The Honorable High Court of Karnataka has recently delivered a significant judgment in favor of the banking industry on the issue of levy of service tax on the maintenance of Minimum Average Balance (MAB) in bank accounts^[1].

While this matter is the subject of an industry wide litigation, the present decision has been pronounced in favour of limited number of petitioners namely: Canara Bank, Bank of Baroda, and the Karnataka Bank (hereinafter collectively referred to as the ‘petitioner banks’).

We have set out a detailed analysis of the judgment below:

Summary of the Industry Issue

1. Banks offer certain free services to the account holders subject to the condition that a prescribed minimum balance must be maintained in their bank accounts.
2. The higher or more premium the category of the bank account, the higher the value/nature of free services offered and correspondingly the customer is required to maintain a higher threshold of MAB.
3. If a customer does not maintain the requisite MAB, he becomes liable to pay a MAB charge (which is offered to service tax by most banks). 
4. Show cause notices (SCNs) were issued to most banks on the ground that:
   • Banks insisted on maintenance of MAB so that they would have liquidity owing to such balance, which allegedly served to recover the cost of providing free services.
   • Such free services were classifiable under the declared service category of “agree to the obligation to do an act”, whereby the banks were alleged to have agreed to the obligation to provide services in consideration for the customers commitment to maintain MAB.
   • The value of the free services was contended to be the MAB charges that the customers would have paid in the event of non-maintenance of MAB.
5. In the instant case, the petitioner banks filed writ petitions against the SCNs before the Karnataka High Court. A larger batch of writ petitions in the case of other banks is pending before the Delhi High Court on the same matter.

Karnataka High Court Analysis and Decision

Requirement to Maintain MAB Does Not Constitute ‘Consideration’ for Provision of Services

The High Court held that requirement to maintain MAB did not constitute ‘consideration’ for services and therefore cannot be taxed on the following grounds:

1. As per Section 67 of the Finance Act, 1994, and the Supreme Court judgment of Bhayana Builders, the levy of service tax requires consideration, which must be charged or exist in a manner that can be quantified. In the absence of consideration, a transaction cannot be brought to tax.
2. Existence of ‘consideration’ necessitates that the customer irretrievably part with funds/pecuniary benefit and the said benefit must flow to the banks. In the present case, no benefit flows to the banks upon the customer maintaining MAB since the customer is always at liberty to withdraw such amount and in fact earns interest on balance maintained with the banks (minimum or otherwise). On the other hand, banks are not allowed to appropriate MAB as their consideration and neither do they account for it as such.
3. The aspect of banks requiring MAB for assured liquidity is a misnomer, given that banks have many customers, all of whom have the unfettered right to withdraw MAB such that liquidity could not be guaranteed via maintenance of MAB.
4. Contractually, banks are not allowed to recover the cost of free services in the event of non-maintenance of MAB. At most, the banks could recover such costs by way of the MAB charges levied in lieu of non-maintenance. However, as MAB charges were already being offered to service tax and no other consideration was flowing to the banks, it would be absurd to levy tax on an imputed value of free services as this would lead to double taxation.
5. CBIC Circulars (Circular 178/10/2022-GST, Circular No. 214/1/2023-Service Tax, and Circular: 62/11/2003-Service Tax)have clarified that the declared service of “agreeing to the obligation to do an act” must be an independent service rendered under a contract for a separate consideration. In the present case, the court found that there is no such nexus between the maintenance of MAB and the provision of banking services, thereby negating the essential element of quid pro quo. Further, the court observed that the revenue was bound by its own circulars.

Reliance on Favorable Order Passed in the Case of South Indian Bank on the Same Matter Under the GST Law

The High Court observed that the Respondents had passed an order in favor of the South Indian Bank on the same matter, under the GST law. Relying on this, the High Court held that, as the provisions under service tax and GST law did not differ on this matter and the Respondents dropped the demand against the South Indian Bank without any further litigative action, the present SCNs also deserve to be quashed.

Maintainability of the Writ Petitions Though Alternative Remedy Exists

1. The High Court observed that banks had made several representations against the institution of the present proceedings. However, no remedial/corrective measures were forthcoming. Further, the SCNs indicated that the Respondents had already pre-determined and concluded that the banks were liable to pay service tax, rendering the adjudication proceedings as a mere ritualistic exercise.
2. The High Court further held that as the present matter posed a pure question of law (such that the High Court had no need to allude to any factual aspects) and considering the ramifications of the SCNs on the industry, the High Court could entertain the petitions.
3. Based on the aforementioned key arguments, the High Court allowed the writ petitions and quashed the SCNs and all further proceedings pursuant thereto.

A&M Comments

In our view, the Karnataka High Court order is well reasoned in the context of the merits of the matter, and more importantly brings out that the revenue appears to have accepted that the demand is not sustainable under GST (in the case of South Indian Bank), and given that the relevant provisions remain the same under both service tax and GST laws, the demand under service tax should also not sustain. Considering this, the judgment is expected to have significant persuasive value in the Delhi High Court proceedings where the larger batch of petitions are lodged.

Apart from this, the judgment should serve as a significant precedent for determination of issues surrounding non-monetary consideration or barter arrangements and penal charges. Key principles upheld by the judgment are as follows:

• Consideration must involve real and identifiable benefit for the payee and irretrievable loss of funds/pecuniary benefit for the payer.
• A clear quid pro quo is essential for taxability under both Service Tax and GST frameworks (where consideration is a prerequisite).
• For declared services of the nature of “obligation to do an act or refrain from an act”, a direct nexus must exist between the obligation and the consideration.

Incrementally, the High Court in its judgment observes that charges for non-maintenance of MAB are penal in nature and do not constitute ‘consideration’ for services. This observation can be relied upon to carry out an in-depth analysis and explore the taxability of any charges perceived to be purely penal in nature.

Disclaimer: This article is based on publicly available information and the authors’ professional experience and market analysis. For questions regarding the underlying sources or analytical methodologies, please reach out to the author directly. The analysis reflects market trends and observations and is intended for general informational purposes only. It does not constitute investment, legal, or financial advice.

[1]Canara Bank versus The Union of India (Karnataka High Court Writ Petition No. 10234/2020)