Valuation of Supplies in GST

1.  Background

     Provisions for valuation of supplies in GST
are common for both goods and services. Section 15 of CGST Act read with nine
rules contained in Draft Valuation Rules (DVR) as approved by the GST Council
in May 2017 lay down the principles of valuation.

    Essentially, these principles of valuation
are to be applied in three buckets, depending on the nature of supply:

For each of the above buckets, different (and in some cases,
alternate) methods of valuation have been prescribed in the law, depending on
existence of specified circumstances in different situations under each
buckets. These methods are discussed in subsequent paras separately.

However, for each of the above buckets, while
determining the value of supply:

a)   Section 15(2) lists specific amounts which
are required to be included; and

b)   Section 15(3) and Rule 7 of DVR lists
specific amounts which are required to be excluded

2.  Mandatory inclusions in value of supply

     Irrespective of the nature of supply, as
per section 15(2), following amounts shall be included in the value of a supply
(some practical examples of these are given in brackets):

i.   any taxes, duties, cesses, fees and charges
levied under laws other than GST related Acts, if charged separately by the
supplier (e.g. basic customs duty, property tax, etc. separately charged by
supplier to recipient);

ii.  any amount that supplier is liable to pay for
the supply but is incurred by the recipient and is not included in the price
actually paid/payable for the supply (e.g. salaries of suppliers’ employees,
electricity bill of supplier etc. paid by recipient);

iii.  incidental expenses, including commission and
packing, charged by supplier to recipient (e.g. outward freight, fumigation
charges etc.);

iv. any amount charged for anything done by
supplier for supply at the time of, or before delivery of goods / supply of
services (e.g. warehousing charges);

v.  interest/late fee/penalty for delayed payment
of consideration for supply; and

vi. subsidies directly linked to price of supply
excluding Government subsidies (e.g. subsidy received by canteen contractor
from recipient for subsidised meals given to recipient’s employees).

3.  Mandatory exclusions from value of supply

     Irrespective of the nature of supply, as
per section 15(3), following amounts shall not be included in the value of a supply,
if the conditions specified there against are satisfied (some practical
examples of these are given in brackets):

i.   any discount given before/at the time of
supply, if it has been recorded in the invoice issued for such supply (e.g.
discount on stock clearance sale);

ii.  any
discount given after supply, if such discount is:

–   established in terms of agreement entered
into at/before time of supply;

–   specifically linked to relevant invoices; and

–   input tax credit (ITC) attributable to it on
the basis of document issued by supplier has been reversed by recipient.

     (e.g. volume/target discount given as
per milestones)

     It needs to be noted that the above
exclusions are specific and conditional. Hence, neither any other type of
discount nor any of the aforesaid two types of discounts where the specified
conditions are not fulfilled, will be allowed to be deducted by the supplier
from the value of supply for computing GST liability of supplier.

    However, net effect of the above is that if
in practice,in respect of post-supply discount:

–   supplier does not want to seek reduction in
its GST liability (already discharged for the supply); and

–   recipient does not want to reverse ITC
attributable to such discount (already claimed earlier based on original invoice
of supplier),

     they can very well do so, with the supplier
issuing credit note to recipient u/s. 34 of CGST Act, only to the extent of the
amount of post supply discount, without giving any credit to the recipient for
the GST already charged in the original invoice for the supply, ITC for which
was already taken earlier by the recipient.

     As per Rule 7 of DVR, expenditure/costs
incurred by a supplier as a pure agent of recipient shall be excluded
from value of supply if all the following seven conditions (as against
twelve conditions specified in present Valuation Rules under Service Tax Law)
are satisfied:

(i)   supplier acts as pure agent of recipient when
he makes payment to third party on authorisation of recipient;

(ii)  payment made by pure agent on behalf of
recipient is separately indicated in invoice issued to recipient;

(iii)  supplies procured by pure agent from third
party are in addition to services (and possibly goods or both² )
supplied on his own account;

(iv) supplier acts as pure agent to incur
expenditure/costs in the course of his supply as per contractual arrangement
with recipient;

(v)  supplier neither intends to hold nor holds any
title to goods/services procured/supplied as such agent;

(vi) supplier does not use goods/services so
procured for his own interest; and

(vii) supplier receives only actual amount incurred
to procure such goods/services, in addition to amount received for supply made
on his own account.

4.  Value of supply to non-related persons

     Supply to a non-related person could be
such where:

(a) price is the sole consideration
for supply; or

(b) price is not the sole consideration
for supply.

     In situation (a), as per section 15(1),
value of such supply shall be ‘transaction value’, which is the price
actually paid/payable for the supply.

     In situation (b), as per section 15(4),
value shall be determined as per Rule 1 of DVR.

     The term ‘consideration’ is defined very
widely in section 2(31) of CGST Act in an inclusive manner. Therefore, in
addition to the specific inclusions stated in that definition, whatever
qualifies as consideration ordinarily and in terms of the Indian Contract Act,
will also be regarded as consideration. Following essential features of such
specific inclusions in the definition of ‘consideration’ need to be noted
carefully:

(a) any payment made or to be made, whether in
money or otherwise (i.e. in kind) in respect of, in response to, or for the
inducement of, the supply of goods/services;

(b) such payment may be made by the recipient or by
any other person (other than subsidy given by Government);

(c) monetary value of any act or forbearance, in
respect of, in response to, or for the inducement of, the supply of goods or
services or both, whether by the recipient or by any other person (other than
subsidy given by Government);

(d) deposit given in respect of the supply of
goods/services, if the supplier applies such deposit as consideration for such
supply.

Treatment of Free Issue/Free of Charge Material

It appears that Free Issue Material (FIM)/Free of Charge
(FOC) material made available by the recipient to the supplier in terms of
a condition precedent stated in the contract with the supplier, clearly
defining the scope and nature of the supplies of the supplier, can be argued to
be not includible in the value of the supply in terms of specific inclusions
stated in (a) and (c) above. To avoid possible disputes in this regard that
could be raised by Departmental Officers on account of the use of phrases like
‘in respect of’ and ‘for the inducement of’ having wide meanings in the
definition of ‘consideration’ as explained above, it would be desirable that
Government appropriately clarifies whether in aforesaid and/or other
circumstances, FIM/FOC material made available by recipient to the supplier is
or is not, required to be added to the value of supply by the supplier. 

Treatment of consideration in kind

Where supply is to a non-related person but price is not
the sole consideration, i.e. where price is partly in money and partly in kind,
or it is wholly in kind, Rule 1 of DVR provides for the following methods of
arriving at valuation in the sequence stated below i.e. if the first method
fails, value has to be determined as per next method and if the next one fails,
the third method and so on, where the last method is prescribed in Rule 5:

(a) Open Market Value (OMV) of the supply;

(b) sum total of consideration in money and such
further amount in money that is equivalent to the consideration not in money
(if such amount is known at the time of supply);

(c) value of supply of goods/services of like kind
and quality;

(d) sum total of consideration in money and such
further amount in money that is equivalent to the consideration not in money as
determined by application of Rule 4 or Rule 5 in that order (these Rules are
briefly narrated at S. Nos. 3 & 4 respectively in the table in Para 6
below).

5.  Meaning of ‘related persons’

     Curiously, the definition of ‘related
persons’ is not given in the definition section 2 of CGST Act, but it is given
in the Explanation to section 15 by clearly stating, ‘For the purposes of
this Act, – ”.

     As per this Explanation, in eight specified
types of relationships, persons will be deemed to be ‘related persons’, and
‘person’ for this purpose will include legal persons. Instances of these
specified types of relationships are – employer and employee; members of the
same family; one person directly/indirectly controls the other; persons who are
legally recognised partners in business; persons who are officers/directors of
one another’s businesses; a person who is associated with another person as its
sole agent/sole distributor/sole concessionaire.

6.  Value of supply to agents, related persons or
between distinct persons³

     Valuation for supply between a person
(being a principal) and his agent (other than sole agent), is prescribed in
Rule 3 of DVR, while valuation of supply between related persons (including
sole agent) or between distinct persons is prescribed in Rule 2 of DVR – both
of which Rules require determination of value as per Rule 4 or Rule 5 in
specified situations.

     Rules 2 to 5 also provide for sequential
method of arriving at valuation summarised in the table below:

*Most importantly, as per second proviso to Rule 2 of DVR,
in all these situations, value declared in invoice of supplier shall be deemed
to be OMV, where the recipient is eligible for full input tax credit.This is
a great relief to businesses, as it will avoid possible valuation disputes with
Department in these situations.

The expressions ‘Open Market Value’ (OMV) and ‘supply
of goods or services or both of like kind and quality’ are defined in the
Explanation at the end of Rule 9 of DVR as under:

a)  ““open market value” of a supply of goods or
services or both means the full value in money, excluding the integrated tax,
central tax, State tax, Union territory tax and the cess payable by a person in
a transaction, where the supplier and the recipient of the supply are not
related and price is the sole consideration, to obtain such supply at the same
time when the supply being valued is made.”

(emphasis supplied) 

     In essence, OMV is arm’s length price.

b)  ““supply of goods or services or both of
like kind and quality” means any other supply of goods or services or both made
under similar circumstances that, in respect of the characteristics, quality,
quantity, functional components, materials, and reputation of the goods or
services or both first mentioned, is the same as, or closely or
substantially resembles, that supply of goods or services or both.”

(emphasis supplied) 

In practice, several challenges could arise in determining
what are ‘similar circumstances’ in light of the above specified
characteristics of a supply and therefore, due caution will have to be
exercised in this regard by drawing support from publicly available
information, opinions of experts, etc. which should be well documented – as is
done in case of transfer pricing regulations under Income Tax Act.

7.  Option to determine value of notified supplies

     As per section 15(5) read with Rule 6 of
DVR, in case of following notified supplies, where the recipient may or may not
be related or price may or may not be the sole consideration, supplier has
the option to determine the value as per method prescribed in Rule 6 of DVR
for each such notified supply (subject to satisfaction of specified
conditions), instead of determining value as per the principles discussed
in Paras 4 to 6 above:

8.  Rate of exchange and value inclusive of GST

     As per Rule 8 of DVR, for determining rupee
value of supplies involving foreign currency, the rate of exchange to be
applied shall be the applicable RBI reference rate on the date and time of
relevant supply in terms of section 12 (time of supply for goods) and section
13 (time of supply for services) of CGST Act.

     As per Rule 9 of DVR, where value of supply
is inclusive of GST, tax fraction shall be applied to determine the GST amount
included in such value i.e.

     GST = Value of supply inclusive of GST X Applicable GST rate for the supply /

               100 + Applicable GST
rate for the supply 

     This method would particularly become relevant
in cases of supplies of taxable goods/services obtained from unregistered
persons, where the registered person (i.e. recipient) is liable to pay GST
under reverse charge as per section 9(4) of CGST Act.

9.  Conclusion

     Given the complexities in real life
situations of supply of goods/services and related matters like conditions
precedent, nature of payments, need for outsourcing, nature of
concessions/incentives given, actual conduct of parties, technological
advancements etc., area of valuation of supplies liable to GST will pose
several challenges as well as opportunities for small, medium and large
businesses.

     All decision makers will have to be
cautious, methodical and process oriented for being fully GST compliant on one
hand and simultaneously achieving tax optimisation, for not only sustaining in
the increasingly competitive and disruptive business environment but also
increasing one’s market share in the world’s fastest growing economy.