Many financial transactions involve interest income, leading tax experts to question its GST implications. Generally, most interest from loans or deposits is exempt under GST, effectively setting the GST rate to zero. However, certain interest types, like those on credit cards or late payment penalties, do not qualify for this exemption and are typically taxed at 18%.

Concept of Interest Income under GST

"Interest" represents the fee charged for using money. While "money" itself is neither a good nor a service under Section 2(75) of the CGST Act 2017, the act of using money can be considered a service. Lending money or accepting deposits is not inherently a taxable supply. Nonetheless, the interest generated from this use is typically classified as a financial service. Consequently, the GST Act regards interest income as part of financial services, although it is often exempted by specific notifications.

GST Rate on Interest Income

As the majority of interest income is exempt, no GST is applied. Notifications No.12/2017-Central Tax Rate and IGST Notification 9/2017 formally establish a Nil rate for interest derived from loans and deposits. If not for this exemption, the standard GST rate for financial services would be 18%. In practice, this means:

• Exempt Interest: Not subject to GST.
• Taxable Interest: Subject to an 18% tax (IGST/CGST+SGST) as part of the total supply value.

Exemptions for Interest Income under GST

The GST framework explicitly outlines exemptions for interest earnings:

• Notification Exemption: Entries 27/12-2017 and 28/9-2017 exempt "services by way of extending deposits, loans or advances insofar as the consideration is represented by way of interest or discount." This means typical interest on loans or deposits is exempt. An Advance Ruling further confirmed that interest on inter-company loans also falls under this exemption.
• Schedule III (No Supply): Some banking services are categorized as 'no supply.' For example, interest paid by a banking entity to account holders on deposit accounts is outside the scope of GST. This implies that a bank paying interest on savings or deposits is not engaging in a taxable service.

Exempt vs. Taxable Components of Interest Income

It is important to distinguish between different types of payments related to money, as not all are exempt:

• Exempt Components: Any straightforward interest payment associated with a loan or deposit is exempt. For instance, if a manufacturer lends ₹1,00,000 to a subsidiary at 10% annual interest, the ₹10,000 interest received is GST-exempt. Similarly, interest earned by a bank on a term loan is exempt under the same notification.
• Taxable Components: Charges that resemble interest but do not meet the exemption criteria are taxable. Credit card finance charges, for example, are specifically excluded from the exemption and are therefore taxed at 18%.

To summarize, pure loan interest is exempt, while incidental charges are taxable.

GST on Interest in Specific Contexts

Let's examine interest under specific scenarios:

• Loans and Advances: Interest from standard loans or advances provided to either third parties or related entities is exempt under Notification 12/2017. This applies regardless of the relationship between the parties. An advance ruling on inter-corporate loans affirmed that the lending company does not owe GST on the interest received, meaning business or personal loans generate GST-exempt interest income.
• Overdue Payments (Penal Charges): Previously, the AAR and AAAR generally held that penal interest on loan defaults or delayed EMIs constituted a taxable supply. However, a clarification issued by CBIC on January 28, 2025, specified that no GST is due on penal charges levied by banks or NBFCs under new RBI guidelines. This circular clarifies that "penal charges" (which are liquidated damages for contract breaches) are not considered compensation for a supply, thus making them non-leviable for GST.
• Inter-company Borrowings: The same rules apply to inter-company loans. If one company lends to another, the interest is a service considered a loan, and the exemption notification applies, meaning no additional GST is required. While the GST registration threshold includes exempt supplies, the interest itself remains untaxed.
• Interest Income of Banks and NBFCs: Banks and Non-Banking Financial Companies (NBFCs) regularly earn interest from loans and pay interest on deposits. All such interest falls within the loan exemption or Schedule III. A bank's interest income from loans is exempt. Furthermore, a bank's interest expense on deposits is not classified as a supply by the bank; Schedule III of the GST law effectively excludes banking services provided to account holders from the definition of 'supply.'
• EMIs and Hire-Purchase: In hire-purchase arrangements or EMI-based sales, the supplier essentially finances the purchase. GST guidelines state that if the interest portion is billed separately, it is not subject to GST. If not itemized separately, the interest is considered part of the taxable price of the goods or services. For credit card EMI loans, court decisions have indicated that GST must be applied to interest unless it originates from a truly distinct loan agreement.