When crafting the laws about the new Goods and Services Tax, the GST council set tax rates on hundreds of services and supplies, and even interest is on the list. If you charge interest to your customers or if you pay interest on loans, you may want to understand how that works with the new GST system.
Interest on Late Payments
To deter your clients from paying late, you may want to charge interest on your invoices. For instance, you could opt to charge 10% interest every time a client pays their bill a month late or more. You may even choose for the interest to increase as you get further past the due date. But you also have to charge GST on the interest.
In this situation, the GST rate should be the same as the rate that applies to the goods or services on the invoice. Let’s say you bill a client ₹1,000 for tailoring services. You give them 30 days to pay, but the invoice says if they don’t pay by that deadline, they face 7% interest on their balance. Unfortunately, they don’t pay so you assess ₹70 in interest. To calculate the GST on that amount, you take the 5% rate applicable to tailoring services and you assess that on the ₹70. That brings the total interest to ₹73.50.
Paying GST on Interest for Delayed Payments
When you charge interests to clients, you don’t have to report or pay the GST until you receive the interest from your client. That may not mirror when you report the GST for the goods and services on your invoice. In particular, if you use accrual-based accounting, you record revenue as earned as soon as you issue the invoice. Typically, you also report the GST to the government on your monthly GST return, even if you haven’t received the payment yet.
In contrast, if you use cash-basis accounting, you don’t record sales until you actually have the funds in hand. That said, in some cases, the GST council may require you to make your reports on a cash basis. For instance, in April 2018, the Finance Minister announced that the GST system was switching to cash-basis accounting for the fiscal period.
To recap, if you’re filing your GST returns on an accrual basis, you report the invoice and the GST on your goods and services when you issue the invoice. But you don’t report the GST on the interest until you receive it. On the other hand, if you’re reporting on a cash basis, you report all the GST when you receive it.
GST on Loan Interest
As a business owner, you may get loans to pay for large purchases or even just to boost your working capital. When your lender assesses interest, you also have to pay GST on those amounts. As of 2018, the GST on financial services is 18%. That applies to loan interest but also to annual charges and processing fees. Prior to the new GST system, the tax on these services was only 15%. As a result, this is one of a small handful of areas where tax has increased under the new system.
To illustrate, if you pay ₹100 in interest, you pay ₹18 in GST. In the past, you would have only paid ₹15 in tax. That’s an increase of ₹3 rupees for every ₹100 you pay in interest or finance charges. Although that’s not an extremely large increase, you may want to budget for it.
Whether you’re repaying loans or writing invoices, the details can be complicated. To make the process easier, consider trying cloud-based accounting software such as QuickBooks.