INTERMINGLING OF INCOME TAX AND GST

Tax laws are not made in a vacuum.
They are expected to be legislated keeping in mind the prevailing social,
economic and legal structure of a State. Yet, once legislated, taxing statutes
are to be implemented strictly and literally without consequences under other
tax laws. It is for the limited purposes of resolving any ambiguity over
undefined terms and / or unclear obligations of transaction where the Courts
have resorted to ancillary tax laws. It becomes imperative for tax subjects to
reconcile multiple laws prior to concluding transactions. This approach
involves a conceptual study and a cautious application of the respective laws
and their precedence.

Enactment of the Goods and Services
Tax laws in India would certainly have parallel implications under the existing
Income tax enactment. The business practices and accounting methodology under
the pre-existing enactments would need to be examined under the GST lens. We
are aware that gross income / receipts / turnover in the Profit and Loss
account of an Income tax return does not equate to aggregate turnover of a GSTR
annual return. Why is this so? Fundamentally, supply represents rendering of
service / sale of goods (outward obligation), while income is the consequence
flowing back from such supply (also called consideration); in other words,
supply of goods is the outward flow of a benefit and the consideration emerging
from such supply is termed as income.

Therefore, supply and income are two
facets of the same coin (one being the source and the other being the
consequence) and are to be viewed differently. They meet only when both
parameters, i.e., outward benefit and corresponding consideration are present
in a transaction; the absence of one any of these elements causes a divergence
in treatment under the respective laws. The other fundamental difference is the
geographical spread of the legislation – Income tax is a pan-India legislation
and GST is a hybrid of both national and State-level legislations.

An attempt has been made in this
article to identify variances and consistencies between both the tax enactments
from a conceptual perspective under four broad baskets: Charge, Collection,
Deductions / Benefits and Procedures.

A)  CHARGE OF TAX

Income
perspective

Income tax is a direct tax on the
income from a transaction (see pictorial representation). The tax can be said
to be outcome-based since it is imposed on the end result, i.e., net business
profit, net capital gains, net rental income, etc. The basis of charge of
Income tax is ‘accrual’ or ‘receipt’ of ‘income’ depending on the accounting
methodology or specific provisions. Income is a term of wide import and has
been defined in section 2(24) in a very wide manner. Its normal connotation
indicates a periodical money return with some sort of expected regularity from
a definite source. It implies the net take-away from a transaction or series of
transactions. Yet, this definition has been the subject matter of scrutiny at
all levels in judicial fora. Every passing Finance Act has only widened the
scope of this term to include artificial items which do not fall in the normal
connotation of income. Certain extensions to this definition overcome general
understanding such as capital receipts, chance-based (lotteries, etc.)
receipts, absence of consideration, etc. For instance, courts have held that
capital receipts do not fall within the natural scope of the definition of
income. As a consequence, compensation on destruction of capital assets was
held to be capital in nature and included in Income tax only by artificial
extension. Capital receipts are thus an extended feature of income, and
therefore any capital receipt not specified in the enactment is outside the net
of Income tax.

GST, on the other hand, is a
transaction-based indirect tax. Transaction of ‘supply’ forms the basis of
charge. However, the term supply appears to be widely defined; it is fenced
with the requirement of being in the nature of sale, lease, exchange, barter,
license, etc. in the course or furtherance of business. Business has been
extended to include occasional, set-up related and closure-related
transactions. The transaction of supply is not significantly influenced by the
intention behind holding the asset. The behavioural aspect may be with
reference to the contractual terms but not behind the ownership of the asset.
For instance, GST may not concern itself with the intention behind holding the
asset but would lay higher emphasis on whether, in fact, the asset was sold or
not. To elaborate this with an example, a manufacturer temporarily leasing an
asset during its construction phase prior to its set-up may not be considered
as generating an income from business but reducing its capital expenditure (a
capital receipt), though such transaction would still be liable to GST. GST
does not treat capital and revenue transactions too differently; sale of
capital assets (or even salvage value), though capital in nature, would be
taxable under the said law.

On the other hand, Income tax
permits deduction of bad debts since it follows the ‘income’ approach. As a
corollary, the write-back of a revenue liability is also income. Since the
charging event of GST ends with the completion of supply, recovery of the
consideration, though relevant for Income tax, may be inconsequential for GST.
On the other hand, there may be certain transactions which are supply but may
not result in any income to the supplier. Recovery of costs may not necessarily
impact the income computation as they are generally netted off, but the very
same transaction could have implications under GST (say, freight costs).

Schedule I transactions certainly
pose a challenge when juxtaposed between Income tax and GST. Take the example
of the movement of goods between principal and agents. While for Income tax
this movement would not have any implications in either hand, under GST this
would be treated as an outward supply from the principal to its agent and a
corresponding inward supply to the agent, akin to a sale and purchase between
these parties. This would be the case even for a transaction between principal
and job-worker crossing the statutory threshold. The principal would have to
forcefully record this as an outward supply but would not give any
corresponding effect in its Income tax records. Therefore, while all GST
consequences would follow, Income tax would refrain from recognising these
transactions, leading to permanent variance between two values for the
taxpayer; for example, Income tax books would report this as stock held with
the job-worker, while the goods would strictly not form part of inventory of
the principal for GST purposes.

Apart from such variances, the
general phenomena of income and supply would more or less reconcile with each
other. The net consequence of the above-cited difference is that a
comprehensive coverage of either Income tax or GST cannot be made only by
reviewing the Profit and Loss account or Income tax computation of the
taxpayer. Transactions beyond Income tax records would need to be examined from
a GST perspective as well.

Characterisation
perspective

The other linkage is the
characterisation of transactions under both laws. Income tax u/s 14 provides
for five broad heads of income: (a) salary, (b) income from house property, (c)
business or profession, (d) capital gains and (e) other sources. The Supreme
Court in the famous case of East Housing & Land Development Trust
Ltd. vs. Commissioner of Income Tax (1961) 42 ITR 49(SC) held that:

‘The classification of income
under distinct heads of income is made having regard to the sources from which
the income is derived. Moreover, Income tax is levied on total taxable income
of the taxpayer and the tax levied is a single tax on aggregate tax receipts
from all sources. It is not a collection of taxes separately levied under
distinct heads but a single tax’.

The distinct heads are for the
purpose of differential computation methodologies of income depending on the
source of income. Income tax would treat computation of gains on sale from
capital assets differently from that of gains on sale of a stock. In fact, any
conversion of capital assets into stock in trade or vice versa would
have Income tax implications but no GST implications. A trader reclassifying an
asset from one balance head to another would not have any GST implications. The
reason for this difference is probably that GST does not look through the
intention of supply; it rather looks at the fact of a supply taking place for
taxation.

Income resulting from an
employer-employee / master-servant relationship is separately taxable under the
head ‘Salaries’ under Income tax. The litmus test of master-servant
relationship would be the extent of supervisory control of the master over the
individual while rendering the said service – independence in functioning would
provide the extent of control exercised by the master [Ram Prashad vs.
CIT (1972) 86 ITR 122 (SC)]. Under Income tax, the definition of salary
includes wages, allowances, accretion to recognised provident funds, etc.
Though the definition of salary u/s 17(1) does not include ‘perquisites’ within
its fold, it is nevertheless taxable under the head ‘Income from salary’ u/s
17(2). The Supreme Court in Karamchari Union vs. Union of India (2000)
243 ITR 143 (SC) stated that the definition of salary itself includes
any allowance, perquisite, advantage received by an individual by reason of his
employment. The perquisites are valued based on the net benefit being provided
to the employee (i.e., gross value of benefit minus the recoveries, if any).

The above analogy could be extended
to GST in matters involving examination of services rendered between the
employer and the employee in the course of employment. From an employee’s
perspective, the commissions, bonuses, monetary / non-monetary benefits arising
on account of employment even received after termination would be excluded from
the net of GST. But one should be cautious to ascertain the capacity under
which the individual is rendering these services. A director, for instance, can
hold two capacities – as an employee and as a director (agent of the company).
Services rendered as an agent of the company would not fall within the
exclusion but those rendered out of a master-servant relationship would stand
excluded.

Under the GST law both employer and
employee are treated as related persons in terms of the explanation to section
15. Schedule I deems certain services between related persons as taxable even
in the absence of a consideration. Therefore, from an employer’s perspective,
in cases where he is providing services for a subsidised charge to an employee
on duty (say subsidised rent accommodation, transport facility, etc.), there
appears to be some ambiguity whether such transaction entails GST. This is
because Schedule III excludes services by an employee to an employer in the
course of, or in relation to, employment, but not the reverse.

Certain services by an employer to
his employee arise on account of the obligations he takes over as part of the
employment agreement (such as providing rented accommodation, transport,
medical facilities, etc.). In the view of the authors, such activity is in the
nature of a ‘self-service’ and the recovery if any is towards the costs of such
activity rather than an independent supply, or an outward flow of benefit to
the employee. We can view this as follows:

The employer provides such benefits
as a condition (express or implied) of the employment. Some activities may also
be gratuitous / implied in nature, such as serving tea during official hours.
Some activity may be either provided free of cost or chargeable at a subsidised
cost (factory lunch). The benefits which are made available to the individual
have emerged from the status of a master-servant relationship. These benefits
are provided by the employer as a means for improving efficiency, productivity,
retention, etc. for his business. Though these actions provide some benefit to
the employee, such benefits are not solely for exclusive personal consumption.
In such cases it can be stated that there is no independent supply from the
employer to the employee, rather, a non-monetary benefit provided to the
individual. Even in case an amount is charged (either at cost or subsidised
rate), it represents a cost recovery / reduction in the quantum of non-monetary
benefit, but not a supply.

Such a view resonates from the fact
that while computing the value of perquisites in the hands of the employee, any
costs recovered by the employer towards the provision of such non-monetary
benefit is reduced from the valuation of salary. Such costs are not treated as
an expense of the employee, rather, they are reduced from the gross value of
monetary benefit received during the course of employment. The employer also
does not treat this transaction as part of his income generation activity but
considers this a reduction of his salary costs.

We should distinguish the above
scenario from a case where an employer provides benefits beyond the contract of
employment, or renders exclusive benefits to individuals in their personal
capacity. 

Situs
perspective

Income tax is imposed on income
which accrues or arises or is received in India, or deemed to accrue or arise,
or received in India. The situs of accrual and receipt of such income
plays an important role in deciding the tax incidence under the Act. Indian
Income tax follows a hybrid of residence and source-based taxation and where
multiple sources exist, the principle of apportionment comes to the fore for
taxation. The Supreme Court in Ahmedbhai Umerbhai [1950] 18 ITR 472 (SC)
held that the place of accrual need not necessarily be the place where the sale
is consummated (i.e., the transfer of property in goods takes place) and income
can be attributed between different places depending on the acts committed at
these places.

Income tax has a recognised
principle of profit attribution where cross-border transactions are attributed
to each nation based on Transfer Pricing principles (involving functions
performed, assets employed and risks assumed). In Anglo-French Textile
Company Ltd. vs. Commissioner of Income-tax [1954] 25 ITR 27 (SC), the
Court stated that sale is merely a culmination of all acts to realise the
profit earned therefrom. The terms accrue and arise themselves have an inherent
principle of apportionment within them and in the absence of a specific
statutory provision (as it was then), general principles of apportionments
would be applicable; of course, subject to application of international treaty
covenants.

GST, on the other hand, taxes all
supplies in their entirety even if such supply takes place partly in India
(section 5-14 of the IGST Act). Being a transaction-based levy, the trigger of
supply takes place in terms of the place of supply provisions. Unlike the
Income tax law, the place of supply would be the particular place as stated in
the statute (rather than a spread) which would closely replicate the place of
probable consumption of the goods or services. Place of supply cannot be spread
across geographies and subjected to apportionment principles. For example, the
Indian branch of a foreign bank may be contracting for banking and financial services
with a multinational group directly but with active assistance from its
headquarters outside India. Income tax would require the profit from this
activity to be attributed to all the relevant jurisdictions based on a
functional analysis, but GST would treat this contractual consideration as
taxable entirely in India. It’s a different matter that the headquarters may
separately raise a GST invoice on the branch office to recover its costs.

IGST law has specific provisions for
identifying the location of supplier or recipient based on the business
establishments across jurisdictions. The term ‘business establishment’ is
defined to involve people, places and permanence and it forms the basis to
decide the location of supplier or recipient (usually residence-driven). The
terms ‘business establishment’ and ‘permanent establishment’ (business
connection) are on similar platforms to some extent. ‘Permanent establishment’
also uses these three parameters (such as a Fixed Place PE, Service PE,
Equipment PE, etc.) to decide the extent of income attributable to a
jurisdiction. The variance is because (a) Income tax has already experienced
significant evolution with changing business dynamics due to which the
permanent establishment concept is quite enlarged to agency functions, etc.;
(b) Income tax does not treat the condition of permanence, place or people as
cumulative and has, over the years, diluted this to significant economic
presence (say, presence of internet users). It may not be totally incorrect to
say that ‘business establishment’ under GST would necessarily entail a
permanent establishment for the overseas enterprise under Income tax, but the
reverse may not always be true.

B)  COLLECTION OF TAX

Income tax is an annual tax. It is
imposed for each year called the assessment year based on the income which is
accrued or received in the preceding year (called previous year). Section 4 of
Income tax prescribes a unique methodology of taxing income of a particular
year (previous year) in the subsequent assessment year. Taxes paid during the
previous year take the form of advance tax and the tax paid during the
assessment year is termed as final self-assessed tax. The liability to charge
arises not later than the close of the previous year but the liability to pay
tax is postponed based on the rates fixed by the yearly Finance Act after the
close of the previous year.

The Supreme Court in CIT vs.
Shoorji Vallabhdas & Co. [1962] 46 ITR 144 (SC) held:

‘Income-tax is a levy on income. No
doubt, the Income-tax Act takes into account two points of time at which the
liability to tax is attracted, viz., the accrual of the income or its receipt;
but the substance of the matter is the income. If income does not result at
all, there cannot be a tax, even though in book-keeping an entry is made about
a “hypothetical income” which does not materialise. Where income has, in fact,
been received and is subsequently given up in such circumstances that it
remains the income of the recipient, even though given up, the tax may be payable.
Where, however, the income can be said not to have resulted at all, there is
obviously neither accrual nor receipt of income, even though an entry to that
effect might, in certain circumstances, have been made in the books of
account.’

Similarly in CIT vs. Excel
Industries 2013 38 taxmann.com 100 (SC) and Morvi Industries Ltd.
vs. CIT (Central), [1971] 82 ITR 835 (SC) the Court considered the
dictionary meaning of the word ‘accrue’ and held that income can be said to
accrue when it becomes due. It was then observed that: ‘……. the date of
payment ……. does not affect the accrual of income. The moment the income
accrues, the assessee gets vested with the right to claim that amount even
though it may not be immediately’.

GST is a transaction-based tax with
reporting and tax payments being made on a monthly basis. Time of supply
provisions (sections 12 and 13) fix the relevant month in which taxes are
payable. The leviability of GST is on supply of goods / services and charge of
tax is applicable even on an agreement of supply (section 7). In view of this,
goods sold but rejected on quality parameters prior to its acceptance itself,
may be a supply in terms of section 7 but would certainly not be an income to
the taxpayer. For example, the taxpayer has removed goods on 31^st January
for sale which are subject to quality approval at the customer’s end for
payment; this would be a supply for the taxpayer for the month of January but
would be income for the very same taxpayer only when the goods are accepted by
the customer and the right to receive the consideration comes into existence in
favour of the supplier. It would be a different case that in case of rejection
the taxpayer can seek a refund of the GST already paid, but one would
appreciate that the GST law is distinct insofar as it imposes taxes and then,
subsequently, grants refund, while Income tax would refrain from imposing tax
itself.

Under Income tax the year of accrual
(other than specified exceptions) determines the relevant assessment year.
Importantly, each assessment year is a water-tight compartment and accruals
pertaining to a particular assessment year have to be considered in the
computation of Income tax for that year only and cannot be adopted in any other
assessment year. This is because Income tax is a single tax (refer preceding
discussion) of an assessment year and can be determined only when all incomes
are reporting in tandem. But GST is a transaction tax and reporting of each
transaction is independent of the other. GST, hence, has this peculiar feature
of permitting transactions of a tax period to cross over to other tax periods
and even financial years. Reporting of transactions in subsequent periods is
not fatal to taxation as each transaction is independent and does not impact
the overall taxability.

C)  DEDUCTIONS / BENEFITS

Income tax law is required to grant
deduction of expenses or costs as a matter of statutory limits and
Constitutional mandate. This is because the entry for taxation in terms of
Entry 82 is with reference to income and not receipts (for example, income by
way of diversion of overriding title would not be income in its true sense
though it may be received by the taxpayer). Section 28 levies a tax on the
‘profit and gains’ from business, section 45 taxes capital ‘gains’, etc.; no
doubt, the Legislature exercised its liberty in denying certain deductions
(penal expenses) and limiting the quantum of deductions (30% deduction in case
of house property income), but the law is drafted to ascertain the income and
not the gross receipts of a taxpayer. As a consequence, it may not be illegal
for assessing officers to grant deduction of expenses from the records
available even if the same were not availed by the taxpayer.

GST also grants a deduction in the
form of input tax credit – this benefit does not emerge from the Constitution
but from the underlying principle of value-added taxation and statutory
provisions made therefrom. The Legislature has a wider latitude insofar as
barring input tax credit on certain inputs (such as motor vehicle, building /
civil structures, etc.) as part of Legislative liberty and one cannot question
this discretion. A theoretical understanding of the statute may also suggest
that the Legislature may have the discretion to deny all input tax credit if it
decides to do so as a matter of policy. Given this, it may not be imperative
for the assessing authority to grant input tax credit if such a claim has not
been put forward. The statute believes that unavailed input tax credit
represents a tax burden passed on to the next person in the value-chain and
hence there is no obligation to grant input tax credit suo motu while
performing an assessment.

As regards the scope of deductions,
both these laws seem to have reconciled on the principle of business purpose.
Income tax permits deductions of business expenses while calculating profits
and gains from business or profession. Apart from specific deductions, there is
also a residuary category for claiming deduction of business expenses u/s 37. GST
has also followed a similar path and granted benefit of input tax credit on
most business inputs / expenses. Both the Income tax deduction and GST credit
are fettered with respective ancillary conditions, but these laws seem to have
aligned themselves as a matter of principle. Therefore, a disallowance u/s 37
on personal expenses may also result in a corresponding disallowance of input
tax credit and vice versa. On the capital assets front, while Income tax
grants depreciation on ownership and use of assets, GST does not concern itself
with ownership of assets and mere business use would be sufficient for claim of
input tax credit.

D)  PROCEDURES

Under Income tax the law prevailing
as on the first day of an assessment year would be the relevant law for taxability,
but in the case of GST the law prevailing as on the date of the transaction
would be the basis of chargeability.

Income tax has adopted a concept of
self-assessment on an annual basis. Being a Central legislation, state-level
reporting is not relevant and entity-level compliance has to be performed. GST
has adopted a monthly assessment methodology with registration-level compliance
for each State, respectively. This makes GST data much more granular in
comparison to the Income tax data collation.

On the assessment front, Income tax
has a tested system of summary assessment, scrutiny assessment, best judgement
assessment, reassessment, review, etc. A taxpayer can be assessed multiple
times for the same assessment year. GST has adopted a hybrid system of
adjudication and assessment (borrowed partially from Excise and VAT laws).
Unlike Income tax where the assessment involves both fact-finding and
adjudication of law, GST has kept the fact-finding exercise under audit
procedures which is independent of legal adjudication (show cause proceedings)
and probably performed by different officers.

CONCLUSION