State Bank of India[1] , a public sector bank (Taxpayer) entered into a tripartite agreement with Non-Banking Financial Companies (NBFC) and Trusteeship company (Taxpayer’s representative) for purchasing 90% of loan assets bearing interest rate of 15% from a pool of loans given by NBFCs to priority sector. The Taxpayer purchased the loans under Direct Assignment route[2] in accordance with Reserve Bank of India (RBI) guidelines. Additionally, NBFC and the Taxpayer entered into a separate agreement the NBFC agreed to administer and service the assets and to devote necessary time and skill for collection and recovery.
Out of total pool of loan assets of NBFC, the Taxpayer cherry-picked good quality loans for purchase through Direct Assignment. Due to such exercise, the market value of good quality loan pool was higher and commanded a premium over the outstanding loans. This premium is generally recovered by NBFC in one of the following ways:
- The assignee agrees to earn a lower rate of interest on its portion of assigned loans; or
- The price agreed upon for the assignment of the pool is at a premium over the outstanding amount of loans being assigned and the entire premium is exchanged upfront.
In the facts of the case, Taxpayer paid premium to NBFC by way of accepting a reduced rate of interest of 10% (instead of 15%) on such purchased loan assets. The Tax Authority contended that the whole of the interest income (including the 5% premium) belonged to the Taxpayer and the Taxpayer had applied the income by paying premium to NBFC. The Tax Authority further contended that allowing NBFCs to retain such excess interest violates RBI guidelines and there is default on the Taxpayer’s part due to non-withholding of tax deducted at source (TDS) u/s. 194A of the Income Tax laws (ITL).
On Taxpayer’s appeal, the First Appellate Authority (FAA) ruled that there is no obligation to deduct TDS u/s. 194A. However, the FAA concluded that such premium is for the services rendered by the NBFCs to the Taxpayer and accordingly, there is withholding obligation u/s. 194J (in case of P2P transaction) or u/s. 194H (in case of P2A transaction).
The issue before Mumbai Tribunal was whether the Taxpayer was required to deduct TDS either under section (u/s) 194A or 194J or 194H of the ITL[3].
Mumbai Tribunal held that TDS is not required under either of the aforementioned sections for the following reasons:
- No withholding obligation u/s. 194A:
- The Taxpayer had purchased loans and had not borrowed money or incurred debt from the NBFCs. Thus, the payment may not qualify as interest u/s. 2(28A) of ITL.
- In absence of any money borrowed or debt incurred, amount received by NBFC was not in the nature of interest. Consequently, no withholding obligation u/s. 194A is triggered on aforementioned payment.
- No withholding obligation u/s. 194J:
- It was contended by the FAA that the consideration agreed for services provided by NBFC to Taxpayer is inadequate and it is effectively discharged by accepting lesser interest.
- The transaction between Taxpayer and NBFC was between two independent parties and it was a commercial transaction. The express terms of agreement entered between two unrelated parties cannot be brushed aside.
- Amount paid cannot be regarded as for the consideration for rendering services to trigger withholding obligation u/s. 194J.
- No withholding obligation u/s. 194H:
- No material was placed on record to support that the loans advanced by the NBFC to the borrowers were on behalf of the Taxpayer. There was a separate service contract entered into for the services provided by NBFC to the Taxpayer. Neither the Taxpayer nor the Tax Authority claimed that the NBFC has acted on behalf of the Taxpayer to conclude that NBFC was an agent of the Taxpayer. Consequently, there was no withholding obligation u/s. 194H.
