JULY 02, 2020

By Dr Shrikant Kamat

(In this 3 part discussion paper, the author brings out the importance of fintech in the modern world and how India's GST law tries to enable this digital revolution)

GST implications for Fintechs in the e-payments ecosystem in India

Of late, most of us are used to hearing an oft repeated term, 'fintech', in our daily conversations. This is perhaps because fintech has become all pervasive and ubiquitous in our lives. Briefly explained, the term 'Fintech' (shortform for Financial Technology) is often used to refer to modern technology and software that seeks to automate and improve the delivery and use of financial services.

Typically, in a financial ecosystem, there are many non-banking companies, banks, payment processors and remittance firms. But all these participants also means that each follows a unique protocol or process which could be incompatible with the other, thus creating confusion and inefficiency for the consumer. Also, if each of these players charges a fee, the total cost for the consumer could be unaffordable. Besides, there is an overriding concern for security and prevention of fraud amongst the consumers as well as participants that has added a whole new dimension to the way financial transactions are undertaken. This is where Fintech comes into play.

Today, the use of Fintech is fairly widespread in the banking and financial services (BFS) ecosystem across the world and also in India. Among a wide array of applications, the most popular use of fintech is witnessed in payment gateways, digital wallets, point of sale (PoS) systems, payments banks, digital insurance, digital credit rating, asset management, micro finance and consumer loans businesses, among others. The Covid-19 pandemic has contributed in further reinforcing the near total dominance of fintech in the modern day financial world, given the emphasis on undertaking financial transactions in the digital mode.

While the burgeoning volume of electronic transactions propelled by an exponential increase in smart phone usage has helped sustain the fintech revolution, new instruments for financing, lending, etc. have also implied that the client adopting the fintech also comes up with unique or novel instruments that are seen not only as the new disruptors in the market but also as the harbingers of a new class of customers.

Fortunately for the businesses as well as for the fintech companies (software developers), Reserve Bank of India (RBI), the market regulator, is well abreast of the rapidly evolving market and often issues timely guidance on regulating the new regimes for each type of business adopting a unique class of fintechs. However, it is the relatively new Goods & Services Tax (GST) law in India that may not be able to fully support the fintech way of doing business. And this is precisely the objective of this discussion paper - to identify the precise gaps in the GST legislation that could have some potential for foreseeable disputes in the near future and to seek some plausible answers to the seemingly difficult questions.

In this first part, we begin by obtaining deeper insights into the electronic-payments (e-payments) business and how fintech is helping the rapid proliferation of this mode of payment in the times of the Covid-19 pandemic. Then we evaluate the provisions of the GST law that may give rise to ambiguities or disputes in positions so far as applicability of tax or rate of tax is concerned. Besides direct transfer of funds from the customer's bank account to the bank account of the merchant or vendor, there are other electronic modes of payments, discussed below in more detail, that are fast becoming the preferred mode of payment for the customer. We shall analyse the GST implications and potential red flags for these modes in this first part.

The E-Payments Business

Payment process forms an integral part of the customer experience across businesses. Today, the consumer has a variety of payment options to choose from while purchasing a product/service. The customer touch-points have evolved significantly with possibilities of interaction online and offline including in-store/ at the branch, at customer's doorstep, remote or kiosk-based. This has led to a corresponding increase in the complexities involved in accepting payments.

Customer demand as well as competition from non-banking service providers, are driving the proliferation of low-cost, instant or real-time payments systems in domestic markets and currencies. With instant payments services also in place or in development in other major economies worldwide, e-payments have become the norm for domestic B2B and retail payments.

Financial Technologies that embrace cloud, artificial intelligence (AI) and application programming interfaces (APIs) have played important roles in making e-payments faster, more automated and cheaper. Thanks to the outbreak of the Covid-19 pandemic, e-payments is revolutionising payments business like never before.

Mobile Point of Sale (MPoS) Payment

Until a few years back, traditional credit card point of sale (PoS) payment terminals were scarce in smaller cities and towns in India, which meant that customers were forced to rely on cash. This was because purchasing the equipment necessary to process plastic payments in the traditional manner was too expensive for many retailers.

However, all that changed with the introduction of mobile technology. This is because mobile phones and tablets make it possible for merchants to use mobile point-of-sale (MPoS) systems to accept credit and debit cards. A MPoS terminal allows merchants to turn their mobile devices into credit card readers. MPoS systems thus allow merchants to bypass significant obstacles to accepting credit card transactions.

Typically, any MPoS is a single payment platform (app) that supports an array of hardware devices and caters to all payment acceptance needs of fast-growing companies and government organisations. The payments solution is designed and developed to address any and every payment challenges faced by businesses today, including acceptance of all payment modes illustrated below and those that may come in the future through a single solution.

Mobile payment solutions companies adopt either an open or closed architecture. Under the open type, payments can be made at any customer touch-point (in-store, at the branch, customer's doorstep, unmanned kiosks, digital marketplaces) for any mode of payment (Card - Debit and Credit, mobile-wallets, UPI or QR-based payment) using any hardware (Mobile POS, Android POS, Pocket GPRS) at the option of the user with any banking partner. An open platform allows any apps to operate and offers freedom to the merchant to buy from any wholesaler.

On the other hand, closed type solutions can be used only at specified stores or specified e-marketplaces. Closed solutions typically offer more incentives or facilitation to merchants than the open ones. However, merchants may be required to order goods only from select wholesale centres to sell to consumers using the MPoS platform.

In either of the types of mobile payment solutions, local merchants are offered attractive offers to drive footfalls to these merchants and push themselves as the preferred payment mode in these locations. The mobile app offers features that allows merchants to offer customised offers, effectively building a more holistic experience for consumers. Options in the app allows consumers to find different retailers in their vicinity which accept payments through the MPoS platform.

Local stores, mostly run by individual proprietors, are habituated to managing their businesses in a certain way and it's difficult to disrupt the relationship they enjoy with suppliers . More than supply and payments, the relationship hinges on a system of credit, which is crucial for these players to survive. Payment solutions companies are expected to offer the merchants/stores/shopkeepers adequate credit facility once these merchants start transacting through the platform.

Also, MPoS solutions provider companies have to relentlessly ensure that they keep the transaction fee (Merchant Discount Rate/MDR) low lest the merchants resort to cash, their most preferred option for receiving money from the buyer of their goods or services. Expanding their basket of services and diversification has also helped the mobile payments service providers to scale and build a platform essential to sustain a high volume and low margin business model. New and innovative revenue streams are being witnessed for these companies. Further, there are various market opportunities to create an ecosystem around the MPoS terminal by vertical as well as horizontal integration. Hence, these fintech companies are now targeting the wholesale business comprising of retailers and wholesalers . Payments transaction data analysis is emerging as the fastest growing business segment for these payments solutions companies.

Unified Payment Interface (UPI)

UPI is an immediate real-time payment system that helps in instantly transferring the funds between the two bank accounts through a mobile platform. Hence, UPI is a concept that allows multiple bank accounts to get into a single mobile application. This idea was developed by the National Payments Corporation of India (NPCI) and is controlled by the RBI and IBA (Indian Banking Association). ¹ The new payment model allows you to use your smartphones as a virtual debit card. It has also made possible the sending and receiving of money in an instance. It also embraces the concept of the Quick Response (QR) code. A UPI ID, a unique identification for a bank account, can be used to send and receive funds. UPI PIN is a 4-digit personal identification number that must be entered to authorise the transfer of money via UPI. The PIN can be chosen by the account holder. You do not have to remember the receiver's account number, account type, IFSC, and bank name. Instead, you can do the money transfer only by knowing their Aadhaar number, mobile phone number registered with the bank account, or UPI ID. The transaction made on the UPI platform is also supposed to be highly secure as it happens in a highly encrypted format. There are many apps available these days that support UPI payments. ²

Also, the Government of India (GoI) has been the primary catalyst in providing the supply side push to the electronic payments ecosystem in the form of subsidies and incentives to merchants and wholesellers adopting UPI. These factors have led to a surge in the usage of mobile payments among the masses. Eg. GoI launched the BHIM cashback scheme for merchants, incentivising transactions done by unique customers. A referral bonus scheme was also launched for customers for incentivising unique transactions and users. NPCI launched a new category of UPI transactions to assist small merchants expecting inward UPI transactions worth INR 50,000 to accept payments without paying any Merchant Discount Rate (MDR).

Payment gateways

Payment gateways are platforms that enable shoppers to pay for a product or service on a merchant's website. Today, there are countless payment methods such as debit cards, credit cards, digital wallets, MPoS, etc. Typically, banks could charge considerable fees to handle transactions from all these different methods, but Fintech companies are integrating all of these payment methods into convenient apps that online merchants can easily afford and integrate on their website. Typical users of these payment apps would be businesses selling either their physical merchandise or services to end users.

A payment gateway solution company helps businesses in India to both collect and disburse payments via multiple payment modes including credit card, UPI, MPoS, NEFT, Digital Wallets, Buy Now Pay Later option and the traditional EMI option. Payment gateways typically offer -

- plug-n-play international payments by connecting with international payments solutions companies overseas;

- linking of the mobile/digital wallet;

- payout APIs to send money to any bank account, UPI ID, mobile wallet instantly

- Collections by NEFT-IMPS mode

- e-marketplace vendor settlement

- 'Pay Later' options and card-less EMI options

Nowadays, payment gateways in India also provide multi-currency options which come at a higher cost.

Digital wallets

A digital wallet business model typically involves giving users the convenience of making payments for a small fee that is typically charged to businesses in the form of a merchant discount rate (MDR) and via the float that they would make on the money lying unpaid in customer/business accounts. Typical end users of wallets would be businesses selling either their physical products or services in stores to end users.

The Reserve Bank of India has issued further guidelines to ease interoperability between mobile wallets. ³ This facility has enabled wallet users to transfer balance from one wallet service provider to another wallet of a different service provider for a small fee.

Digital banking/Payments Bank

Some fintechs are offering no-frills individual and business bank accounts through a complete digital infrastructure. The business model here is almost identical to that of a bank with physical branches except that with the huge cost savings in manpower and real estate, customers can greatly benefit from competitive rates on deposits. There is one catch though, RBI doesn't permit payments bank to lend hence, these companies earn only from the transaction charges/ fee.

A payments bank typically chases transactions that will result into balances. So whether it's a prepaid or prefunded account like the wallet or whether it is a savings account, it leads to some balances. The payments bank brings cash into the banking system without being permitted to offer loans to its customers.

The other service is when it facilitates bill payments through its accounts and then to merchant payments. This unique business pattern for payments bank in the Indian context is witnessed in the form of a loose tie-up between utilities such as telecom network service providers, payments solutions companies and payments bank. Telecom subscribers need to recharge on a regular basis. The digital recharges have to use some financial instrument. The payment solutions service provider steps in here and offers digital re-charges either through an existing bank account of the network subscriber or by UPI, or any open-loop card. The payments bank offers the settlement services for open-loop instruments. Each one of these are viewed as a service to the telecom service providing company and that is one of the revenue streams for the payments bank.

Besides, utility bill payments is a big market for the payments business. In India, where more than 80% of the bills today are still not paid digitally, Government is incentivising online payments of utility bills. The Bharat Bill Pay System (BBPS), run by the National Payments Corporation of India (NPCI), has connected billers and financial services players as authorised operating units. Typically, a Payments Bank is a customer operating unit in BBPS and the telecom services provider is a biller operating unit. Through this, all categories of bills - postpaid, cable and other utility bills under the utility, electricity, landline and other categories as expanded by BBPS are covered. So a consumer of the utility has the ability to pay digitally through a single app (application). This is how fintech works in the payments bank business. It even encompasses the entire process of integration, payments and settlements.

So what are the GST specific challenges for the e-payments business?

Now that we have some idea of different e-payment modes that are essentially fintech driven, this sets the stage to delve deeper into the issues that these fintechs could potentially face on GST applicability, input tax credit availability, tax payment and compliance.

Given that there are multiple persons contributing to an e-payments ecosystem, there may arise cases where an e-payment platform may not be specifically owned by any one person but many could be operating on it and also enabling each other. This challenges the concept of supply as we understand it from the GST law currently in force in India. ⁴

Multiple fintech companies, banks, non-banking companies, etc. enable each other's activities to see through a successful e-payment transaction. There is neither any agency agreement between them nor do they receive consideration from each other. In other words, the essential ingredients of a supply transaction under GST law may not necessarily get established yet there is no denying the fact that without every single participant, the e-payments ecosystem would not work effectively.

In a dispute in the erstwhile Service Tax regime, the Honourable Tribunal had categorically held that if a particular activity does not involve development of Information Technology (IT) Software, adoption or adaptation service related to IT software or certification of IT Software, the activity would not fall under Information Technology Services. ⁵ Fintechs can take heart from this case and hope that so long as they are merely allowing another participant in the payment ecosystem to use their software or platform without really any underlying consideration, GST implications on the same wouldn't arise.

However, even if by any stretch of legal reasoning one holds such loose enabling arrangements between the fintechs and other participants to be supply, question that would arise is on ascribing the precise value to such 'supply transactions'. ⁶ Sharing of customer data base, customer buying habits information, results of other data analytics tools with other participants may not really have any prior guidance which may be the root cause of ambiguities or potential difference in view point between fintechs and tax authorities.

Also, there could be some difficulty in identifying the exact service provider where multiple fintechs are working in collaboration or in classification of the service if there is a layer of transactions that need to be enabled to facilitate an e-payment transaction.

Then there is the interesting issue of deposits received by Fintechs/ Payment Solutions providers from Merchants for deployment of MPoS terminals at their premises. Given the watertight definition of the term 'consideration' in GST law ⁷ and the accounting treatment in the books of the Fintechs for such devices, it may be difficult to make these deposits exigible to GST. However, since the deployment of these devices is essentially at the premises of the merchants, eligibility to Input Tax Credit to the Fintechs on such devices could be questioned by GST Authorities.

Given the limitation of space and the demand on your time, it is most appropriate that these and many such interesting issues may be taken up in the next part of this discussion paper.

… to be continued

(The author is Advocate & Counsel - Taxation & Commercial Laws, Founder & Proprietor - Shrikant Kamat & Associates.)

¹Source: The economic times

²Source: Cleartax accessed

³RBI Notification No. RBI/2018-19/61: DPSS.CO.PD.No.808/02.14.006/2018-19 dated 16th October, 2018

⁴ Under Section 15 of the Central GST Act, 2017, "supply" includes all forms of supply of goods or services or both such as sale, transfer, barter, exchange, licence, rental, lease or disposal made or agreed to be made for a consideration by a person in the course or furtherance of business; import of services for a consideration whether or not in the course or furtherance of business; and among other things specified, supply of goods or services or both between related persons or between distinct persons , made or agreed to be made without a consideration.

⁵Sify Technologies Ltd. Vs CCE & ST, LTU Chennai; 2018-TIOL-954-CESTAT-MAD

⁶Rule 27 of the CGST Rules, 2017 which deals with valuation of services when consideration is not in money terms, states that, "Where the supply of goods or services is for a consideration not wholly in money, the value of the supply shall,-

(a) be the open market value of such supply; (b) if the open market value is not available under clause (a), be the sum total of consideration in money and any such further amount in money as is equivalent to the consideration not in money, if such amount is known at the time of supply;

(c) if the value of supply is not determinable under clause (a) or clause (b), be the value of supply of goods or services or both of like kind and quality;

(d) if the value is not determinable under clause (a) or clause (b) or clause (c), be the sum total of consideration in money and such further amount in money that is equivalent to consideration not in money as determined by the application of rule 30 or rule 31 in that order."

⁷ Section 2(31) of the CGST Act, 2017 states , "… Provided that a deposit given in respect of the supply of goods or services or both shall not be considered as payment made for such supply unless the supplier applies such deposit as consideration for the said supply"