• Notification Date: 04-02-2025
• Notification No: N/A

No GST on Penal Charges Levied by Banks, NBFCs on Loans: CBIC Clarifies

Recently, the government clarified that no Goods and Services Tax (GST) would be levied on penal charges charged by banks, Non-Banking Financial Companies (NBFCs), and other regulated entities (REs) on loans. The CBIC issued the clarification on January 28, 2025, stating that penal charges are colloquially referred to as liquidated damages, which do not constitute a taxable event under GST.

Penalties for a contravention of a loan agreement, as charges of punishment, are therefore essentially intended to mete out punishment to the borrower. Such charges could not be treated as compensation for giving permission for an act or service to be done but were working as a deterrent against non-compliance with loan agreements. In this context, as provided for in the circular issued by the CBIC, such charges would fall outside taxable services as there had been no transaction of goods or services.

This is a much-needed clarification for both borrowers and financial institutions. There are some banks and NBFCs that had, earlier on, charged GST on such penal charges, and due to the confusing nature of such charges, received show cause notices from the GST authorities. Due to this clarification, they will not need to charge GST anymore, thus lowering the cost of borrowing at large.

However, the clarification does not cover penal charges on credit cards, borrowings from outside sources, and other business-related activities, trade credits, or structured obligations, respectively, with varied regulatory directions.

Chartered accountants and tax experts have welcomed the move as it brings clarity for GST-registered entities and potential relief in the pending demands for taxes. Borrowers and financial institutions can now conduct their loan-related penalties without the added complexity of GST.