No GST on penal charges levied by banks, NBFCs and other regulated entities on loans, clarifies CBIC
The government has stated that no Goods and Services Tax (GST) is required to be paid on penal charges on loans levied by RBI regulated entities like banks, NBFCs etc. The Central Board of Indirect Taxes and Customs (CBIC) in its notification dated 28 January 2025 has clarified that penal charges are something which is levied by banks, NBFCs, etc to bring a sense of discipline among customers. The technical term for this type of charge is ‘liquidated damages’. For those unfamiliar with this term, liquidated damages means a preset amount of money that is paid by the defaulting party in the event of breach of any contract with another party.
What clarification did the govt give about charging GST on penal charges of loans
CBIC said in a clarification circular dated January 28, 2025, “...certain payments such as liquidated damages for breach of contract are not a consideration for tolerating an act or situation. They are rather amounts recovered to deter such acts; such amounts are for preventing breach of contract or non-performance and are thus mere ‘events’ in a contract. It has been further clarified that the essence of a contract is its ‘performance’ and not its ‘breach’, meaning thereby that parties enter into a contract for execution and not for its breach.”
“Penal charges levied by REs, in compliance with RBI directions dated 18.08.2023, are essentially in the nature of charges for breach of terms of contract and hence, fall within the ambit of the above clarification. It is hereby clarified that no GST is payable on the penal charges levied by Regulated Entities, in compliance with RBI directions dated 18.08.2023, for non-compliance with material terms and conditions of loan contract by the borrower.”
How does this new GST clarification help loan consumers
Chartered Accountant Bimal Jain, founder, A2Z Taxcorp LLP says this clarification has provided some relief to borrowers who defaulted on their loan contract with banks, NBFCs, others. “Whenever a customer defaults the regulated entities levy penal charges on the customer. Earlier some banks, NBFCs, were charging GST on such charges, while some were not. Those who did not charge GST on penal charges were issued show cause notices (SCNs) by the GST department. Now after this clarification no bank, NBFC, or others will charge GST on penal charges on loan.”
