INTRODUCTION
The charging
section for the levy of GST is under section 9 of the CGST Act, 2017 and the
taxable event, which triggers the levy, is supply, the scope of which is
defined u/s. 7. Section 7(1)(a) thereof defines the normal scope of supply to
include transactions which are generally carried out in the normal course of
business. Section 7(1)(b) includes import of services for a consideration
within the scope. Section 7(1)(c) then refers to schedule I of the Act, wherein
the activities listed are deemed to be included in the scope of supply, even if
made or agreed to be made without a consideration.
Schedule I lists
four specific activities which shall be treated as supply even if made without
a consideration. In this article, we shall discuss entry 2, which reads as
under:
“2. Supply of goods or services or both between
related persons or between distinct persons as specified in section 25, when
made in the course or furtherance of business”.
The scope of the
above deeming fiction is, inter alia, to treat transactions between related
persons or distinct persons as supply, making it liable to tax in the state
from where the supply originates with a corresponding credit, subject to
provisions of section 17 in the state where the supply culminates.
Therefore, what
needs to be analysed to interpret the scope of the above entry is:
- What is meant by related person?
- What is meant by distinct person, as
specified in section 25?
- When can it be said that a supply of goods
or services has taken place between distinct persons?
RELATED PERSON – SCOPE
Vide explanation to
section 15 of the CGST Act, it has been provided that persons shall be deemed
to be related persons, if:
(i) such persons
are officers or directors of one another’s businesses;
(ii) such persons
are legally recognised partners in business;
(iii) such
persons are employer and employee;
(iv) any person
directly or indirectly owns, controls or holds 25% or more of the outstanding
voting stock or shares of both of them;
(v) one of
them directly or indirectly controls the other;
(vi) both of them
are directly or indirectly controlled by a third person;
(vii) together, they directly
or indirectly control a third person; or;
(viii) they are members of the same family.
DISTINCT PERSON – SCOPE
Section 22(1) read
with section 25(1) of the CGST Act, 2017 provides that every supplier is
required to obtain registration in every such state from where he makes a
taxable supply of goods or services or both. Therefore, every taxable person
supplying goods or services or both from multiple states shall be required to
obtain registration in all such states.
Sections 25(4) and
25(5) of the CGST Act deems such separate places from where supplies are made,
whether registration has been obtained or not, to be distinct persons for the
purposes of the Act. In other words, all the locations of a taxable person,
within India but in different states, are treated as distinct persons for the
purpose of GST law.
IDENTIFYING SUPPLIES BETWEEN DISTINCT PERSONS
The important
question that needs consideration while analysing whether entry 2 is triggered
or not, is determining when a supply of goods or services has taken place
between distinct persons. While determining the same in the context of goods
may not be a challenge, owing to the tangibility factor, there will be a
challenge from the perspective of identifying the existence of a service. This
is because when it comes to services, there appears to be confusion on the
scope of the above deeming fiction. Let us try to understand the same with the
help of the following examples of various activities which take place within a
legal entity:
a. A multi-locational entity having a centralised
accounting department for all India operations, which includes a centralised
tax compliance department, too;
b. The head office of a multi-locational entity
receiving auditing services for multiple locations across the country,
including the foreign branches;
c. The senior management, responsible for the
overall operations of the legal entity, operating from the head office which
results in various supplies being made by the multiple locations;
d. An employee from one branch is asked to
support the other branch for a particular project;
e. Multiple branches work on a project, for which
the front-ending to the client is done by a particular branch / head office.
In the above, it is also important to note that at times, the companies
might be accounting the costs / revenue identifying the location to which it
pertains, in which case there will be always a revenue mismatch as costs will
be accumulated in one location while revenue will be lying in another location,
resulting in revenue-cost mismatch and credit accumulation in cost-incurring
locations and liability payout in cash in revenue-generating locations.
A view is therefore
being proposed that in cases where the costs and the corresponding revenues are
booked in distinct jurisdictions, there should be a cross charge of the costs
from the expense-incurring jurisdiction to the income-bearing jurisdiction. Such
cross charge would constitute a consideration for the rendition of ‘service’ by
the expense-incurring jurisdiction to the income-earning jurisdiction and such
deemed / inferred service would be liable for payment of GST due to the
provisions of schedule I entry 2 referred to above. In case the costs are
common costs incurred for multiple revenue-earning jurisdictions, there should
be some reasonable basis of apportionment of costs with similar consequences as
stated above. This view is further corroborated by the ruling of the Authority
for Advance Ruling in the case of Columbia Asia Hospitals Private Limited
[2018 (15) GSTL 722 (AAR – GST)] which was confirmed by the Appellate
Authority as well. The matter is currently pending before the Karnataka High Court.
Though the
objective of schedule I entry 2 and the view expressed above may be to ensure a
smooth flow of credits across multiple jurisdictions, the essential legal
position is that the entry deems certain activities / supplies to be taxable
and therefore imposes a tax in one of the jurisdictions. Therefore, the
question that needs consideration is to what extent can the deeming fiction be
extended to deem an activity carried out by a taxable person as supply of
service?
It is now a settled
proposition of law that a provision imposing a tax has to be strictly
interpreted and cannot be inferred. In fact, the Supreme Court has time and
again held that before a tax can be imposed, the levy has to be certain. To
define this certainty of levy, it is understood that the following constitute
the key corner-stones of the levy:
- Certainty of the taxable
event;
- Certainty of the person on
whom the levy is cast;
- Certainty about the
recipient of service;
- Certainty in the rate of
tax;
- Certainty in the value on
which the tax has to be charged; and
- Certainty as regards the
time at which the tax has to be discharged.
The proposition of
requirement of cross charge canvassed above may not be a correct legal
proposition since there is technically no service rendered by the head office
to the branches and therefore, the deeming fiction needs to be restricted to
the fiction created by the said provision and there are significant
uncertainties in the implementation of the cross charge proposition, resulting
in the probability of the alleged levy itself getting struck down. In
subsequent paragraphs, an attempt is made to understand the answers to the
above issues.
Whether there is certainty of the taxable
event?
The taxable event
under GST is the supply of goods or services or both. It may be important to
note the legislative background of GST. While a plethora of indirect tax
legislations pertaining to various goods and services have been subsumed under
the GST legislation, it is evident that the fundamental distinction between
goods and services is still relevant. It is still not a very comprehensive tax
on all supplies but rather a tax on goods or services or both. This is the
reason why both these terms are defined separately and there are provisions to
determine the nature of supply as either being that of goods or services, or
neither. Further, many provisions like time of supply, rate of tax and place of
supply are distinct for goods and for services.
The term service is
defined u/s. 2(102) as anything other than goods, money and securities.
However, this definition appears to be sketchy and does not in any way define
the essence of what constitutes service and what does not. It is, therefore,
felt necessary that before one embarks to understand the scope of the deeming
fiction referred to above, it may be important to determine the essence of what
constitutes goods and what constitutes services and the essential differences
between the two.
Prior to the
introduction of GST, it was always felt that the fundamental attributes of
goods would be utility, possession, transferability and storage value.
Similarly, the fundamental attributes of service were understood to be an
activity carried out by a person for another for a consideration under an
enforceable contract. It is evident that the concept of ‘goods’ is distinct
from the concept of transaction in ‘goods’ like sale of goods. For example, a
person may possess ‘goods’ and such goods will have utility and value (some
inherent value) and such possession may have no linkage with consideration or
any contract or another person. In distinction to goods, by their very nature
services cannot be viewed in isolation of their rendition or provision. It is
felt that this very essence of goods or services does not change due to the
introduction of GST. The definitions have to be read in this context.
On a co-joint
reading of the definitions under various legislations and the judicial
interpretation, it can be argued that an enforceable contract between two
parties and consideration are essential elements for something to be defined as
a service in general. For example, a musician singing on the road cannot be
treated as providing services to passersby since there is no enforceable
contract between the two. Similarly, acquiring knowledge by reading books
cannot be considered as a service even if the said knowledge is for furtherance
of the business in the future. Most businesses receive free advice from
consultants – all and sundry. The businesses may not even perceive a value in
such advises.
One would generally
consider that an actor provides a service to a film producer. This is because
generally, the producer approaches the actor and pays him a fee for acting in
the movie. However, if a struggling newcomer approaches a producer and offers
to pay him a fee and also act in the movie, one would say that the producer has
provided a service to the actor since the flow of consideration is from the
actor to the producer. Further, it would not be correct to even say that the
actor provided a free service in this case since neither the producer nor the
trade nor the actor himself perceives a value for the ‘acting’ carried out by
him. In that sense, the acting is carried by the actor for himself and not for
the producer.
It is, therefore,
felt that despite a wide residuary definition of service, the essential
attributes of service would be:
- An enforceable contract between
two persons;
- A consideration flowing from
one person to another;
- A defined activity set carried
out by one person for another under specific instructions of another
person.
The issue to be
examined here is whether and to what extent do the above essential elements of
service get diluted due to the deeming fiction prescribed under schedule I
entry 2.
Clearly, the cost
and revenue mismatches across jurisdictions are on account of imbalances in the
underlying activities carried out at the different jurisdictions. For example,
a litigation pertaining to Chennai may land up in Delhi in the Supreme Court
and may be supported by the in-house legal counsel from Mumbai. Would these
activities fall within the mischief of the above deeming fiction?
Admittedly, the
various locations where a taxable person may be registered are deemed to be
distinct persons for the purposes of the GST law since they bear separate GST
registrations. However, does the deeming fiction restrict itself merely to the
distinctness of a person (i.e., entity) or does it create a distinctness
amongst all its relationships with business, employees, clients, assets,
suppliers, government authorities, judiciary, etc.? In order to fit within the
deeming fiction entry mentioned earlier, a series of deeming fictions will have
to be created. This will have its own set of challenges. For example,
- The different locations for
which registration would have been obtained would be treated as distinct
persons. This has been provided in section 25. However, nowhere is it stated
that due to such distinctness of establishments, the legal existence of the
taxable person is to be totally ignored;
- In the above example, the
in-house counsel will have to be treated as an employee of the legal entity.
This is a deeming fiction, but this is nowhere provided under the law. Further,
the reason for treating him as an employee of Maharashtra registration is
merely because he generally sits in the Maharashtra office. This is again a
deeming fiction since the person who is the employer cannot be determined by
the location where the employee usually sits. Similarly, the payment of the
salary to the in-house counsel may be accounted in the books in Maharashtra. In
most of the cases, the entity maintains common books of accounts. Further,
accounting principles cannot determine the tax implications;
- Most
of the other regulations, employment contract, the expectations of the
stakeholders and the conduct of the employee, would not in any way suggest that
the counsel is an employee of a particular registration. Even the GST law may
not restrict the interpretation of the person being an employee of a particular
registration and not the legal entity as a whole. If such an interpretation is
taken by the GST authorities, under which authority could such in-house counsel
located in Mumbai be summoned? Similarly, section 137 of the GST law provides
for liability of officers responsible for the conduct of the business as being
guilty of the offence.
Similarly, can one
really say that the litigation is that of legal entity or will it be said to be
that of registration (and what would be the principles which will determine
this aspect)? Will the artificial distinctness then imply that one office
(registered) has rendered a service to another office (whether or not
registered) by providing the in-house legal counsel requiring a value to be
assigned to such alleged service with a corresponding tax liability in Mumbai
and credit in Chennai? What would be the scenario of hotel booking carried out
by the Delhi office for the in-house counsel? Will the concept of business also
be considered distinctly and, therefore, can it be argued by the Delhi officer
that the stay in the hotel is not for the furtherance of business of the Delhi
branch and therefore input tax credit should not be allowed?
Therefore, the
deeming fiction provided under schedule I entry 2 has to be restricted to the
fiction that it creates. In the absence of a clear intention to extend the
deeming fiction not only to the distinctness of the person but also to all
consequential relationships, it would not be correct to create layers of such
deeming fiction and thereby infer the existence of a service which does not
exist at all and then operationalise the deeming fiction.
Another way to deal
with the cost-revenue mismatch is to suggest that there can be a difference
between a receipt of a supply and the receipt of the benefit of the supply. The
distinction between a recipient of a supply and the beneficiary of the supply
is very well understood in the judicial context. Just because the benefit of a
supply is derived by an artificially dissected distinct person, can it be said
that the original recipient of the supply is a further supplier of service?
The GST law itself
considers the possibility of the recipient of service being distinct from the
beneficiary of service. In this context, the definition of recipient of service
provided under section 2(93) clearly demonstrates that the person liable to pay
the consideration is the recipient of the supply. Further, the definition of
location of recipient of service u/s. 2(70) envisages a joint receipt of
service by more than one establishment and suggests a tie-breaker test to
determine the establishment most directly connected with the supply. The
provision stops at that and does not further provide a deeming fiction to
further suggest that there is a secondary supply by the most directly connected
establishment to the less directly connected establishment.
If the above
proposition is taken as a legal requirement, one may even find the provisions
of input service distributor totally redundant.
In view of the
above discussions, it is felt that there is no element of service rendered by
the corporate office to the branches when there is a cost-revenue mismatch and
certain support functions are performed by the corporate office which may be
intended for the benefit of the branches.
Whether there is certainty about the
person who is liable to discharge the tax liability?
Another important
aspect is the determination of the person who is the service provider and
therefore liable to discharge the GST liability on the so-inferred deemed
supply. It is felt that this aspect itself can be a subject matter of severe
uncertainty.
Let us take an
example of two branches of a taxable person, say Maharashtra and Gujarat
jointly rendering a service to a client. Section 2(15) of the IGST Act will
define either one of the two branches as the establishment most directly
connected with the supply. The issue to be examined is whether there is any
service provided between the two branches? If yes, who renders service to whom?
This question cannot be answered in isolation at all. If at all a conservative
view has to be taken, an additional piece of information will be required as to
which of the two establishments is the establishment most directly concerned
with the supply and then only one can perhaps argue that the less directly
connected establishment is providing service to the most directly connected
establishment. It may be noted that there is no specific deeming fiction to
this effect.
Let us extend the
above example slightly and say that the two branches are jointly rendering free
service to the client. How would one now conservatively operationalise the
deeming fiction?
Therefore, it is
evident that it is difficult to examine who is the service provider with
certainty.
Whether there is certainty about the
person who is the service recipient?
Let us extend the
example provided above to the case of a disaster recovery centre which is
located in Andhra Pradesh. If due to cost-revenue mismatch it is inferred that
there is a requirement to deem a service flow, the question which arises is
whether the Andhra Pradesh unit is rendering services to the corporate office
in Maharashtra or to all the units located across the country? Who is the
recipient of the deemed service alleged to have been provided by the Andhra
Pradesh unit?
Even if a
proportionate cost allocation is carried out across the country, the same may
not be really representative of the receipt of service by the constituent units.
This is because in many cases there may not be a clear period-specific matching
of costs and revenues. To continue the example of VAT litigation, it may be
possible that when the litigation comes up before the Supreme Court, the unit
in Tamil Nadu may have already shut down and therefore there may not be any
distinct person in Tamil Nadu. In such a case, how would one define the
activity to be that of a rendition of service to Tamil Nadu when there is no
such unit? If the cost is cross-charged on proportionate basis to all other
states, the same may be incorrect since they have not received any service at
all.
Whether there is certainty on the nature
of supply and the rate of tax?
The next issue
which arises is the identification of the exact nature of the service rendered.
Each scenario may be different. In the above example, is it the case of legal
services rendered by the Maharashtra office to the Chennai office or is it a
sort of residuary service? The service cannot be described as a legal service
due to various reasons including the regulatory framework in the country. Even
if it is to be treated as a residuary service, the same should be capable of
some description. What is that description? A very common-place answer is that
the same constitutes business support services. This again appears to be a very
circuitous answer because in the normal course the in-house legal counsel would
be expected as a part of his employment contract to perform the said activity.
Notionally attributing a totally different name to the said activity may be
inappropriate.
Similarly, when the
logistics team of the company arranges for the transportation of the products
of the company, does it provide a ‘goods transport agency service’ and
therefore be liable for tax @ 5% or does it provide a business support service?
Does the F&B team provide ‘restaurant services’ or does it provide business
support services? There can be many more examples.
The answers are
obvious. There is really a significant uncertainty in defining the nature of
the supply and the consequent tax rate on such presumed supply.
Whether there is certainty in the value on
which the tax has to be charged?
It is also felt
that if a view is taken that there is a supply between distinct persons under
the above case, the provisions of the law have to provide with certainty the
value of the said supply on which the tax has to be discharged.
Section 15(1) of
the CGST Act, 2017 which deals with the provisions relating to value of taxable
supply, provides as under:
(1) The value of
a supply of goods or services or both shall be the transaction value, which is
the price actually paid or payable for the said supply of goods or services or
both where the supplier and the recipient of the supply are not related and the
price is the sole consideration for the supply.
In the instant
case, there is no transaction value, or the price actually paid by the branches
to the head office. Since there would be one single legal entity, there is no
occasion to maintain state-specific bank accounts and periodic settlements
through receipts or payments from such bank accounts. In some cases, there may
be an internal accounting entry to define location-specific profitability for
MIS purposes. However, this concept of accounting entry is notional and it
deals with location-specific entries and not ‘distinct person’ specific
entries. Further, in many cases there may not be an internal accounting entry
since there may not be any legal requirement to provide for the same.
In the absence of
the transaction value or price, one can say that the value of taxable supply is
NIL with a consequent NIL liability. However, a counter argument could be that
the transaction value is acceptable only if the supplier and the recipient are
not related persons.
The scope of
related persons has already been dealt with in the earlier paragraph. Further,
section 15(4), which is applicable in cases where valuation as per sub-section
(1) is not possible, provides as under:
(4) Where the
value of the supply of goods or services or both cannot be determined under
sub-section (1), the same shall be determined in such manner as may be
prescribed.
From the above, it
appears that reference to section 15(4) is required only when the provisions of
section 15(1) are not applicable, i.e., price is not the sole consideration and
parties are not related. Therefore, the issue is whether the supply made by the
head office to its distinct persons will be classifiable for valuation u/s.
15(1) of the CGST Act or not? This query arises because distinct persons are
not treated as related persons for the purpose of GST, as is evident from the
definition referred earlier.
It can be argued
that the definition of related person deals with legally distinct entities and
not with distinct persons as defined under the GST law. Therefore, the
transaction value of NIL u/s. 15(1) should not be disturbed.
Even if a view is taken
that the distinct persons as defined u/s. 25 fall within the definition of
related persons under explanation to section 15, the question which arises is
how the same will be valued keeping in view the provisions of valuation
prescribed under the CGST Rules. Chapter V of the CGST Rules contain the rules
for determination of value of supply in following specific cases:
- Rule 27 – Value of supply of
goods or services where the consideration is not wholly in money;
- Rule 28 – Value of supply of
goods or services or both between distinct or related persons, other than
through an agent;
- Rule 29 – Value of supply of
goods made or received through an agent;
- Rule 30 – Value of supply of
goods or services or both based on cost;
- Rule 31 – Residual method for
determination of value of supply of goods or services or both.
Rule 28 of the CGST
Rules, 2017 prescribes for situations of defining a value of supply of services
between distinct persons. Rule 28(a) provides that the open market value of the
supply will be considered for the purposes of valuation. This provision itself
implies marketability of the support functions provided by the corporate
office. Most of the activities carried out by the employees at the corporate
office may be such that they may not be amenable to outsourcing or any element
of marketability. For example, it would not be correct to define the activities
carried out by a director for the company as services which are freely
marketable. Such activities are carried out only due to the specific
relationship as a director of the company. The activity and the relationship is
so closely knit with each other that the activity cannot be looked upon de
hors the relationship. In such cases, it may be incorrect to attribute
marketability and consequently open market value to such supply.
Similarly, the
activities carried out by the employees may be so unique that it may not be
possible to define a value of a service of like kind and quality and therefore
Rule 28(b) would also fail.
Rule 30 provides
for a mechanism to determine the value on the basis of the cost of provision of
service. However, the cost incurred on the activities may also not be easily
determinable. For example, if the in-house counsel appears for the matter in
the Supreme Court, will the salary cost be considered as the cost of provision
of service or will the company cost attributable to retirement benefits also be
added into the calculation? Will the notional cost of his cabin be added? Will
the electricity cost be added? How does one determine with precision the cost
of provision of service and attribute fixed overheads when the so-called
service itself is not clear and there is no identification of the unit of
measurement? Therefore, Rule 30 fails to provide a definitive answer to the
calculation of value of the presumed service.
The second proviso to Rule 28 specifies that the value declared in the
invoice shall be deemed to be the open market value of the goods or services in
cases where the recipient is eligible for full input credit. It is felt that
the condition mentioned in Rule 28 will have to be read down by the courts as
leading to artificial discrimination and also leading to a scenario where the
supplier is expected to demonstrate something which is impossible. Once the
condition is read down or read in context, it can lead to the conclusion that
the transaction value should be accepted.
Whether there is certainty as regards the
time at which the tax has to be discharged?
The next issue to
examine is whether there is any certainty as regards the time at which the tax
has to be discharged. Section 13(2) of the CGST Act prescribes the time of
supply of services to be the earliest of the following dates, namely,
(a) the date of
issue of invoice by the supplier, if the invoice is issued within the period
prescribed under sub-section (2) of section 31, or the date of receipt of
payment, whichever is earlier; or
(b) the date of
provision of service, if the invoice is not issued within the period prescribed
under sub-section (2) of section 31, or the date of receipt of payment,
whichever is earlier; or
(c) the date on
which the recipient shows the receipt of services in his books of account, in a
case where the provisions of clause (a) or clause (b) do not apply.
Essentially, if the
invoice is issued within the prescribed time, the date of issue of invoice or
the date of receipt, whichever is earlier becomes the time of supply. In the
instant case, there is no question of any amount exchanging hands and therefore
there is no date of receipt. One will therefore have to refer to the provisions
of the invoicing rules. Section 31(2) read with section 31(5) prescribes the
outer time limit within which the invoice has to be issued in the case of
continuous supply of services. Accordingly, it is mentioned that the invoice
shall be issued as under:
(i) where the
due date of payment is ascertainable from the contract, the invoice shall be
issued on or before the due date of payment;
(ii) where the
due date of payment is not ascertainable from the contract, the invoice shall
be issued before or at the time when the supplier of service receives the
payment;
(iii) where the
payment is linked to the completion of an event, the invoice shall be issued on
or before the date of completion of that event.
It is more than
evident that the above scenarios are not applicable in the instant case and
therefore the provisions relating to the time of supply cannot be implemented
with reasonable certainty.
To summarise, it is
felt that significant uncertainty exists over various elements towards the
implementation of the proposition to consider the impact of cost-revenue
mismatch as a deemed service by the cost-incurring state to the revenue-earning
state, and such uncertainties vitiate the charge sought to be created by
schedule I entry 2, especially vis-à-vis the supply of services between
distinct persons of the same legal entity.
In view of the above discussion, a view
that the common expenditure incurred by the head office, the benefits of which
are claimed by the various other branches, cannot be construed as supply by the
head office to branches is possible. Therefore, a cross charge may not be
required by the head office to the respective branches.
