Rajasthan Financial Corporation vs Commissioner Of Central Excise Commissioner Of Central Excise

Raju, Member (T)

These appeals have been filed by Rajasthan Financial Corporation against orders of Commissioner (Appeals) confirming demand of service tax.

Learned counsel pointed out that service tax has been demanded under the head of banking and financial services in respect of charges collected by them in respect of i) Service charge received against WCTL ii) income from pre-payment for financial charges received against seed capital iii) registration charges on the one time settlement. Learned counsel pointed out that the appellants are engaged in providing banking and other financial services. The objection regarding taxability of amounts received under aforesaid heads was raised during audit objection, the learned counsel pointed out that these issues have been decided by Tribunal in their own case vide order No. 50303/2023 dated 13.03.2023.

Learned Authorized Representative relies on the impugned order.

We have considered the rival submissions. We find that the issues raised in these proceedings are already covered by the decision of Coordinate Bench in appellant’s own case as under:

“(ii) Seed Capital Assistance Scheme: We have carefully gone through Seed Capital Loan Scheme document. Paragraph 7 under heading terms and conditions of the assistance, states the following:

“(i) Rate of Interest

The seed capital (soft loan) will carry a nominal service charge at 1% per annum for the first five years and interest at 10% per annum thereafter. IDBI would levy service charge of three-fourth of 1% on the amount disbursed to SDICs/ SFCs from the date of disbursement for the first 5 years and 9.5% per annum thereafter.”

From the above, it is amply clear that though the term used in ‘service charge’ but the underlying nature of the 1% and 10% is nothing but interest on the seed capital loan, extended to the entrepreneurs. Therefore the same is not liable to service tax. As observed, it is a settled principle of law that interest on loans is not taxable to service tax.

(iii) Service tax on the service charge for prepayment/foreclosure of premature payment of loan:

We note that the leviability of Service Tax on foreclosure has been examined in detail by this Tribunal in Repco Home Finance Ltd.7 The relevant paragraphs are extracted below:

“21. It is, thus, clear that where service tax is chargeable on any taxable service with reference to its value, then such value shall be determined in the manner provided for in (i), (ii) or (iii) of sub-section (1) of Section 67. What needs to be noted is that each of these refer to “where the provision of service is for a consideration”, whether it be in the form of money, or not wholly or partly consisting of money, or where it is not ascertainable. In either of the cases, there has to be a “consideration” for the provision of such service. Explanation to sub-section (1) of Section 67 defines “consideration” to include any amount that is payable for the taxable services provided or to be provided, or any reimbursable expenditure, or any amount retained by the lottery distributor or selling agent. It is clear from the aforesaid definition of “consideration” that only an amount that is payable for the taxable service will be considered as “consideration”. This apart, what is important to note is that the term “consideration” is couched in an “inclusive” definition.

A Larger Bench of the Tribunal in Bhayana Builders (P) Ltd. v. Commissioner of Service Tax [2013 (32) S.T.R. 49 (Tri. - LB)] observed that “implicit in the legal architecture is the concept that any consideration whether monetary or otherwise, should have flown or should flow from the service recipient to the service provider and should accrue to the benefit of the latter.” In the said decision, the Larger Bench made reference to the concept of “consideration”, as was expounded in the decision pertaining to Australian GST Rules, wherein a categorical distinction was made between “conditions” to a contract and “consideration”. It has been prescribed under the said GST Rules that certain “conditions” contained in the contract cannot be seen in the light of “consideration” for the contract and merely because the service recipient has to fulfil such conditions would not mean that this value would form part of the value of the taxable services that are provided. 23. The Supreme Court in Commissioner of Service Tax v. M/s. Bhayana Builders [2018 (2) TMI 1325 = 2018 (10) G.S.T.L. 118 (S.C.)], while deciding the appeal filed by the Department against the aforesaid decision of the Tribunal, also explained the scope of Section 67 of the Act, both before and after the amendment, in the following words :

“The amount charged should be for “for such service provided” : Section 67 clearly indicates that the gross amount charged by the service provider has to be for the service provided. Therefore, it is not any amount charged which can become the basis of value on which service tax becomes payable but the amount charged has to be necessarily a consideration for the service provided which is taxable under the Act. By using the words “for such service provided” the Act has provided for a nexus between the amount charged and the service provided. Therefore, any amount charged which has no nexus with the taxable service and is not a consideration for the service provided does not become part of the value which is taxable under Section 67. The cost of free supply goods provided by the service recipient to the service provider is neither an amount “charged” by the service provider nor can it be regarded as a consideration for the service provided by the service provider. In fact, it has no nexus whatsoever with the taxable services for which value is sought to be determined.”

(emphasis supplied)

What follows from the aforesaid decisions is that “consideration” must flow from the service recipient to the service provider and should accrue to the benefit of the service provider and that the amount charged has necessarily to be a consideration for the taxable service provided under the Act. It should also be remembered that there is marked distinction between “conditions to a contract” and “considerations for the contract”. A service recipient may be required to fulfil certain conditions contained in the contract but that would not necessarily mean that this value would form part of the value of taxable services that are provided.

The “expectation interest” is a popular measure for damages arising out of breach of contract. The foreclosure charges, therefore, are not a consideration for performance of lending services but are imposed as a condition of the contract to compensate for the loss of “expectations interest” when the loan agreement is terminated prematurely. In fact, foreclosure charges seek to deter the borrowers from switching over to cheaper available sources of loan, as has been so clearly stated in the Circular dated 26 June, 2012 issued by the Reserve Bank of India.

The basis for charging foreclosure amount has also been explained by the Karnataka High Court in M/s. Hotel Vrinda Prakash and Another v. KSFC and Another [ILR 2008 KAR 1311]. The writ petitioner had borrowed a loan from the Karnataka State Financial Corporation but before the period of loan could expire made an application for foreclosure of the loan. The Corporation, however, demanded premium on the advance payment/foreclosure amount which demand was challenged in the writ petition. The High Court, after noticing that the contract contained a clause giving discretion to the Corporation to impose premium on the balance amount of loan, observed that granting of loans is a business of the Corporation and if the loan is prepaid, the Corporation may have to suffer loss. It is to overcome this situation that premium is charged. The observations are as follows;

“13………………….Therefore, the granting of loans or advances is one of the business of the Corporation. As stated above, the Corporation borrows funds from the financial institution at the prevailing rate of interest. If an account is prepaid/foreclosure when the interest rates are falling, the Corporation may have to suffer loss. To overcome this situation, if a premium is charged on the outstanding loan being prepaid, the same cannot be found fault with. I am of the considered view that the Corporation has the power and authority to levy prepayment/foreclosure premium.”

The foreclosure of loan is, therefore, a material breach of contract as it curtails the loan service period unilaterally, which can prompt the promisor to claim damages. Damages can be determined by Courts or they can also be incorporated in the loan agreements and other commercial contracts so as to ensure certainty in dealings and also serve as a deterrent measure. This aspect of damage is known as liquidated damages.

The reference is, accordingly, answered in the following terms:

“Foreclosure charges collected by the banks and non-banking financial companies on premature termination of loans are not leviable to service tax under “banking and other financial services” as defined under Section 65(12) of the Finance Act.”

(emphasis supplied)

In view of the above decision, we hold that the service charges for pre-payment or foreclosure of loan amount by the customer cannot be treated as taxable service and is not chargeable to service tax.

(iv) Service charge against Working Capital Term Loan: A perusal of the scheme for short term financing of Working Capital Term loan reveals that the scheme was meant for all small scale and medium scale industrial units financed by the Corporation. Para 7 of the scheme document discloses that the interest liable on such Working Capital Term loan. Paragraph 12 illustrates the Service Charge payable on such loans. The said paragraphs are reproduced for ease of reference:

“7. Rate of Interest: The interest on working capital term loan shall the same what is chargeable on term loan to Small Scale Industries and medium scale units at the time of execution of documents:-

Service charges: The borrower shall pay service charges yearly @ 1% per annum payable quarterly on the outstanding amount for Working Capital Term loan. The first payment shall fall due after the expiry of one quarter on the date as 1st April/ 1st July, 1st October or 1st January fall due after the expiry of one quarter on the date as 1st April/ 1st July, 1st October or 1st January."

Learned Counsel has argued that though the heading indicated is Service Charge, the 1% charge is actually akin to the interest charged on the Working Capital Term Ioan. We are unable to accept this argument of the learned Counsel. The scheme document has clearly differentiated between the interest liable to be charged on such loans and the service charges on such loan. Therefore service charges of 1% indicated separately clearly shows that this amount is a consideration for the services being provided by the appellant to the borrowers. It is apparent that the said service charge is a financial charge on account of providing financial services of loans and advances. In view of the same, we hold that service tax is leviable on the service charge, realized on Working Capital Term Loan by the appellant.”

In view of above, it is seen that the issue is settled in favour of the appellants in respect of income from pre-payment of financial charges received against seed capital and in respect of registration charges on the one time settlement. However in respect of service charges received against WCTL, the issue has been decided against the appellant. In view of above, we set aside the demand in so far as seed capital and registration charged on the one time settlement is concerned and we confirm the charges in respect of WCTL. The impugned order is modified accordingly.