No service tax liability on foreclosure charges collected by banks and NBFCs on premature termination of loans

The CESTAT, Chennai in M/s Sundaram Finance Ltd. [Service Tax Appeal No. 646 and 647 of 2012 dated February 22, 2023] has set aside the orders passed by the Revenue Department levying service tax on Foreclosure Charges ("FC") collected by the assessee. Held that, the FC collected by banks or Non-Banking Financial Company ("NBFC") on premature termination of loans cannot be subject to service tax under "Banking and Other Financial Services ("BOF Services") as defined under Section 65 (12) of the Finance Act, 1994 ("the Finance Act"). 

Facts

M/s Sundaram Finance Ltd. ("the Appellant") is a NBFC, engaged in the business activity of financing the purchase of commercial vehicles, cars, houses and also provide the services of Software Solutions, Business Process Outsourcing, Hire Purchase and Leasing including Equipment Leasing. The Appellant has a system whereby the customer who avails the loan / hire-purchase facility is permitted to pay-up ahead of the scheduled EMI, part of or the entire outstanding principal, i.e. "Preclosure/Foreclosure" of the loan. The Appellant at the time of accepting the part payment for preclosure, in addition, also collects penal charges @ 3% on the outstanding amount as FC penalty.

The Revenue Department ("the Respondent") was of the opinion that, the Appellant is liable to pay Service Tax on the FC penalty collected by them, as the same would fall under the BOF Services and subsequently, issued Show Cause Notices dated October 19, 2010 and May 25, 2012 ("the Impugned SCNs") proposing to demand Service Tax on such FC along with interest and also for imposing penalties Thereafter, vide Orders dated August 29, 2012 ("the Impugned Orders"), the Respondent confirmed the demand along with interest and penalty. 

Being aggrieved this appeal has been filed. 

Issue

Whether the FC collected by the banks and NBFCs on premature termination of loans is subject to levy of Service Tax under "BOFS" as defined under Section 65 (12) of the Finance Act?

Held

The CESTAT, Chennai in Service Tax Appeal No. 646 and 647 of 2012 held as under:

• Relied on its earlier judgment of larger bench in Commissioner of Service Tax, Chennai v. REPCO Home Finance Ltd. [2020 (42) GSTL 104 (Tri-LB) dated June 8, 2020] wherein, it was held that FC collected by banks and NBFCs are not chargeable to Service Tax. 
• Held that, the demand imposed by the Respondent cannot be sustained.
• Set aside the Impugned Orders. 

Relevant Provisions

Section 65 (12) of the Finance Act

"banking and other financial services" means 

(a) the following services provided by a banking company or a financial institution including a non-banking financial company or any other body corporate or commercial concern, namely:—

(i) financial leasing services including equipment leasing and hire-purchase;

Explanation—For the purposes of this item, "financial leasing" means a lease transaction where— 

(i) contract for lease is entered into between two parties for leasing of a specific asset;
(ii) such contract is for use and occupation of the asset by the lessee;
(iii) the lease payment is calculated so as to cover the full cost of the asset together with the interest charges; and 
(iv) the lessee is entitled to own, or has the option to own, the asset at the end of the lease period after making the lease payment;
(iii) merchant banking services;
(iv) Securities and foreign exchange (forex) broking, and purchase or sale of foreign currency, including money changing;
(v) asset management including portfolio management, all forms of fund management, pension fund management, 6[custodial, depository and trust services,
(vi) advisory and other auxiliary financial services including investment and portfolio research and advice, advice on mergers and acquisitions and advice on corporate restructuring and strategy;
(vii) provision and transfer of information and data processing;
(viii) banker to an issue services; and 
(ix) other financial services, namely, lending, issue of pay order, demand draft, cheque, letter of credit and bill of exchange, transfer of money including telegraphic transfer, mail transfer and electronic transfer, providing bank guarantee, overdraft facility, bill discounting facility, safe deposit locker, safe vaults, operation of bank accounts;

(b) foreign exchange broking and purchase or sale of foreign currency, including money changing provided by a foreign exchange broker or an authorised dealer in foreign exchange or an authorised money changer, other than those covered under sub-clause (a);

Explanation.— For the purposes of this clause, it is hereby declared that "purchase or sale of foreign currency, including money changing" includes purchase or sale of foreign currency, whether or not the consideration for such purchase or sale, as the case may be, is specified separately"