No GST will be applicable on penal interest on delayed loan payment

The penal rate or penal interest is a type of penalty interest levied by the loan provider if a borrower does not pay the loan EMI as per the repayment schedule of the loan. Irrespective of whether you pay monthly EMIs or make the payment quarterly or annually, if the lender does not receive the loan payment by the scheduled date, you will be required to pay penal interest on the same.

However, is such penal interest liable to GST? Can the appellate ruling authority rectify their order when they have ruled that penal interest is liable to GST?

Section 102 of the CGST Act, pertains to rectification of an advance ruling. According to Section 102, the Authority or the Appellate Authority may amend any order passed by it under section 98 or section 101, so as to rectify any error apparent on the face of the record, if such error is noticed by the Authority or the Appellate Authority on its own accord, or is brought to its notice by the concerned officer, the jurisdictional officer, the applicant or the appellant within 6 months from the date of the order.

However, no rectification which has the effect of enhancing the tax liability or reducing the amount of admissible input tax credit shall be made unless the applicant or the appellant has been given an opportunity of being heard.

Let us refer to the case of in Bajaj Finance Limited (GST AAAR Maharashtra), where an application was made for rectification of an order passed by the Appellate Authority of Advance Ruling (AAAR).

Facts of the Case

The Appellant is a non-banking financial company, engaged in providing various types of loans to the customers.
The Appellant, enters into agreements with borrowers/customers for providing loans to them. The loan agreements provide for repayment of the outstanding dues/Equated Monthly Instalments (EMI) through cheque/ Electronic Clearing System (ECS)/ National Automated Clearing House (NACH) or any other electronic or clearing mandate.
The instalment of a loan is computed by taking into consideration the amount of loan, rate of interest, duration for a loan etc. Generally, EMI paid by the customer is a fixed amount paid at a specified date. EMI includes the amount of interest and the principal amount.
In case of delay in repayment of EMI by the customers, the Appellant collects penal/default interest as an additional interest for the number of days of delay as per terms of the agreements executed with the customers.
The penal interest is calculated at a fixed percentage on the overdue loan amounts of the customer. The percentage of penal interest varies from customer to customer, and generally ranges between 2% to 4% per month depending on the product.
The Applicants had contended that the amount charged in the nature of penal interest from its customers consideration received through the way of additional interest and the same would squarely fall under the exemption granted vide Serial No. 27 of the Notification No. 12/2017-Central Tax (Rate) dated 28.06.2017.
The Appellate Authority of Advance Ruling (AAAR) rejected the appeal of the Applicants and held that the consideration received by the Applicants was for tolerating the act of its customers and would be covered by the entry 5(e) of Schedule II of the CGST Act, 2017.

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Provisions of Law

Let us refer to the provisions of law before we move forward.

Notification No. 12/2017-Central Tax (Rate) dated 28.06.2017 provides exemptions from the levy of GST for certain services. According to Serial No. 27 of the Notification No. 12/2017-Central Tax (Rate) dated 28.06.2017, Services by way of:

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);
sale or purchase of foreign currency amongst banks or authorised dealers of foreign exchange or amongst banks and such dealers are exempt from GST.

The appellant was of the opinion that amount charged in the nature of penal interest was exempt due to the above entry. However, AAAR held that the consideration received by the Applicants was for tolerating the act of its customers and would be covered by the entry 5(e) of Schedule II of the CGST Act, 2017.

Schedule II of the CGST Act, 2017 pertains to activities to be treated as Supply of Goods or Services. According to Entry 5(e), agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act shall be treated as supply of services.

However, the Central Government vide its Circular No. CBEC-102/21/2019-GST dated 28.06.2019 had issued certain clarifications in respect of the issue as involved in the present appeal. Vide the above circular, it has been clarified that the transaction of levy of additional/penal interest does not fall within the ambit of entry 5(e) of Schedule II of the CGST Act, 2017 as such levies are in the nature of “interest” as covered by the Notification No. 12/2017-Central Tax (Rate) dated 28.06.2017.

Proceedings of AAAR

The applicant, vide their application, submitted that the AAAR order needed to be rectified due to an error, which was apparent from the face of record, as the said impugned ruling was contrary to the Circular No. CBEC- 102/21/2019-GST dated 28.06.2019 issued by the CBIC, which clarified that the transaction of levy of additional/penal interest did not fall within the ambit of entry 5(e) of Schedule II of the CGST Act, 2017.
Whereas vide the AAAR order, it was held that Additional/Penal Interest charged by the Applicant from their customer for the delayed payment of EMI would fall under the ambit of entry 5(e) of the Schedule II to the CGST Act, 2017, and hence would be subject to GST.
The Applicant further argued that since the aforesaid Departmental Circular was merely clarificatory in nature, therefore the legal provisions in this regard remained the same.
As such no new facts or information had emerged.
Since the interpretation drawn in the impugned ruling was contrary to that of the above said Circular issued by the Board, and therefore, the same can be said to be the error apparent from the face of the record, which warranted rectification in terms of provision of section 102 of the CGST Act, 2017.

The Applicant had also argued that the beneficial Circulars/Notification issued by the Government had the retrospective effect.
They argued that the aforesaid Circular would be deemed to be existing even at the time of passing the ruling.
Thus, basis this deeming provision, they argued that the impugned ruling, which was contrary to the clarification issued vide the aforesaid Board’s Circular, deserves to be rectified.
In this regard, they also placed reliance upon the decision of the Supreme Court in the case of Suchitra Components Ltd. [2007 (208) ELT 321 (SC)] wherein it was held that beneficial circulars have to be applied retrospectively.

On perusal of the above contentions made by the Applicant, it was conceded that the Ruling made in the impugned AAAR Order was contrary to the interpretation of the legal provision as envisaged by the Board, and since the said Board Circular was beneficial in nature, the same needed to be applied retrospectively in keeping with the Apex Court Judgment, relied upon by the Applicant.

Therefore, AAAR intended to rectify the impugned AAAR Order and hold that the additional/Penal interest recovered by the Applicant from their customers against the delayed payment of monthly instalments of the loan extended to such customers, would be exempt from GST in terms of SI. 27 of the Notification No. 12/2017-C.T. (Rate) dated 28.06.2017.

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