Along with sweeping changes in federal and state taxation, the goods and services tax (GST) introduced in 2017 also impacted how business was done, particularly in the financial services sector. With the intent of ensuring "smooth roll-out" of GST, the GST Council constituted 18 sectoral working groups to consider issues and problems relating to 18 sectors in June last year. The objectives of these groups included interacting with and examining representations from trade and industry bodies, highlighting specific issues on the application of GST, and providing sector-specific guidance. On 3 June, the Central Board of Indirect Taxes and Customs (CBIC) issued a compilation of 91 "frequently asked questions" (FAQs) on the application of GST to the financial services sector.

The FAQs provide guidance on free services provided by banks, assignment of debt, stockbroking, mutual funds, etc., as well as on procedural matters such as filing claims, deferring credit and providing services to non-residents. While the headlines on free services by banks not being subject to GST have captured the most attention, relatively staid matters that affect the way financial institutions do business with each other have slipped under the radar. Key instances of such clarifications include the non-applicability of GST on the assignment of secured and unsecured debt; transactions under bank borrowing arrangements called collateralized borrowing and lending obligations; repo and reserve repo transactions; derivatives, futures contracts without a delivery option, and forward contracts with a net settlement feature; commercial paper, demand promissory notes, and certificates of deposit; invoice discounting facilities provided by banks; and interest on debt instruments.

Responses to queries on the above generally mention that if any service charges, service fees, documentation fees, or similar charges are payable, GST would be applicable on such amounts. This is a fair position and has not been perceived as controversial.

The lack of clarity on the applicability of GST on institutional matters had threatened to hinder the manner in which financial institutions conduct business with each other. In particular, until the issuance of the FAQs, banks and financial institutions which routinely engaged in securitization transactions and debt syndication transactions had been in a quandary, as the potential applicability of GST impacted their margins and thus the commercial viability of their business model.

However, the FAQs also have some surprises. Additional interest payable by a borrower in case of any default in loan payments is subject to GST. This has the effect of unintentionally penalizing borrowers for even minor infractions. Similarly, late-payment charges on outstanding credit card dues and delayed payment charges on broking facilities are subject to GST. These provisions would impact individual borrowers and consumers the most. In contrast, another FAQ provides that fines or penalties imposed for the breach of any law would not be subject to GST.

Also puzzling is the clarification that providing of stockbroking services to non-resident investors such as foreign portfolio investors and non-resident Indians would not qualify as export of services and would therefore be subject to GST. Aside from the fact that these services would be provided to a non-resident, by increasing transaction costs, this has the effect of discouraging participation by non-residents in the Indian securities markets. This contrasts with the constant efforts of other financial sector regulators to encourage participation by non-resident investors in the Indian securities market.

The financial services sector has welcomed the clarifications provided by the FAQs. However, at a more fundamental level, the manner of providing guidance should be examined. For instance, the document in which the FAQs have been made available in the public domain consists solely of a tabular representation in a query-and-answer format, without any introduction or lead-in explaining the process that was followed to prepare the FAQs, or details of any meetings held by the working group. Notably, the document also does not contain any reference to any legal provisions enabling its issuance.

The issuance of FAQs is an ad hoc mechanism. Without the benefit of the rigour and analysis associated with legislative rule-making, at best, the FAQs reflect the current thought process of the CBIC. Specific legislative changes by way of amendments to the central and state GST legislation are preferable as this provides certainty and clear direction to stakeholders in the financial services sector – both consumers and providers. After all, a predictable legal environment is one of the cornerstones of the economy.

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