AUGUST 09, 2016

By Sushil Solanki, Principal Commissioner of Service Tax (Rtd) & Vishal Agrawal, FCA, Partner, TLC Legal

SECTION 15 of the Model GST Law and GST Valuation (Determination of the value of Supply of Goods and Services) Rules, 2016 deals with the Valuation provisions in the GST scenario. Even a cursory reading would show that the these provisions have been made with the mind set of existing Central Excise or Service Tax or State VAT Tax laws. Either the drafting has been made in great hurry or the best brains of the Empowered Committee has not appreciated the fact that GST would be an all encompassing single indirect tax where tax on entire economic activity from primary sector till the consumption would be levied with seamless tax credit. Most of the apprehension of the tax officials regarding tax avoidance possibilities in the existing taxation laws may not be relevant in the GST scenario because (1) consideration for all forms of supply would be taxed, whether it is goods or service, and (2) normally,there may not be any incentive to under value the supply at one stage, as it would be taxed in subsequent stage. Tax planning arrangements made in the past by creating marketing set up to offload prices from manufacturing company to the marketing company of the same group to save the taxes, has no relevance in new regime. We find that many of the provisions made in the Model law does not justify their existence and their continuation is an open invitation for litigation. Reading the mind of draftsman hint that Valuation provisions starts with lack of trust between the tax department and the assesse. Provision for rejection of Value by tax officers is one such provision. Whether there is any economic or taxation logic to tax free supplies is also a question which the policy maker should ponder over. Moreover, there are glaring drafting gaffe. In this background, this article deals with Valuation provisions in Model GST law in three perspectives - lack of conceptual clarity, drafting issues and logic for taxing free supplies.

2. Lack of Conceptual Clarity:

2.1 Specific provisions for inclusion of royalties, license fee and incidental expenses such as, commission and packing, in the transaction value under section 15(2) appears to be unwarranted. In the present laws, a tax payer can escape the payment of VAT or Excise duty by taking the plea that such recoveries are not forming part of value of the goods sold or manufactured as these are for services and not in relation to goods under consideration. In the GST, the concepts of manufacture or sale or service has been substituted with a very broad concept of 'supply'. Therefore, if a person is recovering any amount as packing charges or commission or royalty, it would be chargeable to GST without any iota of doubt. Keeping such unwarranted provision may create uncalled for dispute, if GST rate on goods and services is different, as tendency to link such recoveries to higher tax rate bracket by department or to lower tax bracket by the tax payer cannot be ruled out.

2.2 The provision for allowing deduction for Discounts subject to fulfilment of certain conditions is also one of the example of copy paste of the existing provision of VAT laws or the doubting mind of tax collectors. Section 15(2)(h) provides that deduction for any discount would not be permissible if it is allowed after the supply has been made. However, the Proviso to said Section stipulates that deduction for such post supply discount is allowed if it was known before the time of supply. Further, Section 15(3) provides that deduction for discount would be allowed if it is allowed in the normal trade practice and has been reflected on the invoice. History of section 4 of the Central Excise Act should have been examined before inserting the provision relating to discount. Prior to introduction of concept of 'transaction value' from the year 2000, in the erstwhile Valuation provisions in the Central Excise Law, there was aspecific provision regarding eligibility of discount in the law. There was reasons for such provision because prior to 2000, the Valuation was based upon 'normal price' concept. After introduction of 'transaction value' concept, the provision regarding discount was deleted from Valuation related law and for right reasons too, as discount is always factored in the value as per the transaction value concept. There have been a large number of litigation on discount provisions and matters have reached upto the Supreme Court. In the GST era, the concept of transaction value has been adopted in the law. If discount of any nature is allowed to the customer, in that case there should not be any reason not to accept his version and dispute reduction in transaction value only on reason that it was not disclosed or it was not known before supply was made. Post supply discounts becomes necessary in many circumstances in real life commercial world. Moreover, when GST is leviable on each stage of the sale/supply, thinking of saving taxes at one stage does not justify because the next player would be required to pay higher amount of tax on such transactions.

2.3. Rule 7 of the Valuation Rules, empowers a tax officer to reject the value in case he has reason to doubt the accuracy of the value declared. The reason to doubt can occur in a situation where same tax payer has sold similar goods at significantly higher value or any other person has sold the similar goods at much higher or lower value. Such provisions are not found in the existing Central Excise or Service Tax. It appears that this concept has been brought from the Customs Valuation System. On the one hand, the Valuation is based on 'transaction value' concept but at the same time power has been given to reject the value if someone else has sold the similar goods at significantly higher or lower value. Both concept can never go hand in hand. Unless the tax officer has got the evidence of receipt of unreported consideration, keeping of such provisions of rejection of value clearly shows the lack of clarity about the basic concept of GST and understanding of Transaction Value, which has been tested for more than 15 years in Central Excise law. Reasons for keeping such provision in Customs law is very different because the supplier is in different country, hence onus to prove under valuation by the tax collectors in India is very difficult. Keeping such provision would lead to many complaints of harassment too. Further it would not be totally wrong to say that in most cases of supply of services, if not impossible, it is very difficult to compare the quality and price of services provided by a person to two different persons or provided by two different service providers. Take a simple case of provision of advice by consultant or a case of architectural service or advertisement service. How can the prices or quality of the services be compared? In the case of services, in majority of the cases tax assessment can be reopened only on this ground.

3. Drafting Issues:

3.1 In section 15(2), at three places, 3 different terms have been used in the same context. Clause (a) refers to 'in relation to such supply', clause (b) refers to 'in connection with the supply' and clause (e) refers to 'in respect of the supply'. Such type of drafting gaffe reflects poorly on the quality of drafting. It would also lead to unnecessary litigation by the department and even by the tax payers to take advantage of faulty drafting. Central Excise history is full of litigation only on the issue of interpretation of the term like 'in relation to' with regard to Cenvat Credit Rules. One should learn lesson from own history rather than repeating mistakes.

3.2 Section 15 (2) (e) provides for inclusion of incidental expenses, 'charged by the supplier'. On the other hand, the in the main definition under Section 15(1), the term used in same context is "paid or payable." It would be preferred to use the similar wordings at different places in the same context.

3.3 'Subsidies provided in any form or manner, linked to the supply' have been made as part of the transaction value under section 15(2)(f). The scope of the term 'subsidy' has not been defined in the Act. Therefore, any amount of financial assistance given by the government or even by non-government bodies can be taken as subsidy. There is also a scope to treat the tax exemptions, like area based exemptions or invest allowances as subsidy. Further, there may be tendency on the part of tax officials to link all type of subsidy with the supply. For example, even the investment subsidy can be treated as linked to the supply because investment is being made for the purpose of supply. The ultimate objective of any commercial organisation is to make supply of goods or services therefore, any subsidy received by the company can be said to have linkages with the supply. It is therefore suggested that the word 'subsidy' may be defined and further 'linked to the supply' may be modified to provide "directly linked to the value of the supply."

3.4 Rule 3(5) of the GST Valuation Rules provides that in case of branch transfer of goods or services, the value would be the transaction value. In fact, there cannot be transaction value in such cases because there is no price paid or payable for the said supply. Valuation in such cases needs be determined under Rule 4 or 5 or 6 of the Valuation Rules. Therefore,Valuation in such cases based upon transaction value is a clear case of a faulty drafting or a case of misplacement of this provision.

3.5 Rule 5 of the Valuation Rules provides one of the method of Valuation based upon costing principle. Clause (b) of Rule 5 provides for inclusion of 'design or brand charges' in the value. Such charges are clearly in relation to production of goods or for provision of services. A specific inclusion made may lead to taking interpretation by the tax payer that the cost of production referred in clause (a) may not include some other charges leading to unnecessary litigations. It is therefore suggested to delete clause (b). Further, Clause (c) of Rule 5 provides for inclusion of profit and general expenses made by other suppliers of similar goods and services. We do not understand as to how the overhead expenses incurred and profit earned by other person become relevant and how to ascertain it too.

4. Is there any logic to tax free supplies – a case of Double Taxation:

4.1. Section 3 of the GST Law provides the meaning and scope of term 'supply'. It means all forms of supply made for a consideration. However, Schedule I, declares certain supply to be taxable even though these are made without a consideration. Clause 5 provides that if the goods or services are supplied by a taxable person to another person in the course of business, same is liable to be taxed to GST even though it is made without any consideration. Illustrations could be a case of free gifts given on purchase of a particular item, say one item given free on purchase of two. Physician samples is another example under this category. To tax such free supplies in relation to goods is commercially not a good decision. It could be considered as quantity discount if the free item and charged item is same. In case of different items (free soap on sale of oil), the value of free item is always included in the price of the charged item. Taxing such free supply of goods would mean double taxation because the price of charged item is inclusive of cost of free item on which GST would also be payable.

4.2. As far as free supply of services is concerned, the situation is still more serious. GST Valuation Rules, in Rule 4, provides for adoption of value of comparable services. Definition of "services of like kind and quality" means services which are identical or similar in nature, quality and reputation which are supplied by the same person or by a different person. This is one area where maximum amount of dispute can arise and it may also lead to harassment of tax payers by calling for information about nature of services provided or the value of similar services provided by a service provider. Every businessman does the business to make profit, therefore if a person provides free services, he would like to recover the cost thereof from services provided to other person. Not only the commercial reason as discussed above, but even the administrative reason of difficulty in Valuation of free service is an important factor to desist from charging GST on free supply of services. Charging tax on interstate branch transfer appears to be logical in order to transfer credits and IGST amount to destination State. However, in that case also, it is suggested to give an option to taxpayer to follow either the comparative price or costing method as per his convenience.

5. MRP Vs Transaction Value:

FMCG and other consumer goods industry is nervous to find that in the GST model law, there is no provision to follow MRP based assessment. There fear are not baseless because past experiences of valuation disputes have been quite bitter and introduction of MRP based assessment from 1997 onward has almost ended all Valuation disputes. But the question arise as to whether MRP based assessment has any relevance in GST structure where entire chain of activities upto retail sale is covered in the tax net, which does not provide any incentive for under valuation by one of the player in entire chain.

But considering the present draft of Valuation provision, there are great chances of disputes being raised by tax authorities on the issue of eligibility of discount or addition of subsidy or rejection of value because of supply at higher prices by same or other person. However, adopting MRP based valuation in the GST may not be a scientific method because of two important reasons. Number of intermediaries between manufacturer and retailers may vary for different commodities or for different tax payers. Secondly, even margins of such intermediaries may vary. For these reasons it would be difficult to fix abatement percentage. It may also lead to input tax credit getting accumulated with one intermediary as his value addition as per abatement percentage may be lower than his actual margin. The solution to the problem is to simplify the valuation provisions.

Conclusion

6. We suggest following modifications in the Valuation provisions in the GST law:

(1) Valuation to be based upon only on 'Transaction Value',

(2) Separate provisions for addition of royalty or licence fee or incidental expenses like Commission or Packing charges to be deleted as these are not warranted once Transaction Value concept is followed.

(3) Provision for deduction of Discount, subject to following certain condition, to be deleted as transaction value is always arrived after allowing discounts.

(4) Drafting deficiencies to be rectified.

(5) Power to reject Value is unwarranted once transaction Value is accepted as the basis.

(6) Free supply of goods or Services not to be charged to GST as cost thereof is already part of other goods and services supplied for consideration, except for inter-state branch transfers.

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