Goods and Services Tax was introduced in India in July 2017 replacing the erstwhile taxation regime of multiple taxes applicable on business transactions. As a result, Service Tax was also subsumed into the GST system. However, even after more than four and half years of the implementation of GST, certain businesses are still grappling with the interpretational challenges of the service tax law on their past business activities. One such instance is the levy of service tax on the interchange fees applicable on credit card services. For years now this one question has kept the banking industry still guessing if the service tax was applicable on the interchange fees or not. If it was applicable, who was liable to pay the service tax!

It is apposite to mention that every credit card usage transaction invokes a series of transactions in the backend to effectuate such usage by the card holder. These includes transactions between the card issuing bank (issuing bank) and the card holder, the merchant and its bank (acquiring bank) which makes the payment to the merchant, the acquiring bank and the issuing bank, and between both the banks and the card network service providers such as Martercard or Visa or AMEX.

The acquiring bank in the above series of transactions, charges a fee called 'Merchant Discount Rate' or MDR which includes the interchange fees. The first dispute on the applicability of service tax was seen in the matter of ABN Amro Bank wherein for the period up to 01.05.2006 the levy of service tax on the MDR was upheld by the CESTAT in 2011 under the category of Banking and Other Financial Services (BoFS) (services provided by a banking company or financial institution). In 2006, the government had carved out credit card services from the BoFS category and created a separate taxable category of 'Credit Card, debit card, charge card or other payment card services' (CCS). Later the service tax regime moved to a negative list regime where few specified services were listed in the negative list as non-taxable.

This issue related to taxability of interchange fees for the period up to 01.05.2006 again came up before CESTAT in the matter of Standard Chartered Bank and others. In 2013, the CESTAT differed with the order of ABN Amro Bank (ABN 1) and referred the matter to the Larger Bench, which in 2015 decided the matter in favour of the bank and held that the service tax was not applicable on the MDR. The CESTAT also observed that the service tax was applicable on the services to be provided to the card holders only. Many cases were brought up before the Supreme Court on this topic from the pre and post negative list regime. However, most of these cases are still pending.

The department demanded service tax under the negative list regime and again in the matters of ABN Amro (ABN 2) and Citibank, different benches of CESTAT in 2018 held that even after 2006 amendments service tax remained non leviable on MDR / interchange fees. While the ABN 2 decision was not challenged further by the authorities, the Citibank case landed before the Supreme Court.

Recently, the Citibank case was heard and decided by the division bench of Supreme Court comprising of Justices Joseph and Justice Bhatt and the decision was delivered on 09.12.2021. Citibank argued that the acquiring bank had already paid service tax on the MDR, so it being the card issuing bank cannot be called to pay service tax again as it would amount to double taxation. Also, that in receiving the interchange fees, Citibank did not provide any service to the acquiring bank. However, the Department while relying on CCS entry contended that Citibank has not provided any documents to prove that the acquiring bank has paid the service tax on the MDR.

The judgement of the Supreme Court is an important one since not only it unsettles the previous legal position settled by the different benches of CESTAT in ABN 2 and Citibank case, the judgement also creates a confusion on the legal position hitherto taken by the banking sector in the service tax regime. The fact two judges of the Supreme Court have delivered a verdict wherein they agree on few aspects but gave a split verdict on few other points.

The views shared by the two-judge bench were that Citibank as an issuing bank was providing service. They further held that the Tribunal's order in ABN Amro was unsustainable and lastly, the judges opined that once tax is already paid on interchange fees by the acquiring bank, it cannot be collected again from the issuing bank as it would lead to double taxation.

However, the two-judge bench of Supreme Court gave a split verdict on taxability of interchange fees. Justice Joseph was of the view that issuing banks earn interchange fees as consideration for providing card payment settlement services and service is taxable in the hands of the issuing bank as when issuing bank and acquiring bank are jointly providing a single unified service. Justice Bhatt held that Citibank was not liable to pay the service tax as services provided by the respondent and acquiring bank were not separated and formed a part of a single unified service. The second point of difference was how the judges viewed service tax machinery provisions. Justice Joseph was of the opinion that since the service was provided by the issuing bank, Citibank was liable to include the interchange fee, file returns and pay service tax on the same. Due to the non-payment of tax by Citibank, Justice Joseph found a possibility of suppression by the issuing bank and sought to remand the matter to the Tribunal for confirmation of facts. However, Justice Bhat on the other hand opined that since interchange fee is part of the acquirer bank's service, there was no need for the Citibank separately disclosing and taxing part of the value in its returns. Lastly, Justice Joseph opined that the service provided by Citibank for which it charged an interchange fee would be liable to the service tax and it would not amount to double taxation. Justice Bhat noted that payment of service tax by Citibank would amount to double taxation as service tax was already collected from the acquiring bank on the entire value of MDR so it should be rendered as a single service by the acquiring and issuing banks as it is taxable as a single service.

All things considered; the judges have agreed that the demand of service tax on interchange fees deserves to be set aside. Since there were dissenting opinions, the case will now be referred to a larger bench. If the larger bench upholds Justice Joseph's opinion, then the onus of proof of payment of tax on the MDR earned by the acquiring bank on the portion of income earned by issuing banks shall lie upon Citibank. If the larger bench of Supreme Court goes with Justice Bhat's opinion, then it will be beneficial to the banking industry as there is no need for issuing bank to file service tax returns and pay service tax separately on interchange fee. How this judgement will impact the other matters pending before the Supreme Court is also to be seen. Till the time the larger bench gives its final verdict, the ambiguity continues.

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