CLASSIFICATION CONUNDRUM

Once the determination of the nature of supply is done, the next question that arises is the rate applicable on such supply. There is a lot of confusion about the entry under which a particular goods / service should be classified in view of conflicting rates prescribed under the respective Rate Notifications, coupled with conflicting rulings by the Authority for Advance Ruling from different locations. This, despite the Rate Notifications specifically providing that rules for the interpretation as provided for under the Customs Tariff Act, 1975 shall also apply for the interpretation of headings covered under the said Notification.

In one of our earliest articles, ‘Principles of Classification’ (BCAJ, November, 2017), we had discussed in detail the subject of Classification under GST. In this article, we have attempted to identify a few instances dealing with Classification – both of a supply as goods vs. services, and the applicable rate on a supply along with conflicting AARs’ which add fire to this controversy.

GOODS VS. SERVICES – INTANGIBLES
The perennial controversy about determining what constitutes goods and what constitute services, although settled by the Supreme Court in the case of Tata Consultancy Services vs. State of Andhra Pradesh [2004 (178) ELT 22 (SC)] (the ‘TCS case’), used to be a burning issue under the earlier regime and continues to be so even under the new GST regime. This is because the definition of the said terms u/s 2 of the CGST Act, 2017. Section 2 (52) defines ‘goods’ to mean every kind of movable property other than money and securities but includes actionable claim, growing crops, grass and things attached to, or forming part of the land which are agreed to be severed before supply or under a contract of supply. Similarly, section 2(102) defines ‘services’ to mean anything other than goods, money and securities but includes activities relating to the use of money or its conversion by cash or by any other mode, from one form, currency or denomination to another form, currency or denomination for which a separate consideration is charged.

The first controversy which pertains to the issue of goods vs. services is in relation to intangibles. The issue of whether software, being an intangible property, is goods or service was already settled by the Apex Court in the TCS case wherein the Hon’ble Court had laid down the conditions for treating an intangible property as goods. Keeping that in mind, in view of the provision of Schedule II of the CGST Act, 2017, if the supply results in transfer of title in goods, the same would constitute supply of goods; while if there is transfer of right in goods without transfer of title thereof, the same would constitute supply of services. However, while dealing with this aspect another recent decision of the Supreme Court in the case of Engineering Analysis Centre of Excellence Private Limited vs. The Commissioner of Income Tax [Civil Appeal Nos. 8733-8734 of 2018], though in the context of income-tax, will always have an important bearing. In this case, the Court had held that licenses granted by way of End-User License Agreements were nothing but sale of goods. The relevant extracts of the decision are reproduced below for reference:

52. There can be no doubt as to the real nature of the transactions in the appeals before us. What is ‘licensed’ by the foreign, non-resident supplier to the distributor and resold to the resident end-user, or directly supplied to the resident end-user, is in fact the sale of a physical object which contains an embedded computer programme, and is therefore, a sale of goods which, as has been correctly pointed out by the learned counsel for the assessees, is the law declared by this Court in the context of a sales tax statute in Tata Consultancy Services vs. State of A.P., 2005 (1) SCC 308 (see paragraph 27).

In view of the above decision, an issue arises in case of import / export transactions through online mode. Such import / export transactions are not regulated through the Customs channel, and therefore, when payment is made for import of software or received for export of software, the nature of the transaction, i.e., whether the same pertains to purchase / sale of goods or service becomes particularly important. For example, if a person purchases all the rights which subsist in an intangible property / a license, the same would undoubtedly amount to supply of goods. The question that would arise in case of import of such goods is whether GST would be payable treating the same as ‘import of services’ or the same would be liable to tax under the proviso to section 5 of the IGST Act, 2017, i.e., the tax would be levied and collected under the Customs Act, 1962? If the latter view is taken, perhaps such transaction would not attract any IGST since there is no mechanism for levy of tax on intangibles under the Customs Act.

An even larger issue may crop up in the case of export transactions, especially when supply is under payment of IGST where there is a system for automated refund. Since the supply of intangibles is not routed through the customs system, the refund for such transactions may not be automatically processed and would therefore necessitate such exporters to file separate refund applications which can give rise to challenges as the Jurisdiction Officer may reject the refund claim on the simple ground that the same falls within the purview of Customs who may not at all be aware of the entire transaction.

GOODS VS. SERVICES – SALE VS. SERVICE
Entry 3 of Schedule II presumes an activity of job-work as service. While under the earlier regime job-work was defined to mean any activity amounting to manufacture, GST law defines the same to mean any treatment or process undertaken by a person on goods belonging to another registered person and the expression ‘job worker’ shall be construed accordingly. However, it would be incorrect to read this definition on a standalone basis, especially when the statute provides for concepts relating to composite supply / mixed supply which needs to be used when determining the nature of supply. Based on this, one would need to arrive at a conclusion whether a particular activity amounts to supply of goods or supply of service as job-work.

This discussion becomes important since there are specific instances where if the activity is treated as supply of goods, the same attracts tax at a different rate, while when treated as supply of service the applicable rate is different. At times where credit is not available fully, this would also involve cost ramifications. One such instance is observed in the context of newspapers. Supply of newspaper attracts nil rate of tax. However, the activity of printing of newspaper, which is classified as service, attracts tax @ 5%. Therefore, it becomes important to determine whether the supply being made is classifiable as supply of goods / services. Of course, while the answer to this question would depend on the facts of each case, the issue becomes more controversial in view of Circular 11/11/2017-GST dated 20th October, 2017 wherein the Board has clarified as under:

4. In the case of printing of books, pamphlets, brochures, annual reports and the like, where only content is supplied by the publisher or the person who owns the usage rights to the intangible inputs, while the physical inputs including paper used for printing belong to the printer, supply of printing [of the content supplied by the recipient of supply] is the principal supply and therefore such supplies would constitute supply of service falling under heading 9989 of the scheme of classification of services.
5. In case of supply of printed envelopes, letter cards, printed boxes, tissues, napkins, wall paper, etc. falling under Chapter 48 or 49, printed with design, logo etc. supplied by the recipient of goods but made using physical inputs including paper belonging to the printer, the predominant supply is that of goods and the supply of printing of the content [supplied by the recipient of supply] is ancillary to the principal supply of goods, and therefore such supplies would constitute supply of goods falling under respective headings of Chapter 48 or 49 of the Customs Tariff.

While in the first case the Board has clarified that the supply of printing service is the principal service, in the second case it has been clarified that supply of goods is the predominant supply. It is difficult to fathom how both the transactions can be dealt with differently as in both the cases the intention of the recipient is to receive back printed material from the job-worker. It is common for publishers to outsource printing activity and the dominant intention is to receive the printed content which is used by them to further supply such printed content.

In fact, this Circular also appears to be contrary to the principles of job-work which have been laid down by the Supreme Court in the case of Prestige Engineering (India) Ltd. vs. CCE Meerut [1994 (73) ELT 497 (SC)] which explained what shall and what shall not constitute job work. The primary rule laid down by the Court was that job work should not be narrowly understood as requiring the job worker to return the goods in the same form as this would render the Notification itself redundant since the definition specifically contemplated ‘a manufacturing process’, but it also cannot be so widely interpreted as to allow an arrangement where the process involved substantial value addition. It is imperative for the readers to note that the above clarification has also been followed by the Authority for Advance Ruling in the case of Sri Venkateswara Enterprises [2019 (30) GSTL 83 (AAR – GST)]. However, in another case, that of Ashok Chaturvedi [2019 (21) GSTL 211 (AAR – GST)], the Authority has held that the principal supply was that of goods and therefore the printed content would be classified under Chapter 49 and taxed accordingly.

A similar issue exists in the hospitality sector where there is confusion as to whether tobacco products such as cigarettes, hookah, etc., supplied and consumed in a restaurant shall be classified as supply of goods or supply of service as a part of restaurant services? The Advance Authority has, in the case of MFAR Hotels & Resorts Private Limited [2020 (42) GSTL 470 (AAR – GST – TN)], held that cigarettes supplied in the restaurant will be treated as supply of goods as the same is not naturally bundled with the service of the restaurant. However, it would appear that the ruling has not taken into consideration Entry 6(b) of Schedule II which deems a composite supply by way of or as part of any service or in any other manner whatsoever, of goods, being food or any other article for human consumption or any drink as supply of service. If aerated beverages, which also attract the higher rate of tax as well as compensation cess supplied in a restaurant can be treated as supply of service, there is no logical reasoning to not extend the same benefit to tobacco as the same also falls within the basket of goods supplied for human consumption, irrespective of whether or not the same is injurious to health!

RATE CLASSIFICATION – GOODS
As discussed in the earlier article also, the Rate Notifications under GST provide that the classification of any goods / services in a particular rate / exemption entry shall be done applying the rules for interpretation as provided for under the Customs Tariff Act, 1975. The said rules were discussed in detail in the said article. However, since the introduction of GST there have been several items the classification of which has continued to be under dispute. In this article, we have attempted to identify and discuss such cases.

The first class of goods which has seen substantial classification dispute is ‘tobacco’ which comes in different forms and varied rates have been notified depending on the nature of the product. The following table summarises the different rates applicable to different types of tobacco:

A particular area of dispute has been as to what constitutes tobacco leaves. The Board has, vide Circular 332/2/2017 – TRU clarified that tobacco leaves shall mean leaves of tobacco as such, broken tobacco leaves and stems. This issue has been examined in detail in the context of Central Excise. The Tribunal has, in the case of Yogesh Associates vs. CCE, Surat II [2006 (195) ELT 196 (Tri – Mum)] wherein the Tribunal held that raw leaf treated with tobacco solution Quimam and other flavours including saffron water did not result in the leaf undergoing any irreversible change and the same continued to remain raw, unmanufactured tobacco leaf. This decision was also approved by the Apex Court in 2006 (199) ELT A221 (SC). However, there have been conflicting decisions from the Authority for Advance Ruling in the context of GST w.r.t. classification of tobacco products in different forms.

In the case of Shailesh Kumar Singh [2018 (13) GSTL 373 (AAR – GST)] and Pragathi Enterprises [2018 (19) GSTL 327 (AAR – GST)]), the Authority has held that dried tobacco leaves which have undergone the process of curing are not covered under Schedule I Entry 109 but will be covered under Schedule IV Entry 13. In Sringeri Yogis Pai [2019 (31) GSTL 357 (AAR – GST)] the Authority has further held that cured tobacco leaves would also get covered under Schedule IV Entry 13.

However, in Suresh G. [2019 (023) GSTL 0483 (AAR – GST)], the Authority has held that sun-cured tobacco leaves would get covered under Schedule I and therefore attract GST at 5%. The Authority held as under:

‘6. It is well-known fact that the fresh or green leaves are having no commercial marketability. Only after the long process of curing the tobacco leaves become capable for marketing. Therefore legislature imposed tax only on cured tobacco leaves which are capable of being traded. As per serial number 13 of Schedule-IV of Notification No. 1/2017-Central Tax (Rate), dated 28-6-2017 “un-manufactured tobacco” is brought under 28% taxable category. But the entry itself clearly specified that unmanufactured tobacco, tobacco refuse (other than tobacco leaves) is taxable at the rate of 28%. Since tobacco leaves are specifically excluded from Schedule-IV Sl. No. 13 it will squarely come under Schedule-I of Sl. No. 109 and taxable at the rate of 5%. Therefore tobacco leaves including the leaves cut from plant, dry leaves, cured leaves by applying natural process ordinarily used by the farmers to make them fit to be taken to market shall qualify for 5% tax rate. It is common knowledge that without curing tobacco leaves cannot be consumed. The curing in relation to tobacco leaves means removal of moisture from the tobacco leaves. Section 2(c) of the Central Excise Act, 1944 specified that the term “curing” includes wilting, drying, fermenting and any process for rendering an unmanufactured product fit for marketing or manufacture. Hence, the unavoidable process of curing of tobacco leaves to make it fit for marketing will qualify the word “curing” mentioned in Chapter 24 of the Customs Tariff Act, 1975.’

The above view has also been followed in the case of Alliance One Industries Private Limited [2020 (32) GSTL 216 (AAR – GST – AP)] and K.S. Subbaih Pillai & Co. (India) Pvt. Ltd. [2020 (32) GSTL 196 (AAR – GST – AP)].

It is therefore clear that there is a lot of confusion with regard to the correct classification of tobacco under GST. Further, with tobacco being liable to tax under Reverse Charge also, the need for a correct solution becomes more important since if a wrong classification is applied there will be an effect on both fronts, outward supplies as well as inward supplies. It therefore becomes more important for the taxpayer to determine the correct classification of the product being dealt with by him to avoid future litigation. In other words, it would be safe to say that applying a wrong classification would not only be injurious to customers’ health, but also to the taxpayers’ health!

The next controversy revolves around classification of fryums. This is because while there is no specific entry for fryums under GST, Entry 96 of Notification 2/2017 – CT (Rate) exempts papad, by whatever name known, from GST except when served for human consumption. On the other hand, there are different entries in the Rate Notification so far as namkeen is concerned. The following table summarises the different rates applicable to namkeen in different forms:

Therefore, the questions which need deliberation are:
* Whether fryums can be treated as papad?
* If not, under which entry will fryums qualify?

The reason behind the need to determine whether fryum can be classified as papad or namkeen arises in view of the decision of the Tribunal in the case of Commissioner of Central Excise vs. TTK Pharma Ltd. [2005 (190) ELT 214 (Tri – Bang)]. The Tribunal had held that fryums can be marketed as namkeen only after they are fried, just like papad. However, the tax implication if this classification is not accepted is substantial because if fryums are classified as papad, the same are exempted from GST, while if classified as namkeen, the same would get classified under Schedule III and become liable to GST at 18%. Thus, the difference is substantial and therefore one needs to be careful while deciding the classification of fryums.

This aspect has also been dealt with by the AAR in the case of Sonal Products [2019 (23) GSTL 260 (AAR – GST)] and Alisha Foods [2020 (33) GSTL 474 (AAR – GST)]. In both instances, the Authority has held that fryums are classifiable as namkeen and not papad and therefore the same would be taxable at 18%. The Authority relied on the decision in the case of TTK Pharma Ltd. vs. Collector of Central Excise [1993 (63) ELT 446 (Tribunal)]. However, it has failed to appreciate that the Tribunal had used the word namkeen / papad interchangeably while dealing with the applicability of an exemption Notification. The Authority further referred to the decision in the case of Commissioner of Commercial Taxes, Indore vs. TTK Healthcare Ltd. [2007 (21) ELT 0197 (SC)]. However, the Authority has again failed to appreciate that the dispute in the said case was whether or not fryums could be treated as cooked food. The Authority has further concluded that the classification was to be done as per the meaning construed in the popular sense and as understood in common language.

It is important to note that the Authority has failed to appreciate that the process followed for making of papad / fryums is similar. In fact, both become ready for human consumption only when fried and when fried, both rather partake the character of namkeen. In this sense, the decision of the Authority to not treat fryums as papad appears to be on shaky ground.

The next item which has seen its fair share of controversy is parantha. Entry 97 of Notification 2/2017-CT (Rate) exempts bread (branded or otherwise) from tax, except when served for consumption, and pizza bread. Bread is something which is generally an accompaniment with the main meal of the day and is cooked in different styles using different ingredients. It is known by different names across the globe. If one does a search for ‘List of Breads’ on Wikipedia, it can be seen that even the roti, chapati, naan, kulcha, dosa, etc., which are consumed in different parts of India and known by different names are also types of bread. However, there is a separate entry for plain chapati or roti under Schedule I of Notification 2/2017-CT (Rate) and the same is taxed at 5%. But other forms of Indian bread do not find a specific entry in the Rate Notifications. This gives rise to the classification issue.

The first such issue reported was in the classification of ‘Classic Malabar parota’ or ‘Whole Wheat Malabar parotta’. The Authority for Advance Ruling has in the case of Modern Food Enterprises Private Limited [2018 (18) GSTL 837 (AAR – GST)] held that there is a substantial distinction between parotta and bread in terms of preparation, use and digestion and, therefore, exemption given to bread cannot be extended to parotta. However, in Signature International Foods India Private Limited [2019 (20) GSTL 640 (AAR – GST)], the Authority has held that paratha was similar to roti and therefore classifiable under Schedule I of Notification 1/2017-CT (Rate) and therefore attracts GST @ 5%. Surprisingly, in this case the Authority proceeded to conclude that naan / kulcha which were not defined anywhere would be classifiable under the residuary entry in Schedule III of Notification 1/2017-CT (Rate) and therefore attract GST @ 18%.

RATE CLASSIFICATION – SERVICES
Let us now look at similar issues while determining the applicable tariff entry for services. The first issue which arises is with classification of certain services provided to Government, whether Central Government, State Government, Union Territory, a local authority, a Governmental Authority or a Government Entity. The relevant entry for discussion is Entry 3(vi) of Notification 11/2017-CT (Rate) which provides for tax at 12% on composite supply of works contract as defined in clause (119) of section 2 of the Central Goods and Services Tax Act, 2017 provided to the Central Government, State Government, Union territory, a local authority or a Governmental Authority or a Government Entity by way of construction, erection, commissioning, installation, completion, fitting out, repair, maintenance, renovation, or alteration of a civil structure or any other original works meant predominantly for use other than for commerce, industry, or any other business or profession. Vide the explanation, it has also been clarified that the term ‘business’ shall not include any activity or transaction undertaken by the Central Government, State Government or any local authority in which they are engaged as public authorities.

Despite the above clarification, there has been substantial confusion as to when a service would be classified under this entry, because when services are being provided to Government it is difficult to distinguish whether the service is for use other than for commerce, industry or any other business or profession. There have been conflicting AARs on this issue as well. In A2Z Infra Engineering Ltd. [2018 (18) GSTL 760 (AAR – GST)], the Authority held that services provided to a Power Distribution Company would be covered under the scope of ‘for use other than for commerce, industry, or any other business or profession’ and therefore concessional tax rate would not be applicable in such a case. A similar view was also followed in the case of Madhya Pradesh Madhya Kshetra Vidyut Vitaran Company Limited [2019 (020) GSTL 0788 (AAR – GST)] as well. In fact, in a recent decision the Appellate AAR in the case of Vijai Electricals Ltd. [2020 (42) GSTL 153 (App. AAR)] wherein despite the appellants submitting an opinion from the Government Departments that the activities of the recipient were non-commercial in nature, the denial of benefit of concessional rate of tax was upheld.

In the case of Tata Projects Limited [2019 (24) GSTL 505 (AAR – GST)], service provided to the Nuclear Fuel Complex engaged in the manufacture and enrichment of nuclear fuel for production of electricity which is a business and commercial activity, the concessional rate of 12% will not be available.

However, the Appellate AAR has in the case of ITD Cementation India Limited [2019 (25) GSTL 315 (AAAR)] set aside the order of the AAR and held that supply of service for construction of multi-modal terminal was for infrastructural development of waterways of India and not meant for commerce and business. A similar view was taken in the case of Vikram Sarabhai Space Centre [2019 (25) GSTL 129 (AAR – GST)] also.

There are many taxpayers who are providing service of this kind to Government and in many cases the contract values are inclusive of GST. Prompt clarification on what constitutes ‘commerce, industry, business or profession’ would be most welcome as there would be severe financial consequences if the end conclusion is not beneficial to the taxpayers.

Another burning issue in the context of services provided to Government is what constitutes ‘pure services’? Entry 3 of Notification 12/2017-CGST (Rate) provides exemption to pure services (excluding works contract service or other composite supplies involving supply of any goods) provided to the Central Government, State Government or Union territory, or local authority, or a Governmental authority, or a Government Entity by way of any activity in relation to any function entrusted to a Panchayat under Article 243G of the Constitution, or in relation to any function entrusted to a Municipality under Article 243W of the Constitution. However, what constitutes ‘pure service’ has not been defined either under the Notification or the Act / Rules.

This has resulted in substantial confusion since taxpayers intend to claim the benefit of the exemption Notification while the tax authorities look at ways to deny the same. In fact, the AAR has on multiple occasions held that only such service where there is no involvement of even an incidental supply of goods would be covered within the scope of ‘pure service’. In fact, in the case of Harmilap Media (P) Limited [2020 (33) GSTL 89 (AAR – GST)], while determining whether or not advertising service would classify as pure service, the Authority held in the negative since there is an element of supply of goods involved, though not material. Fortunately, this anomaly has been sought to be removed by way of insertion of Entry 3A to the Notification which now provides that the exemption shall extend to composite services also, provided that the value of goods involved in the supply is not more than 25% of the total value. This amendment will perhaps put the dispute to rest.

The next dispute revolves around classification of services relating to transport of goods. There are two rates notified for the service of GTA, one being 5% in case the service provider opts to not claim ITC and 12% where the service provider opts to claim ITC. What constitutes ‘GTA’ has been defined to mean any person who provides service in relation to transport of goods by road and issues a consignment note, by whatever name called. The first controversy which prevails is whether for classification as a GTA is the supplier compulsorily required to issue a consignment note? A perusal of the Rate Notification does indicate towards the same. However, the Appellate AAR has in the case of K.M. Trans Logistics Private Limited [2020 (35) GSTL 346 (AAAR -– GST)] while dealing with this issue held that once the possession of goods is transferred to the transporter, irrespective of whether the consignment note is issued or not, he becomes a GTA and would therefore be liable to tax accordingly.

However, in the case of Liberty Translines [2020 (41) GSTL 657 (App. AAR – GST)], in a case involving sub-contracting in transportation business, the Authority held that issuance of a consignment note by the sub-contractor transporter to the main transporter would not make him a GTA and the service would be classified under the entry of ‘renting of vehicles’ and would therefore attract tax at 18%, irrespective of whether the main contractor opts to pay tax under the 5% scheme / 12% scheme, thus involving substantial cost implications for the main contractor. It is, however, important to note that in the case of Saravana Perumal [2020 (33) GSTL 39 (AAR – Kar)] involving a similar fact matrix, the AAR has held that the services provided by the sub-contracting transporter to the main transporter would also get classified as GTA.

CONCLUSION
The above discussion clearly indicates that the classification issue will continue even under the GST regime. Of course, the same will be on multiple fronts, ranging from classifying an activity as that of goods or service or none, and then proceeding to determine the correct tariff classification. The controversy will get more pronounced with conflicting decisions from the AAR which will only add fuel to the fire. However, the taxpayers will need to be more cautious and careful, especially where there is confusion on the classification, because incorrect classification may have serious ramifications on the business.