Is Service Tax applicable on Penal Interest levied on Delayed Loan EMIs? A case reached the CESTAT Chennai and finally the CESTAT Chennai has given its verdict on the case. Let’s read the verdict.
The Customs, Excise and Service Tax Appellate Tribunal (CESTAT), Chennai Bench, has ruled that penal interest charged by banks on delayed or defaulted loan EMIs is not liable to service tax under the Finance Act, 1994.
The tribunal said penal interest is not charged for any service provided by banks. It arises automatically when a borrower fails to pay the EMI on time. The bench explained that penal interest is a result of breach of contract. Its purpose is to discourage delays and to compensate the bank for late recovery of money.
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The ruling was given by Judicial Member P. Dinesha and Technical Member Vasa Seshagiri Rao. The tribunal partly allowed appeals filed by Karur Vysya Bank Ltd. and City Union Bank Ltd. against service tax demands raised by the tax department.
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The tribunal set aside service tax demands on penal interest charged to borrowers and on notice period pay recovered from employees. However, it upheld tax, interest, and penalties on certain Corporate Social Responsibility (CSR) expenses where branding or promotional visibility was involved.
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The cases arose from departmental audits covering the period from October 2013 to June 2017. The tax department claimed that penal interest on delayed EMIs, notice period pay recovered from employees, and CSR expenses were all taxable. According to the department, penal interest and notice period pay were payments for “tolerating an act,” while CSR expenses involving logos or brand names amounted to sponsorship services.
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These claims led to show cause notices and confirmation of tax demands. Before the tribunal, the banks argued that penal interest and notice period pay were not payments for any service. They said these were only consequences of breach of loan and employment contracts. The banks also said most CSR spending was for social welfare and should not be treated as sponsorship unless it involved clear promotion.
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The tax department responded that some CSR expenses were linked to brand visibility and should therefore be treated as taxable sponsorship.
The tribunal agreed with the banks on penal interest. It said there was no independent agreement by banks to tolerate defaults in return for money. On notice period pay, the tribunal held that such recoveries arise from the employer–employee relationship and are outside the scope of service tax.
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On CSR expenses, the tribunal made a clear distinction. It said genuine donations without any benefit in return are not taxable. However, if CSR contributions are linked to display of logos, brand names, or promotional exposure, they fall under sponsorship service and attract service tax. The tribunal clarified that merely calling an expense “CSR” does not change its nature if records show branding or promotional intent.
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