JULY 10, 2017

By S C Jain, Managing Partner, RSA Legal Solutions

1. GST is touted as a Good and Simple Tax. In order to facilitate ease of doing business, the objective that the legislature as well as the Government aimed to achieve with the implementation of GST was simplification of the erstwhile indirect taxes.As there still are various teething issues in the GST law, the trade was under the impression that the Board would come forward and provide clarification on the loopholes, intricacies and confusions that prevail on a lot of issues.

2. The supply of goods by a registered person after incorporating inputs received on FOC basis from the buyer is one of the issues which has created a very anomalous and ambiguous situation in the GST regime. The issue is being interpreted differently by various consultants and experts. However, there is still no clarity in the matter; and if the same is not resolved at the earliest, it would lead to unnecessary and long drawn litigation. The issue may be understood as under on the basis of a hypothetical illustration.

3. Illustration: Company A manufactures a machine whose normal value is Rs.1 Lakh. Company B,one of the buyers of the said machine, proposes that he will supply a component worth Rs.10,000/- to A, and directs A to incorporate the component in the said machine. Company A agrees to charge an amount of Rs.90,000/- for supply of the said machine, as the component worth Rs.10,000/- would be given to A by B on FOC basis. The first question that arises is whether A would be liable to discharge the GST on the value of Rs.90,000/- considering it as a consideration for the supply of the said machine or the value of Rs. 1 Lakh would be considered for the purpose of charging the GST(taking into account Rs.90,000/- as consideration in money value, and Rs.10,000/- as other consideration).On this aspect, different interpretations are being made in the trade and industry by various experts.

4. The second issue relates to the supply of component worth Rs.10,000/- by B on FOC basis to A. B has taken the input credit on the said component at the time of its receipt in its premises (or on the inputs used in the manufacture of the said component). The question is whether the supply of said FOC component would be considered as a non-taxable supply and would require reversal of the input tax credit. This would mean that B would have to make the reversal not only of the input tax credit availed on the said components, but also on the corresponding amount of common input services and capital goods. The other view point is that the said supply may be considered having been made without consideration but certainly is in the nature of permanent transfer/disposal of the business assets of B, and hence, it would be considered as a taxable supply by B, and would be liable to applicable GST.

5. Another interpretation is also being made to say that B would be sending his components as a principal supplier for job work, and therefore, B can clear the same on the strength of delivery challan by following the job work procedure without charging or reversing any GST or input tax credit. 'A' would be considered as job worker in this scenario, as it would be carrying out further process or operations on the material given by 'B'. Therefore, even if 'A' has used 90% of his material while processing the components supplied by 'B' entire thing would be considered as 'job work service'. The total consideration charged by 'A' including the amount of 90% of the materials and his profit margin would be considered as 'job work'.

6. All the above possible scenarios and interpretations instead of resolving the problem create more confusion in a number of ways. The same have been discussed and explained in the following paragraphs.

The whole activity is considered as job work:

7. In case it is understood that 'B' has supplied the 10% material for getting it incorporated in the complete machine in which the remaining 90% of the material/component would be used by 'A', and thus,'A' becomes the job worker for the whole machine. It would be totally absurd. No person in common parlance would accept this proposition. In fact, in the landmark decision of Prestige Engineering India Ltd. v. Collector of Central Excise - 2002-TIOL-151-SC-CX, the Hon'ble Supreme Court has held that in order for a process to be a job work process, it is necessary that the substantial part of the materials are supplied by the principal manufacturer. In a situation where only the 10% material is supplied by the principal supplier and remaining 90% is used by the seller/processor, the process would certainly be in the nature of supply of goods and not in the nature of job work. It is a well settled legal position that any interpretation which leads to absurdity is not to be accepted.

8. Therefore, it can be safely said that supply of a component(10% material) to be incorporated in the complete machine cannot be said to be a job workprocess. Accordingly, neither the principal supplier (B) can send the component by following job work procedure on the strength of delivery challan, nor can the so-called job worker(A) clear the completely manufactured goods wherein he has used 90% of the material without charging applicable GST on such goods by following the job work procedure. This possibility is certainly ruled out.

Supplier of machine charges the GST only for the monetary consideration:

9. A number of tax experts have accepted this view,and have accordingly advised the persons in the trade and industry. According to this view, the manufacturer (A) would supply the machine to 'B' for a consideration of Rs.90,000/-. The component worth Rs.10,000/- supplied by 'B' on FOC basis to 'A' cannot be considered as additional consideration for 'A'. This is for the reason that the said component has been received by 'A' on the basis of a contractual obligation, whereby 'A' has agreed to supply the machine by incorporating the component supplied by 'B'. Hence, Rs.90,000/- alone would be considered as consideration.

10. According to this view point,in order to become the additional consideration, it is necessary that the said amount should go into the pocket of 'A'. In this case, nothing extra is going into the pocket of 'A' apart from Rs.90,000/-. The component supplied by 'B' is being incorporated as per the contractual requirements. According to this view point, if this sort of supply is considered as additional consideration, then it would result in chaos – as the persons who are doing printing, painting or providing similar services on goods would be deemed to have received the additional consideration in the form of goods,and hence, would be liable to discharge the GST liability on the complete value.

11. For supply of the component by 'B' on FOC basis, the argument is being advanced that either 'B' can supply the goods by following the job work procedure without charging any GST or reversing any input tax credit or 'B' may clear the same on some internal challan without any reversal of GST because the said component remains the property of 'B' and it is not in the nature of supply or 'non- taxable supply'.

12. It may be noted that in the Clause 15 of Model GST Law, it was provided in very clear terms that, in case any goods are supplied on FOC basis by the recipient, the value of such FOC goods will be added to the goods supplied by the supplier (A in this case). However, in the final GST Act, the said provision has been deleted consciously. This also leads to the conclusion that 'A' has to charge the GST on the amount of Rs.90,000/- alone as it is a consideration for him for supply of goods. 'B' on the other hand can clear the component without charging GST or reversing the input tax credit or by following the job work procedure.

13. However, there are apprehensions on this school of thought which are as under:

13.1. The first and foremost issue that needs to be considered is as to what are the goods being supplied by 'A' in this situation: whether it is complete machine or it would be complete machine minus (–) the component supplied on FOC basis. Apparently, every person will say that 'A' would supply the complete machine. If it is agreed that 'A' would supply the complete machine, then we would have to see what the value of the complete machine is. Obviously for that complete machine, 'A' has charged Rs. 90,000/- in addition to a component worth Rs. 10,000/-. Thus, the total consideration would be Rs. 1 Lakh. This situation cannot be equated with the erstwhile VAT regime where the VAT had to be charged on the sale value of the goods.

13.2. We have to make a distinction that in case of sale of the title in goods owned by the seller is passed on to the buyer whereas in the case of supply of goods there may be a sale or there may not be a sale. Secondly, it would be difficult to call it a job work procedure for 'B'. GST authorities would certainly object to this sort of understanding unless suitably clarified by the department. GST authorities will raise the demand on the supplier (B) of the component on the one hand and on the supplier of the machine (A) leading to lot of litigation.

13.3. In case it is argued that it is a simple stock transfer by 'B' as he remains the owner of the said component even if supply to 'A' then it would be difficult situation to follow the said practice in case of inter-state supply of the said component because in that situation any stock transfer would be considered as 'supply to a distinct person' and would be liable to GST. In other words, this sort of interpretation would certainly result in litigation.

Adding to value of components as consideration in the value of machine:

14. Section 15 of the GST Act provides, inter alia, that the value of the goods supplied would be the transaction value provided it is the sole consideration for such supply . It has to be noted that the law relating to central excise and customs, the value of the FOC items has to be added in order to arrive at the assessable value. The language employed in the Section 14 of the Customs Act and also in Section 4 of the Central Excise Act for determining the value of manufactured goods is identical and akin to the valuation of the supply of goods under Section 15 of the GST Act.

15. It is immaterial whether the additional consideration is added/incorporated in the machine itself or it is retained by the supplier. Obviously had he (A) purchased the component from any other person he would have taken the input tax credit on such component and would have also charged the GST on the whole value of the machine. There is no rationale to say that in case the additional things supplied to the supplier on FOC basis if is retained by the supplier then it would constitute the additional consideration, but if the same is incorporated in goods themselves then it would not be considered as the additional consideration. So, this defies the basic logic of sole consideration .

16. Accordingly, the more prudent view may be that the value of the FOC component received by 'A' should be added in the 'transaction value' to arrive at the assessable value. In this case the assessable value for payment of GST for 'A' should be Rs.90,000/- + Rs.10000/- = Rs.1 lakh. If this view is adopted, then certainly it would spare Mr. A from any sort of possible litigation. Further, whatsoever he charges as GST would be recovered by him from 'B', and thus there would be no financial loss to 'A' in any manner.

17. As far as 'B' is concerned, it may consider it as 'taxable supply' of the said component without consideration to 'A'. It is not out of place to mention here that the raw materials or finished goods are considered as 'current assets' for any business. Once 'B' has transferred the said component to 'A', it may be considered as transfer/disposal of the said component as the said component would never come back to him in the said form. As per schedule 1 of GST Act, in case any business assets are transferred even without consideration of which the input tax credit was availed would be considered as supply.

18. Hence the said supply of component would be considered as supply for 'B'. Accordingly,'B' would be liable to issue tax invoice and discharge the GST liability. This would take care of the anomalous situation which was arising out of non-reversal of the input tax credit or considering it at par with stock transfer, et. al. Since the goods are transferred by 'B' to 'A' on FOC basis, then 'A' would be in a position to avail the input tax credit. In this situation, there would be no anomaly even if the said component is transferred on interstate basis. Besides there is no reason for the GST authorities to raise any demand on 'B' or 'A' in case this model is followed.

19. Even this situation is not free from doubt. The first and foremost doubt is whether the supply of the said component can be considered as a permanent disposal of business assets. Normally, persons consider a situation as permanent disposal when the business as a whole (or a significant portion) is sold/transferred to some other persons and not to this type of isolated or day to day activities. Besides Section 16 of the CGST Act provides that in case the recipient of the goods does not make a payment within a period of 6 months to the supplier then he will be liable to make a reversal of the entire input credit. In this situation, the goods have been supplied on FOC basis to 'A' and hence there is no question of making any payment by 'A' to 'B'. Obviously it would again be a question mark on the availment of the credit.

20. In a nutshell, looking into all the possible scenarios and ambiguity that prevails in law, we would suggest the Trade and Industry as under:

20.1. If possible, 'B' should sell the component to 'A' against consideration and raise tax invoice so that 'A' can take the input tax credit without any problem. Similarly,'A' should raise the tax invoice for the whole value of the machine and charge the GST accordingly. This is the best solution. This model would be litigation free without any monetary loss to any party in any manner.

20.2. In case the above suggested model is not possible due to any business reasons, then 'B' should supply the component by considering it permanent transfer/disposal of business assets and clear the component on the basis of tax invoice by charging the applicable GST. A should take the credit of the GST reflected in the invoice of 'B'. In turn,'A' should raise tax invoice of the complete value of Rs.1 Lakh of which 'B' will be in a position to take the input credit (if otherwise admissible). This model will save 'A' and 'B' from unnecessary litigation in the hands of department .

20.3. Any other type of treatment is likely to result in litigation. Hence, it should be avoided till the matter is well clarified by the Government or well settled by courts.

(The views expressed are strictly personal.)