Analyzing the Impact of Increased GST on Chit Funds and Their Participants
The Indian government has increased the GST on chit funds from 12% to 18%, a move that is expected to significantly impact both chit fund companies and their investors. This article delves into the implications of this rate hike, illustrating how it could lead to higher commissions, reduced returns for participants, and potentially disrupt the stability of the chit fund industry. It also covers the applicability of GST on foreman commissions, relevant HSN codes, and input tax credit eligibility, while citing advance rulings pertinent to chit fund operations.
Examining the Impact of Higher GST on Chit Funds
The Indian government recently increased the Goods and Services Tax (GST) on chit funds from 12% to 18%. This change has significant consequences for both chit fund organizations and their participants. This article explores the repercussions of this revised tax rate.
GST Applicability for Chit Funds
In India, state governments must approve the formation of chit funds, which are governed by the Chit Funds Act 1982. This legislation permits the foreman, who manages the fund, to collect a commission up to 7% of the total chit value. Under GST law, this commission is categorized as a 'supply of service,' making it subject to Goods and Services Tax.
GST Rates and HSN Code for Chit Fund Commissions
Chit funds fall under HSN Code 9971, which covers financial and related services. Following the 47th GST Council meeting's recommendations, the GST rate on chit fund commissions increased from 12% to 18%. This higher rate applies provided no input tax credit (ITC) has been claimed on goods used in providing these services. The implications of this increase for both chit fund operators and investors are significant, prompting a closer examination of its effects.
Illustrative Calculation of GST on Chit Funds
To illustrate the effect of this tax adjustment, consider a hypothetical chit fund with 40 members, each contributing Rs. 25,000 monthly over 40 months, totaling Rs. 10,00,000. In the initial month, the accumulated fund is auctioned. Suppose three individuals bid: Person A offers Rs. 9,50,000, Person B offers Rs. 9,00,000, and Person C offers Rs. 8,50,000. Person C, having made the lowest bid, receives the fund. Historically, if the foreman charged a 5% commission, it would be Rs. 50,000 (5% of Rs. 10,00,000). At the previous 12% GST rate, the GST on this commission would be Rs. 6,000. Consequently, Person C would receive Rs. 8,00,000 (Rs. 8,50,000 minus the Rs. 50,000 commission). For subsequent cycles, the contribution from each member would decrease. The Rs. 1,50,000 foregone by the winner (difference between total pot and Person C's bid) would be distributed among members. This results in a Rs. 3,750 reduction per member, making the new monthly contribution Rs. 21,250 (Rs. 25,000 minus Rs. 3,750).
Consequences of the GST Rate Increase
It is projected that following the GST rate increase to 18%, chit fund foremen will likely raise their commission to the maximum allowable 7% under the Chit Funds Act. Revisiting our example, a 7% commission on Rs. 10,00,000 would amount to Rs. 70,000. With the new 18% GST rate, the tax on this commission would be Rs. 12,600. Therefore, Person C would now receive Rs. 7,80,000 (Rs. 8,50,000 minus the Rs. 70,000 commission). This means chit fund participants will receive a lower net amount despite their original contribution levels remaining constant. Typically, individuals borrowing from chit funds incur interest costs of about 10-18%, which is considerably less than the 36-60% rates charged by private moneylenders. However, this higher commission, driven by the increased GST, is expected to raise borrowing costs by an additional 0.85%, negatively affecting investors' already small savings. Savers who withdraw funds at the end of the chit's term will also see their cumulative savings diminish due to higher commissions and increased effective interest rates. A potential decline in saver participation due to these changes could jeopardize the entire chit fund industry. A thriving chit fund relies on a balanced mix of early borrowers and long-term savers; a disruption to this balance could force small-time borrowers toward less regulated, informal lenders.
Input Tax Credit (ITC) Eligibility
Services provided by the foreman in the chit fund sector are classified under HSN Heading 9971, 'Financial and related services,' and are subject to an 18% GST. This rate is contingent on the condition that no input tax credit has been claimed for any goods utilized in rendering these chit fund services. Further details regarding situations where ITC cannot be claimed on specific goods and services are available here.
Advance Rulings Pertaining to GST on Chit Fund Operations
Most advance rulings concerning chit funds have focused on the taxation of income received, as the Income Tax Act lacks clarity on how to treat discounts obtained by chit subscribers from the final fund. Nevertheless, the Ushabala Chits (P.) Ltd., In re [2020] case offers insight into GST applicability. The Appellate Authority for Advance Ruling determined that a foreman's collection of overdue or defaulted chit fund installments, along with associated penal interest, constitutes a supply of service under the GST Act. An increase in GST on chit funds negatively affects small savers by elevating the opportunity cost of their investments. This could lead to a contraction of the chit fund industry, limiting alternative financing options for savers. Such a development could particularly disadvantage individuals who have limited access to conventional banking services.