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TMI Blog2018 (11) TMI 884X X X X Extracts X X X X X X X X Extracts X X X X ..... enal 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 outstanding dues/Equated Monthly Installments (EMI) thr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s 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 therefore would be exempt from GST. To further emphasis. penal interest should be treated as part ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... inition 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 the installments, the interest for the period of delay is not included in the EMI / installment amount, and is therefore charged separately from ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... kata 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, reliance is placed on the decision of the Hon'ble Supreme Court in the case of Moped India Limited reported at 1986 (23) ELT 8 (SC) = 1985 (2) TMI 42 - SUPREME COURT OF INDIA. It is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e 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 consideration for the promise." B.5 Furthermore, it is submitted that various dictionaries define the term 'consideration as follows: BLACK LAW DICTIONARY Consideration means something which is of value in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 interest is collected only on happening of any event of default by the customers in making the payment of loan installments. It is submitted in this regard that the intention of the parties entering into loan agreement is to gr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... w, 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-court settlements. In the said ruling at Para 73, it has been clarified that the damages are the most common form of remedy arising out of the termination or breach of contract. The damage, loss or injury, being the substance of the dispute, cannot in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in 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 such terms and conditions are not fulfilled, the defaulting party is obligated to make good the loss by paying liquidated damages. Such liquidated damages/penalty cannot itself become consideration for continuing with the main supply of service/ goods by t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... luding 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 is extracted herein below: SECTION 67. Valuation of taxable services for charging service tax. - For the purposes of this Chapter, the value of any taxable service shall be the gross amount charged by the service provider for such service rendered by him. Explanation 1. - For the removal of d ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 8.06.2017. 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 consideration of the said services is represented by way of interest. A.9 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... itional 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 Interest substantiates that it is nothing but the time value of money, in as much as the same is calculated at a fixed rate per annum on the overdue loan installments for the period of delay. A.14 It is relevant to note that the position in the GST regime is similar to the position in the pre GST regime. Therefore, reference is made to the Revised Education Guide on Taxation of Services dated 20.06.2012 issued by the CBEC in erstwhile Service Ta ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s. 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 the time of supply and make an additional charge for doing so. such a charge will be consideration for an exempt supply or credit." ......Emphasis Supplied A.18. In view of the above, it is submitted that even internationally, the Charges for deferment of payment are treated as consideration for exempt supply of credit, and therefore, the penal interest charged in the present case for deferment of the loan instalment should be treated as a consideration for exempt supply of loan, and hence, shall not ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... T 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 under Section 73 and 74 of the Indian Contract Act, 1872, and even without any specific clause in the contract for the damages or compensation payable upon the breach of contract, the party suffering such breach has the statutory right to claim damages or compensation from the party who has broken the contract. C.3 The provisions of Section 73 and 74 are extracted herein below for reference: *73. Compensation for loss or damage caused by breach of contract. When a contract has been broken, the party who suffers by such breach is ent ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... an 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 default, so as to deter the customers from making such default in future. Therefore, looking from this angle, the penal interest charged by the Applicant may be treated as penalty for the breach of the contract. In any case, if it is held to be not penalty, then, the same Shall be treated as liquidated damages. C.9 Therefore, in view of the above discussions, it is submitted that the penal interest charged in the present case shall be treated either as penalty or liquidated damages. C.10 It is submitted that payment of penalty or liquidated damages is not ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f 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 said term has not been defined in the Finance Act, 1994, or the Rules made thereunder, therefore, reference is being made to the meaning given to it in other Statutes, and its dictionary meaning, as under: * Section 2(a) of the Specific Relief Act, 1963: "Obligation" includes every duty enforceable by law. * Commentary on Section 2(a) of the Specific Relief Act, 1963, by Pollock & Mulla, at Pg. No. 1837 of Volume II, 14th Edition, reads as under: "Clause (a): Obligation An obligation is a bond or tie, which constrains a person to do or suffer something; it implies a right ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e 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, the Applicant is legally entitled to recover damages for such breach and also sue the borrower for such breach. D.6 It is further submitted that a sum which is payable in pursuance of a contractual obligation is different from a sum payable on a breach of contractual obligation. Therefore, the penal interest payable by the borrower on breach of its contractual obligation cannot be treated as a payment for any obligation on the Applicant towards the borrower. D.7 In view of the above discussion, it is submitted that in the absence of an agreement by the Applicant to any obligation to tolerate the act of non-payment or delayed p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 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. E.6 Further, in a decision of the Court of Appeal (U .K.) in case of M/s. Vehicle Control Services Limited reported at (2013) EWCA Civ 186, it has been observed that payment in the form of damages/penalty for parking in wrong places/wrong manner is not a consideration for service as the same arises out of breach of contract with the parking manager. E.7 In view of the above di ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tomer 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 referred in the schedule 2. As per schedule 2 para 5 clause (e) "agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act" As per above provision Bounce Charges on Non-performance of a contract is an activity or transaction which is treated as a supply of service and the Applicant is deemed to have received the consideration in the form of charges, liquidated Damages and is accordingly, required to pay tax on such amount. 2) Definitions:- 31) "Consideration" in relation to the supply of goods or services or both includes-- (a) any payment made or to be made, whether in money or otherwise, in respect of, in response to, or for the inducement of, the sup ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s 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 consideration the amount of loan, duration of the loan and the amount of EMI that would be payable. The EMI paid by the customers is a fixed amount payable at a specified date, which includes both interest and the principal amount. In cases of delay in repayment of such EMI by the customers, the Applicant collects penal/default interest (hereinafter referred to as "penal interest'), in terms of the agreements executed by the customers. The same is calculated at a percentage not exceeding a fixed percentage, on the overdue loan amounts of the customer. The percentage of penal interest varies from customer to customer. The Applicant is of the view that penal interest collected from the customer is in the nature of additional interest, and therefore ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ceipt 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 of the GST Act is as follows:- 7. (1) For the purposes of this Act, the expression "supply" includes-- (a) all forms of supply of goods or services or both..............; (b) import of services for a consideration whether or not in the course or furtherance of business; (c) the activities specified in Schedule I, made or agreed to be made without a consideration; and (d) the activities to be treated as supply of goods or supply of services as referred to in Schedule II. (2) Notwithstanding anything contained in sub-section (1),-- (a) activities or transactions specified in Schedule III; or (b) such activities or transactions undertaken by the Central Government..........., shall be treated neither as a supply of goods nor a supply of services. (3) S ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pecifically 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 Act as to which activities should be treated as supply of 'goods' and which activities to be treated as supply of 'services'. The clause does not define 'supply' but classifies the supply into either 'supply of goods' or 'supply of services'. [Clause (e) of Schedule Il defines "agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act" as a Supply of Services]. Further, Sub-section (2) of section 7 states that--- * certain, specified or notified activities shall be treated neither as a supply of goods nor a supply of services. We also find that Sub-section (3) of section 7 states --- * that certain activities would be notified as being - (a) a supply of goods and not as a supply of services; or (b) a supply of services and not as a supply of goods. In the case before us we find that:- * The applicant has given loans to their customers. * The said loans were re ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... includes interest payable in any manner in respect of any moneys borrowed or debt incurred. They have further submitted that the Penal Charges collected by them is an additional interest for the delay in payment of loan installment beyond the due date and 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. Here we would like to mention that the interest is calculated on the entire tenure of the loan given and then on that basis and the amount of loan EMIS are collected from their customers. The interest amounts are not calculated on a monthly basis and therefore it cannot be said that the default charges is for the period of delay not included in the EMI/installment amount. They have also submitted that the amount of overdue loan an installment is virtually a new loan transaction, the consideration for which is the penal interest charged on such overdue loan installment. This assumption by the applicant that the EMI is nothing but a new loan amount advanced to the applicant is not only fallacious but also devoid of merit because from the agreements it is seen that the rate of interes ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n the referred agreement which clearly indicate that the additional interest is not in the nature of interest but is penal charges. Thus we find that the consideration if any as received by the applicant would clearly qualify as 'supply' as per Sr. No. 5(e) of Schedule II of the CGST Act which reads as under:- (5) Supply of Services : The following shall be treated as supply of services:- "(e) Agreeing to the obligation to refrain from an act or to tolerate an act or a situation or to do an act. In the present case as per details presented before us, we clearly find that there is a clear understanding or agreement between the parties to foresee and tolerate an act or a situation of default on the part of loanees for a monetary consideration which is actually a consideration received by the applicant, though in the agreement they may be giving this consideration, other names such as 'penal interest', penal charges, penalty, etc. as thought proper by them, but these different nomenclatures in their Agreement would in no way change the actual nature of monetary "consideration" which would clearly be taxable for the supply of services as per Sr.No. 5(e) of Schedule Il of the CGST A ..... X X X X Extracts X X X X X X X X Extracts X X X X
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