AAAR upheld the order of AAR that penal interest charged by NBFC to its borrower for default in payment of EMI would attract GST in terms of section 7(1)(a) of CGST Act, 2017 read with entry No. 5(e) of Schedule II of CGST Act, 2017

FACTS

The applicant NBFC charges interest to its customers / borrowers on loans granted and in case of delay in repayment of EMI, the appellant collects penal / default interest (penal interest) in terms of the agreements executed by the customers. The appellant is of the view that penal interest collected from the customer is in the nature of additional interest and, thus, not leviable to

GST. When the appellant filed an application for advance ruling, AAR ruled that penal interest charged by appellant amounts to the supply of services under serial number 5(e) of Schedule II to the CGST Act and is therefore liable to GST. Hence the appeal.

RULING

As regards appellant’s contention that penal interest is in the nature of additional interest, AAAR noted that the agreement between appellant and customer has defined separately the terms ‘Default Interest’, ‘Penal Charges’ and ‘Bounce Charges’, but they are exclusive and what the appellant recovered from his customer is only the penalty for delayed payment of EMI under the term ‘Penal Charges’. Therefore, AAAR held that the penalty recovered by the appellant does not get covered by the term ‘penal interest’ as contended by the appellant, because per se it is not interest but a penalty / penal charges. Further, AAR held that since the definition of ‘interest’ given under clause 2(zk) of Notification No. 12/2017-CTR defines interest only to mean interest in respect of any amounts of money borrowed or debt incurred but does not include any other charges in respect of the amounts of money borrowed or debt incurred, the term ‘interest’ cannot be given extended meaning to include penal charges.

AAAR observed that the substance of the transaction is that the penal charges occur on the failure of the customer to adhere to the conditions of repayment of EMI as per the agreement. Thus, it is not the nomenclature in the agreement but the nature defined in the agreement that is important, that the appellant is entitled to recover and the borrower agreed to pay it. It was noted that one of the important tests to determine whether the levy is penal in nature is to see whether it is for the non-compliance of provisions and if any criminal liability or prosecution is provided, the levy is surely penal in nature. AAR held that the said test is surely passed by the penalty / penal charges in the present case as the consequences provided in the agreement for non-compliance of it may be a prosecution under the Negotiable Instruments Act. Hence, the penalty levied by the appellant cannot be termed as ‘additional interest’ but penal charges.

AAAR held that since there is a mutual agreement between the appellant and the borrower, it can be said that the appellant has tolerated an act or situation of default by the borrower, for which it is recovering some amount in the name of penal charges / penalty. Consequently, AAAR upheld the decision of AAR in terms of section 7(1)(a) of CGST Act, 2017 read with Entry No. 5(e) of Schedule II of CGST Act, 2017.