Consideration – Evolving Judicial trends
Executive Summary & Scope
The article attempts to discuss the broad principle of what constitutes ‘consideration’ alongwith two important decisions under the service tax regime which have been rendered in the context of banks and NBFCs. These decisions crystalize certain crucial guidelines to determine as to what constitutes ‘consideration’ and how, not every payment which is collected is a consideration for a service. Read on to know more…
Introduction & The Litigative Dilemma
What constitutes ‘consideration’ has become one of the most disputed areas of litigation under indirect taxes. The phrase ‘consideration’ attains significance in the context of taxes which are contract-based levies. Under the erstwhile service tax regime, the tax was payable on the consideration which was received by the service provider for the provision of service. In the GST regime as well, but for the exception to Schedule I transactions, a supply is taxed only when it is made for a ‘consideration’.
Usually, to tax a transaction, the steps to be followed are:
- Step 1: Establish the occurrence of the taxable event of provision of service or making of a supply, and
- Step 2: Identify if there exists a consideration towards such an activity of provision of service or making of a supply.
If the conditions given in the aforementioned steps are cumulatively satisfied, one may state that there exists a liability to discharge tax. However, by looking at the recent litigation trends, the revenue authorities appear to directly jump to Step 2 without crossing the threshold of Step 1. In other words, whenever there is any amount which is received or retained by a party, the revenue deems this amount to be a consideration. Subsequently, this amount is mapped towards some activity (in most cases under the declared entry of agreeing to the obligation to perform any act) and tax demand is made. These litigation trends are expected to continue into the GST regime as well.
Concept & Statutory Definition of Consideration
Before dealing with these decisions, it is pertinent to discuss the meaning and scope of the phrase ‘consideration’ and how it is different from a mere condition of the contract.
Under the Service Tax regime, consideration was defined under Explanation to Section 67 interalia to include any amount that is payable for the taxable services provided or to be provided and any reimbursable expenditure or cost incurred by the service provider and charged, in the course of providing or agreeing to provide a taxable service, except in such circumstances, and subject to such conditions, as may be prescribed. Further, Section 2(31) of the CGST Act defines the term ‘consideration’ as any payment (in money or otherwise) or monetary value of any act or forbearance can constitute consideration if it is made in respect of, in response to or for the inducement of supply.
In order to understand the true meaning of ‘consideration’, reliance is also placed on the definition of the term ‘consideration’ under Section 2(d) of the Indian Contract Act, 1872 as follows:
“When, at the desire of the promisor, the promisee or any other person has done or abstained from doing, or does or abstains from doing, or promises to do or to abstain from doing, something, such act or abstinence or promise is called a consideration for the promise”
As per the above definition, ‘consideration’ requires that something of value must be given and that something will either have a benefit to the promisor or be a detriment to the promisee. But the benefit or detriment for each promise should be looked at separately. [Chitty on Contracts, 28th Edition – Page 170 Para 3-007].
“Thus, on a conjoint reading of the above definitions, ‘consideration’ would refer to everything received or recoverable in return for a promise of supply which may be in the form of a monetary or even non-monetary term.”
At this juncture, it is also important to note the decision of the Pinnel’s Case (1602) 5 Co Rep 117, wherein it has been held that the promise to pay part of a debt cannot be consideration for a discharge of the whole debt.
In the Indian context, Section 63 of the Indian Contract Act states: ‘Every promisee may dispense with or remit, wholly or in part, the performance of the promise made to him, or may extend the time for such performance, or may accept instead of it any satisfaction which he thinks fit’. The effect of this section is that the consideration agreed between the parties will change based on the performance of the contract and consideration need not be static.
Condition of Contract vs. Consideration & The N.M. Goel Principle
The question of ascertainment of consideration in a particular contract has to be answered from the terms and conditions of a contract. In such a case, the ‘consideration’ in a contract has to be distinguished from the mere ‘conditions of the contract’.
The determining factor, therefore, to treat a monetary payment or non-monetary facility as consideration is whether it is in the nature of a mere condition of the contract or consideration providing an economic value to the supplier.
Decision of the Hon’ble Apex Court in N.M. Goel & Co.
To understand the concept of condition of contract in contradistinction to consideration, it is important to discuss the decision of the Hon’ble Apex Court in N.M. Goel & Co. Vs Sales Tax Officer, Rajnandgaon [1989 AIR SC 285]. In this case, the assessee was engaged by Public Works Department (PWD) for construction work, wherein PWD agreed to supply the materials from its stores for the construction work and the agreement further provided for deduction of the prices of materials so supplied and consumed in the construction, from the final bill of the assessee.
The issue therefore was whether there was sale of the material by the PWD (an unregistered dealer) to the assessee. The Hon’ble Apex court held that as per the agreement the iron, steel and cement were supplied by PWD to the assessee not free of cost but were to be deducted from the bills payable by PWD to the assessee. Though there is no inherent sale, a sale can be inferred from the transaction. Thus, the Hon’ble Apex Court held that there was passing of property in the goods to the assessee from the PWD, though these materials were later incorporated in the construction for the benefit of PWD.
Judicial Trend 1: Foreclosure Charges – The Repco Finance Case
Having laid out the context and scope of the definition of Consideration, the first decision which merits consideration is the case of the Hon’ble Larger Bench of the Tribunal in the case of Repco Home Finance Limited1.
The issue pertains to taxability of foreclosure/pre-closure charges collected by the banks. Any financial institution’s primary business involves lending of money and the consideration for such money lent is collection of ‘interest’. The interest compensates for the ‘time value of money’. The arrangement with the borrowers usually contains a clause which allows the borrower to ‘foreclose’ or ‘pre-close’ the loan by repaying the outstanding principal amount before the specified time period. One of the incentives for the borrowers to close the loan before its tenure is in cases where the rates of interest in the market is lower and the interest which he has to pay on the original loan obtained is higher than the market rate.
“One of the incentives for the borrowers to close the loan before its tenure is in cases where the rates of interest in the market is lower and the interest which he has to pay on the original loan obtained is higher than the market rate.”
Although, prima facie, it may appear that the recovery of principal from borrowers is beneficial for the financial institution; this practice is in fact detrimental as the financial institutions must now find out new investment opportunities to keep earning the ‘interest’ on this principal. In order to compensate for the ‘interest loss’, the banks usually charge foreclosure charges from the borrower who is foreclosing the loan.
In this backdrop, the revenue alleged that the amount received by the financial institution in the form of foreclosure charges would constitute a consideration for provision of banking services. The Hon’ble Tribunal examined the concept of ‘consideration’ in detail and held that an amount would qualify as a consideration only if such amount flows from the service recipient to the benefit of the service provider. The foreclosure of loan is, therefore, a material breach of contract as it curtails the loan service period unilaterally, which can prompt the promisor to claim damages. The Tribunal further observed that the charges in the present case are recovered as compensation for disruption of a service and not towards provision of “lending” services.
The Tribunal also examined the definition of consideration under Section 2(d) of the Indian Contract Act, 1872, which states that consideration should flow at the desire of the promisor. The Tribunal observed that the financial institutions being the promisors did not desire pre-mature termination of the loan. Once the money did not flow at the desire of the service provider, it no longer retains the character of a consideration.
Judicial Trend 2: Foreign Bank Charges – State Bank of Bikaner’s Case
Another judgement laying emphasis on the aspect of consideration is the decision of the Hon’ble Tribunal in the case of M/s State Bank of Bikaner2.
In this case, a humongous demand of over ₹ 100 Crores was raised on the Assessee claiming they were the recipients of service provided by Foreign Bank. For greater clarity, the brief facts of the case in one of the transactions are stated herein. The Assessee bank was appointed by an Indian Exporter for enabling him to realise the export proceeds from a foreign importer to whom the goods were sold. The Assessee bank, thereafter, co-ordinated with the Foreign Bank of the foreign importer, for realizing the proceeds. For this purpose, various activities were performed by the foreign bank and the Indian Bank (banks in India) such as sending export documents, issuing Letter of Credit, providing documents of title to goods etc. Converse scenarios also existed where the assessee may be an importer and may avail the service of the Indian Bank for remitting payments to foreign suppliers. However, the demand under reverse charge mechanism was made only on export related transactions.
In case of exports, the foreign bank usually deducted their fee for the performance of the activity and remitted the net amount to the Indian Bank. Such fee was either borne by the Indian Assessee or the foreign importer based on mutual agreement between the parties. The Department took a view that the amount retained by the Foreign bank was a consideration for the service it provided to the Indian Bank. In other words, the income earned by the foreign bank was an input service for the Indian Bank for them to provide their output service to the Indian Assessee. The matter was extensively argued before the Hon’ble Tribunal.
The Hon’ble Tribunal dealt with the core issue of whether the amount retained by the Foreign bank would constitute a consideration for the service provided to the Indian Bank. After relying on the landmark decisions of the Hon’ble Supreme Court in M/s Bhayana Builders3 and M/s Intercontinental Consultants and Technocrats4, the Tribunal held that the Assessee Bank has not paid any consideration to the Foreign Bank and the assessee bank would not qualify as a recipient of any service by the Foreign Bank. The Assessee bank was merely facilitating the transaction of export on behalf of the Indian Exporter and there was no service provider and service receiver relationship between the Indian Bank and Foreign Bank.
While holding so, the Hon’ble Tribunal also emphasised on the very important facet that there is a marked distinction between a condition of a contract and a consideration for the contract. A service provider or recipient may be required to fulfil certain conditions of the contract but that may not necessarily mean that same becomes a consideration and thus, a part of the value of the service.
The Four Essential Pillars of Taxation:
The important take away from the State Bank judgement is that before making a demand of tax, it is imperative to clearly identify the four elements of taxation which creates the levy5:
- (i) Person providing service;
- (ii) Person receiving service;
- (iii) Actual rendering of service; and
- (iv) Consideration for service.
Conclusion & Broad Jurisprudential Implications
The two decisions discussed supra are seminal decisions in their own right for determining what constitutes consideration for a service and how to differentiate between a mere condition of the contract which the parties are required to fulfill and the consideration which flows at the desire of the service provider/supplier and has a direct nexus with the service provided.
Further, even though the judgements were rendered in the pre-negative list regime, it will nonetheless go a long way in shaping the jurisprudence on ascertaining the liability to pay service tax (negative list regime)/GST on different types of remittances/retentions. To illustrate a few:
- a. Forfeiture of advance
- b. Liquidated damages due to delay in performance
- c. Failure to comply with minimum commitment requirements
- d. Notice pay
One can only hope, that the taxman and the taxpayers truly appreciate the ratio of the above rulings and adopt their positions on taxability of various transactions accordingly.
Judicial Citations & References
- (2020) 117 taxmann.com 755 (Chennai – CESTAT) (LB)
- 2020 (8) TMI 80 – CESTAT NEW DELHI
- [(2018) 91 taxmann.com 109 (SC)]
- [(2018) 91 taxmann.com 67 (SC)]
- These four elements were explicitly propounded by the Hon’ble Delhi High Court in Delhi Chit Fund Case [(2013) 32 taxmann.com 332 (Delhi)]