Indias second largest private sector lender by assets, HDFC Bank Ltd, has paid Rs131.40 crore, inclusive of interest, to the service tax department after the government agency detected violations of certain provisions of service tax rules, two officials familiar with the matter said.

The service tax liability pertains to Central value-added tax (Cenvat) credit taken by the countrys second largest lender for three fiscal years between 2006 and 2008.

The officials asked not to be named because they are not the official spokespersons of the department.
The bank paid a little over Rs100 crore as service tax dues and about Rs30 crore as interest, said one of the officials.
In an email response to Mint, an HDFC Bank spokesman said: As per rule 6(3) of the Cenvat credit rules, HDFC Bank was maintaining records for exempted and taxable services and thus, as per eligibility, claimed 100% input tax credit. The service tax auditors took a different view than that taken by the bank and the department (and) therefore, raised a demand for Rs131 crore on the bank.

The bank decided to pay up to avoid litigation and related costs and this will not have any impact on the cash flows or on profits of the bank, the spokesman added.

Banks are usually entitled to claim Cenvat credit for service tax, excise duty, counterveiling duty incurred on procurement of goods, and services used for providing a service.

Banks charge service tax on services provided to customers. At the same time, they also pay service tax to vendors such as security agencies. To avoid double taxation, the government permits banks to avail of what is known as Cenvat credit. For instance, if a bank charges a customer Rs10 as service tax and simultaneously pays Rs8 to a service provider, it can get a Cenvat credit of Rs8 and pay Rs2 to the government.

Under service tax regulations, a service provider who does not maintain separate accounts of taxable and non-taxable services can get only 20% of the Cenvat credit, but those who maintain separate accounts can get 100% credit.

The service tax agency carried out an audit of HDFC Bank in April. Such audits are conducted by the department to improve compliance with service tax norms and detect tax evasion.

We found that the bank had misinterpreted the service tax norms on the restriction of availment of Cenvat credit. As a result, there was a tax liability on the bank since 2006, said one official of the department, adding, this is the first ever audit on HDFC Bank.

According to the banks spokesman, since April 2008, the Cenvat credit rules have changed and the unutilized credit till 31 March 2008 can be utilized completely against output tax credit in future.

With the change in the Cenvat credit rules, the payment of the said demand could be offset against future service tax payouts. Hence, the bank was indifferent to whether the demand was paid and the tax set off or the claim was challenged, he said.

HDFC Bank has reported a 30.5% growth in net profit to Rs606.1 crore for the quarter ended 30 June, driven largely by interest income from loans and growth in the other income consisting of fees and commissions and gains from trading bonds.
The banks assets on 30 June 2009 stood at Rs1.86 trillon. It is present in 550 cities through 1,416 branches and 3,382 automated teller machines.

In the past, HDFC Bank has paid penalty to the banking regulator twice for non-compliance with know your customer (KYC) norms.

In 2006, Reserve Bank of India (RBI) had fined the bank twice for violating the KYC norms, breaching prudent banking practices and not adhering to directives and guidelines for granting loans against shares and initial public offers.

HDFC Bank was one of the nine banks that were fined for failing to show prudence in opening multiple savings accounts with one common name and multiple unconnected names. These accounts were used to open many demat and loan-against-share accounts that were involved in the initial public offer (IPO) scam. The demat accounts opened with HDFC Bank were used for making multiple applications in IPOs.

An RBI release in February 2006 had said HDFC Bank had failed to follow norms for monitoring large-value transactions in customer accounts.