Services provided by non-banking finance companies (NBFCs) to banks in co-lending arrangements will attract an 18% Goods and Services Tax (GST), according to a decision by the fitment committee under the GST Council. The move seeks to clarify how the service component of co-lending transactions should be taxed, after prolonged uncertainty over whether income earned by NBFCs should be treated as interest or consideration for a separate service.
Importantly, the 18% GST will not apply to the interest earned on the underlying loan. Instead, the tax will apply to the taxable service supplied by the NBFC to the bank. The committee has also proposed that the value of this service be determined in line with the methodology prescribed by the Reserve Bank of India (RBI), potentially providing lenders with a clearer framework for calculating their GST liability.
18% GST to Apply to NBFC Services
The fitment committee has recommended an 18% GST rate on services supplied by NBFCs to banks under co-lending arrangements.
The proposal is significant because co-lending involves several distinct activities. An NBFC may source customers, assess creditworthiness, service loans and provide other operational capabilities, while the bank supplies a larger portion of the funding.
The tax question has been whether the NBFC’s earnings from such arrangements represent interest income, which is generally exempt from GST, or payment for a taxable service.
The committee’s latest recommendation seeks to distinguish between the two.
What will be taxed?
| Component | GST treatment |
|---|---|
| Interest on underlying loan | Exempt |
| NBFC service supplied to bank | 18% GST |
| Valuation of NBFC service | Based on RBI-prescribed methodology |
| Co-lending arrangement | Tax applies to taxable service component |
The distinction is important because the entire interest income from the underlying loan will not suddenly become subject to an 18% tax. The levy is focused on the service component provided by the NBFC to the bank.
How Bank-NBFC Co-Lending Works
Co-lending allows banks and NBFCs to jointly provide credit to borrowers.
Banks typically have access to lower-cost funding and large balance sheets, while NBFCs can bring customer acquisition capabilities, specialised underwriting expertise and access to borrowers who may not have strong relationships with traditional banks.
The model has become particularly relevant for extending formal credit to segments where banks may have historically had limited reach.
Under these arrangements, the bank and NBFC agree on how loans are funded and how interest income is distributed.
For example, if a co-lender charges a borrower a blended interest rate of 16%, with the bank entitled to receive 10% on its share of the loan, the remaining 6% from the customer’s interest payment on the bank’s portion may be retained by the sourcing NBFC under the arrangement.
This structure created uncertainty over whether the NBFC’s retained amount represented interest or compensation for services.
Why the Tax Treatment Was Unclear
Co-lending transactions contain multiple economic activities.
An NBFC may be responsible for:
- Customer sourcing
- Credit assessment
- Loan servicing
- Collection support
- Technology and operational infrastructure
- Portfolio management
At the same time, the bank provides funding and receives its agreed share of interest.
The industry had therefore sought clarity on whether the NBFC’s income or spread should be treated as exempt interest income or as consideration for taxable services.
The latest recommendation attempts to resolve that distinction by applying GST specifically to the service supplied by the NBFC.
This could reduce the scope for different interpretations among lenders and tax authorities.
RBI Methodology to Determine Taxable Value
Another important part of the recommendation is the proposed linkage between GST valuation and RBI methodology.
The fitment committee has decided that the value of the NBFC’s service should be determined in the manner prescribed by the RBI.
This could provide a regulatory benchmark for calculating the taxable portion of a co-lending transaction.
For banks and NBFCs, a standardised valuation methodology could make tax calculations easier and reduce disputes over how much of the transaction represents a taxable service.
It could also make it easier for lenders and fintech companies to structure partnerships with greater certainty.
Potential Impact on Banks and NBFCs
The immediate impact will be on the economics of co-lending arrangements.
Banks receiving services from NBFC partners may face an additional GST cost on the taxable service component. The ultimate impact will depend on the value assigned to that service and how the tax is treated within the broader transaction.
NBFCs could also need to reassess the pricing and contractual structure of their co-lending partnerships.
Possible implications
| Stakeholder | Potential impact |
|---|---|
| Banks | Higher GST-related cost on taxable NBFC services |
| NBFCs | Greater clarity but possible pricing changes |
| Fintech platforms | More certainty around partnership structures |
| Borrowers | Potential indirect impact depending on cost pass-through |
| Tax authorities | Clearer framework for valuation and classification |
The tax does not directly impose 18% GST on the borrower’s loan interest. This distinction will be important for consumers and businesses using co-lending products.
Could Borrowers Face Higher Costs?
The impact on borrowers is less straightforward.
Because interest on the underlying loan remains exempt, the new tax is not equivalent to adding 18% GST to the interest rate charged to customers.
However, banks and NBFCs could reassess the economics of their partnerships if the service component becomes more expensive after GST.
Depending on contractual arrangements and competitive conditions, some of the additional cost could potentially be absorbed by lenders, while some could influence fees or pricing.
The actual effect on borrowers will therefore depend on how financial institutions respond to the new tax treatment.
GST Council Yet to Give Final Clearance
The fitment committee’s recommendation is not necessarily the final legal position.
According to the report, the proposal would require clearance from the GST Council, with a separate circular expected if the recommendation is approved. The GST Council is scheduled to meet on October 8 to discuss the next set of reforms.
This means banks, NBFCs and fintech companies will need to watch the final decision and any subsequent circular for details on implementation, valuation and compliance requirements.
Until those details are formally notified, the precise operational impact remains subject to the final framework.
Wider Push to Clarify Financial Services Taxation
The proposal forms part of a broader effort to address long-standing GST ambiguities in the financial services industry.
The financial sector contains transactions where interest, fees, commissions, spreads and service charges can overlap economically but receive different GST treatment.
Greater alignment between GST rules and RBI regulations could reduce disputes and make financial institutions more confident when designing new products and partnerships.
The development is particularly relevant as banks increasingly work with NBFCs and fintech companies to reach new customer segments.
Bank Branch Transfers Also Face a Proposed Clarification
The GST Council has separately proposed that notional charges recorded when banks transfer funds between their own branches should be treated as interest.
The approach would align the GST treatment with the economic substance of the transaction.
This is another example of the government’s attempt to reduce ambiguity in financial transactions where accounting entries could otherwise be interpreted as taxable services.
Together, these proposals indicate an effort to bring greater consistency to the treatment of financial-sector transactions under GST.
The Bigger Picture
The proposed 18% GST on NBFC services to banks represents an important clarification for India’s rapidly expanding co-lending ecosystem. The government is drawing a clearer line between interest earned on loans, which remains exempt, and services provided by an NBFC to a bank, which would be taxable.
For the financial sector, the biggest benefit could be greater certainty. Banks, NBFCs and fintech companies have had to navigate questions around the classification and valuation of income generated through co-lending arrangements. Linking valuation to RBI methodology could provide a more predictable framework and reduce future disputes.
At the same time, the change could affect the economics of partnerships. Lenders may need to review agreements, pricing models and the allocation of service costs once the GST Council formally approves and notifies the framework.
Looking Ahead
The next important step will be the GST Council’s decision and any subsequent circular explaining how the 18% levy will be implemented. Financial institutions will particularly watch the valuation rules, the exact definition of taxable NBFC services and whether any transitional provisions are introduced.
Over the longer term, clearer GST treatment could support the growth of bank-NBFC co-lending by reducing tax uncertainty. However, the industry will need to balance that clarity against the additional tax cost associated with the service layer, while ensuring that the change does not unnecessarily increase the cost or complexity of credit for borrowers.
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