Banks and non-banking financial companies (NBFCs) are working together to simplify the way loans are disbursed in the country. This joint arrangement is called co-financing in financial parlance. This model has made it easier to extend loans to remote areas, but taxes have long been dubious. Now to solve this problem the Fitment Committee of GST Council has prepared a big proposal. The committee has recommended that 18 per cent GST should be levied on services rendered by NBFCs to banks under the co-lending model. It is worth noting that this tax has not yet come into effect, but preparations are underway to implement it.

The committee’s move is aimed at ending the ongoing legal disputes in the financial sector. A relief for common loan borrowers is that the interest charged on the original loan will be completely exempt from tax. That means it will not affect the pocket of the customers. This proposal of 18 percent tax is only for that part of the service that NBFCs provide to banks.

New proposal for tax on co-financing system

In a co-lending system, banks and NBFCs jointly pool the loan amount of the customer. In this, most of the capital is invested by the bank, while customer engagement, document verification and loan maintenance are done by the NBFC. The total interest earned from this entire process is shared between the two institutions in a pre-determined ratio.

This can be understood with a simple example. Suppose a loan was given to a customer at a compound interest rate of 16 percent. It has been decided that the bank will get 10 percent interest on its money. The remaining 6 percent is held by the NBFCs that bring in the customer. Last year, the industry asked the government what should be considered when NBFCs have this 6 per cent stake. If it was treated as interest, it was not taxable under the rules. The tax department was treating it as service fee. Companies were getting tax notices for this reason. Now the Fitment Committee has proposed to treat it as a service rendered to the bank and bring it under the ambit of 18 percent GST.

Service value will be determined by RBI formula

The Fitment Committee not only prescribed the rate of tax, but also recommended the manner in which the cost of service would be calculated. For this, the guidelines set by the Reserve Bank of India (RBI) will be used as benchmarks.

Clarification of rules will eliminate scope for disputes between tax department and lending institutions. Banks and fintech platforms will be able to partner with each other without any legal fear. Earlier, due to lack of specific regulations, companies had to face lengthy litigation. Now the value of services like customer acquisition, paper verification and loan recovery will be determined directly by the rules of the banking regulator.

Huge relaxation on mutual transfer of bank branches

Apart from co-lending, the Fitment Committee has made another important proposal related to the internal working of banks. Banks often transfer funds from one branch to another. To record this transaction in the books of accounts, some symbolic or notional charges are entered.

The Council has proposed that these internal charges should also be treated as interest. Hence no separate tax will be levied on these charges. Banks will get huge relief from additional tax liability on money transfers between their own branches.

Final decision in GST Council meeting

The Fitment Committee has prepared all these suggestions after talking to all the concerned parties. All these proposals will be placed before the GST Council for consideration. The next meeting of the council is scheduled for October 8.

If the GST Council approves the proposal, a formal circular will be issued by the Finance Ministry. Only then this new system will be implemented. The proposal is part of a larger government reform, under which old tax-related loopholes in the financial sector are being removed.