India: GST: How It Affects Security Transactions And Banks

Last Updated: 1 October 2018
Article by Shikha Bhardwaj

This article was first published in IACC - 14th Indo US Economic Summit (book).

India's financial markets continue to mature and deepen to support the economic growth with various measures adopted by the Government to promote financial inclusion and bring about infrastructural reforms.

Infact, in the past decade there has been a rise in the merchandise trade between India and United States from USD 44 billion to USD 74 billion. Both the nations have acknowledged at various public platforms that India's commitment to democracy, rule of law, and fundamental freedoms, makes it a preferred strategic partner to US. However, when compared to the bilateral trade between United States and China, which is estimated to be USD 635 billion, it is still very low.

India has time and again showed its eagerness for greater participation in trade with US by refusing to get into reciprocal tariffs and enhancing the oil & gas imports from US.

Indian financial services sector has undergone a sea of change in terms of the nature of products offered and the demands of the market, majorly due to evolving financial goals of the participants. The State seeks to tax the sector efficiently in the right proportions to have its own chunk of the pie while not discouraging investments and savings sentiment.

GST Overview for the Financial Services Sector

Banks and Financial Institutions provide a bouquet of financial services relating to lending or borrowing of money or investment of money and other related services. Levy of Goods and Services Tax (GST) on these instruments and services depends upon whether it would qualify as a 'supply' of 'goods' and/or 'services'.

The definition of 'goods' and 'services' under Central Goods and Services Tax (CGST) Act, 2017 specifically excludes 'money' and 'securities', wherein 'securities' mean the instruments covered under Securities Contracts Regulation Act 1956 (SCRA) and 'money' includes instruments like cheques, drafts, pay orders, promissory notes, letters of credit, etc.  While these transactions would be outside the ambit of supply, the related activity having separate consideration may be chargeable to GST.

The Central Board of Indirect Taxes and Customs (CBIC) has recently issued several clarification(s) pertaining to GST on this sector. In the light of these clarifications issued by the CBIC, the ensuing paragraphs discuss GST on Finance Leases, Derivatives, Collateralized Borrowing and Lending Obligations (CBLO) transactions, Commercial Paper (CP) or Certificates of Deposit (CD), Management oversight or stewardship services by a related person and Stock Brokers.

Finance Lease

Finance Leases primarily includes equipment leases and hire purchase transactions. Such leases involve the substantial transfer of all the risks and rewards incidental to ownership of an asset. The  title, however, may or may not be transferred. A typical structure of financial leases involves collection of transaction fee at the time of entering into the agreement. The lease rental is spread across a period of time and is split between equal installments comprising of both principal and interest amount. The asset may or may not be sold at the end of the term.

Due to the inherent difference between a sale and hire purchase transaction its taxation loomed in the grey and was highly litigated in the erstwhile regime. The Forty Sixth Constitutional Amendment, empowered States to tax it as sale and put some VAT litigation to rest. However their valuation varied across the States, for instance Tamil Nadu excluded transaction fee and interest from the assessable value whereas Delhi prescribed their addition to the taxable turnover and made them taxable upfront.

On the other hand, service tax was  chargeable only on the transaction fee charged and the principal and interest amount were exempt. Therefore, the transaction fee suffered from double taxation of service tax and VAT.

Presently, CBIC perceives financial lease as purchase of an asset by bank to further lend it to a customer therefore, neither qualifying as loan nor interest. Thus, it can be concluded that such interest is taxable under GST.

CBIC's clarification is contrary to ratio laid down by Supreme Court of India in Association of Leasing & Financial Service Companies v. Union of India1, which states that lease management fee/processing fee/documentation charges and administrative charges are chargeable to service tax whereas the amount charged for financing transaction is mainly in the nature of interest and therefore, is exempt of service tax.

In view of the aforementioned ratio, it is argued here that only when the lessee exercises his option to obtain title in the asset, the lease would be deemed as supply of 'goods'. Otherwise, it would be deemed as a 'service'. Accordingly, in first instance GST should be leviable on principal amount as well as transaction fee whereas latter would be subject to GST only on transaction fee. The interest component should be exempt in both the scenario keeping in view the judicial precedent.

Derivatives

Broadly, derivatives can be divided into futures, forwards, swaps and options. The derivatives are covered under the definition of 'securities' under SCRA and are therefore exempt from GST.

CBIC clarifies that forward contracts wherein settlement is by way of actual delivery of underlying commodity, would be treated as supply of goods and thus, liable to GST.

Additionally, it is also clarified that the attendant service charges or transaction fee would be chargeable to GST.

CBLO transactions

In CBLO transaction, the borrowing bank pays an amount as consideration to the lending bank for funds provided by it for a short term. CBIC clarified that such amount(s) qualify as 'consideration represented by way of interest or discount' and hence are exempt from GST. However, if any charges or fees are levied for such transactions, the same would be a consideration and would be chargeable to GST. 

CP or CD

CP and CD are unsecured money market instruments which are issued in the form of a promissory note or in a dematerialized form through any of the depositories approved by and registered with SEBI. CBIC clarifies that in such instruments, consideration is by way of a discount or subscription to CPs or CDs, and thus accordingly, it would be 'services by way of extending deposits, loans or advances' where consideration is represented by way of 'interest or discount' and therefore, not liable to GST. However, ancillary charges or like fees would be taxable.

Management oversight or stewardship services by a related person

In the normal course of business, the Banks receive the aforementioned services from the Head Office without any consideration. Such services are taxable under GST since supply between related parties is taxable even when there is no consideration.

CBIC clarified that Banks may rely upon a certificate from a Branch or Head Office stating the estimated cost of supply, which may be backed by a a chartered accountant or cost accountant certificate. The time of supply will be the date when such costs are determined or certificate is received.

Stock Brokers

Stock brokers as well as sub-brokers are compulsorily required to register under GST and charge tax irrespective of the threshold limit. Even in cases where clients are non-residents like Foreign Portfolio Investors, Non-Resident Indians, Persons of Indian Origin, etc. the GST would be payable on the brokerage.

Stock brokers are eligible to seek exemption available to 'pure agents' from levy of GST on other taxes/duties paid by them, provided they fulfil the requisite statutory conditions.

Additionally, the funds received in advance as security for the potential orders/ trades which is ultimately used during the settlement and net off will not attract GST, provided the stock broker applies such deposit as consideration for the securities.

Mutual funds often charge exit load to discourage investors from shorting their positions in the market. CBIC has explained that such exit loads are liable to GST, even if the exit load is in the form of units in the fund. This interpretation is contrary to law which intends to exempt securities from GST.

The GST regime has kept loans, deposits, interest and securities outside the incidence of tax which is a welcome step for the sector. However, CBIC may need to revisit its stance on taxability of financial leases and exit loads so as to encourage this highly regulated sector. The Government may also explore the option to provide specific tax benefits to non-residents and foreigners availing financial services in India to give a good boost to the sector.

US Ambassador Ken Juster during his first policy speech earlier this year showed great optimism towards bilateral trade between the two nations and remarked that India can seize the strategic opportunity through trade and investment to become an alternative hub for US business in the Indo-Pacific.

Footnote

1 Reported at [2010] 29 STT 316

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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