[Opinion] GST on Penal Interest in Tripartite Advance Payment Transactions | Clarifications and Implications

Sachin Mishra & Mahi Agrawal – [2024] 163 taxmann.com 736 (Article)

Interest payments made by borrowers to lenders for the time value of money lent are generally exempt from Goods and Services Tax (GST) in India. However, the treatment of penal interest or charges levied for breaching contract terms, delayed payments, or prepayments has been a subject of debate.

Clarifications issued by the GST Council and the Ministry of Finance have provided guidance on these matters. Penal interest on loan transactions is generally exempt, aligning with the exemption for loan interest itself. Conversely, penal charges on delayed payments for goods or services supplied are included in the taxable value and liable for GST.

However, a unique scenario arises when a financier makes an advance payment on behalf of a buyer to a seller, and the buyer subsequently repays the financier after a period, potentially with penal interest for any delays. Illustration-I: A warehouse operator (the financier) advances payment on behalf of a retailer (the buyer) to a supplier (the seller) for a bulk order of goods. The supplier delivers the goods to the warehouse, where they are stored temporarily. The retailer later repays the warehouse operator for the advance, and if there are any delays, a penal interest is charged.

This situation differs from a traditional loan, as the financier is not providing a loan but facilitating an advance payment. The tax treatment of penal interest in such tripartite transactions has been addressed here. This article delves into the nuances of this specific scenario, examining the rationale behind the tax treatment and its implications for businesses involved in such transactions.

Under the GST regime, services by way of extending deposits, loans or advances in so far as the consideration is represented by way of interest or discount, are exempt from GST under Sr. No. 27 of the Notification No. 12/2017- Central Tax (Rate) dated 28.06.2017 (hereinafter referred to as ‘the Notification’). Further, definition clause 2 (zk) of the Notification states “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 utilized.

Making payments on behalf of someone else can be considered as a loans/advances under certain circumstances. Indian courts have recognized that such payments can amount to a loan, provided there is clear evidence of an agreement or understanding that these payments are to be repaid. This can include documentary evidence, oral agreements, or other forms of proof that establish the intent of the parties involved.

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