Decoding GST – GST – First Principles on Reverse Charge Mechanism

Introduction

Goods and Services Tax (“GST”), being an indirect tax levy, places the
incidence of the tax on the supplier (i.e. seller/ service provider).  The supplier being the taxable person under
the law is required to discharge the tax liability on the transaction of
supply.  Although GST is said to be a
consumption tax, legislatures the world over choose to collect the tax from the
suppliers rather than the consumers, with an authority to the supplier to
collect the tax in turn from the consumer. 
In the entire scheme, the supplier/ taxable person acts as a tax
collecting agency and deposits the taxes into the Government exchequer after
charging it from recipient/consumer under a contractual arrangement. 

This practice has been
largely imbibed into the Indian GST system. 
However, the legislature has in special cases shifted the burden of
discharging the tax from the supplier to the recipient, commonly known as a
‘reverse charge mechanism’ (RCM).  Under
this mechanism, the legislature places the incidence directly on the recipient
of the supply and in some sense, by-passes the tax collecting agency principle
by opting to collect its taxes directly from the recipient. These are cases
where the scale of administrative convenience tilts towards the recipient
rather than the supplier  (such as
transporters of unorganised sector, small traders/service providers below the
turnover threshold, suppliers located outside India in cross border
transactions, etc.). This system existed even under the erstwhile VAT
regime in the form of purchase tax/URD tax and also in the service tax regime
in the form of full/partial reverse charge tax. 

RCM Mechanism

The RCM mechanism under GST law
can be placed in two broad baskets:

A)Notified transactions [section  9(3)]:

     The
respective Governments under the CGST/SGST law have notified certain
goods/service transactions and the corresponding suppliers/recipients that are
covered under RCM.

     Notification
4/2017-CT (Rate) dated 28.06.2017 provides for reverse charge mechanism in case
of procurement of certain goods. The notification covers specified procurement
of goods like cashew nuts, bidi/tobacco leaves from agriculturists, silk yarn
from manufacturer and lottery tickets from the Government/local authority.

     On a perusal of the above notification, it
can be observed that the reverse charge mechanism is triggered only on the
first point of the supply chain. For example, cashew nuts supplied by an
agriculturist will attract reverse charge. However, subsequent transactions will
not be governed by reverse charge but by normal provisions of the law.

     Similarly,
Notification 13/2017-CT (Rate) provides for reverse charge mechanism in case of
procurement of certain intrastate supply of services whereas Notification
10/2017-IT (Rate) provides for reverse charge mechanism in case of certain
inter-state supply of services. The following table summarises the provisions
in this regard:

B) URD transactions [section 9(4)]:

     The legislature has mandated RCM mechanism
also on transactions where the supplier is an unregistered person (URD).   On a plain reading of the provisions of
section 9(4), it is evident that the cumulative conditions for trigger of this
provision are as follows: (i) supplier is unregistered; (ii) recipient is
registered; (iii) supply is taxable. 
Accordingly, the applicability of RCM on URD activities can be tabulated
as follows:

Applicability of registration 
under rcm transactions

The primary question that
arises is whether RCM provisions by itself trigger a registration requirement
under the GST law. This has to be answered by examining RCM baskets
individually. As regards the notified transactions, the provisions apply to the
‘recipient’ in contradistinction to ‘registered person’. It implies that any
recipient whether registered or not is obligated to comply with the RCM
provisions.  Therefore, in case an
unregistered recipient avails any of the specified services attracting RCM (like
legal services from an advocate), the said recipient would have to necessarily
seek registered (if not already registered) and comply with the RCM
provisions.  The provisions of section 24
of the GST law give effect to the registration requirement on the recipient in
this case.  Respite has been provided
under the corresponding notification where the specified recipients for this
RCM category are either body corporates/ business entity, etc.  The notification therefore consciously
excludes individual consumers or unregistered persons (not engaged in any
business activity) from the rigours of RCM. For example, a citizen seeking the
services of a lawyer would not be subject to RCM and the registration
requirements.

As regards URD transactions, the provisions specify that the recipient
should be a registered person under the GST law, implying that persons who are
not registered may not be subject to RCM provisions.  A contradictory view can come up in view of
the non-obstante provisions of section 24(iii) which makes persons
liable for registration if they are covered by reverse charge provisions.  This can be countered by contending that said
section 24 is non-obstante only with reference to the threshold limit
(of Rs. 20 lakh) and places a registration requirement on business entities
under RCM where they are otherwise engaged in taxable supply but operating at
lower turnover levels.  Further, unlike
the definition of taxable person which includes person ‘liable to be
registered’, the URD provisions restricts its scope only to ‘registered
persons’.  Importantly, the said section
does not override section 23 of the law which specifically waives any
registration requirement in case of a person not liable to tax or engaged in
wholly exempted goods/ services. The law cannot be interpreted to give a
benefit on one hand and take away the benefit by the other hand.  Therefore, in the view of the author, URD
transactions cannot by itself trigger a registration requirement.  The URD transactions will trigger registration
only where the supplier is in business activity and making a taxable supply but
operating below the minimum turnover threshold.   As an example, an agriculturist appointing
contract labour for the tilling of the land under his supervision cannot be expected
to discharge RCM and/ or seek registration under the provisions of section 24
merely on account of section 9(4) of GST law, when he has been specifically
excluded from registration u/s. 23 of the said law. Similarly, a retailer
operating at turnover levels below 20 lakh would also not be required to seek
the registration under RCM in case of a liability u/s. 9(4) of the GST law.
However, if the retailer is already registered under GST (either under normal
or composition option), all procurements from URD will become liable for RCM.

Treatment of rcm transactions

The RCM provisions fixes the specified recipient as the person liable to
pay tax and seeks compliance of all the provisions of the GST law on the
transaction of supply.  As a consequence,
all aspects of a transaction (listed below) have to be determined by the
recipient by placing himself into the shoes of the supplier.  This would result in many challenges at the
recipient’s end. 

Nature of Supply 

A recipient would be
required to ascertain whether supply being made by the notified supplier or
unregistered supplier is in the nature of a composite supply or a mixed
supply.  A simple example may be whether
a company providing end-to-end logistic solutions with or without warehousing
solutions under a single work order qualifies as a ‘goods transport agency’
service.  A recipient cannot merely rely
upon the classification of the supplier as either a GTA or a logistic service
provider.  The recipient would have to
resort to the concept of composite supply or mixed supply and ascertain
whether the RCM provisions apply itself. 
If and only if the supply is a composite supply with the principal
supply being categorised as a GTA service would the RCM provisions be
applicable.

Place of
Supply 

The qualifying recipient is
also required to ascertain the place of supply in determining the nature of tax
payable under the RCM scheme i.e. identify the location of the supplier and
also the place of supply and discharge the respective tax.  RCM may be a local supply or an inter-state
supply depending upon the said parameters. 
This would create anomalies as cited in an example – say a company
registered in State A books a hotel in state B for the stay of its sales employees
which has a declared tariff of more than Rs. 1,000 but is unregistered in
GST.  Going by Place of supply rules, the
supplier (i.e. hotel) and the place of supply (immovable property) are in State
B and it amounts to a local supply in State B. 
Now the company is unregistered insofar as State B is concerned. Going
by the view taken on registration above, the company does not come within the
ambit of section 9(4) of the GST law and the company should not be asked to
register as a non-resident taxable person in State B merely on account of the
RCM provisions.

An issue also arises in
case of inter-state supplies by an unregistered person, say a job worker.  In case the said company send goods to an
unregistered job worker in State C for a job work and receive a job work bill
for the services rendered.  Under the
Place of supply rules, the transaction amounts to an inter-state supply and
provisions of section 5(4) of the IGST law require the recipient to pay tax
under RCM provisions.  However, if one
views section 24 of the CGST law, every person making an inter-state supply is
required to seek registration irrespective of the turnover threshold.  Section 122(3) and 132(i) of the GST law
treats a person receiving services in violation of the GST law as an offender
and imposes a penalty/ imprisonment on such person for such offences.  This seems contradictory since the law
recognises inter-state supplies by unregistered persons but on the other hand
treats inter-state supplies by an unregistered person as a violation of section
24 of the GST law. Until the law is settled on this issue, it may be
challenging to engage in inter-state transactions with URDs.

Rate of Tax/ HSN/ SAC 

GST law expects that a
recipient of supply determines the rate of tax on each supply of goods/
services made from URDs and discharge the applicable rate of tax as if the
recipient is the supplier of goods.  This
is going to place a herculean task on companies to fix the HSN on innumerable
items purchased.  For example, a company
purchasing stationery/groceries from local vendors which are unregistered would
be required to undertake a HSN classification of every item purchased and
discharge the applicable rate of tax. 
This would be a highly onerous obligation on the recipient to comply
with. 

Time of Supply 

In case of supply of goods, the time of supply would be earliest of the
receipt of goods or payment or thirty days from the date of issue of the
supplier’s document.  Similarly in case
of supply of services, the time of supply would be earliest of the payment or
sixty days from the date of issue of the supplier’s document.  The recipient is required to ensure that the
relevant documents are issued by the notified supplier/ unregistered supplier
in order to meet the tax liability requirements within the specified timelimits.

Invoicing and Reporting requirements 

The recipient covered under RCM is required to raise a self-purchase
invoice on the date of receipt of the goods or services or both. The law also
requires the RCM recipient to raise a payment voucher at the time of making
paying to the specified supplier.  The
format and contents of the invoice include, inter-alia, HSN, description
of goods/ services, quantity, etc. 
The proviso to the said rule permits raising a consolidated monthly
invoice for URD transactions under the RCM scheme.  The said invoices are required to be reported
in Part-3 of GSTR-2 and eligible for credit in the same month if the goods/
services have been  received and other
ITC conditions have been complied with. 

specific transactions

RCM mechanism poses significant hurdles in specific transactions which
have been discussed below:

Employee reimbursements 

Employees incur various
expenses during the course of their official duties (such as travel, local
conveyance, food, etc.) and claim reimbursements from the Company for
such expenses. The key challenge which arises is whether such reimbursements
are subject to RCM under the provisions of section 9(3) or 9(4) of the GST
law.  A simple example could be where an
employee avails the facility of an Air-Conditioned Bus travel for official
purposes and claims a reimbursement from the Company.  In this transaction, it is important to
understand whether there are two supplies (ie., between the transporter to the
employee and then from the employee to the Company or just one supply directly
between the Transporter and the Company). 
Another viewpoint could be whether the transportation service ends at
the level of employee or does it percolate through the employee and end at the
Company level.  It is a well-accepted
fact that in these transactions, the privity of contract is usually between
Transporter and the employee and the company merely reimburses the travel costs
at a subsequent stage. Going by a strict reading definition of ‘recipient’, the
person liable for payment of consideration in such a transaction is the
employee and it is the employee to whom the service is rendered.  In such transactions, the company cannot be
strictly termed as a ‘recipient’ (liable for payment for consideration) of the
supply and one may be tempted to conclude that supply ends with the
employee.  The immediate next question
would be to identify whether the transaction between the employee and the
company is a supply of goods/ services in terms of section 7 of the GST
law.  While this point appears prima-facie
taxable as a supply of service, one should also note that the said supply
(whether in terms of section 7(1)(a) or 7(1)(d) r/w entry 2 of Schedule I)
should be in the course or furtherance of business of the supplier
concerned.  Evidently, the employees
cannot be considered to be engaged in any trade, commerce, etc while recovering
the reimbursement from the company. 
Hence, the said transaction cannot be termed as a supply of either
goods/services by the employee to the Company. Another contention on
non-taxability of the transaction under RCM would be based on Entry 1 of
Schedule III of the said law which excludes any service by an employee to the
employer ‘in the course or in relation to’ employment as neither supply of
goods/ services under the GST law.

It would also be pertinent to state that the scenario changes
entirely if the supply is contractually agreed between the Company and the
supplier but the payment takes place by the employee and reimbursed by the Company
(say hotel bookings made by the company but settled partially/wholly by the
employee).  In such a scenario, the
company would be party to the contract of service but the consideration for the
service is being routed through the employee on account of administrative
convenience.  While there is only one
single supply from the supplier directly to the company, the rendition of
service may be to the employee concerned. 
In such cases, the Company being the recipient would be obligated to
comply with the RCM provision on such transactions.

Accordingly, it is
important in such transaction to identify the ‘contractual flow’ as well as the
‘actual flow’ of the transaction. In case of transactions bearing a
consideration, the contractual flow rather than the actual flow of supply
assumes significance. Principles can also be drawn from the Australian GSTR
ruling (GSTR 2006/9) which cites the example of a therapist and the above two
variants to explain the taxability of the transactions by employees:

“……………… Example 5:
occupational therapist

161. A, an occupational
therapist, is engaged by B, a company, to assess the needs of C, its employee.
C suffers from multiple sclerosis and needs to use a wheelchair. A and B enter
into an agreement which requires A to undertake an assessment of C’s condition,
to give recommendations in a report to B and for B to pay for the service.

162. A’s supply of services is made to B. Although C may benefit from
these services, it is B who contracts for the supply of these services and is
the recipient of the supply.

163. This supply is not
GST-free under subsection 38-10(1). This is because paragraph 38-10(1)(c)
requires the supply to be generally accepted in the relevant profession as
being necessary for the appropriate treatment of the recipient of the supply. B
is the recipient of the supply. The supply is not for the treatment of B.
Paragraph 38-10(1)(c) is not satisfied.51F

164. If C engages the
occupational therapist to supply its services and B merely pays the therapist
on behalf of C, the recipient of the occupational therapist’s services is C.
This supply will be GST-free if all of the requirements of subsection 38-10(1) are satisfied.

The above ruling places
significance on identification of the contractual flow of the transaction
rather than the actual flow of consumption and directs that the law should
follow the contracting parties rather than the parties who actually pay for the
transaction or bear the cost of the transaction.   

Custom house/Clearing house
agents (CHAs)

CHAs typically incur significant charges on behalf of the
importer of goods in order to render their services of custom clearance since
it engages with multiple agencies on behalf of the importer. Some of the many
line items which the CHAs recover (with or without a visible margin) are (a)
custom duty and statutory levies, (b) port charges, (c) delivery order charges,
(d) demurrage charges, (e) liner charges, (f) inland freight, etc. While
the statutory levies qualify as pure agent items and are excluded from the
valuation mechanisms, other recoveries by a CHA which purport to be
reimbursements may not be in-fact be reimbursements and amount to a taxable
supply at the supplier’s end. Where the CHA is a registered person, the
obligation to ascertain the appropriate value would vest on the CHA himself.
However, once the CHA is a URD, it gives rise to significant challenges to the
recipient for identification of the taxable line items and exclusions without
having any knowledge of the trade practices prevalent therein. As an example,
liner reimbursements though corroborated with liner documents have an element
of incentive camouflaged therein which is not disclosed to the importer. The
importer would be of the view that such payments would be reimbursements when
in fact they are not reimbursements but also contain an incentive to the CHA
which is includible in the transaction value in terms of section 15 of the GST
law.  It is impossible for the recipient
to ascertain this incentive and determine the appropriate value on which RCM
would be leviable.

Job workers 

Job workers of the textile
and jewellery industry are in the unorganised trade.  A job worker in the jewellery trade is
compensated in terms of the difference in net weight of the precious metal
jewellery before and after the job work. The jeweller orders the manufacture of
jewellery of a particular net weight to the job worker and performs a reverse
calculation of the gross weight required for the said activity. The
differential takes into consideration the wastage and also compensates the job
worker for the services rendered. However, this is not documented in such a
trade and the recipient will not have any document to evidence recoveries of
precious metal by the job worker, in order to discharge the RCM liability.

Notification No.
8/2017-Central Tax (Rate) – De Minimus Exemption

The Central Government and
corresponding State Governments have issued a notification exempting the
applicability of RCM on transactions below five thousand in aggregate in one
day. The said notification categorically states that the limit of five thousand
should be aggregated by each recipient from all the unregistered suppliers on a
daily basis.  Where the aggregate value crosses
the threshold, the entire transaction would be subject to RCM. The said
exemption applies only to intra-state supplies and such a notification under
the IGST law is absent. The said exemption would apply registration-wise and
not entity-wise. 

The law also does not
permit the recipient to assess the threshold based on the statement of accounts
or the recording of ledger entries in its books of accounts.  The law expects that each service is
individually identified with reference to its date of ‘receipt of such service’
and its ‘value’ and only then the said limit be tested at the recipient’s end.
This not only makes it administratively inconvenient but also practically
unviable for any entity to implement with accuracy. 

It should also be noted
that the following transactions would be excluded from the ambit of the
calculation of Rs. 5000/ day – non-taxable supplies, exempt supplies, RCM
supplies covered u/s. 9(3), pure agent reimbursements (say RoC fees), supplies
of the same registrant but received/ consumed (place of supply) in a non-resident
state.

Conclusion