GST – First Principles On Valuation (Part-1)

One of the
important aspects of taxation is the determination of the value on which tax is
sought to be computed and collected.  The
Goods & Service Tax law has been designed on value addition principle and
has adopted the ‘transaction value’ approach for defining the tax base.  In view of the number of concepts in
valuation, the article has been split into two parts – this article captures
the basic concepts and issues in valuation and the next article would capture specific
instances of valuation. 

 A)  Gist
of the Valuation provisions

The scheme of valuation hovers around
‘transaction value’. Section 15 of the Central/ State GST law contain the
valuation provisions and the scenarios where an adjustment should be made to
arrive at the taxable value.  The entire
scheme of valuation can be depicted by way of a flow chart as under:

B) 
Analysis of Valuation Provisions

 a)  Meaning of the term
‘Transaction Value’

Section 15 states that the taxable value
would be the transaction value of supply i.e. ‘price paid or payable’ for the
supply of goods or services.  Though the
term ‘price’ is not defined in the GST law, the Sale of Goods Act, 1930 defines
price to mean ‘money consideration’.  It
is the price which is contractually agreed between the parties to the
supply.  The phrase ‘paid or payable’
implies that the consideration would include all sums which have accrued to the
supplier, irrespective of its actual payment. 
As per Customs Interpretative notes to the Customs Valuation Rules, the
said phrase refers to total payment made by the buyer to or for the
benefit of the seller.  Payment need not
always involve transfer of money and would include payments through letter of
credits, negotiable instruments, settlement of debt, etc. 

 b)  Consideration – Nexus
Theory

The term consideration has been defined in
section 2(31) of the CGST/ SGST law to refer to any payment (monetary or
non-monetary) or monetary value of an act or forbearance, ‘in respect of’
or ‘in response to’ or ‘for inducement of ’ the supply of goods
or services.  It refers to the
counter-promise received in response to the supply and it is immaterial whether
such counter-promise is in monetary or non-monetary form. 

On a reading of the definition of
consideration, it can be inferred that a nexus between the payment and the
supply is essential to term it as consideration.  The italicised phrases indicates this
requirement.  In view of the clear
definition of ‘consideration’, it can be contended that the decision of the
Hon’ble Supreme Court in CCE, Mumbai vs. Fiat India Pvt. Ltd.
would no longer apply¹. Therefore, where prices are subsidised or
set below the cost (such as market penetration sales), it would still be termed
as sole consideration, unless the supplier has received any other direct
benefit for the said supply. 

Activities
undertaken by the buyer on his own account are not to be considered as indirect
payments to the seller, even-though that might be regarded as resulting in a
benefit to the seller.  As an example,
advertisement expenses incurred to advertise aerated products (finished goods)
manufactured by a third party bottler were held to be excludible from
assessable value of concentrates (which are raw materials) manufactured and
sold under an agreement with the bottlers (CCE, Mumbai v. Parle
International Ltd.²). These costs are incurred by the
concentrate manufacturer on his own account and not as an indirect payment to
the bottler of goods. 

  1 2012 (283) E.L.T. 161 (S.C.) – The Court had
interpreted the term ‘consideration’ to include market considerations/ factors
which influence price, such as reduction of price for market penetration.
Accordingly, it held that price was not the sole consideration as market
penetration was an additional consideration for deciding the price.

 c)  Price to be sole consideration

According to Black laws dictionary, ‘sole’
refers to single, individual, separate as opposite to joint.  By sole, the legislature requires that price
should be the lone consideration for it to be accepted as the transaction
value. It should not be adversely affected by any supplementary or ancillary
transaction.  As per Customs
Interpretative Notes, price would not be regarded as being the sole
consideration, where the seller establishes or places a restriction on the
buyer that sale of goods is conditional to purchase of other goods, and
therefore, reference to valuation rules may be warranted. Further, if money
consideration is affected by any other non-monetary payment or any act or
forbearance, then price  is not
considered as a sole consideration and reference should be made to the
valuation rules.

Where price is not the sole consideration
(in case of a non-monetary component in the transaction) or where price is not
determinable, Rule 27 is to be invoked. 
A sort of an hierarchial valuation structure has been provided where
subsequent clauses would apply only if the preceding rule fails to provide
reliable basis of valuation: 

Once a comparable transaction is identified,
certain adjustments may be required to bring parity for ascertainment of value,
such as:

 –   Difference
in commercial level of supply

– Difference
in commercial terms (such as freight, insurance, warranty, etc.)

–  Difference
in product characteristics (additional features, add-ons, etc.)

In the above flow chart, Open market value
(OMV) would refer to ‘full money value’ of the goods/services supplied at the
same time when the supply being valued is made. 
Comparable value (CV) would refer to value of goods or services of like
kind and quality under similar commercial terms. Substantial resemblance to the
subject supply would suffice while determining comparable value. It may be
worth appreciating that the law has made a subtle difference between OMV and
the Comparable Value.  This can be
tabulated as follows:

 d)  Transaction to be between
unrelated parties

Price would be adopted as the transaction
value only if the supply is between unrelated parties.  Explanation to the said section deems, inter-alia,
the following persons as related parties:

a.     Persons are officers or
directors in one another’s business

b.     Persons are legally
recognised partners – say joint venture partners

c.     Employer and their
employees

d.     One of the parties
directly or indirectly controls the other or they are controlled by a third
person or they together control a third person

e.     Members of same family

f.     Sole agent or
distributor or concessionaire would be deemed to be related.

The said definition has been borrowed from
the Customs Valuation rules.  In cases
where the transaction is between related parties, Rule 28 requires the assesse
to follow the similar pattern as applicable in Rule 27 (above).  By way of a second proviso, a concession is
provided by way of an assurance of acceptance of invoice value in cases where
the recipient of such supply is eligible for full input tax credit.  It may be interesting to note that the
proviso does not explicitly state whether the full input credit should be
examined at the entity level or at the invoice level eg. A sells to its related
entity B certain goods.  B is entitled to
full input tax credit at the invoice level (T4 bucket of Rule 42) but avails
proportionate credit at the entity level. 
A view can be taken that the test of full input tax credit should be
examined at the invoice level and not at the assesse level.  Simply put, if the recipient is able to justify
that the credit is exclusively for taxable supplies i.e. (for inputs or input
services), then valuation in related party transactions cannot be questioned.
This is purely on the rationale that any under-valuation would be revenue
neutral since the output tax at the supplier’s end would become the input tax
credit at the recipient’s end. 

 e)  Principal-Agent Transaction
for supply of Goods (Rule 29)

Transaction of supply of goods, inter-se,
between the principal and agents have been deemed as supply transactions in
terms of entry 3 of Schedule I of the CGST/ SGST law.  The valuation rules would be invoked in the
absence of a ‘price’ between the principal and agent.  Rule 29 provides for an option of adopting
the OMV or 90% of the re-sale price of the goods by the supplier. 

 f)   Common provisions for Rule
27, 28 & 29 (Rule 30 & 31)

The valuation rules also provide a last
resort (in cases where value is in indeterminable under the preceding rules)
under Rule 30.  The said rule prescribes
that cost of ‘production/manufacture’ or cost of ‘acquisition’ or cost of
‘provision of services’ with 10% mark-up can be adopted as the transaction
value. The rules do not provide for a mechanism to determine such costs.  In such cases, it may be advisable to apply
the generally accepted accounting/costing standards³. An indicative
matrix of costs which may be generally included or excluded has been provided
below:

 Rule 31, as residuary rule provides that
valuation should be made keeping in line with the valuation principles outlined
in the preceding rules. The purpose of Rule 31 is to ease the valuation
mechanism in the case of failure of the preceding rules to arrive at a
value.  It must be appreciated that this
rule is not a ‘best judgement assessment’ as it would still require the person
invoking the valuation to establish failure of preceding methodologies and also
give a justifiable basis of valuation. 
To cite an example, in case of renting of an immovable property between
related parties (say recipient is unable to avail entire credit), earlier
mechanisms may not in some circumstances be suitable to arrive at the
appropriate value.  It may be possible
for an assessee or the tax officer to use the discounting model or the IRR
model and arrive at the fair lease rental for the subject immovable
property.  Similarly, in case of supply
of intangibles, it is challenging to identify the OMV/CV or even the cost of
such intangible. The intangibles may have been developed over a fairly long
period of time (including several failures) which would not be clearly
ascertainable.  In such cases, a
discounted free cash flow method from an independent valuer may form a suitable
basis under this Rule. ____________________________________________________________

 3 Cost Accounting Standards Issued by Cost Accounting Standards Board (CASB) may form a reliable basis

4 Including cost of consumables

 C)      Table
comparing the erstwhile valuation schemes

A comparative tabulation of the broad
features of erstwhile law would assist in appreciating the essence of the
valuation scheme:

 As evident from the table above, the scheme
of valuation under the GST law is a concoction of the valuation scheme under
the erstwhile laws. The settled principles in earlier laws may not have a
direct application to the GST law, yet a possible conclusion/inference can be
drawn from those decisions. Though there is an excise/customs hue to the
current valuation scheme, the term Supply is more akin to the term
sale/service, both being based on a contractual arrangement.

Therefore, the basic tenet of valuation
under GST should ideally follow the sales tax law principle rather than
excise/customs valuation principles. It may be worthwhile to study the
important principles under the earlier law in this context and appreciate the
difference in approach under the said laws.

 Sales Tax Law

In the famous
case of State of Rajasthan vs. Rajasthan Chemists Association⁵,
the Hon’ble Supreme Court struck down the attempt of the Legislature to tax a
sale transaction on the basis of the MRP of the product. But importantly, it
stated that unlike in Excise where the duty is on the goods itself, the levy of
sales tax is on the activity of sale rather than the goods itself. Therefore,
the attempt of the Legislature to adopt a measure of tax on the value of goods
at a point distinct from its taxable event is unconstitutional. The legislature
cannot attempt to tax a ‘likely price’ in a contract of sale since what can
only be taxed is a completed sale transaction and not an agreement of
sale.

5   (2006)
147 STC 542 (SC)

 Service Tax Law

 In the context of service tax, the Delhi
High Court in Intercontinental Consultants and Technocrats Pvt. Ltd. vs. UOI
(2013) 29 STR 9 (Del) stated that the valuation should be in consonance
with the charging provision under the Finance Act, 1994. Since the charging
section levied a tax on service, nothing else apart from the consideration for
the service can be included in arriving at the value of a service. On this
basis, the Court struck down a valuation rule which exceeded the scope of the
charging section of the Service tax law. 
In a slightly different context, the Delhi High Court in G.D.
Builders vs. Union of India 2013 (32) S.T.R. 673 (Del.) also stated that
the value of a service should be restricted only to the service component in
the transaction, implying that the valuation scheme is limited by the scope of
the charging provisions.

Excise Law

The excise law has had significant amount of
litigation over the valuation of goods manufactured and removed from the
factory premises of a manufacturer. The excise law has progressively evolved
from a wholesale price approach to a normal price approach and then to a
transaction value approach w.e.f 01. 07. 2000. Though the Central Excise scheme
focused on determining duty on manufacture of goods, the valuation provisions
were linked to the price paid or payable (i.e. including post manufacturing
costs and profits) with adjustments where price was not a reliable basis of
valuation. On a challenge over inclusion of post manufacturing costs/profits,
the Hon’ble Supreme Court in Union of India vs. Bombay Tyres International
case (1983) ELT 1896 (SC), made a clear distinction between the subject
matter of tax and the measure of tax and held that the Legislature had the
flexibility to fix the measure of tax different from the subject matter of
taxation so long as the character of impost is not lost.  Courts have concluded that while the levy of
excise duty was on the manufacture or production of goods, the stage of
collection need not in point of time synchronise with the completion of the
manufacturing process; the levy had the status of a constitutional concept, the
point of collection was located where the statute declared it would be.  This issue is again under consideration
before a larger Bench of the Hon’ble Supreme Court in the case of CCE,
Indore vs. Grasim Industries⁶  in view of a difference in opinion by the
coordinate three judge bench in Commissioner of Central Excise vs. Acer Ltd.⁶.  Be that as it may, the basis of levy of duty
under excise law is clearly distinct from that of the GST law and therefore,
excise law principles should not be directly applied while interpreting the
valuation scheme under the GST law.

GST Law

In GST, the term ‘supply’ is a contractual
term.  It comes into existence only under
an obligation of a contract.  The list of
transactions cited as examples in section 7 (sale, exchange, barter, lease,
license, etc.) arise out of contractual obligations. In line with the
sales tax law, it is very well possible to contend that the taxable event of
supply should also be understood in the context of the obligations agreed
between parties under a contract. 
Consequently, valuation should also be undertaken with due consideration
to the obligations between the contracting parties for the supply. Therefore,
where there was no supply intended between the contracting parties, say FOC
materials, its value cannot be included in the transaction value. This
principle may have implications in various scenarios which have been discussed
later. 

Valuation principle – Conceptual aspects

D)   Key
principles emerging from a reading of valuation provisions

 Conceptual aspects

The following conceptual points may be
applied while addressing a point on valuation in GST:

i. Taxable value is a
function of the contracted price. 
Intrinsic value/fair value/market value of goods or services are not
relevant except in specific circumstances.

______________________________________________________________________

6 in Civil Appeal No. 3159 of 2004 & (2004) 8 SCC 173

ii.  Price implies monetary
consideration agreed for the subject supply.

iii.  Valuation of a supply
would succeed its categorisation – into ‘composite or mixed supply’
basket. 

iv. Valuation provisions are an
amalgam of erstwhile laws including the Customs law.

v.  Receipt of
price/consideration could be from any third party and not necessarily by the
recipient.

vi. Each supply transaction is
distinct and independent from the previous transactions and price of one
transaction cannot generally have a bearing on another transaction.

vii. Transaction value is not
with reference to any particular time or place – a distinguishing feature in
comparison to the erstwhile Excise law or Customs Law. 

viii.  Every ‘gross amount
charged’ (like service tax) is not the transaction value – there should be some
nexus between the amount charged and supply of goods/services.

 Other Procedural aspects

i. Valuation Rules would
trigger only under specific scenarios – in all other cases, price should be
accepted as transaction value – Onus is on the revenue to establish that the
pre-requisites of invoking the valuation rules have been satisfied.  Valuation guidelines have to be followed
necessarily and best judgement assessments are not permissible.

ii.  Valuation rules attempt to
identify undervaluation of transaction. While valuation rules do not
specifically prohibit questioning over-valuation, the consequential legal
implications of over-valuation in terms of adjudication/recovery etc. do
not capture cases, such as excess payment of output taxes, etc.

iii.  Any upward or downward
revision in price or value should be undertaken by issuance of a debit or a
credit note by the supplier of the goods or services only. Downward revision in
price is different from non-recovery of consideration (such as bad debts).  Bad debts are not deductible from taxable or
already taxed value, though non recovery on account of there being no supply of
goods or services or on account of deficient supply are deductible by way of
credit notes.

iv. Valuation rules are not
mutually exclusive. Eg. in case of second hand goods between related parties
operating under the margin scheme, valuation officer can invoke the valuation
rules to recalculate the sale price for arriving at the appropriate gross
margin.

 E)      Specific
issues in Valuation

 Ex-works/
FOB/CIF basis of pricing and delivery

The erstwhile sales tax and excise law were
flooded with disputes over valuation especially in the context of inclusion of
freight, insurance and other costs in the taxable value. The pricing and terms
of delivery in the transaction were critical in deciding the issue on
valuation.  Under sales tax law, ex-works
sales indicated exclusion of post-sale freight and insurance charges. Under the
excise law, ex-works delivery terms indicated exclusion of all costs recovered
after removal of goods from the factory gate. 

In the context of GST, the price agreed
between parties is considered as the taxable value of the supply. Sub clause
(c) to section 15(2) specifically includes an incidental expense charged by the
supplier for anything done before delivery of goods to the customer. The
law has clearly shifted the goal post from the point of supply to the point of
delivery of goods. All recoveries from the customer until the supply/sale of
goods would be includible in price agreed for the goods. Additional recoveries
post sale/ supply but until delivery of goods would be includible in the
taxable value u/s. 15(2), even if the ownership or price agreed between the
parties is on ex-works or FOB basis. On application of section 15(1) and 15(2),
all pre-delivery costs charged from the customer would be includible in the
taxable value of supply. 

There are cases where the sale and delivery
by the manufacturer is ex-works/FOB, but the supplier arranges for the
transportation in pursuance of the buyer’s instructions. The supplier incurs a
‘freight advance’ and recovers the same either in the invoice our buy way of an
additional debit note. In such cases, the supplier has undertaken post-delivery
activities as a ‘pure agent’ of the buyer and hence should not form part of the
taxable value either u/s. 15(1) or 15(2) of the GST law. An alternate
contention can be placed by invoking the concept of composite supply, ie, the
arrangement of transport by the supplier is naturally bundled with the supply
of goods and hence, part of transaction value. Disputes on this front are bound
to continue unless the supplier takes a conservative view in cases where the
recipient is eligible for full input tax credit.

Discount
Policies

Like the issue over freight, the sales tax
law and excise law experience litigation over deduction of discounts.  Trade discount granted at the time of sale or
at the time of removal of goods were generally deductible under the sales
tax/excise law. The issue arose especially where discounts were granted after
sale or removal of goods. 

Under the excise law, trade discounts given
at the time of removal of goods were considered deductible, while any post
removal discounts were held to be non-deductible.  In Union of India & Ors vs. Bombay
Tyres International (P) Ltd.⁷  and subsequently in the case of Purolator
India Ltd. vs. CCE, Delhi⁷, it was held that discounts stipulated
in the agreement of sale but provided subsequently would be eligible for
deduction from the price “at the time of removal”. 

In a recent decision of the Hon’ble Supreme
court in Southern Motors vs. State of Karnataka⁸, the
Supreme Court read down a rule contained in the VAT law which required
discounts to be disclosed in the invoice for it to be eligible to claim a
deduction from the total turnover of a dealer. The Court relying upon the
decision of the Supreme Court in IFB Industries Ltd. vs. State Of Kerala and
Deputy Commissioner of Sales Tax (Law) vs. M/s. Advani Orlikon (P) Ltd.⁹  observed as follows:

 “21. This Court
referred to the definition of “sale price” in Section 2(h) of the Act and noted
that it was defined to be the amount payable to a dealer as a consideration for
the sale of any goods, less any sum allowed as cash discount, according to the
practice normally prevailing in the trade. While observing that cash discount
conceptually was distinctly different from a trade discount which was a
deduction from the catalogue price of goods allowable by whole-sellers to
retailers engaged in the trade, it was exposited that under the Central Sales
Tax Act, the sale price which enters into the computation of the turnover is
the consideration for which the goods are sold by the assessee. It was held
that in a case where trade discount was allowed on the catalogue price, the
sale price would be the amount determined after deducting the trade discount.
It was ruled that it was immaterial that the definition of “sale price” under
Section 2(h) of the Act did not expressly provide for the deduction of trade
discount from the sale price. It also held a view that having regard to the
nature of a trade discount, there is only one sale price between the dealer and
the retailer and that is the price payable by the retailer calculated as the
difference between the catalogue price and the trade discount. Significantly it
was propounded that, in such a situation, there was only one contract between
the parties that is the contract that the goods would be sold by the dealer to
the retailer at the aforesaid sale price and that there was no question of two
successive agreements between the parties, one providing for the sale of the
goods at the catalogue price and the other providing for an allowance by way of
trade discount. While recognizing that the sale price remained the stipulated
price in the contract between the parties, this Court concluded that the sale
price which enters into the computation of the assessee’s turnover for the
purpose of assessment under the Sales Tax Act would be determined after
deducting the trade discount from the catalogue price.”

7   1984
(17) E.L.T. 329 (S.C.) & 2015 (323) E.L.T. 227 (S.C.)

8   [2017]
98 VST 207 (SC)

9  
(1980) 1 SCC 360

 
 The Court also expounded the meaning of
trade discount as follows:

 “28. A trade
discount conceptually is a pre-sale concurrence, the quantification whereof
depends on many many factors in commerce regulating the scale of sale/purchase
depending, amongst others on goodwill, quality, marketable skills, discounts,
etc. contributing to the ultimate performance to qualify for such discounts.
Such trade discounts, to reiterate, have already been recognized by this Court
with the emphatic rider that the same ought not to be disallowed only as they
are not payable at the time of each invoice or deducted from the invoice
price.”

 The GST law seems to have simplified the law
to the extent that any pre-supply discount is considered as deductible provided
it is recorded in the invoice issued to the customer. The law also provides an
additional deduction in respect of post supply discounts provided two
conditions are satisfied – (a) the terms of discount is agreed before the
supply and (b) corresponding input tax credit has been reversed by the
recipient of supply. As regards the first condition, the law requires that the
principles, eligibility or formula of discount is agreed before the supply
occurs. The quantification of the discount could take place any time subsequent
to the supply by way of credit notes (of-course within the permissible time
limit). The objective is to deny benefit of discounts which are an
afterthought.  The second condition
requires that corresponding input tax credit on such discounts is reduced by
the customer. 

 Price
Support vs Discounts

Section 15(2)(e) provides that price
subsidies (i.e. directly linked to the price of a product), except those
provided by the Central/State Governments are includible in the transaction
value. ‘Subsidy’ refers to paying a part of the cost.  Subsidy could be received from any party
interested in the transaction and is not restricted to the manufacturer of
goods. Commercial trade adopts innovative formats and nomenclatures in order to
subsidise the price of their products and promote their sale. One such format
of subsidy is providing a ‘price support’ to the person stocking the goods in
order to liquidate the stocks for commercial reasons. The price support could
be in the form of monetary reimbursements by issuance of credit notes in favour
of the stockist or also in non-monetary form but it ultimately reduces the
original sale price for the stockist. In certain states like Tamil Nadu/
Karnataka, the VAT law required reversal of input tax credit where the sale
price was less than the purchase price but such a provision is absent in the
GST law.  Is this price support a subsidy
or a discount or neither of these?  The
possible differentiating factors can be tabulated below:

On the above basis, the treatment of price
support may be adopted as follows:

 a.  Where price support is
provided by the supplier (contracting parties to the supply), it should be
treated as a trade discount and treated in accordance with section 15(3).

 b.  Where price support is
provided by third parties (such as an online platform), it should be treated as
a subsidy and treated as per section 15(2)(e) and added to the sale value.

 Moulds/
Dies/ Tools, etc.

Under the excise law, products were
manufactured from moulds or dies supplied by the buyer of such goods.  Generally, the intellectual property of these
moulds and dies continued to be with the buyer of the said goods.  These moulds were usually sent on free of
cost (FOC) and returnable basis.

Resultantly, the conditions of transaction
value were not satisfied since the price of the manufactured goods was not the
sole consideration – in view of section 4(1)(a) read with Rule 6 of the Excise
Valuation Rules, such FOC items were termed as additional consideration. The
said rule contained an explanation requiring the manufacturer to amortise or
apportion the value of such moulds, etc. as additional consideration to
the transaction.

The GST law imbibes the concept of ‘price
being sole consideration’ but does not contain corresponding rules like Rule 6
of Excise Valuation rules.  Since this
rule was made in order to identify and attribute a value towards additional
consideration, a question arises regarding an attribution similar to excise.  There are arguments both for and against this
which have been tabulated below:

In the view of
the author, GST being a transaction tax rather than a duty on goods, the case
for a non attribution seems to be a stronger proposition. Reliance can be
placed on the decision of the Hon’ble Supreme Court in Moriroku UT India
(P) Ltd. vs. State of UP 2008 (224) E.L.T. 365 (S.C.), which was
rendered in the context of the sales tax law wherein the court stated that
toolings and moulds supplied by the customer to the manufacturer/seller cannot
be amortised as in the case of Excise Duty under the Central Excise Act,
1944.  A CBEC circular dt. 26^th
October, 2017 has been issued in the context of valuation of supply of paraffin
by way of extraction from Superior Kerosene Oil (SKO). The circular clarifies
that the value of supply is the quantity of paraffin retained from extraction
of SKO rather than the entire quantity of SKO sent by refinery for extraction.
This in a way resounds that valuation of supply is with reference to the
charging section and limited to price paid or payable in a supply transaction.

The subsequent article on valuation
would address specific instances where valuation under GST would pose certain
challenges and possible resolutions to such issues by taking hints from the
earlier indirect tax laws.