GST on Factoring Arrangements

 

Receivables constitute a significant portion of current assets of a firm. But, for investment in receivables, a firm has to incur certain costs such as costs of financing receivables and costs of collection from receivables. Further, there is a risk of bad debts also. It is, therefore, very essential to have a proper control and management of receivables. In India, transfer of receivables arising out of sale or loan transactions takes place quite frequently. In such a case, a firm may avail the services of specialized institutions engaged in receivables management, called factoring firms.

 

Factoring

Basically factoring is a kind of Financial Service in which a business organization sells its Account Receivables to another person, called a Factor, at a discount in order to raise money. However factoring is completely different from concept of bill discounting. Factoring is a wider concept of financing as compared to bill discounting. In bill discounting, invoices are discounted at certain rate to get the instant funds whereas in factoring services, trade receivables are sold to an outside factoring agency or company. The term" factoring" has been defined in various countries in different ways due to non-availability of any uniform codified law. The study group appointed by International Institute for the Unification of Private Law (UNIDROIT), Rome during 1988 recommended, in simple words, the definition of factoring as under:

 

"Factoring means an arrangement between a factor and his client which includes at least two of the following services to be provided by the factor:

- Finance

- Maintenance of accounts

- Collection of debts

- Protection against credit risks

 

Factoring can broadly be defined as an arrangement in which receivables arising out of sale of goods/services are sold to the "factor". The same can be depicted in chart as follows:

 

Implications of GST

 

GST is levied on supply under the law. It can be supply of goods or services or both. While discussing applicability of GST on factoring transaction, it is important to conclude first, whether parts/components of factoring arrangement qualify to be supply or not under the provisions of the Act. A factoring arrangement or contract may include the following steps or transactions which need to checked individually from lenses of GST implication:

 

1.    Sale of Receivables: Seller of goods or services sells its receivables arising out of sale of goods or services to the Factor.

2.    Processing Fee or Service Fee: Sale of receivables is followed by servicing and collection for a management or factoring charges. These charges are charged towards various services to seller namely- sales ledger administration, MIS reporting, collection etc. These charges are also called administrative charges or factoring charges. In general, the factor receives payments from the buyer on due dates and pays the balance money to the seller after deducting the service charges.

3.    Finance/Discount Charges: These charges are normally computed on periodic basis towards providing advance finance to the seller. These charges are similar in nature of interest levied by bank on cash credit facilities.

 

Let us now analysis the impact of GST on above transactions one by one:

 

1.  Sale of Receivables: Since GST is levied on supply of goods or services, thereby it is important first to determine character/form of transaction under discussion. In general, receivables are actionable claims i.e. it is a right to claim of money. The term "Goods" is defined u/s 2(52) - "goods" means every kind of movable property other than money and securities but includes actionable claim, growing crop..." Thus, under GST laws, actionable claims would be goods. But Schedule III to Section 7 of CGST Act provides list activities or transactions which shall be treated neither as a supply of goods nor a supply of services. The list includes "Actionable claims, other than lottery, betting and gambling."

 

Thus, plain reading of schedule III would mean that actionable claims, being goods in nature by virtue of definition of goods, are neither a supply of goods nor a supply of services. But three categories of claims- Lottery, Betting and gambling are still to be considered as goods due to non-exclusion in schedule III. Accordingly sale of receivables shall be treated neither a supply of goods nor a supply of services and will not be chargeable to GST since a right to claim money is itself in nature of money and therefore excluded from GST. Further definition of actionable claims shall be taken from section 3 of the Transfer of Property Act for the purpose of GST Law.

 

Section 3 of Transfer of Property Act - "actionable claim" means a claim to any debt, other than a debt secured by mortgage of immovable property or by hypothecation or pledge of movable property, or to any beneficial interest in movable property not in the possession, either actual or constructive, of the claimant, which the civil courts recognize as affording grounds for relief, whether such debt or beneficial interest be existent, accruing, conditional or contingent."

 

On reading the definition of actionable claims, it is noted that those claims which are backed by mortgage or hypothecation or pledge of movable or immovable property are excluded from definition of actionable claims.

 

However, proper view in this regard would be to consider nature of activity i.e. If an actionable claim is nothing but a right to receive money, then it is money itself, and therefore, excluded from the GST law. Definition of goods exclude money and a claim of debt secured by tangible or intangible property is nothing more than money to money transactions. The position would not change if the receivable was backed by any tangible or intangible property, because the property is just a collateral to back up a monetary claim in case of any default. FAQs on Financial services as released by CBIC also says that sale, transfer or assignment of debts falls within the purview of actionable claims, the same would not be subject to GST in answer to the question as to whether assignment or sale of secured or unsecured debts is liable to GST.

 

Therefore, we can draw a conclusion that sale of receivable shall not be taxable under GST.

 

2.  Processing fee or Service Fee: The CGST Act defines the term "services" in the following manner: Section 2(102) "services" means anything other than goods, money and securities but includes activities relating to the use of money or its conversion by cash or by any other mode, from one form, currency or denomination, to another form, currency or denomination for which a separate consideration is charged.

 

GST Act excludes money from definition of goods as well as services. But transaction in money w.r.t. to use of money or activities in relation to conversion of money are included in definition of services. In the factoring arrangements, processing of receivables and collection from the debtors is an activity in relation to use of money and it falls under the definition of 'Services" Therefore processing fees charged by factoring companies for processing the transaction and others becomes taxable under GST in absence of any specific exemption.

FAQs on Financial services as released by CBIC also says that, any charges collected in the course of transfer or assignment of a debt would be chargeable to GST, being in the nature of consideration for supply of services.

 

3.  Finance/Discount Charges: As stated earlier, these charges are similar in nature of interest levied by bank on cash credit facilities. The factoring company remits advance against receivables to the extent of 75% to 80% to seller and rest of payment is made after realization from customer. This act of factoring company will be treated as supplies of services because of activities in relation to use of money are treated as supply of services. However we find an exemption for such supply of services and excluded from taxability under GST.

 

S.No-27 of N otification No.12/2017-CGST (Rate) dated 28.06.2017 provides exemption to services by way of extending deposits, loans or advances in so far as the consideration is represented by way of interest or discount (other than interest involved in credit card services). Therefore, it can be concluded that discount or interest charges recovered by factoring company will not be taxable under GST.

 

Sometimes factoring arrangement may not contain separate charges for collection and servicing of receivables but adjusted with the discounting rate. In this situation, the discounting rate has two components attached to it, first, compensation towards the credit facility in form of advance payment and another one in form of charges for facility of collection and servicing. As discussed earlier in this document above, the former one is exempted from GST and the latter one is taxable. Therefore it will become a mixed supply and taxability of the same need to be determined from that point of view also.

Section 8 of CGST Act provides for taxability manner of mixed supply. According to said section mixed supply comprising two or more supplies shall be treated as a supply of that particular supply which attracts the highest rate of tax. This would mean that in such factoring arrangement, discount charges and service charges, both will be chargeable to GST at the rate which is applicable to the supply of collection and servicing services.

 

Conclusion

India went under a paradigm shift in its Indirect Tax regime with introduction of GST in July 2017. GST rate, which was earlier the 15 per cent service tax on financial services, has now been increased to 18 per cent in GST, and is financial charges and other charges, such as late payment, annual and renewal fees, as was the practice in the pre-GST era. Other charges that have gone up include service charges, service fees, documentation fees and brokering charges etc. We need to relook into arrangements considering implications of GST on different components of arrangement.