Financial Sector - Service Tax Practice Manual / Ready Reckoner - Service Tax

Chapter 14 Financial Sector Effective date: 1.7.2012 Scope of Negative Service Section 66D(n) Services by way of (i) extending deposits, loans or advances in so far as the consideration is represented by way of interest or discount; (ii) inter-se sale or purchase of foreign currency amongst banks or authorized dealers of foreign exchange or amongst banks and such dealers; It may be noted here that if bank is charging any Bank commission for providing various services for issuing, pay order, demand draft or bank guarantee, will not be covered in this entry. Also charges related to minimum balance requirements, use of Safe deposits lockers/vaults loan processing charges will be out of this entry. In case of remittance of money, it is clarified by The CBEC vide Circular no. 163/14/2012-ST, dated 10-7-2012 that remittance of money is transaction in money. The definition of service excludes transaction in money. In cases, fees or conversion charges are levied for sending such money from outside India, they are also not liable to service tax as the person sending the money and company conducting the remittance are located outside India. Therefore the place of provision of service will be outside India. It is further clarified that even the Indian counterpart bank or financial institution who charges the foreign bank or any other entity for the service provided at the receiving end, is not liable to service tax as the place of provision of such service shall be the location of the recipient of the service. Meanings and Definitions: Section 65B(14) - authorised dealer of foreign exchange shall have the meaning assigned to authorized person in clause (c) of section 2 of the Foreign Exchange Management Act, 1999; (42 of 1999.) Section 65B(30) - interest has the meaning assigned to it in clause (28A) of section 2 of the Income-tax Act, 1961; (43 of 1961.) Clarification by the Board (Taxation Guide Guidance Note 4 Exemptions dated 20.06.2012) 4.14 Financial sector 4.14.1 What is the manner of dealing with various services provided by banks and other financial institutions? Banks and financial institutions provide a bouquet of financial services relating to lending or borrowing of money or investments in money. For such services invariably a variety of instruments, often complex in nature, are used in the financial markets. Transactions in such instruments have to be examined on the touchstone of definition of 'service' given in clause (44) of section 65B and the list of services specified in the negative list to see whether such transactions would be chargeable to service tax. Broadly, the following legal provisions would have a bearing on determining the taxability of such transactions. The definition of 'service' excludes activities that constitute only transactions in money or actionable claims. 'Money' has been defined in clause (33) of section 65B to include instruments like cheques, drafts, pay orders, promissory notes, letters of credit etc. Therefore activities that are only transactions in such instruments would be outside the definition of service. This would include transactions in Commercial Paper ('CP') and Certificate of Deposit ('CD') (on the understanding of being in the nature of promissory notes), issuance of drafts or letters of credit etc. Explanation 2 to clause (44) of section 65B has to be kept in mind which clarifies that transaction in money does not include any activity in relation to money by way of its use or conversion by cash or by any other mode, from one form, currency or denomination to another form, currency or denomination for which a separate consideration is charged. The implications of this explanation are that while mere transactions in money are outside the ambit of service, any activity related to a transaction in money by way of its use or conversion by cash or by any other mode, from one form, currency or denomination to another form, currency or denomination would not be treated as a transaction in money if a separate consideration is charged for such an activity. While the transaction in money, per-se, would be outside the ambit of service the related activity, for which a separate consideration is charged, would not be treated as a transaction of money and would be chargeable to service tax if other elements of taxability are present therefore service tax would be levied on service charges normally charged for various transactions in money including charges for making drafts, letter of credit issuance charges, service charges relating to issuance of CDs/CPs etc. Activities that constitute only transactions in 'goods' are also excluded from the definition of service. 'Goods' have been defined in clause (25) of section 65 B to include 'securities'. Definition of 'securities include 'derivatives'. These two instruments have been discussed in detail in point no. 2.6.6 to 2.6.8. Transactions in instruments like interest rate swaps and foreign exchange swaps would be excluded from the definition of 'service' as such instruments are derivatives, being securities, based on contracts of difference. Since only transfer of title in securities is excluded from the definition of 'service' any attendant service charges or fees would be chargeable to service tax. Further services by way of extending deposits, loans or advances in so far as the consideration is represented by way of interest or discount. This has been explained in point nos. 14.2 to 14.4 below. 4.14.2 What are the services by way of extending deposits, loans or advances in so far as the consideration is represented by way of interest or discount ? The negative list entry covers any such service wherein moneys due are allowed to be used or retained on payment of interest or on a discount. The words used are 'deposits, loans or advances and have to be taken in the generic sense. They would cover any facility by which an amount of money is lent or allowed to be used or retained on payment of what is commonly called the time value of money which could be in the form of an interest or a discount. This entry would not cover investments by way of equity or any other manner where the investor is entitled to a share of profit. Illustrations of such services are - Fixed deposits or saving deposits or any other such deposits in a bank or a financial institution for which return is received by way of interest. Providing a loan or overdraft facility or a credit limit facility in consideration for payment of interest. Mortgages or loans with a collateral security to the extent that the consideration for advancing such loans or advances are represented by way of interest. Corporate deposits to the extent that the consideration for advancing such loans or advances are represented by way of interest or discount. 4.14.3 If any service charges or administrative charges or entry charges are recovered in addition to interest on a loan, advance or a deposit would such charges be also a part of this negative list entry? No. The services of loans, advances or deposits are exempt in so far as the consideration is represented by way of interest or discount. Any charges or amounts collected over and above the interest or discount amounts would represent taxable consideration. 4.14.4 To what extent is invoice discounting or cheque discounting or any other similar form of discounting covered in the negative list entry? Such discounting is covered only to the extent consideration is represented by way of discount as such discounting is nothing else but a manner of extending a credit facility or a loan. 4.14.5 Would services provided by banks or authorized dealers of foreign exchange by way of sale of foreign exchange to general public be covered in this entry? No. This entry only covers sale and purchase of foreign exchange between banks or authorized dealers of foreign exchange or between banks and such dealers. 4.14.6 Would transactions entered into by banks in instruments like repos and reverse repos be covered in this negative list entry? Section 45U(c) of the RBI Act, 1934 defines 'repos' as' an instrument for borrowing funds by selling securities with an agreement to repurchase the securities on a mutually agreed future date at an agreed price which includes interest for the funds borrowed'. Section 45U (d) of the RBI Act, 1934 defines 'reverse repos' as' an instrument for lending funds by buying securities with an agreement to resell the securities on a mutually agreed future date at an agreed price which includes interest for the funds lent'. Repos and reverse repos are financial instruments of short term call money market that are normally used by banks to borrow from or lend money to RBI. The margins, called the repo rate or reverse repo rate in such transactions are nothing but interest charged for lending or borrowing of money. Thus they have the characteristics of loans and deposits for interest. However they are more appropriately excluded from the definition of service itself being the sale and purchase of securities, which are goods. 4.14.7 Would subscription to or trading in Commercial Paper (CP) or Certificates of Deposit (CD) be taxable? Commercial Paper ('CP') and Certificate of Deposit ('CD') are understood as unsecured money market instruments issued in the form of a promissory note or in a dematerialized form through any of the depositories approved by and registered with SEBI. CPs are normally issued by highly rated companies, Primary Dealers and Financial Institutions at a discount to the face value. On the maturity date, the holder of CPs receives the income in the nature of discount or interest from the issuer. CDs can be issued by Scheduled Commercial Banks (excluding RRBs and Local Area Banks) and All - India Financial Institutions (FIs) permitted by RBI. Promissory note is included in the definition of money in the Act as given in clause (33) of section 65B . Thus both the issue and subscription to such commercial paper will be a transaction in money. However if some service charges or service fees or documentation fees or broking charges or such like fees or charges are charged, the same would be considerations for provision of service and chargeable to service tax. 4.14.8 Would forward contracts in commodities or currencies be within the ambit of definition of 'service'? A forward contract is an agreement, executed today, to purchase or sell a pre-determined amount of a commodity or currency at a pre-determined future date at a pre-determined price. The settlement could be by way of actual delivery of underlying commodity/currency or by way of net settlement of differential of the forward rate over the prevailing market rate on the settlement date. In a forward contract effectively two contracts are entered into, one for purchase and other for sale at a future date at a pre-determined price. These contracts would be in the nature of transfer in title in goods (in case the forward contract relates to a commodity) or transaction only money (in case the forward contract relates to transaction and money). Therefore, forward contracts in commodities or currencies would not fall in the ambit of definition of 'service'. However if some service charges or service fees or documentation fees or broking charges or such like fees or charges are charged, the same would be considerations for provision of service and chargeable to service tax. 4.14.9 Would 'future contracts' be chargeable to Service tax? Future contracts are similar to forward contracts. Main difference is that in future contracts, the underlying are stocks or index of stocks or certain approved currencies and the settlement happens only by way of net settlement with no actual delivery. Another difference is that future contracts are traded only on recognized stock exchange while forward contracts may also be traded over-the-counter. Since future contracts are in the nature of contracts of difference based on the prices of underlying stocks or index of stocks or approved currencies, they would be outside to the ambit of definition of 'service' as being transactions only in money or transfer of title in derivatives. 4.14.10 Would charges for late payment of dues on credit card outstandings be chargeable to service tax? In case of a credit card, issuing entity allows the facility of payment of the purchases made by the card holder within a specified period failing which some charges are levied. The question that arises is whether the credit so extended for this payment is in the nature of a loan or advance for interest. Interest for delayed payment of any consideration for the sale of goods or provision of service has been specifically excluded from value by rule 6 of valuation rules. Thus ordinarily any interest charged for delayed payment of consideration would have been outside the gambit of service tax. However in the case of credit cards the credit extended is not for the delayed payment of consideration for the provision of services. The services in the case of the credit card are by way of levy of issuing charges or the commission charged from merchants etc. The interest in this case is not for the consideration for the use of the card. Thus the benefit under the valuation rules will not be available to credit card companies. The other question is whether such credit extended will amount to loans or advances. Loans and advances are meant to signify amounts contractually negotiated as such (loan or advance) and not merely failure to pay an amount at the due date. The exorbitant charges have also no relationship with the prevailing interest for the same class of creditworthiness and are in the nature of consideration for the services rendered for using the convenience of using the services by way of a credit card and hence taxable.