Synopsis: In this article, we will outline how GST, the poster child of the indirect tax regime, impacts enterprises seeking business loans. 

The Indian government introduced the Goods and Services Tax (GST) regime in July 2017 to streamline the indirect taxation structure and eliminate tax cascading. But its impact goes beyond mere tax compliance, resonating across several aspects of the economy, including lending. 

By influencing the rates applicable to the taxable services provided by financial institutions while extending business loans, GST’s implementation has altered the way businesses seek financial assistance. 

Below, we delve into how GST affects business loans and the overall impact on borrowers. 

Understanding GST and its relevance 

GST, a landmark indirect tax reform, unifies various indirect taxes, such as services tax, central excise duty, value added taxes (VAT), and more, under a single umbrella, thus, minimizing the issues associated with paying multiple taxes. 

While the GST regime does not directly apply to loans, its influence can be felt indirectly in the various financial services provided by the bank during loan disbursal. A business loan generally involves processing and foreclosure charges, which attract a GST levy as they are categorized as banking services. 

Hence, even though GST has been at the forefront of the tax system’s reformation, eliminating several taxes applicable to loans under the previous regime, it entails its own set of nominal costs, albeit with more transparency and efficiency.  

Having said that, GST’s impact varies across loan categories. For instance, personal loans attract a GST levy only on processing and prepayment charges, without any impact on EMI payments. But home loans, in addition to attracting GST on processing fees, are levied additional goods and services taxes based on whether the underlying home is in the renovation or construction phase. 

GST’s impact on business loans 

The advent of GST has nominally raised the cost associated with availing of business loans. As stated above, business loans don’t fall under the remit of the GST law. However, the services related to the loan sanction are subject to indirect taxation. 

1. GST on processing fees 

Processing fees are charges levied by lenders for evaluating loan applications, conducting due diligence, and processing the loan disbursement. Moreover, financial institutions have had to grapple with altered compliance requirements post the implementation of this unified tax regime, which has impacted administrative costs that also factor into processing fees. 

This insinuates that GST has impacted the cost structures of lenders differently, with some absorbing the additional costs while others passing them on to borrowers. However, generally, processing fees are charged in the range of 1-2% of the loan amount. 

Pre-GST, business loan processing fees were subjected to a service tax of 15%. After the implementation of GST, service taxes have been phased out, instead, processing charges are now levied with an additional 18% GST.  

To illustrate, assume a manufacturing company, TYU Ltd., is seeking a business loan of Rs. 10,00,000 from a bank that charges 1.5% of the loan amount (Rs. 15,000) as processing fees. The cost after the application of GST charges will be Rs. 2,700 (Rs. 15,000 x 18%). Before July 2017, it would have only cost businesses Rs. 2,250 (Rs. 15,000 x 15%). Hence, GST has resulted in an additional cost incurrence of Rs. 450 in this case. 

2. GST on interest rates of business loans 

There is no direct impact of GST on the interest rates of business loans. It neither applies to interest payments nor to principal repayments. 

However, as GST affects the input cuts and supply chain dynamics of enterprises, it has had a significant impact on the economy. This macroeconomic impact shows up in the form of fluctuations in demand, productivity, and inflation, which, in turn, affect the interest rates charged by lending institutions. 

GST’s impact can also be observed through the pass-through effect, which results from businesses making changes to their pricing strategies and production costs that impact their bottom line. Lenders may respond to these changes in profitability and creditworthiness by adjusting interest rates on business loans to manage their risk exposure. 

3. GST on pre-payment charges 

When firms choose to pay back their loans early, they are charged a fee ranging between 2-5% of the outstanding loan balance. This is called a prepayment charge. Pre-GST, these charges were subject to a 15% service tax. Now, similar to processing fees, pre-payment charges attract an 18% GST. 

For instance, assume the remaining loan balance is Rs. 3 lakh and the lender charges a 3% prepayment fee. In this case, the prepayment charges amount to Rs. 10,620 (3,00,000 x 3% x 1.18) under the current taxation system. Pre-2017, the charges would have been 10,350 (3,00,000 x 3% x 1.15). 

Business impact in the GST era 

The introduction of goods and services tax (GST) has raised the overall cost of availing of business loans by increasing the processing charges, pre-payment fees, and bounce charges (in some cases). Additionally, due to the evolving nature of GST compliance, firms need to reassess their financial plans, incurring additional costs that may impact their profitability, loan eligibility, and creditworthiness. 

Businesses can mitigate the effects of GST by optimizing their regulatory compliance, exploring input tax credit benefits, and adopting technology-enabled financial management systems to enhance their creditworthiness and access loans at competitive rates. 

Why are business loans important? 

Even though enterprises have seen an increase in the cost of business loans after the implementation of GST, the impact has been minimal. Besides, business loans continue to play a pivotal role in fueling the growth of firms by providing them with affordable finance. They serve as lifelines for businesses, providing the necessary capital to invest in new equipment, scale their operations, hire more workers, and pursue innovation. 

Bottom Line: Power up your organization’s success with a business loan 

In a dynamic business environment, accessing opportune, inexpensive financing can make a momentous difference in an organization’s ability to navigate financial challenges and seize growth opportunities. Business loans enable entrepreneurs to pursue their visions, grow their businesses, and contribute to economic growth.  

With GST indirectly impacting loan costs by raising processing charges, businesses must pay heed to how it affects their profitability. Efforts must be made to improve their operations and financials to signal better creditworthiness. Download the Protium app