The Central Board of Indirect Taxes & Customs (CBIC), through the Circular No. 245/02/2025-GST made clarifications regarding applicability of GST on penal charges being levied by the Regulated Entities (REs)in view of RBI instructions dated 18.08.2023 directing such Regulated Entities (REs) to levy penal charges in place of penal interest.
The clarification was based on the recommendations of the GST Council in its 55th meeting held on 21st December 2024, at Jaisalmer, and in exercise of the powers conferred under section 168(1) of the Central Goods and Services Tax Act, 2017.
in view of RBI instructions dated 18.08.2023 directing such Regulated Entities (REs) to levy penal charges in place of penal interest.
Representations have been received seeking clarification on the applicability of GST on penal charges being levied by the Regulated Entities (REs) in view of RBI instructions dated 18.08.2023 directing such Regulated Entities (REs) to levy penal charges in place of penal interest.
Through RBI directives of 18.08.2023, Regulated Entities (REs), including banks and non-banking financial corporations (NBFCs), have been directed to stop using penal interest for loan terms that are not being met. According to the guidelines, REs are to impose penal costs for loan conditions non-compliance rather than penal interest. Penal charges are primarily intended to instill a feeling of credit discipline. Credit cards, trade credits, external commercial borrowings, and structured liabilities are exempt from these guidelines, which go into effect on January 1, 2024. Instead, they are governed by product-specific guidelines.
Some field formations believe that the penalties imposed are a type of compensation or consideration for putting up with an act or circumstance. Similar topics were covered in Circular No. 178/10/2022-GST, dated 03.08.2022, where it was previously made clear that some payments, including liquidated damages for contract violations, are not taken into account when tolerating an act or circumstance. These are merely “events” in a contract; rather, they are sums recovered to discourage such behavior. They are used to stop non-performance or contract violations. Parties engage into a contract for execution, not for breach, as it has been further explained that the core of a contract is its “performance” rather than its “breach.”
It was stated that penal charges levied by REs, in compliance with RBI directions dated 18.08.2023, are essentially in the nature of charges for breach of terms of contract and hence, fall within the ambit of the above clarification.
As suggested by the 55th GST Council, it is made clear that, in accordance with RBI directives dated 18.08.2023, no GST is due on the penalties imposed by Regulated Entities for the borrower’s failure to comply with material terms and conditions of the loan contract.
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