GST Notice Shocks Banks: Maharashtra’s Move on FPI Custodial Services

The Maharashtra Goods and Services Tax (GST) Department has recently issued notices to several banks regarding the taxability of custodial services provided to foreign portfolio investors (FPIs). This move has significant implications, as it challenges the prevailing understanding and treatment of these services in the banking sector.

  1. Nature of the Dispute: The core issue revolves around the classification of custodial services offered to FPIs. The Maharashtra state GST authorities contend that these services, provided by SEBI-registered custodian banks, do not qualify as zero-rated supplies, which typically apply to exports. This interpretation implies that these services are liable for GST​​​​.
  2. Implications for Banks: Banks offering these custodial services to FPIs, which number over 11,000 in India, are potentially facing a significant tax burden. The financial impact could amount to a few hundred crores in taxes on the fees earned from these services, along with applicable penalties​​​​.
  3. Banks’ Stance: Banks have traditionally treated custodial services to FPIs as exports, given that these services are rendered to entities outside India and involve earning fees in foreign currency. A key argument from the banks is that no GST is applicable on invoices raised on FPIs for custodial services, provided the payment is received in foreign currency and credited to the service provider’s account, not the FPI account. This perspective is based on the understanding that the service is exported out of India​​​​.
  4. Legal Arguments and Counterarguments:
    • GST Department’s View: The GST department’s stance is based on Section 13(9) of the Integrated Goods and Services Tax (IGST) Act, 2017, which stipulates that if a bank provides services to an account holder, the place of supply is where the bank is located, i.e., India in this case. Consequently, the service does not qualify as an export​​​​.
    • Banks’ Counter: The banks argue that this interpretation is incorrect, emphasizing that the accounts in question need to be interest-bearing, and custodian services are not directly related to bank account services. Moreover, the bank accounts held by FPIs do not earn interest, which, according to the banks, makes Section 13(9) inapplicable. They also refer to Section 13(3) of the IGST Act, arguing that the location of service performance is crucial and that the definition of ‘goods’ under the GST law excludes securities​​​​.
  5. Broader Impact and Response: The interpretation of the GST department is seen as potentially detrimental to business sentiment, necessitating reconsideration. Many banks acting as custodians are registered in Maharashtra and have reportedly reached out to the finance ministry to exempt custodian services from the GST purview. This situation is further complicated by SEBI’s 2022 directive that GST would be levied on registration and annual fees it receives, implying GST applicability to fees paid by custodians to SEBI based on the assets they manage​​​​.

This development in Maharashtra concerning GST on custodial services to FPIs highlights a complex intersection of finance, international business, and tax law, with potential ramifications for the banking sector and foreign investments in India.

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