In a fresh dampener to borrowers, who are already reeling under sky-high interest rates, the finance ministry has clarified that foreclosure charges on loans will attract service tax.
Foreclosure or pre-closure charges refer to the monetary penalty that a bank or lending agency imposes on borrowers when the latter decide to pay the entire loan prematurely or before the date given in the loan agreement.
Such charges will now be considered as a part of the host of services provided by banks and lending institutions that are liable to pay service tax at the rate of 12% (excluding cess) under the category of ?banking and other financial services.?
Any amount collected by the service provider on account of lending is either interest or service charges, the Central Board of Excise and Customs has reasoned. Pre-closure or foreclosure charges are however not collected by banks as interest or for delayed payment, the department has also pointed.
?These charges should be appropriately treated as consideration for the services provided and accordingly leviable to service tax,? the CBEC has clarified and asked its field formation to collect tax on such transactions.
While foreclosure and pre-closure charges vary across banks, the type of loan and the disbursal date, they can be anywhere between 2% to 6% of the principal outstanding amount. Many public sector banks, however, do not impose such penalties.
The clarification is expected to hurt customers, as banks are likely to pass on the service tax bill to them.
?While banks would be liable to pay the tax, they will charge it from the borrower, like they do in many other cases,? a tax expert said. He also pointed out that the added burden might in fact discourage customers from opting to foreclose loans.
Punjab National Bank CMD KC Chakrabarty agreed and said many banks would also pass on the service tax component to the consumer. He also added that India would be a unique case where the pre-closure or foreclosure charges collected by banks from their borrowers are treated as consideration for service.
Tax officials however said the move would have very little impact as relatively few people in India foreclose their loans. ?A clarification was issued as there is some confusion amongst lending institutions and the tax department on the issue and divergent practices were being followed,? a tax official said.
K Unnikrishnan, deputy chief executive and senior vice president, Indian Banks? Association, also said the move would not have much impact on either customers or banks.
?Since it is not an amount on which the working of the banks is dependent on, it will not have any impact on their balance sheet. Moreover, not many borrowers are closing their loans ahead of its tenure.?