Taxation of financial services - Dr Sanjiv Agarwal - Article published in Business Advisor, dated December 25, 2016 - http://www.magzter.com/IN/Shrinikethan/Business-Advisor/Business/

1. Volume XVII Part 6 December 25, 2016 10 Business Advisor
Taxation of financial services
Dr Sanjiv Agarwal
Banking and financial services are generally liable to
service tax. However, in terms of section 66D(N) of the
Finance Act, 1994, the following specified services are
not taxable:
Services by way of—
(i) extending deposits, loans or advances insofar as the
consideration is represented by way of interest or
discount;
(ii) inter se sale or purchase of foreign currency amongst banks or authorised
dealers of foreign exchange or amongst banks and such dealers.
The above-mentioned two specified services have been included in the
negative list.
For the purpose of this entry, interest has been defined in section 65B(30)
as under –
‗Interest‘ means interest payable in any manner in respect of any money
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.
It should only be in the form of interest and does not include any service
charge, fee or other charge, by whatever name called. For example,
processing charges, pre-payment fee, late fee, cheque bounce charges etc.,
will not be called interest. Also such ‗interest‘ has to be paid or received in
relation to –
• Money borrowed;
• Debt incurred;
• Deposit;
• Claim or other similar right or obligation.
However, in section 2(28A) of Income Tax Act, 1961, the expression ‗interest‘
has been defined to mean interest payable in any manner in respect of any

2. Volume XVII Part 6 December 25, 2016 11 Business Advisor
money borrowed or debt incurred (including a deposit claim or other similar
right or obligation) and includes any service, fee or other charge in respect
of the moneys borrowed or debt incurred in respect of any credit facility
which has not been utilised.
Thus, there is a vast difference in scope of ‗interest‘ in direct tax and service
tax. In service tax, scope of interest has been limited to restrict inclusion of
fee, service charge or other charges.
‗Authorised dealer of foreign exchange‘ is defined in section 2(c) of the
Foreign Exchange Management Act, 1999. Authorised dealer of foreign
exchange has been defined to have the meaning under section 2(c) of the
Foreign Exchange Management Act, who deals in foreign exchange or
carries out certain transaction in foreign exchange. The authorised dealer
should be a person authorised by the Reserve Bank of India and must have
obtained a licence to deal in foreign exchange. Authorised dealer may be a
person or a firm or a juristic person. Authorised person means an
authorised dealer, moneychanger, offshore banking unit or any other person
to deal in foreign exchange or foreign currency or foreign securities. Thus,
such person must be authorised by the Reserve Bank of India to act as
such.
The negative list entry covers any such service wherein moneys due are
allowed to be used or retained on payment of interest or on a discount. The
words used are ‗deposits, loans or advances,‘ and have to be taken in the
generic sense. They would cover any facility by which an amount of money
is lent or allowed to be used or retained on payment of what is commonly
called the time value of money which could be in the form of an interest or a
discount. This entry would not cover investments by way of equity or any
other manner where the investor is entitled to a share of profit.
Illustrations of negative list services could be as follows –
 Fixed deposits or saving deposits or any other such deposits in a bank for
which return is received by way of interest.
 Providing a loan or overdraft facility or a credit limit facility in
consideration for payment of interest.
 Mortgages or loans with a collateral security to the extent that the
consideration for advancing such loans or advances are represented by
way of interest.
 Corporate deposits to the extent that the consideration for advancing
such loans or advances are represented by way of interest or discount.

3. Volume XVII Part 6 December 25, 2016 12 Business Advisor
The services of loans, advances or deposits are exempt insofar as the
consideration is represented by way of interest or discount. Any charges or
amounts collected over and above the interest or discount amounts would
represent taxable consideration.
Invoice (bills) discounting or cheque discounting or any similar form of
discounting is covered only to the extent consideration is represented by
way of discount, as such discounting is nothing else but a manner of
extending a credit facility or a loan.
Services provided by banks or authorised dealers of foreign exchange by way
of sale of foreign exchange to general public will not be covered in this entry.
This entry only covers sale and purchase of foreign exchange between banks
or authorised dealers of foreign exchange or between banks and such
dealers.
CBEC Guidance Note dated 20.06.2012 has clarified on taxability of ‗repo‘
and ‗reverse repo‘ instruments, trading on commercial papers, certificate of
deposit and credit card dues and forward and future contracts as under –
Repos and reverse repos are financial instruments of short-term call money
market that are normally used by banks to borrow from or lend money to
RBI. The margins, called the repo rate or reverse repo rate in such
transactions are nothing but interest charged for lending or borrowing of
money. Thus they have the characteristics of loans and deposits for interest.
However they are more appropriately excluded from the definition of service
itself being the sale and purchase of securities, which are goods.
Commercial paper (‗CP‘) and Certificate of Deposit (‗CD‘) are instruments for
lending or borrowing money, wherein consideration is represented by way of
a discount issue or subscription to CPs or CDs, would be covered in the
negative list entry relating to ‗services by way of extending deposits, loans or
advances insofar as consideration is represented by way of interest or
discount.‘ It may also be borne in mind that promissory note is included in
the definition of money in the Act as given in clause (33) of section 65B.
However, if some service charges or service fees or documentation fees or
broking charges or such like fees or charges are charged, the same would be
considerations for provision of service and chargeable to service tax.
A forward contract is an agreement, executed to purchase or sell a pre-
determined amount of a commodity or currency at a pre-determined future
date at a pre-determined price. The settlement could be by way of actual
delivery of underlying commodity/ currency or by way of net settlement of

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differential of the forward rate over the prevailing market rate on the
settlement date.
In a forward contract, effectively two contracts are entered into, one for
purchase and other for sale at a future date at a pre-determined price.
These contracts would be in the nature of transfer in title in goods (in case
the forward contract relates to a commodity) or transaction of only money
(in case the forward contract relates to transaction and money). Therefore,
forward contracts in commodities or currencies would not fall in the ambit
of definition of ‗service‘. For transactions in money Explanation 2 to clause
(44) of section 65B should also be kept in mind.
Future contracts are in the nature of financial derivatives, price of which is
dependent on the value of underlying stocks or index of stocks or certain
approved currencies and the settlement happens normally by way of net
settlement with no actual delivery.
Since future contracts are in the nature of contracts of difference based on
the prices of underlying stocks or index of stocks or approved currencies,
they would be outside of the ambit of definition of ‗service‘ as being
transactions only in transfer of title in derivatives.
In the case of a credit card, issuing entity allows the facility of payment of
the purchases made by the card-holder within a specified period failing
which some charges are levied. The question that arises is whether the
credit so extended for this payment is in the nature of a loan or advance for
interest.
Interest for delayed payment of any consideration for the sale of goods or
provision of service has been specifically excluded from value by rule 6 of
valuation rules. Thus, ordinarily, any interest charged for delayed payment
of consideration would have been outside the gambit of service tax.
However, in the case of credit cards, the credit extended is not for the
delayed payment of consideration for the provision of services. The services
in the case of the credit card are by way of levy of issuing charges or the
commission charged from merchants etc. The interest in this case is not for
the consideration for the use of the card. Thus the benefit under the
valuation rules will not be available to credit card companies.
The other question is whether such credit extended will amount to loans or
advances. Loans and advances are meant to signify amounts contractually
negotiated as such (loan or advance) and not merely failure to pay an
amount at the due date. The exorbitant charges have also no relationship
with the prevailing interest for the same class of creditworthiness and are in

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the nature of consideration for the services rendered for using the
convenience of using the services by way of a credit card and hence taxable.
Corporate guarantees are often given or issued by business entities to
provide comfort to lenders or bankers. This may yield certain income to the
entity giving corporate guarantee in the form of fees or commission.
Corporate guarantee is not covered under any entry of negative list or more
particularly in financial services and, as such, these will be subject to levy
of service tax. In Olam Agro India Ltd. v. CCE (2014) 33 STR 234 (Delhi),
where the Department wanted to levy service tax on corporate guarantee
commission received from a subsidiary company, it was held that, prima
facie, corporate guarantee provided to a bank for loans taken by another
entity falls outside the banking or financing services.
Under the proposed GST regime, the following would prevail –
(i) Scope of ‗goods‘ does not include money.
(ii) ‗Service‘ would mean anything other than goods. Services include
transaction in money but do not include money.
(iii) Services do not include transaction in money other than an activity
relating to the use of money or its conversion by cash or by any other
mode, from one form, currency or denomination, to another form,
currency or denomination for which a separate consideration is
charged.
(iv) So far as place of supply of services concerned, the place of supply of
banking and other financial services including stock-broking services to
any person shall be the location of the recipient of services on the
records of the supplier of services. If the location of the recipient of
services is not on the records of the supplier, the place of supply shall
be location of the supplier of services.
(v) Whether interest would be taxed or not is not yet clear, as exemption
list/ negative list has not yet been released.
(vi) There may be composition levy of GST in case of moneychanger‘s
services.
The scope of taxable services in case of banking services would be known
once the exemptions are finalised as there is no specific exclusion in the
draft law.
(Dr Sanjiv Agarwal is Partner, Agarwal Sanjiv & Company, Jaipur.)