SEPTEMBER 03, 2019

By Dr G Gokul Kishore

VALUATION under indirect tax laws has been subject to interpretative divergences eternally. This is no surprise considering the fact that value of the goods or service is the basis for quantum of tax to be paid. For the Revenue Department, inclusions in taxable value is the path to salvation of revenue maximisation. For the taxpayers, more the exclusions, prettier the balance sheet looks. The contradictions in taxing intra-company transactions under the GST law need serious thought and action. This 53 rd part is intended to initiate the debate on this subject.

Supplies to self - Rationale of taxation

Stock transfer of goods from one State to another is typically an intra-company transaction. As registration under GST law is State-specific, such transfer needs to be recognized as transaction between two registered persons. A new nomenclature provides modicum of GST being generation next tax law. Two different registrations of the same company / entity are 'distinct persons' as per Section 25 of CGST Act. But to tax such transfer, taxable event should include transfer and Section 7 of CGST Act with its inclusive definition endeavours to accomplish this task. However, for supply to be complete, consideration should also flow. Transactions within the company then need to be excluded from the condition of involvement of consideration to be covered under the tax net. Schedule-I to CGST Act serves this purpose by treating supply of goods or services between distinct persons when made in the course or furtherance of business as supply under GST law even if the same is made without consideration. By such deeming fiction, the objective has been achieved i.e. transactions between distinct persons sans consideration are deemed as supply and, therefore, stock transfer of goods from one State to another by an entity attracts tax.

By deeming fiction, anything can be achieved but human thinking still demands reason and rationale. The rationale behind taxing stock transfers is primarily GST being dual-tax regime with a State component always in-built. But, legislative reason may not always support the economic rationale as no money changes hands between receiving unit and the supplying unit of the same company. The plan is to tax the transaction first and get the same captured in the government system and to subsequently relieve the burden through input tax credit that can be availed by the receiving unit. The condition on payment of amount towards value of the supply as contained in Section 16 for entitlement to input tax credit needs to be relaxed in such situations of stock transfers. By a proviso in Rule 37 of CGST Rules, such condition is effectively waived for supplies between distinct persons.

Can ITC alleviate the pain of taxpayers?

A liberalized input tax credit sub-regime is often publicised as one of the key progressive elements of GST. Taxing stock transfers and extending ITC are stated as involving no pain to taxpayers and no gain to the exchequer. Rule 28 is intended to showcase the liberal face of ITC when supplies are made between distinct persons. But law cannot be simpler. Rule 28 carves out various situations whereby open market value (OMV) is taken as the taxable value. Semi-finished goods in very many cases cannot have comparable goods being sold and bought in the market. Therefore, if OMV is not available, value of supplies of like kind and quality is to be taken as taxable value. If both these methods cannot be applied, then cost plus and residual methods can be considered. Two provisos under Rule 28 seeks to provide certain option in a particular situation to distinct persons. If the recipient intends to supply the goods as such, then 90% of the price charged by such recipient to unrelated buyer can be taken as taxable value. If the recipient is eligible for full input tax credit, value declared in the invoice shall be deemed to be the OMV of the goods (or services).

Section 15 of CGST Act considers transaction value as the basis for quantifying tax. It speaks about a situation where the supplier and recipient are not related. If they are related, transaction value does not apply and one needs to venture out of Section 15 and travel to valuation rules. However, Section 15 does not mention distinct persons. But Rule 28 has been specifically carved for supplies between distinct persons. Can it be assumed that transaction value is never applicable to supplies between distinct persons and one has to directly go to Rule 28? While assumption has no place in law, such recourse to valuation rules is generally permitted in valuation provisions only if the transaction value is not acceptable. What if the value adopted for stock transfer is an arm's length value and is comparable to similar supplies? Let us leave this larger question aside for now.

Rule 28 states that value declared in the invoice shall be deemed as open market value for such stock transfers. It makes the same conditional whereby benefit of such deeming provision will be available only if the recipient is eligible for full ITC. As to what is the true meaning of 'full ITC', one has the "full freedom" to assume that it relates to the recipient unit as a whole or it pertains to particular supply on which ITC will be fully available, etc. If show cause notices are not guaranteed, then valuation provisions will not have respect. Demand notices are bound to be issued adopting different interpretation once the normal period for notices is over so that extended period can be invoked to ensure maximisation of revenues through penalties as well. An apparently beneficial provision of taking invoice declared value as OMV gets defeated by such ambiguous drafting. May be, ambiguity is for taxpayers only as the discussion in the following paragraphs reveal.

Advance ruling on valuation of supplies between distinct persons

Some taxpayers are generally optimistic. Despite majority of advance rulings adopting the view of the department, taxpayers file applications with the hope of obtaining clarity on issues like the one mentioned above. In a particular case, the applicant sought to know the value to be adopted for transfer of goods to branches outside the State of Tamil Nadu. The applicant was of the view that as the recipient branch is entitled to full ITC, value declared by them on the invoice will be acceptable as per second proviso to Rule 28. In particular, it was contended that the clause in the rule on OMV is not applicable as the proviso on deeming invoice declared value as OMV is applicable in their case. The AAR was not impressed and it held that the intention was to tax value addition and if applicant's stand is accepted, it may mean adoption of much higher or much lower value leading to ITC accumulation (Specsmakers Opticians Pvt. Ltd . - 2019-TIOL-245-AAR-GST). As per the ruling, OMV shall be adopted in such cases and 90% of price charged can also be adopted (as the goods are sold by recipient, as such, to unrelated persons) and such value will be deemed as OMV if recipient is entitled to full ITC. When the rule specifically states that value declared in the invoice shall be deemed as OMV, adopting the view that OMV or 90% of price shall be the taxable value and recourse cannot be taken directly to such proviso, appears to be legally not tenable.

Time to consider exempting intra-company transactions

When the recipient is entitled to ITC, the destination State does not gain any net revenue. When the situation is revenue neutral, value adopted for supplies hardly matters. If capturing the economic activity and monitoring such stock transfers are the objectives, then some amount of brainstorming may lead to more prudent options. Taxing them at the first instance and extending ITC is certainly not a pragmatic solution. For the taxpayer, this results in increase in compliances by populating outward supply returns with such routine stock transfers and then paying tax resulting in blockage of working capital for some time. For the department, ITC availed by the taxpayer of the same amount of tax as paid by supplier unit nullifies any revenue effect. When both the parties do not materially gain, taxing a transaction by creating elaborate deeming fiction and rules only for statistical or surveillance purpose does not appeal to reason. Amending the law may be complicated but an exemption can be explored by the GST Council when such supplies are between distinct persons and the recipient unit is entitled to ITC. Though supplies involving goods alone has been discussed in this article, supply of services and taxation based on cross-charge will get covered once such exemption is positively considered.

[…To be continued]

See Part 52

[The author is an Advocate. Views expressed are strictly personal.]