MARCH 06, 2018

By Brijesh Kothary

IN the recent past, many instances of financial fraud pertaining to banks have come into light. The quandary of non-performing assets has also severely impacted the operations of banking and financial institutions in India. It is expected that the lending to corporates would be choked as a fallout of the recent fraud involving public sector banks. It is also likely that the banks will squeeze lending operations and focus on scattering their loan portfolios, thereby widening their customer base and limiting the quantum of advances per borrower.

Various surveys have identified financial crunch due to lack of access to capital via loans and borrowings to be one of the reasons for closure of many promising startups in India. Funding is the fuel on which a business progresses. Many companies therefore turn to their group entities for funds. Inter-corporate deposits, loans and advances are a popular source of short-term finance. Companies with excess funds often find it safe to lend them to their group entities, while the borrower benefits from lower interest rates and lenient credit terms.

The companies can lend money, subject to the limits and in compliance with Section 186 of the Companies Act, 2013. It is mandatory for the lenders to charge interest at a rate not lower than the prevailing yield of one, three, five or ten year Government Security closest to the tenor of the loan. The lending companies are required to charge interest on loans given even to their wholly owned subsidiaries.It is therefore important to examine the tax implications on the interest earned on inter-corporate deposits, loans and advances, under the Goods and Services Tax (GST) law.

Tax on interest earned by lending company

Primarily, the following conditions are required to be fulfilled for an activity to be taxable in terms of the provisions of Section 7, 9, 11 and Schedule I to the Central Goods and Services Tax Act, 2017 (for brevity, CGST Act):

- There should be a supply of goods or services or both;

- Such supply is to be made or agreed to be made for a consideration;

- The said supply is made in the course or furtherance of business; and

- The activity is not specifically exempted by way of any Notification.

It is essential to analyse each of the above conditions to examine if the activity of extending deposits, loans or advances, where the consideration is represented by way of interest, can be considered as taxable supply under GST law.

The definition of service under Section 2 (102) of CGST Act means anything other than goods, money and securities. In transactions relating to inter-corporate borrowings, the lender extends deposits to its group entities and in-turn receives consideration by way of interest. The consideration for the supply is represented by way of interest hence the same cannot be regarded as transaction in money. Therefore, the activity of providing services of extending deposits, loans or advances where the consideration is represented by way of interest would be considered as supply of services. Therefore, the first ingredient for a transaction to qualify as a taxable supply is satisfied.

The second ingredient of supply is in relation to the consideration against supply. It may be pertinent to note that the criterion of consideration for a supply is not mandatory for transactions with related persons in terms of entry 2 of Schedule I, read with the Explanation to Section 15 of the CGST Act. Further, as indicated supra , Section 186(7) of the Companies Act, 2013 provides threshold rate of interest for lending money by a company, which must be complied for a company to lend money.

The activity of providing services by way of extending deposits, loans or advances, where the consideration is represented by way of interest in the hands of a lending company can be regarded to be in the course or furtherance of its business and hence the third ingredient for a transaction to qualify as a taxable supply is also satisfied.

Notification No. 12/2017- Central Tax (Rate) dt. 28.06.2017, as amended, provides a list of services exempted from payment of Central Tax on intra-State supply. Entry 27(a) of the Notification relates to services by way of extending deposits, loans or advances in so far as the consideration is represented by way of interest. The relevant part of the Notification is extracted hereunder:

The services under consideration is covered under the above Notification. Therefore, such services are exempted from payment of GST and the lending company is not required to discharge GST on the activity of providing services by way of extending deposits, loans or advances where the consideration is represented by way of interest.

Input Tax Credit eligibility

The primary condition for taking input tax credit in respect of any supply of goods or services or both under GST law is that such supply is used or intended to be used in the course or furtherance of business of the recipient. The other conditions relating to possession of tax invoice, receipt of goods/services, payment of tax and filing of returns as provided under Section 16(2) of the CGST Act must also be fulfilled.

In addition to the above conditions, the restrictions in taking input tax credit under Section 17 of CGST Act must also be examined, which provides for apportionment/reversal of input tax credit to the extent goods or services or both are used for providing supplies for non-business purpose and exempt supplies. As per Section 17(2) of CGST Act, where the goods or services or both are used partly for effecting taxable supplies and partly for effecting exempt supplies, then the amount of credit shall be restricted to so much of the input tax as is attributable to the said taxable supplies.

The Central Goods and Services Tax Rules, 2017 (for brevity, CGST Rules) is amended vide Notification No. 3/2018-Central Tax, dated 23.01.2018, wherein the Explanation to Rule 43 has been substituted to provide that the value of services by way of accepting deposits, extending loans or advances, etc. shall not be included in the aggregate value of exempt supplies for the purpose of reversal of input tax credit. The relevant portion of the CGST Rules is extracted hereunder:

Explanation :-For the purposes of rule 42 and this rule, it is hereby clarified that the aggregate value of exempt supplies shall exclude:-

(a)…

(b) the value of services by way of accepting deposits, extending loans or advances in so far as the consideration is represented by way of interest or discount, except in case of a banking company or a financial institution including a non-banking financial company, engaged in supplying services by way of accepting deposits, extending loans or advances;

(c) …

[Emphasis supplied]

By virtue of the above amendment, lending companies providing exempt supplies would not be liable to apportion input tax credit of GST paid on common inputs and input services under Rule 42 of the CGST Rules.

Retrospective applicability of substitution amendment

In the above paragraphs, we have concluded that interest earned by a lending companies for providing inter-corporate loans and advances is exempted from payment of GST. We have also concluded that the lending companies are not required to reverse input tax credit of GST paid on common inputs and input services, though the activity of lending is exempted from payment of tax. It is pertinent to note that the amendment relating to non-reversal of input tax credit was introduced vide a Notification dated 23.01.2018 by way of a substitution. It is, therefore, important to examine if there would be an exposure for reversal of input tax credit for the period starting from the date of introduction of GST to the date of substitution i.e., from 01.07.2017 to 22.01.2018.

For enacting an amending law, it is alegislative practice to delete an existing provision and substitute a new provision. If there is both repeal and introduction of another provision in place thereof by a single exercise, the expression substituted is used. Such deletion has the effect of the repeal of the existing provision and also introduction of new provision.   It is now being examined if this amendment can be interpreted retrospectively, in favour of the assessee, to say that the assessee is not liable to reverse input tax credit in respect of inputs and input services that are attributable to services of extending deposits, where consideration is represented by way of interest.

Reliance can be placed on the following judgments holding that anamendment by way of substitution has retrospective operation:

- Chunnilal Sohanraj v. Gurushantappa [1972(1) Mys.L.J. 327 DB]

- The Hassan Co-operative Milk Producers Societies Union Limited v. State of Karnataka [AIR 2014 Kant 120]

- Commissioner of Central Excise and Service Tax v. Fosroc Chemicals - 2014-TIOL-1609-HC-KAR-CX.

- Government of India v. Indian Tobacco Association - 2005-TIOL-109-SC-CUS

- Commissioner of Income Tax (Central) v. Vatika Township (P) Ltd. - 2014-TIOL-78-SC-IT-CB

Thus, what emerges from the aforesaid judgments of the Honourable Courts is that an amendment which has the effect of substitution of a provision has the effect of replacing the old provision by the substituted beneficial provision and the same must be construed as if it has been incorporated in the Rules, right ab initio.

It can, therefore, be inferred that as per the substituted Explanation to Rule 43 of the CGST Rules, the value of services by way of extending deposits, loans or advances, etc. is not includable in the aggregate value of exempt supplies for the purpose of apportionment of input tax credit, with retrospective effect from 01.07.2017. However, the above interpretation regarding retrospective applicability of the Explanation may be prone to litigation and may invite scrutiny from departmental authorities.

In all fairness, the Board should come out with a clarification quickly and show to the Trade & Industry that they sincerely intend to have a Good and Simple Tax.

(The author is Principal Associate, Lakshmikumaran & Sridharan, Bangalore and the views expressed are strictly personal.)