GST on NBFC: Preparations to impose 18% tax on co-lending services, council to take final decision

New Delhi: Banks and non-banking financial companies (NBFCs) are working together to simplify loan disbursements in the country. This collaborative arrangement is known as co-lending in financial parlance. This model has made it easier to extend loans to remote areas, but there has long been uncertainty regarding tax implications. 

To resolve this confusion, the GST Council's Fitment Committee has prepared a major proposal. The committee has recommended that 18% GST be levied on services provided by NBFCs to banks under the co-lending model. It's worth noting that this tax hasn't been implemented yet, but preparations are underway to implement it.

The committee's move aims to resolve ongoing legal disputes in the financial sector. A significant relief for ordinary borrowers is that the interest on the principal loan will be completely exempt from tax, meaning it will have no impact on customers' pockets. This proposed 18% tax applies only to the service component that NBFCs provide to banks.

New proposal to tax co-lending arrangements

In a co-lending arrangement, a bank and an NBFC jointly fund a customer's loan. The bank contributes the majority of the capital, while the NBFC handles customer engagement, document verification, and loan management. The total interest generated from this process is shared between the two institutions in a pre-determined ratio.

This can be understood with a simple example. Suppose a loan is given to a customer at a compounded interest rate of 16%. Of this, the bank is guaranteed to receive 10% interest on the loan. The NBFC that brought the customer retains the remaining 6%. Last year, the industry asked the government what this 6% portion should be considered by the NBFC. If it were considered interest, it would not be taxable under the rules. However, the tax department was treating it as a service fee, resulting in companies receiving tax notices. Now, the Fitment Committee has proposed that this be considered a service provided to the bank and brought under the 18% GST ambit.

Service value will be determined by RBI's formula

The Fitment Committee not only suggested the tax rate, but also recommended determining how the service would be priced, using guidelines set by the Reserve Bank of India (RBI).

Clear regulations will eliminate the scope for disputes between the tax department and lending institutions. Banks and fintech platforms will be able to partner without legal fear. Previously, due to the lack of precise regulations, companies faced lengthy litigation. Now, the value of services such as customer acquisition, paperwork, and loan recovery will be directly determined by the banking regulator's regulations.

Big relief on mutual transfer of bank branches

In addition to co-lending, the Fitment Committee has proposed another important approach related to banks' internal operations. Banks often transfer funds from one branch to another. To record this transaction in the books, they add a nominal charge.

The Council has proposed that these internal charges be treated like interest. This would eliminate any separate tax on these charges. This would significantly reduce the additional tax liability for banks transferring money between their own branches.

Final decision in GST Council meeting

The Fitment Committee has developed these recommendations after consultation with all stakeholders. These proposals will be presented to the GST Council for consideration. The Council's next meeting is scheduled for October 8th.

If the GST Council approves this proposal, a formal circular will be issued by the Finance Ministry, which will then implement this new system. This proposal is part of a major government reform aimed at addressing long-standing tax deficiencies in the financial sector.