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GST - An agenda for reforms - Part - 84 - GST completes three years - Tolerating free samples

JULY 01, 2020

By Dr G Gokul Kishore

GST is now three years old. Considering the political, economic and social peculiarities of Indian federal set-up, GST has been a truly landmark reform. The GST Council, tax administration at the Centre and the States, taxpayers, tax media and tax professionals deserve to be congratulated on this day. 

This article series was started in September 2018, a year after introduction of GST. Various issues faced by members of industry have been highlighted along with suggestions for suitable amendments or clarifications. GST Council and tax administration have been responsive to some of them. In this 84th part and in the coming few parts, certain major points in the unfinished agenda are highlighted for resolution in the fourth year of the grand tax reform.

Costly troubles for free samples

This is the title given in Part-II of this article series (11 September, 2018) for the discussion on restriction on input tax credit on sales promotion items. It is repeated as this issue remains entangled though CBIC has issued circulars after this issue was highlighted in various articles and it has withdrawn one of these circulars.

The conflict arises from the spirit of the provisions as obvious from Section 16(1) of CGST Act and the letter of the provisions as contained in Section 17(5) of CGST Act. While the former unequivocally exhibits the larger objective of extending credit to all supplies used or intended to be used in the course or furtherance of business, the latter with the non-obstante clause frustrates such endeavor. This is not to say that law should be large-hearted and extend credit to everything as equity and fairness are not part of DNA of tax laws. However, the wordings in Section 17(5) barring credit on goods which are disposed as free samples or gifts could have been drafted better. Use of the word 'disposed' connotes severance from business whereas free samples are given only as part of business and not divorced from business activities. It will be repetition of the obvious to say that freebies are essential part of any sales promotion plan for every company.

Presumption that goods used for business promotion are no more used in the course or furtherance of business is erroneous. Restrictions on availment of credit in certain situations may be as per legislative wisdom and one need not question the same but such bar cannot be in conflict with the very essence or objective of the tax regime itself. Placing free samples or business promotion items in the same league as those used for personal consumption reveals the gap in translating the intention of seamless credit into reality. Within the entry itself, bunching those which get destroyed or which are written off along with samples eloquently manifests lack of appreciation of subtilities of business scenarios.

Arguments are also advanced referring to Schedule-I to CGST Act whereunder disposal of business assets, temporary or otherwise, is treated as supply even if such disposal is free. Various strategies are being adopted by taxpayers to somehow navigate such provisions like taking and retaining ITC on such goods but paying tax at the time of making such free supply. The restriction being ab initio as per the wordings of Section 17(5) presents a greater risk to taxpayers adopting such exercise.

Too much of discussion has taken place on this issue through various articles and once the Covid-19 situation recedes, pushed by pressure of revenue shortfall, tax administration is certain to issue show cause notices for interest and penalty wherever ITC has been availed but later reversed and in those cases where ITC has been retained but tax paid at the time of free disposal. GST Council Secretariat may step in to include this issue in the agenda in future so that the problem is recognized and the need to amend the law is realized.

Refraining from taxing toleration

Agreeing to the obligation to refrain from an act, or to tolerate an act or situation, or to do an act, is treated as supply of service as per Schedule-II of CGST Act. This entry has been one of the most ambiguous in GST law. Though it has been carried forward from service tax provisions, due to lack of development of jurisprudence at the level of High Courts and Supreme Court, understanding of the implications of this entry has been relatively poor. In Part-VIII of this series (23 October, 2018), this issue was discussed to highlight the complications when there is no consideration for such obligation to tolerate or refrain and yet, the tax administration starts looking at the penal clauses providing for damages in contracts between parties and seeks to cover such damages under the above entry.

Section 15 on valuation includes late fee or penalty in the value of supply if it is related to delayed payment of consideration for the supply as such. The legislative intention to tax additional consideration flowing from the recipient for delay in payment of invoice price is clear. Taxing price escalation even if the same is termed as late fee or penalty is quite understandable as nomenclature cannot deprive such amount the character of consideration. There appears to be an inherent contradiction in the letter of law as contained in Section 15 and the spirit of law as provided in Schedule-II in the manner in which it is interpreted and implemented. Had the intention been to tax all damages or compensation for breach of contract or unsatisfactory performance as per contract terms, Section 7 or Section 15 would have been drafted to include the same.

Schedule-II merely categorises a supply as either as supply of goods or of service and does not create any charge or seek to levy tax on a transaction. Every receipt from the counter-party can potentially be dragged into the vice of such entry if the true import of various provisions are not properly understood and applied. Like free supplies, liquidated damages is one of the most widely debated issues. Grant of exemption to receipt of such damages by government is cited to fortify the argument that such amount is leviable to GST and, therefore, exemption in such cases has been granted. Issuance of an exemption notification to cover a particular scenario does not validate an action which is, otherwise, not legally sustainable. Revisiting such exemption entry and proposal to bring an appropriate amendment to law so as to remove the ambiguity over such issue of taxing amounts received due to breach of contract should get included in the agenda of the GST Council in the fourth year.

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

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