The Karnataka High Court has ruled in favour of the banking sector by quashing service tax show cause notices issued to several banks over the maintenance of Minimum Average Balance (MAB) in customer accounts.
The bench of Justice S.R. Krishna Kumar has observed that the mere maintenance of MAB by customers cannot be treated as “consideration” for banking services and therefore cannot be subjected to service tax under the pre-GST regime.
In a batch of petitions filed by the Banks challenging service tax demands raised by the Directorate General of GST Intelligence (DGGI) and other tax authorities.
The dispute arose from show cause notices issued by the tax department alleging that banks were liable to pay service tax on various facilities provided to customers who maintained the stipulated Minimum Average Balance in their accounts. According to the department, customers who maintained MAB received a bouquet of banking services without being charged separately. The authorities contended that the customer’s commitment to maintain MAB constituted a form of non-monetary consideration for the services provided by the banks.
The department further argued that where customers failed to maintain the prescribed MAB, banks levied penalty charges but continued to provide services. On this basis, it was claimed that the value of services rendered to customers maintaining MAB could be notionally determined and subjected to service tax under the Finance Act, 1994.
The banks challenged the notices contending that no consideration was charged from customers who maintained the required MAB. They argued that maintaining MAB was merely one of the contractual conditions governing the banking relationship and could not be equated with consideration for a taxable service.
The petitioners submitted that penalty charges collected from customers for failure to maintain MAB were in the nature of charges for breach of contractual conditions and could not be used to infer the existence of consideration in cases where customers complied with the requirement. They further relied upon various CBIC and GST circulars clarifying that payments arising from breach of contractual obligations do not automatically constitute consideration for a taxable service.
The High Court extensively analysed the definition of “service” under Section 65B(44), the charging provision under Section 66B, the concept of “declared services” under Section 66E(e), and the valuation provisions contained in Section 67 of the Finance Act.
The Court noted that service tax could be levied only when an activity is carried out by one person for another for consideration. It also examined CBIC Circular No. 178/10/2022-GST, which clarified that for a transaction to qualify as an agreement to tolerate an act or to do an act, there must be a clear contractual arrangement and a direct nexus between the activity and the consideration received.
The circular further clarifies that payments arising from breach of contractual obligations, penalties, liquidated damages and similar recoveries are generally compensatory in nature and do not amount to consideration for a separate taxable supply.
The Court accepted the banks’ contention that maintenance of MAB is merely a contractual condition attached to the operation of an account and does not amount to consideration flowing from customers to banks.
It held that the tax department’s attempt to assign a notional value to the maintenance of MAB and treat it as consideration for banking services lacked legal foundation. The Court observed that the relationship between the bank and the customer cannot be artificially converted into a taxable service transaction merely because certain benefits are available to customers who comply with account conditions.
The judgment emphasized that consideration must have a direct nexus with the service rendered and cannot be presumed merely because a customer maintains a specified balance in an account. The Court also found support in CBIC’s own clarifications regarding the requirement of a contractual arrangement involving consideration before a service can be taxed.
Holding that the impugned show cause notices were contrary to the statutory framework governing service tax and inconsistent with the department’s own circulars, the Karnataka High Court quashed the proceedings initiated against the banks. The Court concluded that banking facilities provided to customers maintaining Minimum Average Balance, without any separate consideration being charged, cannot be subjected to service tax under the pre-GST regime.
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