This tax newsletter summarises the recent ruling of CESTAT, Chennai in the case of Commissioner of Service Tax, Chennai vs M/ Repco Home Finance Limited on non - applicability of Service tax on loan foreclosure charges.

It is imperative to note that principles of this judgement shall have wide reaching implications and a substantial bearing on interpretation of provisions under the negative list as well as the Goods and Services Tax (GST) regime, as it lays down important parameters to determine the applicability of tax on contractual damages/penalties.

There has been much debate and controversy on the taxability of such payments, including payment towards damages for breach of contract, liquidated damages, notice pay recovery, etc., in the pre-GST and the GST regime. As the ruling pertains to the period prior to July 2012, it would be relevant to examine the applicability of this ruling in the negative list and GST regime in light of the declared service provision, considering that the EU VAT directives and the ECJ ruling referred by the Tribunal provide that the ‘supply of services’ includesinter alia ‘an obligation to refrain from an act or to tolerate an act or situation’.

 The Key observations of the Ruling are:

• Consideration as defined under section 2(d) of the Indian Contract Act, 1872 should flow at the desire of the promisor;

• There is a marked distinction between conditions contained in the contract and consideration for the contract;
• Foreclosure of loan results in breach of one of the essential terms of the loan agreement. The charges are imposed as a condition of contract to compensate for loss of interest;
• The amount of damages is clearly stipulated in the contracts and no element of service is sought to have been rendered by the banks to borrowers/customers;
• Foreclosure is antithesis to lending and, therefore, cannot be construed to be ‘in relation to lending’;
• Thus, foreclosure charges collected by the banks and non-banking financial companies on premature termination of loans are not leviable to service tax under ‘banking and other financial services’.

A copy of the press release has been enclosed for your reference.

For additional information or queries, please feel free to reach out to our tax partner:

Ms.Shampa Bhattacharya (Partner - Indirect Tax) at shampa.bhattacharya@kochhar.com

for more information please click the link below :

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