Context:
The Ministry of Finance notified that penal charges imposed by banks and non-banking financial companies (NBFCs) for noncompliance with loan terms will not attract an 18 per cent goods and services tax (GST).
Key Highlights:
- Penal Charges
- Not Taxable under GST Banks and NBFCs are exempted from charging 18% GST on penal charges imposed as a result of loan term noncompliance.
- RBI Circular dated August 18, 2023
- The RBI has issued an August 18 ,2023 circular that has commanded banks and NBFCs to change penal interest to penal charges when a borrower fails to comply with loan terms.
- Objective
- The changes effective from January 1 2024, aim to promote credit discipline among borrowers.
- Exclusions
- The RBIs guidelines exclude certain financial products like credit cards, external commercial borrowings, trade credits and structured obligations which are governed by separate rules.
- Clarification on Penal Charges
- The Central Board of Indirect Taxes and Customs clarified that penal charges are not payments for tolerating an act but are penalties for breaching loan agreements ensuring the focus remains on loan performance not breaches.
Penal Charges
Penal charges are fees charged by lenders on the defaulting borrower for failure to pay loans or breach of the loan agreement. It is a measure to deter defaulting borrowers and ensure financial discipline.
How are penal charges calculated?
- Penal charges are charged by the lender on the defaulted amount
- Penal charges are charged on a pro rata basis on the default period
- Penal charges are not included in the rate of interest
What are penal charges?
- Over drafting a bank account, Late payment of interest, and Late payment of installment.
What are the RBI’s directives on penal charges?
The Reserve Bank of India (RBI) has guidelines that prohibit banks and finance companies from charging penal interest on loan defaults. Instead, they must charge penal charges, which are fixed fees.
- Penal charges cannot be added to the loan amount
- Penal charges cannot be capitalized, meaning no further interest can be computed on them
- Penal charges must be reasonable and levied in a non-discriminatory manner
Who suffers from penal charges?
- The same penal charges apply to the same loan product for retail and corporate borrowers.
