2020 (7) TMI 472 - AT - Service Tax

Foreclosure charges not taxable as service tax: Tribunal rules in favor of banks and financial companies

Commissioner of Service Tax, Chennai Versus M/s Repco Home Finance Ltd.

The tribunal held that foreclosure charges collected by banks and non-banking financial companies on premature termination of loans are not subject to ... Levy of Service Tax - banking and other financial services - foreclosure charges levied by the banks and non banking financial companies on premature termination of loans - matter referred to Larger Bench - HELD THAT:- Where service tax is chargeable on any taxable service with reference to its value, then such value shall be determined in the manner provided for in (i), (ii) or (iii) of sub-section (1) of section 67. What needs to be noted is that each of these refer to “where the provision of service is for a consideration”, whether it be in the form of money, or not wholly or partly consisting of money, or where it is not ascertainable. In either of the cases, there has to be a “consideration” for the provision of such service. Explanation to sub-section (1) of section 67 defines “consideration” to include any amount that is payable for the taxable services provided or to be provided, or any reimbursable expenditure, or any amount retained by the lottery distributor or selling agent - It is clear from the definition of “consideration” that only an amount that is payable for the taxable service will be considered as “consideration”. This apart, what is important to note is that the term “consideration” is couched in an “inclusive” definition. A Larger Bench of the Tribunal in M/S BHAYANA BUILDERS (P) LTD. & OTHERS VERSUS CST, DELHI & OTHERS. [2013 (9) TMI 294 - CESTAT NEW DELHI (LB)] observed that “implicit in the legal architecture is the concept that any consideration whether monetary or otherwise, should have flown or should flow from the service recipient to the service provider and should accrue to the benefit of the latter.” In the said decision, the Larger Bench made reference to the concept of “consideration‟, as was expounded in the decision pertaining to Australian GST Rules, wherein a categorical distinction was made between “conditions‟ to a contract and “consideration‟. The foreclosure of loan is, therefore, a material breach of contract as it curtails the loan service period unilaterally, which can prompt the promisor to claim damages. Damages can be determined by Courts or they can also be incorporated in the loan agreements and other commercial contracts so as to ensure certainty in dealings and also serve as a deterrent measure. This aspect of damage is known as liquidated damages - It would thus be seen that clauses relating to damages for foreclosure of loan are usually incorporated in contracts as an agreed measure of damages which can be enforced in the event there is a breach of contract with a view to bring about certainty in contracts. These clauses do not and cannot give rise to any “consideration”. These clauses also come into effect only after the contract comes to end. A penalty is a sum of money so stipulated in terrorem, and liquidated damages are a genuine pre-estimate of damages. So far as the law in India is concerned there is no qualitative difference in the nature of liquidated and unliquidated damages, as section 74 eliminates the somewhat elaborate refinement made under the Common Law between stipulations providing for payment of liquidated damages and stipulations in the nature of penalty, which under the Common Law is stipulation in terrorem; a genuine pre-estimate of damages is regarded as liquidated damages, and is binding - It, therefore, clearly follows that foreclosure charges are recovered as compensation for disruption of a service and not towards “lending” services. In fact, the amount for processing charges and documentation charges or like charges are subjected to service tax because they are essential for the activity of lending and are treated as activities “in relation to lending”. Foreclosure is anti thesis to lending and, therefore, cannot be construed to be “in relation to lending”. The phrase “in relation to lending” cannot be so stretched so as to bring within its ambit even activities which terminate the activity. The foreclosure charges should not be viewed as ‘alternative mode of performance’ of the contract because they arise upon repudiation of specified terms of contract and are intended to compensate the injured party banks and non banking financial companies. This is because ‘alternative mode of performance’ still contemplates performance, whereas foreclosure is an express repudiation of the contractual terms giving rise to the levy of foreclosure charges - merely because the clause relating to damage is featuring in a contract, it would be incorrect to conclude that the party has been given an option to violate the contract. Hence, to treat eventuality of foreclosure as an optional performance is incorrect. The contract cannot be understood to be providing an option to the parties to either perform or not perform/violate. Foreclosure charges collected by the banks and non banking financial companies on premature termination of loans are not leviable to service tax under “banking and other financial services” as defined under section 65 (12) of the Finance Act. The appeal may now be listed before the regular Bench for hearing. Issues Involved:1. Whether foreclosure charges levied by banks and non-banking financial companies on premature termination of loans are subject to service tax under 'banking and other financial services.'Detailed Analysis of the Judgment:Conflicting Tribunal Decisions:1. Hudco vs. Commissioner of Service Tax, Ahmedabad (2012): Service tax is leviable on foreclosure charges.2. Magma Fincorp Limited. vs. Commissioner of Service Tax, Kolkata (2016): Service tax is not leviable on foreclosure charges.3. Small Industries Dev. Bank of India vs. Commissioner of Service Tax, Ahmedabad (2015): Referred the matter to a Larger Bench due to conflicting decisions.Case Background:- Respondent: Registered for service tax under 'banking and other financial services,' provided housing loans, and collected foreclosure charges without paying service tax.- Show Cause Notice: Demanded Rs. 20,50,399/- under section 73(1) of the Finance Act, 1994.- Joint Commissioner's Order: Confirmed the demand but refrained from imposing penalties.- Commissioner (Appeals): Allowed the appeal, setting aside the Joint Commissioner's order, stating that foreclosure charges are not for rendering any service but are in lieu of anticipated interest loss.Legal Provisions:1. Section 66 of the Finance Act, 1994: Levies service tax at 12% on the value of taxable services.2. Section 65 (105) of the Finance Act: Defines 'taxable service.'3. Section 67 of the Finance Act: Deals with the valuation of taxable services, emphasizing that consideration must be for the service provided.Arguments:- Banks and Non-Banking Financial Companies: Foreclosure charges are not 'consideration' for a service but compensation for breach of contract due to premature loan termination.- Revenue: Foreclosure charges are a facility available to borrowers at a price, thus falling under 'banking and other financial services.'Tribunal’s Analysis:- Consideration Definition: Must flow from the service recipient to the service provider and be for the taxable service provided.- Foreclosure Charges: Viewed as compensation for loss of 'expectation interest' due to premature loan termination, not as consideration for a service.- Liquidated Damages: Foreclosure charges are akin to liquidated damages for breach of contract, not a service provided.Key Judgments Referenced:1. Bhayana Builders (P) Ltd. vs Commissioner of Service Tax (2013): Consideration must be for the service provided.2. Commissioner of Service Tax vs. M/s Bhayana Builders (2018): Reinforced the nexus between the amount charged and the service provided.3. Union of India vs. Intercontinental Consultants and Technocrafts (2018): Valuation of taxable service is based on the consideration paid for the service provided.Conclusion:- Foreclosure Charges: Are not leviable to service tax as they are not for rendering any service but are compensation for breach of contract.- Hudco Decision: Not accepted as it incorrectly interpreted foreclosure charges as a service.- Final Decision: Foreclosure charges collected by banks and non-banking financial companies on premature termination of loans are not subject to service tax under 'banking and other financial services' as defined under section 65 (12) of the Finance Act.Order:- The reference is answered in favor of the respondent, and the appeal is to be listed before the regular Bench for hearing. (Order pronounced on 08 June, 2020)