.
There are provisions that state that interest on loan contracts is not leviable to service tax, and for this they relied upon the Explanation (1) to Section 67 of the Finance Act, 1994 and also Rule 6(2) of the Service Tax (Determination of Value) Rules, 2006. The said provisions are reproduced below:’
a) Finance Act, 1994/ Section 67 -Valuation of taxable services for charging service
For the purpose of this chapter, the value of any taxable service shall be the gross amount charged by the service provider for such service provided or to be provided by him.
Explanation 1 – For removal of doubts, it is hereby declared that the value of taxable service, as the case may, includes-
(a)…………..
but does not include-
(viii) interest on loans.
b) Service Tax (Determination of Value) R.6(2)
Subject to the provisions, contained in sub-rule (1), the value of any taxable service, as the case may, does not include-
…………………….
(iv) interest on loans.
c) Notification 4/2006-ST dated 01.03.2006
In exercise of the powers conferred by sub- section (1) of section 93 of the Finance Act, 1994 (32 of 1994) (herein referred to as the Finance Act), the Central Government, on being satisfied that it is necessary in the public interest so to do, hereby exempts the taxable service, specified in sub-clause (zm) of clause (105) of section 65 of the Finance Act, that is to say the financial leasing services including equipment leasing and hire-purchase as defined in item (i) of sub-clause (a) of clause (12) of section 65 of the Finance Act, provided or to be provided to any person, from so much of the service tax leviable thereon under section 66 of the said Finance Act, as is equivalent to the service tax calculated on ninety per cent. of an amount, forming or representing as interest, i.e. the difference between the installment paid towards repayment of the 52 ST/87648/2013,86215/2015,86329/2016 lease amount and the principal amount contained in such installment paid.
Explanation.- This exemption shall not apply to any amount, other than an amount forming or representing as interest, charged by the service provider such as lease management fee, processing fee, documentation charges and administration fee.”
However, we need to analyse the jurisprudence behind the interpretation, and how courts have categorized subvention.
CASE LAW ANALYSIS
1. Cauvery Spinning and Weaving Mills Ltd [340 ITR]
It was held that to call an amount received as interest at least one of the conditions should be satisfied that the amount has been received as due on account of any money either borrowed or debt incurred. In the present case the debt is incurred when bank has extended credit for payment purchase price of vehicle. Same has been inserted by way of section 65B(30) in Finance Act, 1994, “interest” means interest payable in any manner in respect of any money borrowed or debt incurred (including deposit, claim or similar right or obligation) but does not include any service fee or other charge in respect of the money borrowed or debt incurred or in respect of any credit facility which has not been utilized.”
Law do not prescribe that the interest income should have been received from the borrower only. It only says that interest is excluded from purview of service tax.
2. A. Thyssenkrupp JBM Private Limited [2005 (180) ELT 285 (Commr Appl)]
B. Magus Construction Pvt Ltd [2008 (11) STR 225 (Gau)]
C. Rohan Builders Ltd [2009 (13) STR 56 (T- Bang)]
All these cases dealt with the subvention of income from automobile industries. The ratio was that subvention do not arise due to any marketing service by the appellant to any third person but has direct correlation to its own business activities. Them being banking company neither have any expertise or are equipped with any facility to market the motor vehicles. They only promote their financial products and not the vehicles sold by the dealers/ manufacturers. Their role is limited to that of financier in the low-cost financing schemes.
“Thus, if it is argued that there is promotion at all they are promoting their own business. For the limited purposes of promotion of its financial products, undertaken jointly with the dealers/ manufacturers, they can by no stretch of imagination be said to be promoting the business of the dealers. As per Oxford dictionary “interest is money charges or paid for use of money”. In view of the above definition subvention income earned by them is akin to interest. It is to compensate them for the losses incurred by them for providing loans to customers at subsidised rates.”
3. Association of Leasing and Financial Service Companies Vs Union of India [2010 (20) STR 417 (SC)
It held that the impugned levy relates to or is with respect to the particular topic of “banking and other financial services” which includes within it one of the several enumerated services, viz., financial leasing services. It also includes long time financing by banks and other financial institutions (including NBFCs).
These are services rendered to their customers which comes within the meaning of the expression “taxable services” as defined in Section 65(105)(zm). The taxable event under the impugned law is the rendition of service. The impugned tax is not on material or sale. It is on activity/ service rendered by the service provider to its customer.
It also stated that ‘Equipment Leasing/ Hire- Purchase’ finance are long term financing activities undertaken as their business by NBFCs. As far as the taxable value in case of financial leasing including equipment leasing and hire-purchase is concerned, the amount received as principal is not the consideration for services rendered. Such amount is credited to the capital account of the lessor/ hire- purchase service provider. It is the interest/ finance charge which is treated as income or revenue and which is credited to the revenue account. Such interest or finance charges together with the lease management fee/ processing fee/ documentation charges are treated as considerations for the services rendered and accordingly, they constitute the value of taxable services on which service tax is made payable.
In fact, the Government has given exemption from payment of service tax to financial leasing services including equipment leasing and hire- purchase on that portion of taxable value comprising of 90% of the amount representing as interest, i.e., the difference between the instalment paid towards repayment of the lease amount and the principal amount in such instalments paid (Notification No. 4/2006 – Service Tax dated 1.3.2006). In other words, service tax is leviable only on 10% of the interest portion, in which it has been clarified that service tax, in the case of financial leasing including equipment leasing and hire- purchase, will be leviable only on the lease management fees/ processing fees/ documentation charges recovered at the time of entering into the agreement and on the finance/ interest charges recovered in equated monthly instalments and not on the principal amount).
Merely because for valuation purposes inter alia “finance/ interest charges” are taken into account and merely because service tax is imposed on financial services with reference to “hiring/ interest” charges, the impugned tax does not cease to be service tax and nor does it become tax on hire- purchase/ leasing transactions under Article 366(29A) read with Entry 54, List II. Thus, while State Legislature is competent to impose tax on “sale” by legislation relatable to Entry 54 of List II of Seventh Schedule, tax on the aspect of the “services”, vendor not being relatable to any entry in the State List, would be within the legislative competence of the Parliament under Article 248 read with Entry 97 of List I of Seventh Schedule to the Constitution.
4. Siemens Public Communication Network P. Ltd. vs. CIT (Supreme Court)[1]
This case is the most relevant case in this issue. The Supreme Court (SC) recently held that subvention received by an Indian company from the parent company to make good the losses incurred by it, was in the nature of a capital receipt. The SC arrived at this conclusion on the ground that the subvention was a voluntary payment made by the parent company in Germany to protect the capital investment in the subsidiary company.
The SC further distinguished its earlier decisions in the case of Ponni Sugars and Sahney Steel on the grounds that in those cases, the subsidies were received as a grant-in-aid from public funds and not by way of a voluntary contribution from the parent company.[2]
5. Tata Motors Ltd. v. Commissioner of Customs 2018 SCC OnLine CESTAT 10741
The court follows from the SC judgement in exempting this income, although on different facts and grounds.
The court overturned the commissioner’s verdict, when he categorized it as service, hence liable for taxation. The court held that:
“Commissioner has made reference to all irrelevant and extraneous issues to skirt the issue on hand. It is question of common understanding that the Banking and Financial services are not service simplicitor as loan, deposit or advances but are Financial Products, designed with combination of various isolated services so that adequate finance is made available to consumer/ buyer at competitive prices. How these products are organized is not relevant, but whether these products get classified under the category of taxable services specified under Banking and Financial Services needs to be examined Commissioner have concluded on the basis of extraneous or irrelevant considerations”
It further held:
“The interest does not arise on account of any loan simplicitor. They recover from the vehicle purchaser, finance charges on the principal amount. Where a prospective purchaser is unwilling to pay at the said rate, the dealers in order to increase their sales, agree to bear part of these finance charges. It is clear that the real cost/ value of the services provided by the assessee is worth 9% of the principal amount. Therefore, the entire amount shall in toto form’ the gross amount charged’ for, the purpose of determining taxable value under Section 67, even if the dealer undertakes to pay part of the financial charges on behalf of the vehicle purchaser.
They would not get covered as a provider of taxable service in respect of the aforesaid services. Even assuming that they are not engaged in any banking/non-banking financial services, they would still come within the ambit of “body corporate”. Since the words “or any other” precede the words, “Other Body Corporate”, it is made explicitly clear that such body corporate can be somebody “Other” than the specially mentioned bankers, financial/non-financial bodies.”
The most recent and important judgement, however, is the HDFC case, which overturns what was held in the Tata Motors case. The final part of the paper will analyse the HDFC case and its implications towards this issue.
ANALYSIS OF THE HDFC CASE[3]
The court noticed that mere categorization of subvention as ‘interest income’ in book of accounts is not sufficient.
The main issue that came up before the court is whether subvention income should be subjected to service tax under the category of ‘Business Auxiliary Services’ as defined by Section 65 (19) of Finance Act, 1994. Section 65 (19)[4] of the Finance Act, 1994?
The court held that the rendering of service is from both the sides. While the dealers and manufacturer promote the business of the NBFC, it is the NBFC who also promotes the business of the manufacturer and vehicle dealers. The availability of nil or very low interest to buy vehicle enable the dealers to enhance their business of vehicle selling. The facility of these special schemes serves as special purpose vehicle (SPV) or platform, whereon, the business of the manufacturer and the vehicle dealers get promoted. It is for this reason that this arrangement is always between the NBFC and the manufacturer and vehicle dealers only.
Since the schemes of the NBFC and the arrangement entered into between the NBFC with the manufacturer and the vehicle dealers, in the process, enables the enhancement of vehicle sales of manufacturer/ vehicle dealers the NBFC renders service, which promotes or markets the vehicles and their availability at loans with nil or very low interest. The rendering of the business auxiliary service by the NBFC gets rendered to these manufacturers and the vehicle dealers. [5]
In view thereof, it is NBFC, who also renders the business auxiliary service to the manufacturer and vehicle dealers within the meaning and comprehension of Section 65(19) and Section 65(105)(zzb) of Chapter V of the Finance Act, 1994. The subvention income which is received by the noticee out of the commission earned by the manufacturer and vehicle dealers is the consideration for rendering the business auxiliary service.[6]
The case clearly states that this is a commissionaire arrangement, where the NBFC acts as an agent of the manufacturer to promote and advertise their vehicles and more in the nature of co-dependent principle and agents as opposed to a bank who does not have any commercially vested interest. Another major difference is that a bank would want companies to fail, as it can take the security and build up interest. However, with related party this will build more debt as they are related companies and would be burdening themselves with more of it.
CONCLUSION
It is yet to be seen if the Supreme Court will adopt this view, However, the most recent precedent is the HDFC case, which categorises it as a business auxiliary service and hence taxable. It will be interesting to see if this view changes on appeal.
Notes:
[1] Civil Appeal No. 11934/2016, 11936/2016, 11937/2016
[2] Tax Insights from India Tax & Regulatory Services/ www.pwc.in /Subvention from parent company for making good losses is a capital receipt not chargeable to tax/ December 14, 2016
[3] HDFC Bank Ltd. v. Commissioner of Central …, 2018 SCC OnLine CESTAT 6276
[4] Business Auxiliary Service” means any service in relation to, —
(i) promotion or marketing or sale of goods produced or provided by or belonging to the client; or
(ii) promotion or marketing of service provided by the client; or [Explanation – For the removal of doubts, it is hereby declared that for the purposes of this sub-clause, “service in relation to promotion or marketing of service provided by the client” includes any service provided in relation to promotion or marketing of games of change, organised, conducted or promoted by the client, in whatever form or by whatever name called, whether or not conducted online, including lottery, lotto, bingo;]
(iii) any customer care service provided on behalf of the client; or
(iv) procurement of goods or services, which are inputs for the client; or [Explanation — For the removal of doubts, it is hereby declared that for the purposes of this sub-clause, “inputs” means all goods or services intended for use by the client;]
(v) production or processing of goods for, or on behalf of the client; or
(vi) provision of service on behalf of the client; or 14 ST/85741/2014
(vii) a service incidental or auxiliary to any activity specified in sub-clauses (i) to (vi), such as billing, issue or collection or recovery of cheques, payments, maintenance of accounts and remittance, inventory management, evaluation or development of prospective customer or vendor, public relation services, management or supervision, and includes services as a commission agent, but does not include any activity that amounts to “manufacture” of excisable goods.
Explanation — For the removal of doubts, it is hereby declared that for the purposes of this clause, —
(a) “Commission Agent” person who acts on behalf of another person and causes sale or purchase of goods, or provision or receipt of services, for a consideration, and includes any person who, while acting on behalf of another person — means any
(i) deals with goods or services or documents of title to such goods or services; or
(ii) collects payment of sale price of such goods or services; or
(iii) guarantees for collection or payment for such goods or services; or
(iv) undertakes any activities relating to such sale or purchase of such goods or services;
(b) “Excisable Goods” has the meaning assigned to it in clause (d) of Section 2 of the Central Excise Act, 1994;
(c)”Manufacture” has the meaning assigned to it in clause (f) of Section 2 of the Central Excise Act, 1944;”
[5] Para 17
[6] Para 18
*(Author is 5th Year Student of Jindal Global Law School.)
