Revenue authorities are on weak legal footing

The banking sector in India has been going through turmoil in the recent past for various reasons. It appears that tax woes are around the corner too, deepening the sense of crisis.

Currently, as per media reports, the following three types of indirect tax demands are being pursued by authorities against various banks. These demands are mostly based on a hyper-technical interpretation of the legal provisions and are unlikely to sustain in the face of judicial scrutiny. However, contesting such highvalue tax litigations would be a massive drain on the resources of the already beleaguered banking sector. This, in turn, would push up the cost of banking services in a country like India where banking penetration is anyway low.

In the following paragraphs, we have briefly discussed the three areas of investigations against the banks and how these investigations are without a strong basis in law:

1. Service Tax demand on the ‘free’ valueadded services offered by the banks Commercial banks offer value-added banking services (like phone/ mobile/ net banking services, free debit card and free cash transactions at other bank ATMs) vis-a-vis accounts with a prescribed minimum average balance (MAB) or average quarterly balance (AQB). Show cause notices have been issued to various banks for non-payment of service tax on the provision of ‘free’ valueadded services in relation to MAB/ AQB accounts.

Essentially, the Revenue has alleged that when banks commit to providing value-added services, it is a case of bank ‘agreeing to the obligation to do an act’ [a ‘declared service’ under the Finance Act, 1994 (“Finance Act”) – the service tax legislation] in lieu of the customers maintaining MAB/ AQB. Such a claim of service tax is legally untenable owing to the following reasons:

A. Maintenance of AMB/AQB does not constitute ‘consideration’ for the valueadded services provided in such accounts by the banks

It is well-settled that the tax department cannot construe agreements in the light of tax laws to impose a liability on the assessee -- when the contract between the banks and the customers does not contain any provision for consideration for the provision of valueadded services by the banks.

B. Maintenance of MAB/AQB is only a ‘condition of contract’ which is different from ‘consideration for a contract’

2. The allegation of incorrect availment and utilisation of credit on input tax paid to ATM vendors The input services in the nature of maintenance services and cash feeding services received by the banks are also being investigated by the department. Tax authorities allege that as the banks do not charge for all transactions of withdrawal of cash from ATMs, being their output service, the banks cannot avail full credit of the GST/service tax paid on input services of maintenance and cash feeding.

This seems to be an attempt to establish a one-to- one correlation between the input and the output services and deny credit in cases where such correlation cannot be established, which would be a complete antithesis to the concept of ‘free flow of credit’ as prevalent under the GST regime.

3. Attempt to disallow the supply of ATMs by the vendors to the banks According to media reports, the Directorate General of Goods and Services Tax (DGGST) is investigating alleged collusion between some banks and ATM service-providers to avoid payment of value added tax (VAT). They are essentially examining transactions in the pre-GST era in relation to the supply of ATMs by the vendors to the banks (which did not amount to ‘sale’ of ATMs by the vendor to banks; vendors were charging service tax which was availed as input credit by banks), attempting to treat the same as ‘deemed sales’ and recommend levy of VAT, thereon. That, in turn, may lead to disallowance of the credit availed by the banks.

Determining whether a transaction constitutes deemed sale or service is essentially a question of fact. The approach adopted by the department to try and classify all selected cases where the vendors supplied ATM to the banks as cases of ‘transfer of the right to use’ the ATMs is erroneous.

Contesting high-value tax litigation would be a massive drain on the resources of the already beleaguered banking sector

Parting thoughts

Media reports suggest that the government is planning to withdraw the service tax notices on the ‘free services by banks’ issue and also issue a clarification that such services would not be liable to GST either. The foregoing would indeed be a positive development for the beleaguered banking sector.

One hopes that favourable instructions/clarifications would also be issued apropos the other two issues in order to provide some relief to the banks – else, prolonged litigation would be the only remedy left for banks.