No service tax payable on penal interest & cheque bouncing charges

The CESTAT Mumbai recently held that penal interest and cheque bouncing charges received by Bajaj Finance as “consideration” for “tolerating an act” are not leviable to service tax under Section 66E(e) of the Finance Act, 1994.

The Division Bench of S.K. Mohanty (Judicial Member) and M. M. Parthiban (Technical Member) has observed that “the issue of penal charges in respect of delay in payment amounting to declared service as contemplated by the department under section 66E(e) of the Finance Act, on which service became taxable w.e.f. July 1, 2012, has already been decided by Principal Bench of this Tribunal in the case of M/s. South Eastern Coalfields Ltd. Vs. Commissioner of Central Excise and Service Tax in Final Order No. 51651/2020 dated 22.12.2020. In this case, the Tribunal had held that the penal clauses are in the nature of providing a safeguard to the commercial interest of the appellant and it cannot, by any stretch of imagination, be said that recovering any sum by invoking the penalty clauses is the reason behind the execution of the contract for an agreed consideration”.

Accordingly, the Bench concluded that the demand for service tax in respect of the amount collected on account of bouncing of cheques cannot be sustained, as the charges are penal in nature and thus are not towards consideration for any service.

Advocate Vinay Jain appeared for the Appellant, whereas the Respondent was represented by Advocate Nitin Ranjan.

Briefly, the appellant/assessee, Bajaj Finance, a NBFC, is engaged in the business of providing various types of finance, such as auto loans, personal loans, consumer durable loans, loans against property, etc., to various customers and borrowers. The loan agreements provide for the repayment of the outstanding dues or Equated Monthly Instalments through cheque, electronic clearing systems (ECS), or any other electronic or clearing mandate on the due dates stipulated in the agreement. In case of delay in payment of dues by the customers or borrowers, the appellants collect ‘penal interest’ as additional interest for the number of days of delay in terms of the agreement executed by the customers or borrowers. The appellants collect ‘bounce charges’ on account of dishonour of a cheque, ECS, or any other electronic or clearing mandate given by the customers or borrowers, which is in line with agreed terms and conditions.

During assessment, the AO interpreted that the penal interest and bounce charges are not part of the EMI of the loan amount or principal loan amount, and these are extra amounts imposed by the appellants as penal interest and bounce charges, which are accounted for in the profit and loss accounts.

Hence, the Department treated it as compensation received by the appellants on account of delay in payment of EMI by the customer or borrower, and these are part of consideration for declared services provided by the appellants, i.e., service of tolerating the act of delay or default by customers or borrowers.

Later, the show cause proceedings were initiated for the recovery of service tax, which was adjudicated by the Commissioner in concluding that the activity of appellants in tolerating the act of ‘default and non-payment and late payment in payment of EMI by the borrowers and dishonour of payment instruments towards repayment of loan instalments’ as ‘Declared Service’ of ‘agreeing to tolerate an act or situation’ in terms of Section 66(E)(e) read with Section 65B(22) of the Finance Act, 1994 and treating it as ‘service’ in terms of Section 65B(44) and ‘taxable service’.

The assessee contended that they were under the bona fide belief that the penal interest collected by them was additional interest on the loans and advances provided by them and that the same was exempt from payment of service tax.

The appellants were also under the bona fide belief that bounce charges collected from their customers or borrowers were merely in the nature of penalties, liquidated damages, or compensation for the breach of the terms and conditions of the loan agreement. The assessee therefore, urged that damages, penalties, or compensation for breach of contract are not consideration for any service and thus not leviable to service tax.

Opposing the same, the Department contended that an activity of tolerance of a situation of delay in payment of EMI is adequately covered in the second expression ‘to tolerate an act’ provided in clause 5(e) of Schedule II to the CGST Act, 2017, enumerating activities or transactions to be treated as supplies of goods or services.

The Department also highlighted that a tolerance of an activity of delay in payment is against the agreed consideration, and it is in the form of penal charges or penalties, since it was agreed between appellant and borrower or customer that in case any delay has occurred, the appellants are entitled to recover the penal charges or penalty from defaulting borrowers.

After considering the submission, the CESTAT found that the issue regarding charging of penal interest in respect of delay in payment of EMI, had been examined by the Ministry of Finance in the context of applicability of GST and it was clarified vide CBIC Circular No. 102/21/2019-GST dated 28.06.2019, 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 i.e. “agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act”, as this levy of additional/penal interest satisfies the definition of ‘interest’ as contained in Notification No.12/2017-Central Tax (Rate) dated 28.06.2017.

Accordingly, it was clarified that ‘penal interest’ charged on a transaction would not be subject to GST, added the Bench.

The CESTAT therefore held that the additional or 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.

Cause Title: M/s Bajaj Finance Ltd. Versus Commissioner of Central Excise & GST, Pune-I [Service Tax Appeal No. 90043 of 2018 / 2023-Enterslice-2-CESTAT-Mum]

Click here to read/ download the Order

Bajaj-Finance-Ltd-Versus-Commissioner-of-Central-Excise-and-GST-Pune