GST on Personal Loan: Rates, Impact and Benefits

The first question that probably comes to most people's minds when they are considering taking a personal loan or have already taken one is: How much extra do I have to pay over the tenure of the loan? 

GST is one of the additional costs you will incur when taking a personal loan. This blog discusses everything you need to know about GST on personal loan.

GST Rates on Personal Loan-Related Charges

To answer the question, “How much GST do I have to pay on a personal loan?” it is essential to break down the loan into its components. A personal loan consists of three key components: the principal, interest, and charges such as loan processing fees and foreclosure or prepayment charges.

• Principal amount - When repaying the principal amount of the loan, you are essentially transferring money to the lender. GST applies to the supply of goods and services, but both are defined in a way that excludes money. The principal amount is not subject to GST, and consequently, there is no GST personal loan EMI.
• Interest - The charging of interest is an agreement between the borrower and the lender based on predetermined rates that have to conform to guidelines laid down by the Reserve Bank of India. There is no service rendered by the lender for charging interest from the borrower, and therefore, there is no GST on interest on personal loans.
• Loan Processing Fees - The processing of a loan is a finance service rendered by the lender since it involves administrative and operational costs of disbursing and managing a loan payout. Therefore, GST on personal loan processing fees applies at the rate of 18%.
• Foreclosure Charges - If you plan to foreclose or make a prepayment on your personal loan before the agreed-upon tenure, the lender will typically impose charges. While it may not seem obvious that these charges qualify as a service subject to GST, international case laws have established that when a lender cannot collect interest due to early repayment, it is considered a service. Therefore, GST on personal loan foreclosure charges applies at the rate of 18%.

Impact of GST on Personal Loan Costs

Did you know that GST can increase the cost of borrowing for your personal loan? While the principal and interest treatment may seem straightforward, additional charges like loan processing fees and foreclosure charges are subject to GST. Let’s consider the impact of GST on personal loans with the help of examples.

You have an outstanding loan of Rs.1,00,000, and the lender levies a charge of Rs.5,000 for foreclosure or prepayment. The GST on this charge would be Rs.900 (18% of Rs.5,000). The total foreclosure charge you would need to pay, including GST, would be Rs.5,900

Let’s take another example. You have applied for a personal loan of Rs.5,00,000, and the lender charges a processing fee of Rs.10,000. The GST on the processing fee would be Rs.1,800 (18% of Rs.10,000). The total processing fee you would need to pay, including GST, would be Rs.11,800.

Therefore, it is advisable to negotiate lower personal loan-related charges to avoid paying additional GST.

GST Exemptions and Exclusions

The interest paid on personal loans is not subject to GST. In simpler words, you won’t pay GST on the interest amount. Similarly, the principal amount is a mere transfer of money and is not considered a supply of goods or services to be subject to GST.

Processing fees for handling your loan application are subject to an 18% GST. Similarly, if you decide to foreclose the loan, the charges levied by the lender are subject to 18% GST as well.

Pros and Cons of GST on Personal Loans

Since GST is an additional cost, you might be wondering what the pros could possibly be? The pros of GST include the following:

• Simplification of Taxation: GST simplifies the tax system by consolidating several indirect taxes levied by the state and central governments into one levy.
• Uniform Rate of Tax: The rate of GST on services like loan processing and foreclosure charges is uniform at 18%. Uniformity in rate reduces complexity for borrowers regardless of location and leads to consistency.
• Encourages Formal Borrowing: The introduction of GST helps bring more financial activities into the formal sector, benefiting both borrowers and lenders through regulation and transparency.

Some of the cons of GST on personal loans include the following:

• Higher Costs: The levy of GST on personal loan-related charges increases the cost of borrowing.
• Additional Financial Burden: While the principal and interest remain unaffected, these added taxes on administrative fees and services may make personal loans more expensive than before.
• Complexity for Borrowers: Borrowers might not fully understand how GST affects their loans, leading to confusion about the costs involved.