When "Interest" Isn't a "Service": AP High Court's Chit Fund GST Clarity (Now in Step with Kerala)

Chit funds are one of India's oldest "people-first" financial innovations-part savings club, part credit line, and part social contract. They thrive where formal credit is slow, collateral-heavy, or simply unavailable. But over the past few years, a familiar tax anxiety began creeping into this ecosystem: if a subscriber pays late, and the foreman recovers interest/penalty, can GST be charged on that recovery too?

The Andhra Pradesh High Court has now delivered a decisive answer in M/s Ushabala Chits Private Limited v. Lissa & Ors (2025(12)LCX0017) and the answer aligns neatly with the Kerala High Court's approach in KSFE's case [2024(09)LCX0505]. In short: GST is payable on the foreman's commission for running the chit, but not on interest (or penalty) collected for delayed installments-because that interest is compensatory and flows from a debtor–creditor relationship, not from a "supply of service."

The Chit Fund's "Internal Architecture" Matters (A Lot)

Both High Courts reached their conclusions by refusing to treat chit funds as a single, bundled "financial service" where every rupee received becomes taxable. Instead, they looked at how the Chit Funds Act, 1982 structurally separates:

1. Foreman's commission/remuneration (the true consideration for the service of conducting the chit), and

2. Interest/penalty on default (a consequence of delayed payment of an existing obligation).

The AP High Court specifically highlighted the statutory scheme: the foreman earns a commission for organizing subscribers, conducting auctions/draws, and managing the process, and that commission is the taxable service component.

What the GST Notifications Say: Tax the Service, Not the Time Value of Money

Under GST, the foreman's activity of conducting a chit is already treated as a taxable service. The AP High Court noted that the rate notification fixes GST on "services provided by the foreman of a chit fund, in relation to chit" under Heading 9971, commonly taxed at 12%.

But GST law also carries a crucial "carve-out" for interest. Entry 27 of Notification No. 12/2017–Central Tax (Rate) dated 28.06.2017 exempts services by way of extending deposits, loans or advances insofar as the consideration is represented by interest or discount (other than credit card interest).

So, the legal question becomes: is delay interest in a chit fund closer to "consideration for a service" or closer to "interest on a debt/advance"? The High Courts answered: it's the latter.

AP High Court (Ushabala Chits): Why the Department's "Bundling" Failed

1) The dispute started with AAR/AAAR (and a familiar theory)

Ushabala Chits had gone to the AAR seeking clarity. The AAR (2020(05)LCX0054(AAR)) and AAAR (2020(09)LCX0220(AAAR)) took the view that the additional amount charged for late payment-called interest/late fee/penalty-"takes colour" from the original supply, i.e., chit fund services, and therefore becomes taxable as part of value.

2) The High Court re-centred the analysis on Section 21

The AP High Court examined Section 21 of the Chit Funds Act, 1982, which clearly lists the foreman's entitlements:

The Court underlined an important practical implication: the foreman's "service fee" is already capped under Section 21(b), and interest under 21(c) cannot be re-branded as an additional service fee, otherwise the statutory cap becomes meaningless.

3) Supreme Court's "debt" characterization sealed the issue

The AP High Court relied on the Supreme Court's decision in Oriental Kuries Ltd. v. Lissa (2019) 19 SCC 732, which treats the prized amount drawn by a subscriber as being in the nature of a loan/advance from the common fund, creating a debt payable in instalments.

The AP judgment reproduced the Supreme Court's reasoning that the subscriber incurs a debt and default triggers recovery mechanisms to protect the chit system.

Once the relationship is acknowledged as debtor–creditor, the rest follows: interest/penalty for delayed instalments fits within the "interest on debt" idea, and therefore falls under the interest exemption logic rather than becoming payment for a separate taxable service.

4) Final holding (clear and taxpayer-friendly)

The AP High Court set aside the AAR/AAAR rulings and held that interest and penalty recovered by a foreman due to default in installments is not exigible to GST.

Kerala High Court (KSFE): Same Destination, Slightly Different Route

In Kerala State Financial Enterprises Ltd. v. Union of India [2024(09)LCX0505], the controversy came with real financial weight: the department issued a show cause notice proposing GST demand of Rs. 61.55 crore (with interest and penalty) on interest collected from defaulting subscribers.

Kerala HC's key reasoning (as reported in contemporaneous legal summaries and case reports) was straightforward:

The Common Legal Thread: "Two Buckets, Not One"

Put both judgments side by side, and a stable doctrine emerges:

Bucket 1: Taxable

☑ Foreman's commission/remuneration for conducting the chit (the service element) - taxable under GST as chit fund services.

Bucket 2: Exempt / Not taxable as supply consideration

☑ Interest/penalty for delayed instalments, because:

This directly blocks the department's tendency to treat all receipts as one composite taxable value.

Practical Compliance Takeaways for Chit Operators & Consultants

If you advise or run chit funds, these rulings aren't just courtroom wins-they're an accounting and documentation playbook:

1. Keep commission and default-interest strictly segregated in books
Separate ledgers/GL codes; do not club them under a single "service income" head.

2. Draft the chit agreement carefully
Interest/penalty clauses should read like compensation for delayed payment of instalments (debt), not as "fees" for providing a facility.

3. Avoid creative labels that look like service fees
If something is styled as "processing fee for late payment approval" or "facility continuation charges," the department may revive the "service" argument even after these rulings.

4. Be assessment-ready In audits, anchor arguments in:

5. Know the litigation posture
These are High Court rulings-highly persuasive, especially now that two states converge-but a future Supreme Court contest could still arise. For now, the trend is clearly taxpayer-favourable.

Why This Matters Beyond Tax: Financial Inclusion, Preserved

The deeper win here is economic. Chit funds are often the first (and sometimes only) structured credit option for small traders, informal workers, and households. Taxing delay interest under GST would:

By drawing a bright line-tax the foreman's service income, not the time value of money on default-the AP and Kerala High Courts have protected the affordability that makes chits viable in the first place.

Disclaimer: The information given in this article is solely for purpose of understanding the law. It is completely based on the interpretation of the author and cannot be constituted as a legal advise, the author of this article and Lawcrux team is not responsible for any legal issues if arises on the basis of the interpretation given above.