SERVICE TAX: TAXABILITY OF NOTIONAL INTEREST

[Dr. Sanjiv Agarwal]

The Revenue Department have been taking a stand that notional interest would be liable to be taxed to Service Tax, despite the fact that there was no deeming faction in valuation law during Service Tax regime for taxation of services. Moreover, no service was rendered or received while attempting to tax non-existent interest, on the presumptive basis. This led to rampant litigation throughout various field formations and then appellate forums have now held that notional interest cannot be subjected to levy of Service Tax.

Normally, assessees or service providers are registered under the Service Tax in the category of “Renting of Immovable Property Service” under erstwhile section (65) (105) (zzzz) of the Finance Act, 1994 and are engaged in providing the said services. The taxpayers apart from renting out the property to the lessee/tenant also collect interest free refundable security deposit. The Revenue felt that the assessee had received the said amount as interest free security against the renting of immovable properties service from the recipients of service, which indicates that the service provider had not computed the taxable value of rent equivalent to notional interest on security against the impugned service as the assessee must have lowered the taxable value of rent equivalent to notional interest on security flowing indirectly from the recipients to them in relation to the service provided. Further, the said notional interest is an additional consideration which is liable for payment of service tax in terms of section 67 of the Finance Act, 1994, read with rule 3 of the Service Tax (Determination of Value) Rules, 2006 calculating the notional interest at the rate of 18% - 24 % per annum and therefore, service tax was recoverable from them under Proviso to section 73 (1) along with interest under section 75 of the Finance Act, 1994.

It can be contended that the amount of notional interest earned on the security amount can be included in the taxable value only if the said amount has nexus with the depression of the prices, i.e., amount of rent charged by the assessee for renting out the properties to the lessee. Neither the advances received by them in the form of security deposit has impacted on lowering down the rental charges collected by them nor the department has discharged the burden of proving that the interest free security deposit has influenced the amount of rent fixed for renting out the properties and therefore no amount of notional interest can be considered as any additional consideration.

Further, the amount received as refundable security deposit is as per industry norms while notional interest is calculated on assumption basis which is not subject to levy of service tax. As per the Section 66D, interest on any amount retained would come under the ambit of negative list and no service tax would be chargeable on that. As per clause (n) of Section 66D of Finance Act, 1994 “negative list of services” includes any such services wherein moneys due are allowed to be used or retained on payment of interest or at discount. This would cover any facility by which an amount of money is lent or allowed to be used or retained on payment of interest or a discount. As per the Section 66D, interest on any amount retained would come under the ambit of negative list and no service tax would be chargeable on that. Therefore, interest on refundable security deposit in any form including notional interest if any would not be chargeable to service tax.

Relevant judicial pronouncements

• In M/S VIKHROLI CORPORATE PARK VERSUS COMMISSIONER OF SERVICE TAX, MUMBAI - 2016 (12) TMI 484 - CESTAT MUMBAI where assessee had constructed commercial building for renting and had taken interest free security deposit from customers and forfeited amount of advance given by customers on relegation of contract by customer, it was held that interest free security deposit and forfeited. Amount were not liable to service tax under ‘renting of immovable property’.

• In SAMIR RAJENDRA SHAH VERSUS COMMISSIONER OF CENTRAL EXCISE, KOLHAPUR - 2014 (11) TMI 499 - CESTAT MUMBAI, where security amount was refundable at time of termination of lease/rent agreement of property, it was held that it does not form part of services provided and Service Tax was held to be not payable on security deposit.

• In THE LAKE PALACE HOTEL AND MOTELS P LTD. VERSUS COMMISSIONER OF CENTRAL EXCISE, JAIPUR II - 2016 (1) TMI 1062 - CESTAT NEW DELHI where assessee was engaged in providing “Renting of Immovable Property Service”, it was held that notional interest on security deposit cannot be added to ‘agreed rent’ for demanding service tax.

• In M/S PARADISE MEHAK PROPERTIES PVT LTD VERSUS COMMISSIONER OF CENTRAL EXCISE, JAIPUR-I - 2012 (6) TMI 490 - CESTAT, NEW DELHI, it was held that no service tax shall be leviable on notional interest accrued on the security deposits. In the instant case as per the lease deed entered by the assessee with ICICI Bank Ltd. the retention money taken by the assessee has to be refunded by the assessee on expiry of lease term. Therefore it is not a consideration for renting out of immovable property for levy of service tax. 

• Further in  the case of MURLI REALTORS PVT. LTD., MAGRPATTA TOWNSHIP DEVELOPERS & CONSTRUCTION CO. LTD., JAIN CONSTRUCTION, SAI CONSTRUCTION PVT. LTD., INDIA LAND INFRASTRUCTURE DEVELOPMENT PVT. LTD., RVS HOSPITALITY & DEVELOPMENT PVT. LTD., VANSUM INDUSTRIES AND THE MANJRI STUD FARM PVT. LTD. VERSUS COMMISSIONER OF CENTRAL EXCISE PUNE-II - 2014 (9) TMI 461 - CESTAT MUMBAI,where in determining value of renting of immovable property service provided by assessee landlords, Department added notional interest @ 18 per cent per annum on interest free security deposits received by them, it was held that section 67 of the Finance Act, 1994 clearly provides that only the consideration received in money for the service rendered is leviable to service tax. The consideration for renting of the immovable property is the amount agreed upon between the parties and on this amount the assessee is discharging service tax liability. It observed as under :

“The security deposit is taken for a different purpose altogether. It is to provide for a security in case of default in rent by the lessee or default in payment of utility charges or for damages, if any, cause to the leased property. Thus, the security deposit serves a different purpose altogether and it is not a consideration for leasing of the property. The consideration of the leasing of the property is the rent and, therefore, what can be levied to service tax is only the rent charged and no notional interest on the security deposit taken can be levied to tax. There is no provision in service tax law for deeming notional interest on security deposit taken as a consideration for leasing of the immovable property. Therefore, in the absence of a specific provision in law, there is no scope for adding any notional interest to the value of taxable service rendered. Even in the excise law, under Rule 6 of the Valuation Rules, unless the Department shows that the deposit taken has influenced the sale price, notional interest cannot be automatically included in the sale price for the purpose of levy. In the absence of a provision in law providing for a notional addition to the value/ price charged, the question of adding notional interest on the security deposit as a consideration received for the services rendered cannot be sustained.

  In the instant case, it was further held that there was not even an iota of evidence adduced by the revenue to show that the security deposit taken has influenced the price, i.e., the rent in any way. In the absence of such evidence, it is not possible to conclude that the notional interest on the security deposit would form part of the rent. There was no reason for adopting a rate of 18 percent per annum as rate of interest, which is neither the bank rate of interest for deposits or loans or the market rate of interest. Adoption of such an arbitrary rate mitigates against the concept of valuation. Hence, notional interest on interest free security deposit cannot be added to the rent agreed upon between the parties for the purpose of levy of service tax on renting of immovable property. There was also no reason for adopting rate@18% per annum as rate of interest as same was neither bank rate of interest for deposits or loan nor market rate of interest which, being arbitrary rate mitigates against the concept of valuation. Thus, notional interest or deposit could not be added to rent for the purpose of levy of Service Tax [Relied upon: COMMISSIONER OF INCOME-TAX VERSUS JK. INVESTORS (BOMBAY) LTD. - 2000 (6) TMI 9 - BOMBAY HIGH COURT”.

More recently, the stance of non-taxability of notional interest has been upheld by CESTAT in M/S SINGHAL PREMISES PVT LTD VERSUS COMMISSIONER, CENTRAL EXCISE, JAIPUR, M/S STARWOOD REALESTATE PVT LTD VERSUS COMMISSIONER, CENTRAL GOODS & SERVICE TAX, JAIPUR, M/S GREEN WONDER ESTATE PVT LTD VERSUS COMMISSIONER, CENTRAL GOODS & SERVICE TAX, JAIPUR - 2023 (10) TMI 1166 - CESTAT NEW DELHI; M/S SHUBHAM RESORTS (P) LTD. VERSUS COMMISSIONER (APPEALS) , CENTRAL EXCISE & & CENTRAL GOODS AND SERVICE TAX, JAIPUR - 2024 (3) TMI 68 - CESTAT NEW DELHI

It can thus, be conclude that no service tax can be levied in respect of the notional interest earned on the refundable security deposits.