Employee share based payments: Understanding the taxation aspects

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By Rahul Maharshi (rahul@vinodkothari.com), (finserv@vinodkothari.com)

Introduction

Employee share based payments (ESBPs) are an effective way of incentivising employees. ESBPs work as a two way growth strategy for both company as well as the employees. On one hand, it helps the employees to participate in the growth of the entity and in turn reap out the benefits from it, on the other hand it helps the entity to boost the growth rate and align the vision of the employees with that of the company. The ESBPs work as a catalyst for the employee growth as well as the growth of the company.

The theme of this article revolves around the taxation aspects of different types of ESBPs, but before we proceed further, let us have a quick understanding about the different types of ESBPs. Read more →

Private virtual currencies out: India may soon see regulated virtual currency

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-Kanakprabha Jethani | executive

kanak@vinodkothari.com

Background

A high-level Inter-ministerial Committee (IMC) (‘Committee’) was constituted under the chairmanship of Secretary, Department of Economic Affairs (DEA) to study the issues related to Virtual Currencies (VCs) and propose specific action to be taken in this matter. The Committee came up with its recommendations[1] recently. These recommendations include, among other things, ban on private VCs, examination of technologies underlying VCs and their impact on financial system, viability of issue of  ‘Central Bank Digital Currency (CBDC)’ as  legal tender in India, and potential of digital currency in the near future.

The following write-up deals with an all-round study of the recommendations of the committee and their probable impacts on the financial systems and the economy as a whole.

Major recommendations of the Committee.

The report of the Committee focuses on Distributed Ledger Technologies (DLT) or blockchain technology and their use to facilitate transactions in VCs and their relation to financial system. Following are the major recommendations of the Committee.

  • DEA should identify uses of DLT and various regulators should focus on developing appropriate regulations regarding use of DLT in their respective areas.
  • All private cryptocurrencies should be banned in India.
  • Introduction of an official digital currency to be known as Central bank digital currency (CBDC) which shall be acceptable as legal tender in India.
  • Blockchain based systems may be considered by Ministry of Electronics and Information Technology (MEITY) for building low-cost KYC systems.
  • DLT may be used for collection of stamp duty in the existing e-stamping system.

Why were these recommendations needed?

  • DLT uses independent computers (called ‘nodes’), linked together through hash function, to record, share and synchronise transactions in their respective distributed ledgers. The detailed structure of DLTs and their functions and uses can be referred to in our other articles.[2]

Among its various benefits such as data security, privacy, permanent data retention, this system addresses one major issue linked to digital currency which is the problem of double-spend i.e. a digital currency can be spent more than once as digital data can be easily reproduced. In DLT, authenticity of a transaction can be verified by the user and only validated transactions form a block under this mechanism.

  • Many companies have been using Initial Coin Offerings (ICO) as a medium to raise money by issuing digital tokens in exchange of fiat money or a widely accepted cryptocurrency. This way of raising money has been bothering regulators as it has no regulatory backing and such system can collapse any time. The regulators also fail to reckon whether ICO can be even considered as a security or how it should be taxed.
  • Some countries allow use of VCs as a mode of payment but no country in the world accepts VCs as legal tender. In India, however, no such permissions are granted to VCs. Despite the non-acceptability of VCs in India, investors have been actively investing in VCs like bitcoin, which is a sign of danger for the economy as it is draining the financial systems of fiat money. Further, they pose a risk over the financial system as they are highly volatile, with no sovereign backing and no regulators to oversee. It has been witnessed in the recent years that there have been detrimental implications on the economy due to volatility of VCs such as bitcoins. the same has been dealt with in detail in our report[3] on Bitcoins. They are also suspected to have been facilitating criminal activities by providing anonymity to the transactions as well as to the persons involved.
  • The future is of digitisation. An economy with everything running on physical basis will not survive in the competitive world. A universally accepted system for digital payments would require digitisation of currency as well.

What is the regulatory philosophy in the world?

As a mode of payment: Countries like Switzerland, Thailand, Japan and Canada permit VCs as a mode of payment while New York requires persons using VCs to take prior registration with a specified authority. Russia allows only barter exchange through use of virtual currency which means that such exchange can only take place when routed through barter exchanges of Russia. China prohibits use of VCs as a mode of payment.

For investment purposes: Russia, Switzerland, Thailand, New York and Canada permit investment in VCs and have in place frameworks to regulate such investments. Further, countries like Russia, Thailand, japan, New York and Canada have also allowed setting up of crypto exchanges and have a framework for regulating the setting up and operations such exchange and subsequent trading of VCs on them. On the other hand, China altogether prohibits investments and trading in VCs and the law of Switzerland is silent as to allowing setting up of crypto exchanges.

Further, China has imposed a strict ban on any activity in cryptocurrencies and has also taken measures to prohibit crypto mining activities in its jurisdiction. No country in the world has allowed acceptance of virtual currency as legal tender. It is noteworthy that though Japan and Thailand allow transactions in VCs, such transactions are restricted to approved cryptocurrencies only.

Tunisia and Ecuador have issued their own blockchain based currency called eDinar and SISTEMA de Dinero Electronico respectively. Venezuela has also launched an oil-based cryptocurrency.

Issue of official digital currency

Sensing the keen inclination of financial systems towards technological innovation and witnessing declining use of physical currency in various countries, the Committee is of the view that a sovereign backed digital currency is required to be issued which will be treated at par with any other legal tender of the country.

Various legislations of the country need to be reviewed in this direction. This would include amendments to the definition of “Coin” as per Coinage Act for clarifying whether digital currency issued by RBI shall be included in the said definition. Further, on issue of such currency, it must be approved to be a “bank note” as per section 25 of RBI Act through notification in Gazette of India.

Various regulators would also be required to amend their respective regulations to align them in the direction of allowing use of such digital currency as an accepted form of currency.

Key features of CBDC are expected to be as follows:

  • The access to CBDC will be subject to time constraints as decided in the framework regulating the same.
  • CBDC will be designed to provide anonymity in the transaction. However, the extent of anonymity will depend on the decisions of the issuing authority.
  • Two models are under consideration for defining transfer mechanism for CBDC. One is account-based model which will be centralised and other one is value-based model which will be decentralised model. Hybrid variants may also be considered in this regard.
  • Contemplations as to have interest-bearing or non-interest-bearing CBDC are going on. An interest-bearing CBDC would allow value addition whereas non-interest bearing CBDC will operate as cash.

Why should DLT be used in financial systems?

  • Intermediation: Usually, in payment systems, there are layers of intermediation that add to cost of transaction. Through DLT, the transaction will be executed directly between the nodes with no intermediary which would then reduce the transaction costs. Further, in cross-border transactions through intermediaries, authorisations require a lot of time and result in slow down of transaction. This can also be done away through DLT.
  • KYC: Keeping KYC records and maintaining the same requires huge amounts of data to be stored and updated regularly. Various entities undergoing the same KYC processes, collecting the same proofs of identity from the same person for different transactions result in duplication of work. Through a blockchain based KYC record, the same record can be made available to various entities at once, while also ensuring privacy of data as no centralised entity will be involved. Loan appraisal: A blockchain technology can largely reduce the burden of due-diligence of loan applicant as the data of customers’ earlier loan transactions is readily available and their credit standing can be determined through that.
  • Trading: In trading, blockchain based systems can result in real-time settlement of transactions rather than T+2 settlement system as prevailing under the existing stock exchange mechanism. Since all the transactions are properly recorded, it provides an easier way of post-trade regulatory reporting.
  • Land registries and property titles: A robust land registry system can be established through use of blockchain mechanism which will have the complete history of ownership records and other rights relating to the property which would facilitate transfer of property as well as rights related to it.
  • E-stamping: A blockchain based system would ease out the process of updation of records across various authorities involved and would eliminate the need of having a central agency for keeping records of transaction.
  • Financial service providers: They can be benefited by the concept of ‘localisation of data’ due to which their data is protected from cyber-attacks and theft. Our article[4] studies implementation of blockchain technology in financial sector.

What will be the challenges?

  1. For implementation of DLT: Though a wide range of benefits can be reaped out of implementation of DLT in various aspects of financial systems, it has still not been implemented because there are a few hindrances that remain and are expected to continue even further. Some of the challenges that are slowing the pace of transition towards this technology are as follows:
  • Lack of technological equipment to handle volumes of transactions on blockchains and to ensure data security at the same time.
  • Absence of centralised infrastructure or central entity to regulate implementation of DLT in the financial system. Also, the existing regulators lack the expertise to oversee proper implementation.
  • First, a comprehensive regulatory framework needs to be in place that ensures governance in implementation. The framework will need to address concerns like jurisdiction in case of cross border ledgers, point of finality of transactions etc.
  1. For common digital currency: Decisions regarding validation function, settlement, transfer, value-addition etc. are of crucial importance and would require extensive study. Factors that might be hampering issue of such currency are as follows:
    • Having in place a safe and secure blockchain network and robust technology to handle the same will require significant investments.
    • High volumes of transactions may not be supported and might result in delays in processing.
    • In case an interest bearing CBDC is issued, it would pose great threat over the commercial banking system as the investors will be more inclined towards investing in CBDCs instead of bank deposits.
    • This is also likely to increase competition in the market and lower the profitability of commercial banks. Commercial banks may rely on overseas wholesale funding which might result in downturn of such banks in overseas market.
  2. For banning of private cryptocurrencies: A circular issued by the RBI has already banned its regulated entities from dealing in VCs. Many other countries have also banned dealing in VCs. Despite such restrictions, entities continue to deal in VCs because their speculative motives drive the dealing in VCs to a great extent.

Conclusion

The recommendations of the Committee intend to ensure safety of financial systems and simultaneously urge the growth of the system through innovation and technological advances. Rising above the glorious scenes of these recommendations, one realises that achieving this is a far-fetched reality. One needs to accept the fact that India still lacks in technology and systems sufficient to support innovations like blockchain. Various reports have already shown that operation of blockchains consumes huge volumes of energy, which can be the biggest issue for the energy-scarce India. India needs to work in order to strengthen its core before flapping its wings towards such sophisticated innovation.

[1] https://dea.gov.in/sites/default/files/Approved%20and%20Signed%20Report%20and%20Bill%20of%20IMC%20on%20VCs%2028%20Feb%202019.pdf

[2] https://vinodkothari.com/2019/06/blockchain-technology-its-applications-in-financial-sector/

https://vinodkothari.com/2019/06/an-introduction-to-smart-contracts-guest-post/

[3] https://vinodkothari.com/wp-content/uploads/2017/08/Bitcoints-India-Report.pdf

[4] https://vinodkothari.com/2019/07/blockchain-based-lending-a-peer-to-peer-approach/

BLOCKCHAIN-BASED LENDING – A PEER-TO-PEER APPROACH

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Ind AS vs Qualifying Criteria for NBFCs-Accounting requirements resulting in regulatory mismatch?

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-Financial Services Division and IFRS Division,  (finserv@vinodkothari.com  ifrs@vinodkothari.com)

The transition of accounting policies for the non-banking financial companies (NBFCs) is on the verge of being completed. As was laid down in the implementation guide issued by the Ministry of Corporate Affairs, the Indian Accounting Standard (Ind AS) was to be implemented in the following manner:

Non-Banking Financial Companies (NBFCs)
Phase I

 

  From 1st April, 2018 (with comparatives for the periods ending on 31st  March, 2018)
·         NBFCs having net worth of rupees five hundred crore or more (whether listed or unlisted)
·         holding, subsidiary, joint venture and associates companies of above NBFC other than those already covered under corporate roadmap shall also apply from said date
Phase II From 1st April, 2019 (with comparatives for the periods ending on 31st March, 2019)
·         NBFCs whose equity and/or debt securities are listed or in the process of listing on any stock exchange in India or outside India and having net worth less than rupees five hundred crore

 
·         NBFCs that are unlisted companies, having net worth of rupees two-hundred and fifty crore  or more but less than rupees five hundred crore
·         holding, subsidiary, joint venture and associate companies of above other than those already covered under the corporate roadmap
· Unlisted NBFCs having net worth below two-hundred and fifty crore shall not apply Ind AS.

· Voluntary adoption of Ind AS is not allowed (allowed only when required as per roadmap)

· Applicable for both Consolidated and Individual Financial Statements

As may be noted, the NBFCs have been classified into three major categories – a) Large NBFCs (those with net worth of ₹ 500 crores or more), b) Mid-sized NBFCs (those with net worth of ₹ 250 crores – ₹ 500 crores) and c) Small NBFCs (unlisted NBFCs with net worth of less than ₹ 250 crores).

The implementation of Ind AS for Large NBFCs has already been completed, and those for Mid-sized NBFCs is in process; the Small NBFCs are anyways not required implementation.

The NBFCs are facing several implementation challenges, more so because the regulatory framework for NBFCs have not undergone any change, despite the same being closely related to accounting framework. Several compliance requirements under the prudential norms are correlated with the financial statements of the NBFCs, however, several principles in Ind AS are contradictory in nature.

One such issue of contradiction relates to determination of qualifying assets for the purpose of NBFC classification. RBI classifies NBFCs into different classes depending on the nature of the business they carry on like Infrastructure Finance Companies, Factoring Companies, Micro Finance Companies and so on. In addition to the principal business criteria which is applicable to all NBFCs, RBI has also laid down special conditions specific to the business carried on by the different classes of NBFCs. For instance, the additional qualifying criteria for NBFC-IFCs are:

(a) a minimum of 75 per cent of its total assets deployed in “infrastructure loans”;

(b) Net owned funds of Rs.300 crore or above;

(c) minimum credit rating ‘A’ or equivalent of CRISIL, FITCH, CARE, ICRA, Brickwork Rating India Pvt. Ltd. (Brickwork) or equivalent rating by any other credit rating agency accredited by RBI;

(d) CRAR of 15 percent (with a minimum Tier I capital of 10 percent)

Similarly, there are conditions laid down for other classes of NBFCs as well. The theme of this article revolves the impact of the Ind AS implementation of the conditions such as these, especially the ones dealing with sectoral deployment of assets or qualifying assets. But before we examine the specific impact of Ind AS on the compliance, let us first understand the implications of the requirement.

Relevance of sectoral deployment of funds/ qualifying assets for NBFCs

The requirement, such as the one discussed above, that is, of having 75% of the total assets deployed in infrastructure loans by the company happens to be a qualifying criteria. IFCs are registered with the understanding that they will operate predominantly to cater the requirements of the infrastructure sector and therefore, their assets should also be deployed in the infrastructure sector. However, once the thresholds are satisfied, the remaining part of the assets can be deployed elsewhere, as per the discretion of the NBFC.

The above requirement, in its simplest form, means to have intentional and substantial amount of the total assets of the NBFC in question to be deployed in the infrastructure area, both, at the time of registration, as well as a regulatory requirement, which has to be met over time. Breaching the same would result in non-fulfilment of the RBI regulations.

Impact of Ind AS on the qualifying criteria

The above requirement might seem simple, however, with the implementation of Ind AS on NBFC, there can be important issues which might result in the breach of the above requirement.

With the overall slogan of “Substance over Form”, and promoting “Fair Value Accounting” and an aim to make the financial statements more transparent and just, Ind AS have been implemented. However, the same fair value accounting can result in a mismatch of regulatory requirement, to such an extent that the repercussion may have a serious impact on the existence of being an NBFC.

As already stated above, once an NBFC satisfies the qualifying criteria, it can deploy the remaining assets anywhere as per its discretion. Let us assume a case, where the remaining assets are deployed in equity instruments of other companies. All this while, under the Indian GAAP, investments in equity shares were recorded in the books of accounts as per their book value, but with the advent of Ind AS, most of these investments are now required to be recorded on fair values. This logic not only applies in case of equity instruments, but in other classes of financial instruments, other than those eligible for classification as per amortised cost method.

The problem arises when the fair value of the financial instruments, other than the NBFC category specific loans like infrastructure loans, exceed the permitted level of diversification (in case of IFC – 25% of the total assets). Such a situation leads to a question whether this will breach the qualifying criteria for the NBFC. A numeric illustration to understand the situation better has been provided below:

Say, an NBFC-IFC, having a total asset size of Rs. 1,000 crores would be required to have 75% of the total assets deployed in infrastructure loans i.e. Rs. 750 crores. The remaining Rs. 250 crores is free for discretionary deployments. Let us assume that the entire Rs. 250 crores have been deployed in other financial assets.

Now, say, after fair valuation of such other financial assets, the value of such assets increases to ₹ 500 crores, this will lead to the following:

Under Indian GAAP Under Ind AS
Amount

(in ₹ crores)

 As per a % of total assets Amount

(in ₹ crores)

 As per a % of total assets
Infrastructure Loans 750 75% 750 60%
Other financial assets 250 25% 500 40%
Total assets 1000 100% 1250 100%

 

Therefore, if one goes by the face of the balance sheet of the NBFC, there is a clear breach as per the Ind AS accounting, as the qualifying asset comes down to 60% as against the required level of 75%. However, is it justified to take such a view?

The above interpretation is counter-intuitive.

It may be noted that the stress is on “deployment” of its assets by an IFC. Merely because the value of the equity has appreciated due to fair valuation, it cannot be argued that the IFC has breached its maximum discretionary investment limits. The deployment was only limited to 25% or so to say that even though the fair value of the exposure has gone up but the real exposure of the NBFC is only to the extent of 25%. Under Ind AS, the fair value of an exposure may vary but the real exposure will remain unchanged.

Taking any other interpretation will be counter-intuitive. If the equity in question appreciates in value, and if the fair value is captured as the value of the asset in the balance sheet, the IFC will be required to increase its exposure on infrastructure loans. But the IFC in question may be already fully invested, and may not have any funding capability to extend any further infrastructure loans. Under circumstances, one cannot argue that the IFC must be forced to disinvest its equities to bring down its investment in equities, particularly as the same had nothing to do with “deployment” of funds.

This is further fortified by Para 10. Accounting of Investments, Chapter V- Prudential Regulations of the Master Direction – Non-Banking Financial Company – Systemically Important Non-Deposit taking Company and Deposit taking Company (Reserve Bank) Directions, 2016 about valuation of equities:

“Quoted current investments for each category shall be valued at cost or market value whichever is lower”.

Hence, the RBI Regulations have been framed keeping in view the historical cost accounting. There is no question of taking into consideration any increase in fair value of investments.

Conclusion

Therefore, it is safe to say that while determining the compliance with qualifying criteria, one must consider real exposures and not fair value of exposures as the same is neither in spirit of the regulations nor seems logical. This will however be tested over time as we are sure the regulator will have its own say in this, however, until anything contrary is issued in this regard, the above notion seems logical.

Whether burden shared by captives comes under GST?

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Extended clarification required

-Yutika Lohia

yutika@vinodkothari.com

Introduction

Interest subvention income are earnings received from the third party i.e. person other than the borrower. This scheme work as a compensation to the seller who intends to penetrate the market. They arrange low cost finance for their customers (though not low cost because the part of it is compensated by its captive unit).Therefore the seller (lender) offers subsidized rate to the buyer (borrower) and the discounts are borne by the third party who is either a captive unit of the seller or also by Central or State Government who plans to provide financial aid through subvention.

In the case of Daimler Financial Services India Private Limited[1] (DFSI), the advance authority passed a ruling where it was concluded that interest subvention is like “other miscellaneous services” which was received from Mercedes-Benz India Private Limited (MB India) by DFSI and will be chargeable to GST as a supply.

The case of Daimler Financial Services India Private Limited

In the said case, DFSI is registered as an NBFC and is engaged in the business of leasing and financing. DFSI is a captive finance unit of MB India where the customers get a rebate in the interest component when DFSI acts as a financer and the car is purchased from one of the authorized dealers of MB India. MB India is engaged in the manufacture and sale of car which is usually done through its authorized dealer. The difference interest amount for each transaction is paid upfront by MB India to DFSI who raises an invoice against MB India. Payments made by MB India for the interest subvention was done after deducting TDS under section 194A of the IT Act.

The assessee contended that the interest subvention received is an interest and is an exempt supply. Also, the GST law and the Indian Contract Act 1872 recognize that consideration for a transaction can flow from anybody. The loan agreement with the customers also mentioned the applicable interest rate, the interest subsidy received from the MB India and the net interest payable by the customer.

Several reference of rulings were submitted by the assessee through which it contended that

  • The interest subvention is a subsidy which is made to offset a part of the loss incurred by charging a lower rate of interest.
  • Consideration can flow from a person other than the borrower.
  • If a contract stipulates that for the use of creditor’s money a certain profit shall be payable to the creditor, that profit is interest by whatever name called.

The following points were put up by the department:

The department that DFSI had not borrowed money from MB India. Also interest income can be exempt when there is a direct supply. It was also put that the interest income exempt through notification is not valid for a payment made by third party. The whole structure was set up to promote the business of DFSI.

The department gave reference to section 15 of the CGST Act, where value of supply includes subsidies directly linked to price and the amount of subsidy will be included in the value of supply. Therefore “interest subvention” is an interest subsidy and hence chargeable to GST. Also it was noted that income booked by DFSI is shown under revenue from operations as subsidy income.

The ruling concluded that interest received by DFSI from MB India was to reduce the effective interest rate to the final customer is chargeable to GST as supply under SAC 999792 as other miscellaneous services, agreeing to do an act.

The law behind interest subvention

As per the exempted list of services[2], consideration represented by way of interest or discount on services by way of extending loans or advance is an exempt supply. As it is evident, that services exclude any transaction in money but includes activities relating to use of money i.e. processing fees falls within the meaning of activities relating to use of money and therefore charged to GST.

When there is an interest subsidy, there are two arrays of interest involved- “applicable fixed interest rate gross” and “Net applicable fixed interest rate”. The borrower is under no obligation to pay the lender interest on principal i.e. the applicable fixed interest rate gross. The lender pays at the net applicable fixed interest rate. The difference between the two arrays of interest is the interest subvention borne by the third party. Technically the consideration paid by the borrower is the subsidized rate of interest. The borrower indirectly pays the differential amount of interest through the third party. Therefore referring section 7 of the CGST Act, consideration paid by the borrower is in the course of business whereas consideration paid by the third party is for furtherance of business. The two considerations received are totally different as one is “interest” and the other is “interest subsidy”.

Further, referring to section 15 (2) (e) of the CGST Act, value of supply of includes subsidies directly linked to the price excluding subsidies provided by the Central and State Governments. The interest subvention received are directly linked to price i.e. the interest paid by the borrower to lender and should be considered as value of supply.

Also the definition of “interest” is defined by the council as – “interest” means interest payable in any manner in respect of any moneys borrowed or debt incurred (including a deposit, claim or other similar right or obligation) but does not include any service fee or other charge in respect of the moneys borrowed or debt incurred or in respect of any credit facility which has not been utilised;

The interest paid on money borrowed is under the exempted category of services. Interest subvention disbursed by the captive unit of the lender is not paid on any money borrowed. It is a form of consideration paid so as to promote the business indirectly. They are like any other charges and therefore should not be considered as interest on money borrowed.

Since interest subvention is not interest on money, the same is not an exempt supply and therefore under the purview of GST.

Conclusion

The Advance Ruling Authority (AAR) interpreted the law and considered interest subvention to be taxable under GST. Further clarification is still required on its taxability as  one may note that as per section 103 of the CGST Act, the rulings pronounced by the  Authority is only binding on the applicant.

Therefore, whether interest subvention is taxable under GST or not requires further attention from the department.

 

[1] http://www.gstcouncil.gov.in/sites/default/files/ruling-new/TN-16-AAR-2019-Daimler%20FSIPL.pdf

[2] http://www.cbic.gov.in/resources//htdocs-cbec/gst/Notification9-IGST.pdf;jsessionid=B71F3824BBE3E6EF8C805B56978C9C9F

SEBI requires companies to be serious in reporting Insider Trading lapses

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Pammy Jaiswal

Partner, Vinod Kothari and Company

corplaw@vinodkothari.com

The listed entities are burdened with the compliance requirements under numerous regulations issued by SEBI including the SEBI (Prohibition of Insider Trading) Regulations, 2015 (‘PIT Regulations’). The said regulations lay down various to dos for the listed companies as well as the designated persons (‘DP’) for the purpose of regulating and prohibiting the insider trading in the securities of the listed company.

SEBI has vide its circular[1] dated 19th July, 2019 laid a format for reporting insider trading lapses thereby forcing all companies to follow a standard reporting format. The existing practice of companies using rather informal and self- generated reporting formats will no longer be available to them.

It is not that insider trading lapses noted by companies are those of profiteering based on Unpublished Price Sensitive Information (UPSI). Most of the noted instances in practice are technical and unintentional breaches of either the trading window closure or contra trading restrictions. Most of these are reported to the audit committee or stakeholder’s relationship committee which typically takes action based on the gravity of the offence. However, reporting to SEBI was done on a rather diminutive manner.

Further, the circular also provides for recording the violations in the digital database maintained by the compliance officer under the PIT Regulations for the purpose of taking appropriate action against the offender. The said circular is effective with immediate effect.

Current Reporting Scenario

The current practice of the corporates for reporting the violation under the code (either for entering into contra-trade within a period of six months or trading during the closure of trading window, etc.) along with the action taken by the entity is diverse. While some companies used to mark a copy of the reprimand to SEBI while sending the same to the concerned DP or their immediate relatives, others used to send a brief of the violation along with the action taken to SEBI depending on the frequency and gravity of the violation so made in accordance with their respective codes.

Revised Reporting

The revised reporting format contains all the required fields for the entity (listed entity, intermediary or fiduciary) to report the violation to SEBI. Following is the summary of details that is mandatory required to be filled up about the entity, the DP or his immediate relative and the violation along with the action taken by the entity:

Information about the entity Information about the DP/ immediate relative Transaction details
·            Name and capacity of the entity.

·            Action taken by the entity.

·            Reasons for the action taken.

 ·     Name and PAN.

 

·     Designation and functional role of DP.

 

·     Whether a part of the promoter and promoter group or holding CXO position.

 

 

 ·      Name of the scrip

·      No. and value of shares traded (including pledge)

·      In case trading value exceeds Rs. 10 lakhs date of disclosure made under regulation 7 of the PIT Regulations by both the entity as well as the concerned person.

 

·      Details of violation observed under the PIT Regulations.

 

·      Instances of any violation in the previous financial year.
Concluding Remarks

Evidently, the format contains concrete information about the violation which will place SEBI in a better position to oversee and take on record the instances of violation taking place in the regulated entities. While the current practice had deficiencies in terms of the basic information supplied to SBI, the revised reporting format will take care of the same henceforth.

However, the prompt reporting will be a task for the entities. At the same time, SEBI will now be in receipt of the complete information on the offence and may take strict action against the offender or may even direct the entities to take stricter action in cases where it feels the action taken is not commensurate with the nature and gravity of the violation.

 

Our other resources on SEBI PIT Regulations can be viewed here

[1] https://www.sebi.gov.in/legal/circulars/jul-2019/standardizing-reporting-of-violations-related-to-code-of-conduct-under-sebi-prohibition-of-insider-trading-regulations-2015_43618.html

Abrupt auditor resignations: SEBI seeks transparency

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By Vinod Kothari & Vinita Nair,

Partner, Vinod Kothari & Co

corplaw@vinodkothari.com

Original: July 19, 2019

Version: October 19, 2019

 

A SEBI proposal by way of a Consultative Paper[1] dated July 18, 2019 to amend Reg. 33 of SEBI (LODR) Regulations, 2015 (Regulations) sought to lay down in the rule book of listed entities that when auditors want to resign in the middle of an auditing assignment, they cannot be allowed to leave citing reasons such as “pre-occupation”. They must be encouraged and asked to open their heart, and speak out the real reason, or confirm that there is no reason other than the one that they mention while resigning. Also, the auditor must not leave the auditee in the lurch, and complete the on-going audit engagement to the point of completing the audit of the year or limited review of the quarter. The resignation must be discussed with the Audit Committee chairman, and thence, to the Audit Committee, highlighting the concerns, if any. The views of the Audit Committee will be filed before the stock exchanges.

In essence, the proposal of SEBI tried to implement what seems to be the clear intent – that the veil of secrecy behind auditor resignation, where everyone can sense that everything is not alright but does not get to know what exactly it is – should be lifted.

The Consultative Paper was open for public comments till 8th August, 2019. Accordingly, on 18th October, 2019, SEBI came out with a Circular[2] implementing the aforesaid proposal. While the Circular does not amend Reg. 33 of Regulations, as proposed, it has laid down the doables for the auditors of the listed entities and material subsidiaries at the time of resignation.

Inspiration of the amendment

The inspiration of the amendment is the recent turmoil in the corporate sector, where, mostly in the midst of worsening financial position, auditors put in papers. There are rumours of auditors’ discomfort with the financial statements; mostly people smell transactions that may involve transfer of assets to connected entities, inflation of profits or hiding of losses. One wonders as to why most of these resignations come only when the financial position of the entity is suddenly worsening – is it that in good times, financial statements are immune from such vulnerable transactions or practices? However, it mostly seems that an impending default will bring the entity into regulatory glare, and the auditor may have to face persecution action.

What has made the auditor fraternity even more jittered is the action of the regulators against auditors of a failed financial entity, seeking to use the very heavy provisions of section 140 (5) of the Companies Act. It is just a matter of time when the country will witness class action suits against auditors, which abound in the Western world.

The instinctive auditor action in such cases is, to try to control the damage by quitting the scene, rather than qualifying the statements which, in the past, have been affirmed by the same auditor. Of course, the reasons cited can be as slippery as “pre-occupation” or lack of bandwidth.

It was reported in 2018 that the Minister of State for Corporate Affairs, P P Chaudhary’s written reply to the Rajya Sabha stated that as per the filings in MCA 21 registry, auditors of 204 listed entities had resigned since January 1, 2018 to July 17, 2018.

ICAI also constituted a Group and the task of developing guidance for the members was entrusted to the Auditing and Assurance Standards Board (AASB). In December 2018, ICAI released ‘Implementation Guide on Resignation/Withdrawal from an Engagement to Perform Audit of Financial Statements’ [3] which provides matters to be included in the resignation letter (Para 19) which is similar to the Annex-B of the SEBI Consultative Paper. It additionally required the response from the management or those charged with governance, on the written communication made by the auditor, to be included in the resignation letter.

Is it wrong to resign?

No, as ICAI’s auditing standards (SA-705) provides the situation under which an auditor may resign from the audit. If the auditor concludes that the possible effects on the financial statements of undetected misstatements, if any, could be both material and pervasive so that a qualification of the opinion would be inadequate to communicate the gravity of the situation, the auditor shall resign from the audit, where practicable and not prohibited by law or regulation.

Is it necessary to cite reason for resignation?

Section 140 (2) of Companies Act, 2013 mandates an auditor to indicate the reason and other facts as regard to its resignation while filing the statement of resignation with the Registrar and the Comptroller and Auditor-General of India, where applicable.

What is the meaning of resignation?

It is important to note that the appointment of an auditor is done for a term of 5 years. Therefore, even if an auditor resigns after completion of the audit for a financial year, within the term of 5 years, it is still a case of resignation.

Provisions of section 139 (9) may be interpreted to mean that the auditor may actually state before a general meeting, within the term of 5 years, that he is not willing to be reappointed. However, is that a case of resignation?

Read with section 140 (2), even an unwillingness to be reappointed becomes a case of resignation. This is so because the appointment is done for 5 years, and the ratification of the appointment at the annual general meeting, every year during the 5 year term, has been done way with by the Companies (Amendment) Act, 2017 w.e.f. May 7, 2018.

Therefore, the following are some examples of what may be construed as a case of resignation:

(a) The auditor was appointed in the AGM of Year 1, for completing the audit for FY 1 to FY 5, until the conclusion of the AGM for year 5. At the end of Year 2, after completing the audit of year 2, auditor gives a letter to the management that the auditor is not willing to audit for year 3.

(b) Same case as above, however, instead of the auditor indicating unwillingness to be reappointed, the audit committee while evaluating the performance of the auditor does not recommend continuation of appointment.

(c) Same case as (a), however, the auditor becomes ineligible to continue.

 

Case (a) is a case of resignation; (b) is a case of removal and (c) is a case of vacation of office resulting in casual vacancy.

SEBI’s prescription: Reveal the truth

The resigning auditor shall reveal all the reasons for resignation in the resignation letter along with the efforts made by the auditor prior to resignation. Whom the concern was raised? In relation to what the concern was raised? Why the concern was not addressed – due to a management-imposed limitation or circumstances beyond the control of the management. The auditor is expected to pour his heart out in the resignation letter, which is in line with the prescription made in ICAI’s implementation guide.

Role of Audit Committee

There are recourse available with the auditors of the listed entity/ material subsidiary as follows:

  1. In case, the listed entity/ material subsidiary does not co-operate or they do not provide information as required by the auditors, which may hamper the audit process, the Auditors may approach the Chairman of the Audit Committee and the Chairman shall receive such concern directly without waiting for the quarterly meetings.
  2. In case, the auditor proposes to resign, all concerns with respect to the resignation, along with the relevant documents shall be brought to the notice of the Audit Committee. In cases, where the proposed resignation is due to non-receipt of information / explanation from the company, the auditor shall inform the Audit Committee of the details of information / explanation sought and not provided by the management, as applicable.
  3. The auditor can provide an appropriate disclaimer in the audit report in accordance with the ICAI/ NFRA if the requisite information is not provided to the auditor as sought.

After the auditor approaches the Chairman/ Audit Committee, the Audit Committee has to communicate its views to the management and the auditor, which is also required to be disclosed to the stock exchange within 24 hours after the date of such Audit committee meeting.

As per the Regulations, the Audit Committee is responsible for the appointment, performance evaluation, ensuring independence of the auditors, finalising the audit plan and reviewing and monitoring effectiveness of the audit process. In view of the Circular, the companies shall now be required to modify the letter of appointment of the existing auditors. Further, the Audit Committee is also required to mandatorily review management letters / letters of internal control weaknesses issued by the statutory auditors.

Auditor’s duty to complete pending assignments

While the language of the Consultative Paper seemed unclear, the  Circular has clarified that the auditor shall be required to complete the audit in the following manner before resigning:

  1. If the resignation of the auditor is tendered within 45 days from the end of the quarter- the auditor shall, before such resignation, issue the limited review/ audit report for such quarter.
  2. If the resignation of the auditor is tendered after 45 days from the end of the quarter- the auditor shall, before such resignation, issue the limited review/ audit report for such quarter as well as the next quarter.
  3. If the auditor has signed the limited review/ audit report for the first 3 quarters- the auditor shall, before such resignation, issue the limited review/ audit report for the last quarter of such financial year as well as the audit report for such financial year.

A comparison between the Consultation Paper and the Circular

A quick snapshot of the major highlights of the Circular along with a comparison with what was proposed in the Consultation Paper is given below:

Sl. No. Requirement SEBI’s Consultation Paper SEBI’s Circular Impact of the change
1 Time of resignation i. If the auditor has signed the audit report for all the quarters (limited review/ audit) of a financial year, except the last quarter, then the auditor shall finalize the audit report for the said financial year before such resignation.

 

ii. In all other cases, the auditor shall issue limited review/audit report for that quarter before such resignation (i.e. previous quarter in reference to the date of resignation).

 

iii. In case of material unlisted subsidiary, the auditor shall issue the limited review/audit report for that financial year/ quarter, as applicable, before such resignation (i.e. previous financial year/ quarter in reference to the date of resignation)

 

 iv.                 i. Resignation of the auditor within 45 days from the end of the quarter- the auditor shall, before such resignation, issue the limited review/ audit report for such quarter.

v.

ii.                   Ii. Resignation of the auditor after 45 days from the end of the quarter- the auditor shall, before such resignation, issue the limited review/ audit report for such quarter as well as the next quarter.

iii.

iv.                 Iii. If the auditor has signed the limited review/ audit report for the first 3 quarters- the auditor shall, before such resignation, issue the limited review/ audit report for the last quarter of such financial year as well as the audit report for such financial year.

 With respect to the quarterly audits, the auditors shall be obligated to issue limited review report for the next quarter as well where the resignation is after 45 days from the end of the quarter. This shall provide the listed entity a reasonable time to search another auditor.

 

Further, with respect to the rest, the same was in line with the proposal provided in the Consultation Paper.
2. Reporting of concerns to Audit Committee i.                Approach the Chairman of the Audit Committee and the Chairman to receive the concern directly and immediately without waiting for the quarterly meetings.

 

ii.              All concerned reasons alongwith the relevant documents for shall be brought to the Audit Committee’s notice in case the resignation is due to non-receipt of information/ explanation from the company.

 

 i.                   Approach the Chairman of the Audit Committee and the Chairman to receive the concern directly and immediately without waiting for the quarterly meetings.

 

ii.                 All concerned reasons alongwith the relevant documents for shall be brought to the Audit Committee’s notice in case the resignation is due to non-receipt of information/ explanation from the company.

 The consultation Paper as well as the Circular are in sync.

 

The change shall enhance the role of the Chairman of the Audit Committee w.r.t. reporting the concerns to the management.
3. Deliberation by the Audit Committee Audit Committee shall deliberate on the matter and communicate its views to the management and the auditor. Audit Committee shall deliberate on the matter and communicate its views to the management and the auditor not later than the date of the next Audit Committee meeting. The Circular is in the line with the proposal made in the Consultation Paper.

 

The change shall keep the management in loop and it shall also know the detailed reasons of the resignation of the auditor within a specific time period.

 
4. Disclaimer in case of non-receipt of information from the entity If the reason for the auditor’s resignation is the entity not providing information, the auditor shall provide an appropriate disclaimer in the audit report to that extent. The auditor shall provide an appropriate disclaimer in the audit report, which may be in accordance with the Standards of Auditing as specified by ICAI / NFRA in case the entity does not provide information as sought. Again the Circular is in line with the Consultation Paper.

 

Such change shall now put the entity under an obligation to provide necessary support/ relevant information/ co-operation to the auditor in order to complete the audit.

 
5. Ensuring proper terms and conditions in the letter of appointment No such proposal The aforesaid shall be included in the letter of appointment of the auditor.

 

Where the auditor has already been appointed, the company shall issue modified letter of appointment.

 Considering the appointment of auditors must have been made in listed entities in the AGM held in the FY 19-20 and shall be valid till FY 2023-24, actionable on the part of the listed entities is to amend/ modify the terms of engagement and issue a fresh letter of appointment to the auditors.

 
6. Certification in Annual Secretarial Compliance Report (ASC) No such proposal A practicing company secretary shall be required to certify the aforesaid in the ASC Report. The same shall be an additional responsibility of the practicing company secretary while issuing ASC Report.

 
7. Disclosure of the views of the Audit Committee’s to the Stock Exchange The views of the Audit Committee and the Board of Directors of the entity be required to be submitted to the stock exchanges along with the disclosure of the resignation letter of the auditor in the format as prescribed.

 

 Post the deliberation of the views by the Audit Committee, the same shall be disclosed to the Stock Exchanges as soon as possible but not later than 24 hours after the date of such Audit Committee meeting. The Circular lays down a time which aligns with the requirement of Regulation 7(A) of Part A para A of Schedule III of the SEBI Listing Regulations.

 

The Circular does not prescribe any format for disclosing the views of the Audit Committee to the Stock Exchange.

 
8. Format of resignation letter Provided as Annexure- B Provided as Annexure- A Slight cosmetic changes have been made in the format.

Concluding remarks

Thankfully, for all Indians, one can relate most tricky situations in life to a Bollywood song, and that really helps to dismiss the gravity of the matter. When it comes to something like auditor’s resignations (judaai), or auditors’ silence (khamoshi), there will a large number of songs or flicks on such situations, evidently the popular themes for Bollywood. Therefore, without claiming to be the best for the situation, here is one that may possibly help to lighten the pain that SEBI and investors may be having:

कभी ऐसा लगता है

दिल में एक राज़ है

जिसे कहना चाहूँ, पर मैं कह पाऊँ ना

आँखों ही आँखों में कह जाती है जो ये

खामोशियों की ये कैसी ज़ुबां

मैंने सुना जो ना उसने कहा

 

[1] https://www.sebi.gov.in/web/?file=https://www.sebi.gov.in/sebi_data/attachdocs/jul-2019/1563449963980.pdf#page=1&zoom=auto,-15,842

[2] https://www.sebi.gov.in/legal/circulars/oct-2019/resignation-of-statutory-auditors-from-listed-entities-and-their-material-subsidiaries_44703.html

 

[3] https://resource.cdn.icai.org/52929aasbicai-igr.pdf

Applicability of GST on penal charges

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By Yutika Lohia (yutika@vinodkothari.com), (finserv@vinodkothari.com)

Introduction

The Goods & Services Tax (GST) has been the biggest tax reform in India founded on the notion of ‘one nation, one market, one tax’. It has and will further affect the entire economy including core industries such as agriculture, manufacturing, finance, service, infrastructure etc. The tax reform has been touted to create a significant positive impact on the economy in the long run. Unfortunately however, GST has not been exception to the fact that any big transition faces short term pains. The GST council has been receiving numerous queries and doubts from the myriad industries and trading associations regarding its applicability and nuances on the supply of various goods and services. One such concern had been on the issue of its applicability on additional/penal interest.

Recently the Council came up with a circular on “Clarification regarding applicability of GST on additional / penal interest” on 28th June, 2019[1] to address the issue.

The word “penal”

Black’s law dictionary defines penalty as ‘punishment imposed by statute as a consequence of the commission of a certain specified offense.” Subsequently as such the word “penal” is something relating to or containing a penalty. To put it in perspective, any default in payment of a loan transaction or in the supply of goods or services is liable for a penalty, which may be fixed or variable and thus may be in the name of additional interest or penalty interest, or overdue interest.

In a financial transaction, when there is a delay in the payment of EMI by the customer/borrower, the lender collects penal /default interest as additional interest for the period of delay, determined in days, months or years as per the agreed terms between the two.

Chargeability of GST

Penal charge is levied when there is delayed payment in a money-to-money transaction or when there is a supply of goods or services.

First let us understand whether the penal interest will be included in the value of supply.

As per section 15(2)(d) of the CGST Act, value of supply includes “interest or late fee or penalty for delayed payment of any consideration for any supply.”

Therefore, any interest or penalty paid for delayed payment in the supply of goods or service or a loan transaction shall be included in the value of supply i.e. the consideration amount.

Further, penal charges will not be covered under Schedule II- Activities to be treated as a supply of goods or services in clause 5(e), where supply of services include “agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act”

The expression “to tolerate an act” used in the above clause, should be understood to cover instances where the consideration is being charged by one person in order to allow another person to undertake any particular activity. Therefore it is very clear that at the very inception of the transaction, the intention of one party is to undertake an activity and the other party shall allow the same without any deterrent. To say, the contract is entered to allow the other person to carry out an activity, and not as a penalty or limit the person for carrying out such act in future.

Furthermore, the word “obligation” used in the clause 5(e) of Schedule II where the service recipient requests the service provider to tolerate an act/situation and the service provider obliges to tolerate for a consideration, then such a contractual relationship shall be covered in the above mentioned clause. Therefore it can be said that there is a consensus ad idem between the contracting parties.

Contrary to the above, penal interest/charges are collected only when an event occurs i.e. when there is a default in a payment of a loan transaction or supply of goods/services. The intention of the parties entering into a contract is either to avail the services in way of loan or supply of goods. Penal charges are to be paid if there is a breach in the contract and therefore it does not mean that the parties have entered into a contract for the penal interest.

Therefore penal charges does not fall under the deemed supply list given in Schedule II of the CGST Act.

As penal interest satisfies the definition of “interest” given in the notification, penal interest charged by parties who enter into a contract of giving loans will be covered under serial no. 27 of the notification dated 28th June, 2017.

Ergo, penal charges levied by the lender in a money to money transaction will have no GST implications.

Services by way of extending deposits, loans or advances in so far as the consideration is represented by way of interest or discount is an exempt service and penal charges levied by the vendor on delayed payment in case of supply of goods and services shall be under the purview of GST.

Various clarifications by the GST Council on additional/ penal interest taxability

The GST department’s explanations regarding the applicability of GST of additional / penal interest are listed below:

1.      FAQs on financial sector

The Central Board of Indirect Taxes and Customs (CBIC) came up with a frequently asked questions document (FAQs documents) on financial sector[2] where taxability of additional interest in GST was discussed in serial no 45 of the document.

Any additional interest charged on default in payment of instalment in respect of any supply which is subject to GST, will be included in the value of supply and therefore will be liable to GST.

2.      Notification No. 12/2017-Central Tax (Rate) dated 28th June 2017[3]

The department exempts services by way of extending deposits, loans or advances in so far that the consideration is represented by way of interest or discount (other than interest involved in credit card services).

Also the notification defines the word “interest” which means “interest payable in any manner in respect of any moneys borrowed or debt incurred (including a deposit, claim or other similar right or obligation) but does not include any service fee or other charge in respect of the moneys borrowed or debt incurred or in respect of any credit facility which has not been utilised.”

Further there was a ruling passed by the Advance Ruling Authority on the applicability of GST on penal interest when there is a delayed in repayment of loan.

3.      The case of Bajaj Finance Limited

In case of Bajaj Finance Limited [4](BFL), an advance ruling was passed on 6th August 2018, where it was concluded that penal charges collected by the BFL shall attract GST.

Here it was said that in case of default of payment of EMI by the customer, the applicant tolerated such an act of default or a situation and the defaulting party i.e. the customer was required to compensate the applicant by way of payment of extra amounts in addition to principal and interest. Also, the additional interest is not in the nature of interest but penal charges.

Therefore, the charges levied for any default in repayment of loan will be covered under clause 5(e) of Schedule II of the CGST Act. Also, the same is not an exempt service and will be liable to tax under GST.

4.      Circular no 102/21/2019-GST dated 28th June 2019

Given the numerous queries, the department finally released clarification on the matter. Penal interest charged on delayed payment for supply of goods and services will be included in the value of supply and will stand liable for GST. Whereas penal interest charged on the delayed payment of loan repayment will be exempt under GST.

The clarification given under the notification is discussed at length below.

The various clarifications by the GST Council on additional/ penal interest taxability is represented below in a tabular form:

 

 

FAQs on financial sector

 

  

Notification No. 12/2017-Central Tax (Rate) dated 28th June 2017

  

Case of Bajaj Finance Limited

  

Circular no 102/21/2019-GST dated 28th June 2019

 
Additional interest in case of default payment of instalment in respect of supply, which is subject to GST will be included in the value of supply and therefore liable to GST Consideration by way of interest or discount on deposits loans and advances are considered as exempt service. Charges levied for any default in repayment of loan will be liable to tax under GST.

 Penal interest charged on delayed payment for supply of goods and services will be included in the value of supply and will stand liable for GST. Whereas penal interest charged on the delayed payment of loan repayment will be exempt under GST

 

Implication of GST on penal charges

Accordingly, there are different GST implications, which are discussed by way of examples. Financing to a borrower may be done in the following ways:

  • Situation 1: ABC Co (lender/shopkeeper) sells a car to Mr A (borrower) where the selling price of the car is ₹6,00,000. However ABC Co gives Mr A an option to pay the selling price of the car in 24 months (24 instalments) i.e. ₹ 26,250 (Repayment of principal ₹ 25000 + Interest @5% i.e. ₹ 1250). The instalment shall be paid every 10th of the month, and any delay on such payment shall be liable for a penal interest of ₹ 500 per day for delay in payment.

Here the transaction between ABC Co and Mr A is that of supply of taxable goods and not a money to money transaction. The shopkeeper has broken down the payment into tranches referred to as the EMI facility. The said EMI includes interest component as well which is subjected to GST. Also a penal interest is charged on the delayed payment. Accordingly, the interest and penal charges paid on the delayed payments shall be included in the value of supply and as a consequence, it will be under the ambit of GST.

Also this situation will not be covered under clause 5(e) of the Schedule II of the CGST Act. The expression to tolerate an act cannot be said to include a situation wherein penal charges are imposed on the erring party for delayed or non-payment.

Since the above is not covered under serial no 27 of the notification[5], the same is not exempt and taxable under GST.

  • Situation 2: ABC Co sells a car to Mr. A where the selling price of the car is ₹6,00,000. Mr A has an option to avail a car loan at an interest of 12% per annum for purchasing the car from XYZ Co. The term of the loan from XYZ Co allows A, a period of 24 months to repay the loan and an additional /penal interest @1% per annum for every day of delay in payment.

Here the transaction between XYZ co and Mr. A is that of money to money transaction. The penal interest charged will be covered under serial no 27 of notification no 12/2017 Central Tax (Rate) dated the 28.06.2017 “services by way of (a) extending deposits, loans or advances in so far as the consideration is represented by way of interest or discount (other than interest involved in credit card services)”is exempted.

Accordingly, in this case, the “penal interest” charged thereon on transaction between XYZ Co and Mr. A would not be subject to GST. The value of supply by ABC Co to Mr. A would be ₹ 6,00,000 for the purpose of GST. Whereas there will be no GST charged on the interest and additional/ penal interest charged by the XYZ Co (lender) as the same is considered as an exempt supply.

Therefore, the vendor has the following option to sell the car to the customer:

  • Provide a deferred payment facility by the vendor himself on account of purchase of the car, or
  • Provide a loan facility to purchase the asset through the vendor’s captive lending unit, or
  • Provide a loan facility to purchase the asset through any bank/NBFC

In all the three cases mentioned above, GST taxability will be different. In case the deferred payment facility is provided by the vendor and there is a delay in payment of EMI by the borrower, GST shall be charged on the additional interest due to such delay in payment. However, in case a loan facility has been provided by the vendor’s captive lending unit or by an independent bank or an NBFC, the additional interest charged on the delayed repayment will not be taxable under GST.

Conclusion

The circular by the government came up as a clarification in regard to GST implications on penal charges. This clarification brings ease to various NBFCs who were levying penal charges as per the agreement on the delayed payment of loan instalment. Also, the circular overrides the advance ruling in the case of Bajaj Finance Limited.

To summarise the above discussed concept:

  • Penal charges in case of delayed payment of instalment of supply of goods and services shall be included in the value of supply as per section 15(2) (d) of the CGST Act. The same shall be liable to tax under GST
  • Penal charges in case of delayed payment of instalment of a money to money transaction will be included in the value of supply as per section 15(2) (d) of the CGST Act. The same shall be exempt through serial no 27 of the notification No. 12/2017-Central Tax (Rate) dated 28th June 2017. Therefore penal charges in this case shall not be taxable under GST.

 

[1] http://www.cbic.gov.in/resources//htdocs-cbec/gst/circular-cgst-102.pdf;jsessionid=4085899A448EFF7FCF1762E53BC68D3F

[2][2] http://gstcouncil.gov.in/sites/default/files/faq/27122018-UPDATED_FAQs-ON-BANKING-INSURANCE-STOCK-BROKERS.pdf

[3] http://www.cbic.gov.in/resources//htdocs-cbec/gst/Notification12-CGST.pdf;jsessionid=3D2C63EDD8A1183AEB262F41985CB224

[4] https://mahagst.gov.in/sites/default/files/ddq/GST%20ARA%20ORDER-22.%20BAJAJ%20FINANCE%20LTD.pdf

[5] [5] http://www.cbic.gov.in/resources//htdocs-cbec/gst/Notification12-CGST.pdf;jsessionid=3D2C63EDD8A1183AEB262F41985CB224