Banking Penalties Are Not "Supply": Karnataka HC Relies on CBIC Circular to Shield Banks from Pre-GST Service Tax Demands [Read Order]

The KarnatakaHigh Court has quashed show cause notices issued to public sector banks, ruling that penal charges levied by banks do not constitute a "supply" of service liable to pre-GST service tax. The court noted that the Circular explicitly establishes that penalties are amounts recovered for not tolerating a breach of contract and are meant to deter non-performance.

The High Court heard a bunch of writ petitions brought by Canara Bank (formerly Syndicate Bank), Bank of Baroda (formerly Vijaya Bank) and Karnataka Bank. The petitions dispute show cause notices (SCNs) issued by the Directorate General of GST Intelligence for recovery of service tax for periods up to June 30, 2017. The tax agency asserted that the banks had not paid service tax on a range of facilities extended to savings and current account holders.

The Revenue Department had contended that the collection of penal charges specifically for the non-maintenance of Minimum Average Balance (MAB) indicated that banks were providing additional services to compliant customers, thereby treating the penalty as a deemed consideration for a taxable supply.

Rejecting this premise, Justice S.R. Krishna Kuma relied on CBIC Circular No. 178/10/2022-GST, which clarifies the taxability of penalties and liquidated damages arising out of a breach of contract. The Court noted that the Circular explicitly establishes that penalties are amounts recovered for not tolerating a breach of contract and are meant to deter non-performance.

As per the Circular, such payments are mere "events" in the course of a contract and cannot be presumed to be consideration for an independent activity of tolerating an act or situation. Consequently, the Court held that banking penalties do not meet the threshold of a taxable supply, shielding the banks from the contested pre-GST service tax demands.

The High Court decided that the impugned SCNs were in violation of the legislative provisions and the executive circulars. The Court dismissed the show cause notices and held that the free banking facilities offered to MAB-compliant consumers were not liable to service tax, thereby providing substantial relief to the banking sector.