TaxTMI 
TaxTMI 
2018 (11) TMI 884
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....gative, Whether the activity of collecting penal interest by the Applicant would amount to a taxable supply under the GST regime? At the outset, we would like to make it clear that the provisions of both the CGST Act and the MGST Act are the same except for certain provisions. Therefore, unless a mention is specifically made to such dissimilar provisions, a reference to the CGST Act would also mean a reference to the same provision under the MGST Act. Further to the earlier, henceforth for the purposes of this Advance Ruling, a reference to such a similar provision under the CGST Act / MGST Act would be mentioned as being under the "GST Act". 02. FACTS AND CONTENTION - AS PER THE APPLICANT The submissions, as reproduced verbatim could be seen thus- 1. The Applicant is a non-banking financial company and is inter alia engaged in providing various types of loan to the customers such as auto loans, loan against the property, personal loans, consumer durable goods loans, etc. All these loans are interest bearing loans. 2. The Applicant inter alia enters into agreements with borrower/customers for providing loans to them. The loan agreements provide for repayment of the o....
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....ility of penal interest under the GST law, as an abundant caution, the Applicant is filing the present application for Advance Ruling. Statement containing the Applicant's interpretation of law and/or facts, as the case may be, in respect of question(s) on which Advance Ruling is sought 2. Issue(s) requiring Advance Ruling 2.1 Based on the above, the Applicant would like to seek an advance ruling, on the following questions: i) Whether the Penal Interest is to be treated as interest for the purpose of exemption under Sr. No. 27 of Notification No. 12/2017-Central Tax (Rate) dated 28.06.2017, Sr. No. 27 of Maharashtra State Notification No. 12/2017-State Tax (Rate) dated 29.06.2017, and Sr. No. 28 of Notification No. 9/2017-lntegrated Tax (Rate) dated 28.06.2017? ii) If the answer to the above is negative, whether the activity of collecting penal interest by the Applicant would amount to a taxable supply under the GST regime? 3. Applicant's Interpretation 3.1 With respect to the questions framed above, the Applicant has analyzed the relevant legal provisions in the ensuing paras. A. Penal Interest is an additional interest on the overdue loan installment and ....
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....rest. In other words, interest on loans is not subjected to GST levy. A.5 In this regard, attention is kindly brought towards the definition of the term 'interest provided under clause (zk) of para 2 of the above said Exemption Notifications, which reads as under: "(zk) "interest" means interest payable in any manner in respect of any moneys borrowed or debt incurred (including a deposit, claim or other similar right or obligation) but does not include any service fee or other charge in respect of the moneys borrowed or debt incurred Orin respect of any credit facility which has not been utilised;" ............Emphasis Supplied A.6 The above definition clearly states that interest' means interest payable in any manner in respect of any moneys borrowed or debt incurred. It is submitted in this regard that the Penal Interest collected by the Applicant is an additional interest for the delay in payment of loan installment beyond the due date. It is relevant to note here that while computing the EMI/ installment amount, the interest is factored in the EMI on the assumption that all the installments would be paid on time. However, in case, there is any delay in payment of th....
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....Court, wherein it was held that any amount paid over and above the principal amount was interest: • Edupuganti Pitchayya and Ors. vs. Gonuguntla Venkata Ranga Row, AIR 1944 (Mad) 243 = 1943 (10) TMI 18 - MADRAS HIGH COURT • V. Srinivasachariar vs. Conjeevaram Hodgsonpet Dharamarakshaka Nidhi Ltd, 1940 APR (Mad) 937 = 1940 (8) TMI 32 - MADRAS HIGH COURT A.11 From the above judgments, it comes out clearly that any consideration received for money is nothing but interest only. In the present case, the Penal Interest charged by the Applicant is the additional interest for usage of the amount of overdue loan installment by the borrowers/ customers for additional time beyond the stipulated time period. This additional interest received is therefore in the nature of interest' only. Therefore, the above said judgments explaining the meaning of the term interest' would be applicable in the present case as well. A.12 It is further submitted that the nomenclature given to a particular, object/ transaction would not affect its taxability. It is a settled principle of law that nomenclature alone would not determine the nature of transaction. In this regard, relia....
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....onse to, or for the inducement of, the supply of goods or services or both, whether by the recipient or by any other person but shall not include any subsidy given by the Central Government or a State Government: B2 Since the above definition is an inclusive one, the meaning of the term 'consideration will have to be understood from various external aids, including the natural meaning given in various dictionaries, meaning given to the term in rulings by various forums, etc. B.3 It is submitted that the concept of consideration has been derived from the Latin phrase "quid pro quo" which means "something for something". It is a well settled principle that "where there is no consideration, there is no contract". B.4 Reference in this regard is made to the definition of the term 'consideration provided in Section 2(d) of the Indian Contract Act, 1872 (hereinafter referred to as 'the Contract Act), which reads as under: "When, at the desire of the promisor, the promisee or any other person has done or abstained from doing, or does or abstains from doing, or promises to do or to abstain from doing, something, such act or abstinence or promise is called a consider....
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....uch activity is repeated in future, there is no intention to deter the happening of the same, B.10 The expression agreeing to tolerate in act' cannot be construed to include situations wherein liquidated damages/penalty is charged by a party for defaults' breach committed by other party under the contract. In fact, the very intention of such penal clauses is to create a deterrent effect and ensure that the defaults/ violations are not repeated by the erring party. B.11 It is further submitted that the word 'obligation used in Clause (e), Entry 5 of Schedule II of the CGST Act, indicates the need for the existence of the desire in the person for whom the activity is done. In other words, when the service recipient requests the service provider to tolerate an act/situation and the service provider obliges to tolerate for a consideration, then such a contractual relationship will get covered by the said clause of Schedule II of the CGST Act. In such situation, the service provider binds himself to act in a particular manner as desired by the service recipient and there is consensus ad idem between the contracting parties to this effect. B.12 Contrary to the above, the penal i....
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....fers by such breach is entitled to receive from the party who has broken the contract, compensation for any loss or damage caused to him thereby, which naturally arose in the usual course of things from such breach, or which the parties knew, when they made the contract, to be likely to result from the breach of it." ... ...Emphasis Supplied C.4 In view of the above, it is submitted that the liquidated damages / penalty charged for breach of contract are legal consequences of the defaulting party, and therefore, the said amount Shall not be treated as consideration for any activity. It is further submitted that the consideration for breach of contract, in the form of liquidated damages, cannot be treated as the consideration for the contract per se, hence, would not be taxable under the GST regime: C.5 It is submitted that even internationally, it is a settled position that the damages received in compensation for termination or breach of a contract cannot be treated as a supply and therefore not subjected to GST /VAT. C.6 In this regard, reference is made to GSTR 2001/4, issued by the Australian Tax Office (ATO),explains the GST treatment of court orders and out-of-cou....
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....that an association, in accepting the payment of fine or penalty, does not enter into an obligation with the particular member to tolerate the misconduct, but rather is fulfilling its obligation to all members to enforce the rules. The member does not gain rights additional to those which are already enjoyed by virtue of being a member. That is, upon payment of the fine or penalty, the member continues to enjoy the same rights and privileges and it follows that the association is required to continue to provide the benefits of membership. In this sense, it cannot be said that the association 'makes' a supply where it already has a pre-existing obligation to continue to provide the benefits of membership C.10 In view of the above discussed rulings, the Applicant would like to submit that the very purpose of liquidated damages / penalty is to restitute or make good, the loss incurred by a person because of a default, non-compliance, etc. of the other person. Such liquidated damages/ penalty may be in relation to some other supply of service or goods which would have a separate consideration and would be subject to certain terms and conditions to certain terms and conditions. When ....
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.... definition of banking and other financial services' under Section 65(12) of the Finance Act, 1994, The amended definition read as under: *(12) "banking and other financial service" means -- (a) the following services provided by a banking company or a financial institution including a non-banking financial company or any other body corporate or any other person. namely: (i) financial leasing Services including equipment leasing and hire-purchase; .......... .......... (ix) other financial services, namely, lending issue of pay order, demand draft, cheque, letter of credit and bill of exchange, transfer of money including telegraphic transfer, mail transfer and electronic transfer, providing bank guarantee, overdraft facility, bill discounting facility, safe deposit locker, safe vaults, operation of bank accounts;" ........Emphasis Supplied A.3 At the same time, with effect from 10.09.2004, an amendment was carried out in the Service Tax Valuation provisions to exclude interest on loans' from the value of taxable service under clause (viii) of Explanation I to Section 67 of the Finance Act, 1994. The relevant provision as inserted with effect from 10.09.2004....
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.... interest on loans have been kept outside the levy of service tax, and therefore, any amount charged as interest was not taxable in the pre-GST regime. Position under the GST regime A.7 Under the GST regime, interest on loans are exempted from payment of CGST under Serial No. 27 of the Notification No. 12/2017-Central Tax (Rate) dated 28.06.2017. Similar exemption has been granted by the respective State Governments for the SGST leviable on intra-state supplies (refer Serial No. 27 of Maharashtra State Notification No. 12/2017 State Tax (Rate) dated 29.06.2017. The relevant portion of the said Exemption Notification is reproduced herein below: Sl.No. Chapter, Section, Heading, Group or Service Code (Tariff) Description of Services Rate (per cent.) Condition (1) (2) (3) (4) (5) 27 Heading 9971 Services by way of (a) extending deposits, loans or advances in so far as the consideration is represented by way of interest or discount (other than interest involved in credit card services): Nil Nil A.8 In view of the above, it is submitted that even under the GST regime, services of providing loans are exempt, in so far as the considera....
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.... Interest rate 2% p.m. H. Penal Interest for the period of delay (Rs. 10000 * 2% * 20/30) Rs. 133/- A.12 It is submitted that the amount of overdue loan installment is virtually a new loan given to the borrower/ customer for the period of delay, the consideration for which is the penal interest charged on such overdue loan installment. In the above illustration, the overdue loan installment of Rs. 10,000/- is an additional loan given to the customer, for which penal interest is charged, from the date of default till the date of payment of such installment, i.e., from 10th June 2018 to 30th June 2018. A.13 It is submitted in this regard that where the Applicant grants loan to a customer for a specified duration of time, it earns interest on such loan, which represents consideration for use of money for that specified period of time. Similarly, when the customer delays the payment of installment of loan beyond the due date as provided in the agreement, the Applicant levies additional interest (which is termed as Penal Interest) for use of the money beyond the stipulated period of time by the borrowers/customers. The manner of Calculation of such Penal Inte....
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....ll also be equally applicable to the present GST Exemption Notifications. Hence, the Penal Interest charged by the Applicant, which represents the consideration for time value of money (as explained above) would fall under the ambit of the GST Exemption Notifications, and accordingly, shall be exempt from GST. A.16 In view of the above, it is submitted that the Penal Interest is nothing but interest on loans. Hence, the same shall be exempted from payment of GST under the Exemption Notifications. A.17 Further, even under UK VAT law, the charges levied for deferment of payment beyond the time of supply have been treated as consideration for an exempt supply of credit. In this regard, reference is made to the UK VAT Notice 701 / 49: Finance, the relevant portion of which is extracted herein below: *4.5 Deferred payments You may allow customers to defer payment but make an extra charge for allowing them to do so, If the charge relates to periods before and up to the time of the supply (see VAT Notice 700: the VAT Guide) it is not a charge for credit, but is further consideration for the supply of the goods or services. Alternatively, where you agree to defer payment beyond....
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....t supplies as well. B.4 In View of Section 15(2)(d) of the Act, any treatment given to the main consideration of supply shall also be equally applicable to the amount of interest or late fee or penalty charged/levied or collected for delayed payment of any consideration for a supply. Hence, by applying the said provision, the penal interest so collected by the Applicant in the present case, would be having the same tax treatment as that of the main consideration, i.e. interest, and therefore, it would also be exempt from GST under the Exemption Notifications. C. In any case. the penal interest charged by the Applicant in the nature of penalty or liquidated damages for breach of contract, which does not amount to consideration for an contract and therefore there cannot be any supply of service. C.1 In any case, if the penal interest is not treated as interest on loan, then, the same shall be treated either as penalty or as liquidated damages for the default committed by the customers. C.2 It is submitted that upon breach of contract, the aggrieved party is entitled to claim compensation for breach of contract. Such compensation is a legal and statutory right provided und....
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.... a contract, is in the nature of penalty has to be determined by the court against the background of various relevant factors, such as the character of the transaction and its special nature. C.6 It is relevant to note that the Explanation to Section 74 (supra), clearly states that a stipulation for increased interest from the date of default may be a stipulation by way of penalty. C.7 In the present case, the Applicant lends money to the customers with one of the conditions in the loan agreement that the customers shall make timely repayment of loan installments on the due dates as per the repayment schedule, and in case of any default, the Applicant shall be entitled to charge penal/ default interest for the period of default at the specified rate (Refer Pg. No. 23, 26, 36 of the submissions made on 09.05.2018). Therefore, upon default in payment of the installments, the Applicant shall be entitled to receive damages stipulated in the contract in accordance with Section 74 of the Indian Contract Act, 1872. C.8 The Explanation to Section 74 (supra) directly covers the case of penal interest, wherein, higher rate of interest is charged from the customers from the date of d....
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....t the expression "agreeing to the obligation" is a prefix to all the three entries, viz. 'to refrain from an act: to tolerate an act or a situation, and to do an act. Therefore, the correct interpretation of the law would be to read the above said clause as under: - agreeing to the obligation to refrain from an act, - agreeing to the obligation to tolerate an act or a situation, - agreeing to the obligation to do an act D.2 Therefore, to attract the above said clause, there must be an agreement to the obligation in respect of any of the three entries. In absence of any such agreement, there cannot be a service. For a valid agreement, there has to be a consideration between the promisor and the promisee. However, as submitted above, the penal interest levied by the Applicant in the present case are merely damages for the breach of contract of loan, and are not consideration for any contract per se, and therefore, in the absence of any consideration, there can be no agreement to tolerate. D.3 Further, the above said clause uses the word 'obligation', therefore, it is important to understand the meaning of the said term to give correct interpretation to the entry. The s....
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....ch constrains a person to do or suffer something and it implies a right in another person to which it is correlated. As defined in the Specific Relief Act, 1963, obligation includes every duty enforceable by law, so that when a legal duty is imposed on the person in respect to another, the other is invested with a corresponding legal right. Therefore, an obligation comes into existence, only when there is a duty or a liability on the person making the obligation, with a corresponding right to the other person to enforce such obligation. D.5 However, in the present case. there is no obligation upon the Applicant to tolerate the act of non-payment or delayed payment by the borrower, in as much as, neither the Applicant has any duty or liability towards the borrower, for the borrower has any right on the Applicant. The payment of penal interest neither Obligates the Applicant not to take any legal action against the borrower, nor the borrower gains any right to sue the Applicant for any legal action taken by the Applicant. On the contrary, the borrower is under the contractual obligation to make timely repayment of the loan to the Applicant, and upon the breach of such obligation, ....
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....damage, loss or injury in itself does not constitute a supply under the provision of Australian GST. E.4 It is pertinent to bear in mind that the definition of supply" under the Australian GST legislation includes within its ambit an obligation to tolerate an act". Thus, when the aforesaid GSTR namely GSTR 2001/4 states that payment of liquidated damages is not toward's, any supply, it is reasonable to conclude that the GSTR has also considered the clause "an obligation to tolerate an act". In other words, the GSTR impliedly concludes that the acceptance of liquidated damages does not amount to tolerating an act and hence would not fall within the ambit of "supply" for the purposes of GST. E.5 Further, in New Zealand case S65 (1996) 17 NZTC 7408, the Determination stated that an association, in accepting the payment of fine or penalty, does not enter into an obligation with the particular member to tolerate the misconduct but rather is fulfilling its obligation to all members to enforce the rules. The member does not gain rights additional to those Which are already enjoyed by virtue of being a member. That is, upon payment of the fine or penalty, the member continues to enjo....
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....oans, consumer durable goods loans etc. All these loans are interest bearing loans. The applicant inter alia enters into agreements with borrower/ customers for providing loans to them. The loan agreements provide for repayment of the Loano are equated monthly instalments (*EMI) through ECS i.e. Electronic Clearing System/NACH i.e. National Automated Clearing House/Cheque/any other electronic or clearing mandate. In case of dishonour of Cheque/ECS/NACH or any other electronic or clearing mandate by the customers, the applicants collects penal/bounce charges which is in line with the agreed terms and conditions. The bounce charges are generally a fixed amount per default commited by the customer for e.g.Rs.350/- for each dishonour of cheque/ECS for the breach of the terms and conditions of the loan. The amount of bounce charges collected from the customers are accounted by the Applicant in its core accounting platform i.e. SAP under General Ledger Code 60000150. 3. Scope of Supply Section 7 of the Central Goods and Services Tax Act 2017 (CGST 2017) defines scope of supply. As per Sec 7(1) (d) the activities to be treated us a supply of good or supply of services as....
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....dictional Officer Sh. Vinit Thite, State Tax Officer (VAT-C-707) Pune appeared and made written submissions. The final hearing was held on 18.07.2018, Sh. Sandeep Sachdeva, Advocate along with Sh. Arpit Caturvedi, Advocate and Sh. Ganesh Mandhane National Head Taxation appeared and reiterated their submissions and contentions as per their submissions in case of GST ARA no.21 in their own case. Jurisdictional Officer Sh. Vinit Thite, State Tax Officer (VAT-C-707) Pune appeared and stated that they have already made written submissions earlier. 05. OBSERVATIONS We have gone through the facts of the case, submissions made by the applicant and the documents on record. The Applicant, a non-banking financial company are providing various types of loan such as auto loans, loan against the property, personal loans, consumer durable goods loans, etc, to their customers and charge interest on such loans disbursed, for which they enter into agreements with borrower/customers. The agreements provide for repayment of the loan in the form of Equated Monthly Installments (EMI) vide cheque/ Electronic Clearing System (ECS), etc. The installment of the loan is computed taking into consi....
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....ceeding 3% per month on amount due calculated on pro-rata basis from due date till actually paid'. It would be pertinent to mention here that interest charges in general course of business are fixed at a certain rate and not at a rate 'not exceeding a certain percentage'. Thus it is very obvious that the amounts collected by the applicant from their customers are nothing but amounts towards Penalty / Penal Charges and can in no way be construed as additional interest. Such penalty/ penal charges are collected by them from their customers for the reason that the said customers have delayed the payment of EMI and the applicant has tolerated the said act of their customers of delaying payment of such EMI. It is therefore seen that the transaction is about the receipt by the applicant, of certain sums towards - a. Compensation in the form of penal charges for delayed payment of EMIs by their customers. Section 9 of the GST Act says that there shall be levied a tax on supplies of goods or services or both. So we need to understand as to whether the aforesaid receipt of penal charges/penalty amounts would be for a supply made by the applicant. A 'supply' defined under Section 7 ....
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.......... 3.......... 4.......... 5. Supply of services The following shall be treated as supply of services, namely:- (a)............; (b).........; (c) .........; (d).........; (e) agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act; and (f) .........;. 6........... 7.......... From the above, we find that under sub-section (1) of Section 7 -- • Supply' as per clause (a) is for supply of goods or services or both. It is for a consideration AND has to be in the course or furtherance of business. • 'as per clause (b) is for import of services. It is for a consideration AND may or may not be in the course or furtherance of business. • 'Supply' as per clause (c) are the activities specified in Schedule I appended to the GST Act. It is not for a consideration. And though it has not been specifically mentioned in the clause, if we look at Schedule l, as reproduced above, the 'supply' herein would be in the course or furtherance of business. • Supply' as per clause (d) is the enumeration or categorization as given in Schedule II appended to the GST....
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....eading, Group or Service Code (Tariff) Description of Services Rate (per cent.) Condition (1) (2) (3) (4) (5) 27 Heading 9971 Services by way of (a) extending deposits, loans or advances in so far as the consideration is represented by way of interest or discount (other than interest involved in credit card services): Nil Nil It is very clearly seen from a reading of the said Sr. No. 27 that Services by way of (a) extending deposits, loans or advances is exempted in so far as the consideration is represented by way of interest or discount. In this particular matter the amount of default charges are received by the applicant only because their customer/s have defaulted in making the due EMIs. This amount is over and above the interest amount received by them on account of extending deposits, loans, etc. The applicant has further in A5 of their submissions stated that "interest" means interest payable in any manner in respect of any moneys borrowed or debt incurred... ..and therefore the word interest includes interest payable in any manner in respect of any moneys borrowed or debt incurred. They have further submitted that th....
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.... thereof, the same would definitely be a 'supply' under the GST Act and therefore, there arises an occasion to levy tax under the GST Act on the impugned transactions. Thus we find clearly from the above discussions and as per the terms and conditions of the agreement submitted by them that there is clearly an agreement that the applicant, in the case of default of payment of EMI by their customer, the applicant would tolerate such act of default or a situation and the defaulting party i.e their customer was required to compensate the applicant by way of payment of extra amounts in addition to principal and interest as per the terms and conditions of the Agreement. It is also very clear as to the amount or quantum which is consideration in the form of penal charges being additional interest to be received by the applicant if these are suitable compensation only for tolerating the act of default or situation of default by their customers and are not additional interest as claimed by the applicant. We see from the definition of 'Additional Interest' is given in the referred agreement which clearly indicate that the additional interest is not in the nature of interest but is penal ....