Rs 1500 Crore GST on Penal Charges - A Compliance Failure Auditors Must Examine in FY 2025-26

Introduction

The levy of GST on penal charges by banks and NBFCs during FY 2024–25 has surfaced as a significant compliance and audit concern. What initially appeared as a routine operational practice has now evolved into a systemic issue involving an estimated Rs 1,500 crore, with implications for financial reporting, regulatory compliance, and customer fairness.

Despite a clear clarification that such charges are not taxable, the amounts collected have largely not been refunded, warranting close attention from Chartered Accountants.

Regulatory Background

With effect from 1st April 2024, RBI mandated that banks discontinue penal interest and instead levy flat penal charges for loan defaults.

(RBI link - https://www.rbi.org.in/commonman/english/scripts/FAQs.aspx?Id=3558 )

However, banks treated these charges as taxable and levied GST @18%, increasing the burden on borrowers.

The position was later clarified by the 55^th GST Council Meeting (December 2024) and clarification was issued by Central Board of Direct Taxes. Circular link - Circular-55thGSTC-Services-1.pdf

Penal charges for breach of contract do not constitute consideration for supply and are therefore not liable to GST .

Following this, banks discontinued GST on such charges from January 2025 onwards . But NBFCs continue to levy GST on the penal charges.

The Core Issue - Non-Refund of GST

While prospective correction was implemented, the key concern remains unresolved:

• GST collected during April–December 2024 has not been refunded
• No uniform mechanism has been adopted by banks/NBFCs
• Customers continue to bear the burden of an incorrect levy

RTI data from select public sector banks reveals:

• GST collected by 7 PSBs: Rs 366.59 crore
• Estimated total across the sector: ~Rs 1,500 crore

This clearly indicates a material and industry-wide issue .

Legal Position under GST

GST is applicable only where there is:

• Supply of goods or services
• For a consideration

Penal charges do not satisfy these conditions:

• They arise from breach of contractual terms
• They are deterrent in nature, not consideration
• They are akin to penalties/fines, which are outside GST scope

Thus, the levy of GST in such cases was legally unsustainable.

Key Issues for Chartered Accountants

This development raises several important professional considerations:

1. Liability vs Income

• Whether GST collected (now held invalid) should be recognised as:
• Liability payable to customers, or
• Income already accounted for

2. Provisioning Requirements

• Need for creating provisions for refund obligations
• Impact on financial statements for FY 2025-26

3. Unjust Enrichment

• Retaining such amounts may violate the principle of unjust enrichment, as:
• The incidence has been borne by borrowers

4. Disclosure and Reporting

• Requirement of adequate disclosures
• Potential implications for audit qualifications or emphasis of matter

Regulatory Gap

The issue remains unresolved due to lack of coordinated action:

• Banks: Already remitted to the Central Govt, cannot refund.
• RBI: GST matters stated to be outside its purview
• CBIC: Refund to be initiated by banks as taxpayers
• Banks/NBFCs: No proactive refund mechanism implemented

This has resulted in a regulatory deadlock, leaving affected customers without remedy.

Implications for NBFCs

NBFCs are equally exposed, as they:

• Follow similar lending and penal charge structures
• May have adopted identical GST practices
• Face comparable accounting and compliance risks

Way Forward

A structured resolution is necessary:

• CBIC: Provide clarity and procedural support for refunds
• RBI: Issue advisory in the interest of consumer protection
• Banks/NBFCs: Initiate suo motu refunds or credit adjustments

Timely action will help mitigate litigation risk, reputational damage, and audit concerns.

Audit Relevance - FY Ending 31st March 2026

This issue assumes critical importance for statutory audits.

Auditors of banks and NBFCs should specifically examine:

• Treatment of GST collected on penal charges
• Recognition of liabilities/provisions
• Adequacy of disclosures in financial statements
• Compliance with applicable accounting and legal requirements

Given the materiality involved, this area warrants focused audit procedures.

Role of ICAI

Considering the widespread impact, it is imperative that ICAI :

• Examines the legal, accounting, and audit implications
• Issues guidance or technical clarification
• Sensitizes members on the appropriate treatment

Such intervention will ensure uniformity and uphold professional standards.

Conclusion

The incorrect levy of GST on penal charges represents a significant compliance lapse with far-reaching implications .

With nearly Rs 1,500 crore involved, the issue goes beyond taxation—it touches upon financial reporting integrity, regulatory accountability, and customer rights.

Chartered Accountants and auditors now have a crucial role to play in ensuring that this matter is properly recognised, reported, and addressed in the financial ecosystem.

Further references:

• Loan Penal Charges: Accounting and GST implications – Vinod Kothari Consultants
• https://www.moneylife.in/article/gst-on-bank-penalties-the-rs1000-crore-wrong-that-needs-righting-now/77804.html

The author is an Ex-Banker with 38 years of service in a Public Sector Bank. Writing articles on matters affecting general public, especially customers of Banks and consumers in general