The Hindu Business Line : Unjust enrichment by rounding off

At that point of time general interest rates were hovering at 18-20 per cent and Dr Manmohan Singh introduced this levy as a fiscal as well as monetary measure. It was introduced at 3 per cent on chargeable interest and the law allowed credit institutions to pass on the said interest by way of increasing the rate of lending.

The reintroduced Act was applicable to banking companies, public financial institutions and financial companies. There were several controversies associated with this legislation, including doubts on how to compute chargeable interest in some cases.

One of the controversies associated with this levy related to the manner of increasing or varying the rate of interest to provide for this levy. Banks resorted to loading the interest tax element in the rate of interest and rounding off the tax element by an extra 0.25 per cent thereon.

As a result, various banks had passed on several crores of rupees to the ultimate borrower through this tactic of extra rounding off.

Whether the luxury of extra rounding off is legal or otherwise was the subject matter of a writ petition and has now been decided by the Supreme Court in the Indian Banks' Association and Others vs Devkala Consultancy Service and Others (2004 267 ITR 179) case.

Issues

The crux of the issue in this case was: How does one apply the provision of passing on the interest tax through increasing the rate of interest? In this context one may note the wordings in Section 26C of the Act which reads thus:

"Notwithstanding anything contained in any agreement under which any term loan has been sanctioned by the credit institutions before October 1, 1991, it shall be lawful for the credit institution to vary the agreement so as to increase the rate of interest stipulated therein to the extent to which such institution is liable to pay the interest-tax under this Act in relation to the amount of interest on the terms loan which is due to the credit institution."

Apparently on the plain reading of Section 26C it is clear that what was contemplated is that the banks in question can only recover the amount of tax from the borrowers and nothing more. However, the banks had, citing the reason of practical difficulties, increased the interest rate by more than merely the tax element and consequently arrived at a figure much higher than what they were legally entitled to.

This action on the part of the banks was questioned by a public interest litigation before the Karnataka High Court on the ground that such purported rounding off is illegal and without jurisdiction and, as a result, the banks had collected an extra Rs 723.79 crore annually only through the rounding off mechanism.

The Karnataka High Court, by its order dated December 18, 1998, rejected the contention of the appellant and held that action of increasing the load of tax by rounding off was illegal, arbitrary and untenable. The High Court also directed all the banks to submit the amount of extra interest collected from the borrowers and deposit the same with the RBI. The appellants naturally took the matter further to the Supreme Court.

The apex court decision

The Supreme Court affirmed the decision of the Karnataka High Court and held that having regard to the provisions contained in article 265 read with article 366(28), the purported demand of banks and credit institutions from the borrowers for a higher amount of tax and consequently a higher amount of interest by way of rounding off was wholly illegal and without jurisdiction.

The court also observed that that neither the Reserve Bank nor the Indian Banks' Association was competent to interpret the provisions of Section 26C.

As the banks had by misinterpretation of the statute unjustly enriched themselves, the doctrine of de minimis could not be applied in equity or otherwise.

The court went on to highlight that "The amount collected from the borrowers may be negligible for the appellant banks but the amount they have realised from five crores of borrowers is not a small one.

By reason of a self-created confusion, misconception as regards application of a statute and misapplication and misconstruction thereof by the appellants herein had resulted in an illegal action: as a result whereof the borrowers have been deprived of a huge amount.

"Consequently, the Union of India and the appellants have unjustly enriched themselves. When such an unjust enrichment takes place, the doctrine of de minimis, in our view, should not be applied in equity or otherwise."

The apex court accordingly held the action of the banks illegal and ordered the formation of a trust for the benefit of disabled persons and its administration, with the excess tax recovered as well as contributions from the banks and credit institutions concerned.

The principle of unjust enrichment has been dealt with on earlier occasions by the courts, especially in the context of Central excise. Wherever the law requires the tax to the passed on to the consumer/borrower, the mechanics and modalities have to be made clear; if not in the Act at least in the Rules.

Apparently, there was some confusion in passing on the tax. The matter got complicated by the RBI circular on the subject, permitting banks to effect the round off to the next higher 0.25 per cent. The court held the circular and such rounding off invalid in law.

While in hindsight one may say that what is not permitted by law cannot be dictated by a circular, here is a case where probably the CBDT could have stepped in and provided clarity before that issue reached the courts.

(The author is a Chennai-based chartered accountant.)

More Stories on : Taxation | Courts/Legal Issues

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page

Stories in this Section
Ambitious agenda

Indian entrepreneurship on a high

`Law of the Unenforceable'

Let's save the punishment

The IATA hiatus

Unjust enrichment by rounding off

`Fee' engineering put to test

Blinkers off, and veil pierced in colourable deals

Monetary Policy: Divorced from reality

Babus are not accountable and netas can be ignorant