Interest on Loan not Taxable in absence of a mechanism for bifurcation of Service prior to March 2006: Bombay HC

The Bombay High Court held that interest on the loan is not taxable in absence of a mechanism for bifurcation of service prior to March 2006.

Facts of the case:-

The respondent, Shriram Transport Finance Company Ltd. is engaged in the business of lease and equipment finalizing which is squarely covered by the definition of ‘banking and other financial services’ in Section 65(12) of the Finance Act. It is well-settled position that hires purchase is a loan by which the hirer obtains goods from a seller and the banking and financial institution finances the purchase of goods with the title firmly rest with the hirer and the financing institution being vested with the right to acquire possession of the said goods in the event of default in payment of the contracted amount or equated monthly instalments. A contract for hire purchase is substantially different from that of an operating lease.

Interpretation of law:-

The taxability of the service is not in question. Every consideration for the taxable service is leviable in accordance with the charging section unless excluded by the charging section which is Section 66 of the Finance Act read with Section 65(105)(zm) and Section 65(12) thereof.

In computing the value of taxable service mandated by Section 67 of the Finance Act, the law provides exclusion either by explanation or by rules. It is that exclusion that has been claimed by the respondent as its statutory right which is disputed by the Revenue.

In the present case consideration for the taxable service rendered by the respondent is received as EMI which is thereafter assigned as principal and interest. The revenue raised the issue of whether the Tribunal was correct in holding that the activity is not taxable prior to March 1, 2006, as there was no mechanism provided for bifurcation of the value of service from the interest amount. The other issue was whether the tribunal was correct in holding that the period prior to March 1, 2006, is not taxable in the absence of a mechanism for bifurcation of Service Income as provided in Notification No.4/2006 – ST.

Conclusion:-

The coram consisting of Justice Milind Jadhav and Ujjal Bhuyan held that CESTAT was correct in holding that for the period prior to March 1, 2006 interest on the loan is not taxable in the absence of a mechanism for bifurcation of service. Therefore, recovery of service tax on interest for the period to March 1, 2006, is without the authority of law as there is a presumption of attributing the entire amount to an interest in the absence of any mechanism to isolate the processing or management cost even if that were collected by way of equated monthly instalments.

The court noted that CESTAT has returned a clear finding that hires purchase is but loan and that hirer obtains goods from the seller and the banking and financial institution finalised the purchase of the goods with the title firmly resting with the hirer with the financial institution vested with the right to acquire possession of the goods through judicial intervention.

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