2023 (2) TMI 896 - AT - Service Tax

Foreclosure charges not taxable as service tax, following distinction from interest in banking services.

M/s. Sundaram Finance Ltd. Versus Commissioner of GST & Central Excise, Chennai

The Tribunal held that foreclosure charges collected by banks and non-banking financial companies are not subject to service tax under the definition of ... Levy of service tax - Banking and Other Financial Services or not - Foreclosure charges collected by the banks and non-banking financial companies on premature termination of loans - HELD THAT:- The Larger Bench in the case of COMMISSIONER OF SERVICE TAX, CHENNAI VERSUS M/S REPCO HOME FINANCE LTD. [2020 (7) TMI 472 - CESTAT CHENNAI] has considered the issue and held that such charges are not liable to service tax. The demand cannot sustain and requires to be set aside - Appeal allowed - decided in favor of appellant. ISSUES PRESENTED AND CONSIDERED 1. Whether charges collected by lenders (banks and non-banking financial companies) on premature preclosure/foreclosure of loans constitute a taxable service under 'Banking and Other Financial Services' as defined in Section 65(12) of the Finance Act, 1994. 2. Whether the amendment to the definition of 'banking and other financial services' (effective 10 September 2004) by inclusion of 'lending' brings prepayment/foreclosure charges within the scope of taxable financial services. 3. Whether foreclosure/prepayment charges are compensatory damages arising from breach of contract (and therefore not a service) or are consideration for a service rendered by the lender. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Taxability of foreclosure/prepayment charges under 'Banking and Other Financial Services' Legal framework: The question is governed by the definition of 'banking and other financial services' in Section 65(12) of the Finance Act, 1994 and the scope of taxable services under Section 65(105)(zm). The post-10-September-2004 substitution of Section 65(12) added clause (ix) including 'other financial services, namely, lending...'. Precedent treatment: The Larger Bench examined prior Tribunal decisions (including Hudco and Small Industries) and construed the amended definition. It concluded that foreclosure charges are not leviable to service tax. The Larger Bench decision was followed by the Tribunal in the present matter. Interpretation and reasoning: The Court analysed the nature of foreclosure/prepayment charges and the statutory definition. It observed that foreclosure charges are stipulated in loan contracts as payable on premature termination and represent compensation for breach of contract and losses (e.g., asset-liability mismatch, cost of redeployment). The presence of a contractual entitlement to liquidated damages negates the characterization of those charges as payment for a distinct 'service' rendered by the lender. The mere fact that the lender processes a prepayment request, calculates charges and collects payment does not transform a contractual damage into a taxable service. Ratio vs. Obiter: Ratio - foreclosure/prepayment charges are compensatory in nature and not taxable as 'banking and other financial services' under Section 65(12). Obiter - discussion distinguishing earlier decisions that treated the activity as a service because of processing activities incidental to collection. Conclusion: Foreclosure/prepayment charges collected by lenders on premature termination of loans are not leviable to service tax under the definition of 'banking and other financial services'. Issue 2 - Effect of amendment of Section 65(12) (inclusion of 'lending') on taxability Legal framework: Section 65(12) was amended effective 10 September 2004 to add lending to the list of 'other financial services'. The legal question is whether that addition changes the character of foreclosure charges. Precedent treatment: The Larger Bench considered the Tribunal decision in Hudco which held that post-amendment foreclosure charges became taxable, but the Larger Bench rejected that reasoning and distinguished earlier decisions that dealt with pre-amendment periods. Interpretation and reasoning: The Court found that the amendment to include 'lending' in the definition does not automatically convert contractual damages into a taxable service. The amendment expands the category of activities considered 'banking and other financial services' but does not alter the essential nature of stipulated damages which compensate for breach rather than remunerate a service. The analytical focus must be on the character of the charge (damages vs. service consideration), not merely on its association with lending activities. Ratio vs. Obiter: Ratio - the inclusion of 'lending' in Section 65(12) is not determinative; charges that are contractual damages remain outside the scope of service tax despite the broadened definition. Conclusion: The 10-September-2004 amendment to Section 65(12) does not render foreclosure/prepayment charges taxable when those charges are compensatory in nature. Issue 3 - Characterisation of foreclosure charges as damages vs. service consideration Legal framework: Classification of a receipt as service consideration requires that the payment be for a service provided; conversely, liquidated damages for breach of contract are compensatory and not consideration for a service. Precedent treatment: The Larger Bench re-examined earlier decisions and rejected the approach that treated foreclosure charges as payment for a service merely because administrative acts (consideration of request, computation, collection) occur. Interpretation and reasoning: The Court emphasised contractual stipulations and the legal nature of the charge. It noted that foreclosure charges are fixed/contractual and serve to compensate the lender for losses resulting from premature termination (e.g., anticipated interest shortfall, cost of redeployment). The routine administrative acts incident to collection do not change the substantive character of the charge. The Court also rejected the departmental submission that availability of prepayment as a 'facility' at a price equates the charge with a service akin to lending. Ratio vs. Obiter: Ratio - foreclosure/prepayment charges are damages for breach of contract and not consideration for a taxable service; administrative acts incidental to collection are insufficient to change that characterization. Conclusion: Foreclosure/prepayment charges are compensatory damages and not service consideration; they therefore fall outside service tax liability under the 'banking and other financial services' definition. Remedial outcome and consequential orders Following the Larger Bench reasoning, the Tribunal held that the demand of service tax (including interest and penalties) on foreclosure charges could not be sustained. The impugned orders confirming the demand were set aside and the appeals allowed with consequential reliefs as per law.