JANUARY 29, 2019

By Debasish Bandyopadhyay

THE phenomenon of cross-charge has dramatically become a trending topic across the country thanks to the ruling of the Karnataka Authority of Advance Rulings ("AAR") in the matter of Columbia Asia Hospitals Private Limited [2018-TIOL-113-AAR-GST] . Let us have look at the concept and definition of cross-charge in the GST regime;

In terms of schedule 1 of CGST Act, 2017, any supply between different GST registrations having the same PAN (being distinct persons) shall be treated as "supply" even when made without consideration. The relevant part of the said provision is extracted below;

"Schedule 1: ACTIVITIES TO BE TREATED AS SUPPLY EVEN IF MADE WITHOUT CONSIDERATION

1. ………………………..

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:

3. …………………………

4. …………………………"

Further, Section 25 of the CGST Act states that “A person who has obtained or is required to obtain more than one registration, whether in one State or Union territory or more than one State or Union territory shall, in respect of each such registration, be treated as distinct persons for the purposes of this Act.”

Thus, it is clear from the above that a deeming fiction is created in respect of two separate registrations of a legal entity as distinct persons and the supply between them, even made without consideration becomes a deemed supply and subject to sufferance of applicable GST on the same. The said provision is brought in the framework of GST legislation in order to maintain the input tax credit chain unbroken and to make sure that the respective consuming States get their share of revenue from GST. The purpose of such provision may be sincere and well-intended but the practical difficulty of implementation of the same may lead to overwhelming miseries to the trade and industry.

Columbia Asia Ruling

The question on which advance ruling is sought by M/s. Columbia Asia Hospitals Private Limited (hereafter referred as ‘Applicant') - whether the activities performed by the employees at the corporate office in the course of or in relation to employment for the units located in the other States, shall be treated as supply in terms of Entry 2 of Schedule I of the CGST Act or it shall not be treated as supply of services as per Entry 1 of Schedule III of the Act?

In respect of the aforesaid case, the applicant stated that it is an international healthcare group operating a chain of modern hospitals across Asia. The Company is currently operating across six different States having eleven hospitals out of which six units are in the State of Karnataka and also has its India Management Office (“IMO”) i.e. Corporate Office in Karnataka. Some of the activities for all the units with respect to accounting, administration and maintenance of IT system are carried out by the employees from IMO. The applicant had explained that the activities carried out by employees from its IMO for accounting and other administrative functions with respect to other unit amounts to supply of services between distinct persons without consideration as per Entry 2 of Schedule I. However, the same shall not be treated as taxable supply of services by virtue of specific relaxation provided in Entry 1 of Schedule III of the CGST Act .

As per the findings of the Karnataka AAR, activities performed by the employees at the corporate office in the course of employment, the employees employed in the corporate office are providing services to the corporate office, hence there is an employee-employer relationship only in the IMO. The other offices are distinct persons and, therefore, the employees in the IMO have no employer-employee relationship with other offices. Therefore, the AAR vide ruling KAR/ADRG/15/2018 dated 27-07-2018 (supra) held that the activities performed by the employees at the corporate office in the course of or in relation to employment such as accounting, other administrative and IT system maintenance for the units located in the other states shall be treated as supply as per Entry 2 of Schedule I of the CGST Act.

In respect of valuation of such supply, it was held that valuation would be done as per the provision of Section 15 of the Central Goods and Services Tax Act, 2017. Further, it was elucidated that the valuation includes all costs, the employee cost also needs to be included in the consideration at the time of valuation of goods or services provided by one distinct person to the other distinct persons.

Appellate Journey

M/s. Columbia Asia Hospitals Private Limited (hereafter referred as ‘Appellant'), being aggrieved by the aforesaid ruling took the appellate avenue and filed appeal under section 100 of CGST Act, 2017 against the said Advance Ruling No. KAR/ADRG/15/2018 dated 27.07.2018 pronounced by the Karnataka AAR. The summary of the facts and contentions based on which the said appeal was filed as follows:

++ The benefit of activities carried out by employees at IMO may flow to the other locations and may have been treated as ‘supply' under entry 2 of schedule I, if the said entry read in isolation. However, the same should not to be treated as supply, if the same is read with entry 1 of schedule III which specifically excludes “services by employees to the employer in the course of employment” as neither supply of goods or supply of service.

++ The employment relationship between the employee and employer exists with a single legal entity as a whole and is not confined to the location of registered person from where the said employee renders service. When an employee renders any service to other registered persons of the same legal entity, the nature of activity still assumes the character of services by an employee to the employer in the course of or in relation to his employment as he is an employee for the legal entity as a whole and not for any registered person. The functions of head office are inherent basic stewardship roles of the legal entity as a whole and can be considered an extended arm and necessary for all units.

++ The multiple registrations under the Act are merely procedural aspects for the purpose of compliance of GST procedure which is the responsibility of any legal entity as a whole. Employment is generally not confined to the geographical boundaries of the State or to the registered persons.

++ The strategic directions are given by the corporate office of the company to its units. The employee of the corporate office perform certain activities which benefit all the offices of the company, therefore, disregarding the employee-employer relationship merely to fasten GST liability is not correct and bad in law.

++ The employee is working for an organization and the organization shall be treated as his employer and not a particular branch. Thus, entry 1 schedule III of the Act holds goods and services by an employee to employer in the course of employment, shall not be treated as supply.

Subsequently, the Appellate Advance Ruling Authority (‘AAAR') [2018-TIOL-31-AAAR-GST] has upheld the ruling dated 27.07.2018 passed by the Karnataka AAR without considering the submissions as discussed supra, made by the appellant. The AAAR has concluded that IMO of the appellant is providing service to other distinct units with the use of services of the employees working in corporate office, the outcome of which benefits all the other units and such activity is to be treated as taxable supply in terms of entry 2 schedule I read with section 7 of the CGST Act. In the course of delivering the said judgement, in the body of discussion and findings, in respect of function and design of Input Service Distributor (ISD) and cross-charge, AAAR has inter alia, observed that there is a fundamental difference between the concept of ISD and that of cross charge. In the ISD concept, only ITC on input services which are attributable to other distinct entities are distributable. Whereas, in case of cross charge mechanism, all expenses incurred by a distinct person for the purpose of carrying out activities which benefits other distinct persons is required to be cross charged. In case of cross charge, there is an element of service rendered by person who cross charges to the other units even though they belong to same legal entity whereas in case of ISD, there is no element of service at all, but a mere distribution of credit. It was also observed that certain expenses of corporate office cannot be distributable under ISD route, rather they are required to be cross charged, thereby repudiating the mechanism of ISD as an alternate design to the concept of cross charge.

Impact & Issues

The upholding of the said ruling by AAAR will certainly have a huge implication on the tax policy and strategy of the organizations which have multi-State operations. This ruling has delivered a lethal blow on the very core concept and design of good and simple tax in the country. In pursuance to the above ruling, the idea of good and simple tax is literally sounding f erociously funny. The ruling casts a huge uncertainty on any inter-company transactions involving employee cost sharing arrangement in its aftermath. There may be practically a flurry of thought processes already in action for creating an ideal design or exercise in order to dig out such expenses in an appropriate manner to comply with such an unrealistic and impractical procedure.

It is pertinent to note that not only the sales and marketing office providing services to head office or other units in other States are going to come under the spell of such cross charge imbroglio but also there may be many more activities such as product development in a factory or research and development wings of the organization situated in any State etc. which may create difficulty in exercising cross charge mechanism to other units leading to an atmosphere of utmost unease of doing business in the country. Now, the companies with multi-State operation will have to take a position and plan their operation to realign their cost sharing mechanism in line with the tax policy of the company to offset the challenges posed in the form of cross charge in order to avoid any future consequences.

Conclusion

It is abundantly clear from the above discussion that the Columbia Asia ruling has caused huge disruption and uncertainty in the trade in a way arousing the old memory of ‘CENVAT' which contributed phenomenally in creating such a towering edifice of litigation in the erstwhile regime. Can it be said that "a star is born" in the new regime that may similarly contribute in producing litigation under GST regime in the days to come! However, dispelling the apprehension of the trade, it is hoped that GST council will make a timely intervention in an appropriate manner to resolve the issue for good.

(The views expressed are strictly personal.)