The existing Indirect tax framework in India extends to the financial services (FS) sector. Since 2001, service tax has been made applicable on these services. The scope of the levy has been broadened over a period of time. Currently, all fee-based income is liable to tax. Interest, however, is excluded from the levy.
In fact, in India, service tax also applies on margins on fund-based activities, for example, sale of foreign exchange. While such transactions may be entirely non-fee based, and may also be out of proprietary investments, service tax still applies on the act of selling or buying foreign exchange, based on a presumption that when a buy or sell rate is quoted, a margin is inbuilt, which is partially in the nature of service. Such transactions between banks and authorized dealers have been exempted. Another example would be tax on financial leasing transactions. Tax applies on 10% of the interest earned by the lessor on the presumption that there is an embedded service.
Therefore, currently, in general, the entire fee-based revenue, and in some cases a portion of the fund-based revenue is liable to tax. As a matter of fact, India is one of the few jurisdictions, which substantially exploit the entire tax base of the FS sector.
Top controversies include the characterisation of incomes between interest and fees (and therefore from non-taxable to taxable), taxability of margin on debt securitization transactions, applicability to reverse charge tax on services of overseas banks with regard to trade payments, eligibility to certain input credits, etc.
What does GST mean for FS?
Currently, place of supply (POS) for FS needs to be segregated between “within India” and “outside India”. With the introduction of GST, the first significant impact area for the FS sector will be the need to determine POS “state wise”. While POS rules are yet to be released, it is expected that POS for FS could be the place where the service recipient is located. Therefore, for players in the retail segment, POS could potentially be in all states, though there may be no physical presence in each such state. Furthermore, clear provisions are required to handle situations where multi-state presence of a service provider is potentially servicing a multi-state presence of the service recipient.
Conceptually, GST should usher in a clear outcome for fund-based incomes. Whether they are fully exempt, or fully taxable (so that the sector can take full credits), or are continued to be taxed on the same basis as today. This will be important, since although currently certain margin transactions are taxed (for example, insurance underwriting margin), the concept of value added tax has not been fully enshrined in the provisions of the current framework (by allowing a deduction of the claims paid to the insurance company whose underwriting margins are being taxed). This also affects derivative transactions.
For exports, the concept of zero rating in the current law makes a distinction between supplies made to co-branches or head office and supplies made to independent legal entities (albeit of the same group). This distortion needs to be addressed.
The next aspect relates to input credits. Currently, FS generally gets adhoc 50% recovery on input credits. It needs to be clear that with GST, is this likely to change – by moving to actuals or by altering percentage recovery. In case it moves to actuals, the big question would be the determination of exempt income. The exempt basket primarily has interest earned and income from treasury. As regards interest, only net-interest-income (NII) should be treated as exempt. Computation of NII may be different from bank to bank, and therefore, its determination itself can trigger tax disputes. Similarly, clear provisions will be required to ascertain exempt value of treasury transactions. Such trades could result in profits or losses.
Get prepared for the big change
First step will be to collectively analyse high impact areas of the proposed change. There is a strong need to engage with the Government as a part of the formative process of the GST code. This does not necessarily mean seeking exemptions; it is important to get clarity of tax outcomes on complex transactions.
Next step will be to assess impact on business once draft regulations are available. GST will impact not just the tax organization, but the entire end-to-end supply chain. There will be opportunities to optimize, and threats due to increased taxes. Both need to be understood well in advance and planned for.
The third major step will be to prepare the organisation for the change. GST will make all filings online, with possibly the need to upload all procurement and supply transactions. Of course filings will need to be done state-wise depending on POS. This will mean a significant change in the technology employed. Moreover, a transformation of the internal finance and tax setups will be required to match the changed framework. There would be a need to set up a project management team to ensure a proper transition to new regulation.
Overall, GST will usher in a positive change for the economy as a whole. State barriers would fall and tax-related inefficiencies will be minimised or eliminated. This will certainly benefit all sectors. From an FS perspective, the move will also trigger some internal challenges. At the same time, it is a potential opportunity to contribute to the law-making process, aiming to create a predictable and less controversial indirect tax environment.
Divyesh Lapsiwala, Partner – Indirect Tax has contributed to this Article