JULY 07, 2020

By Dr G Gokul Kishore & R Subhashree

THE pandemic has brought unique challenges to humanity and to business environment. Many responded with aid - providing food, medicine and other services and the focus was on life rather than livelihood. However, when dust settles, businesses have to look into the tax aspect of these expenses also. Whether the businesses would get tax credit under CGST Act, 2017 and deduction as expense under Income Tax Act, 1961 (the IT Act) for these acts of charity, humanitarian aid or Corporate Social Responsibility (CSR) spends during times of COVID-19 and also in normal times would require examination.

Voluntary charity versus mandatory charity under IT Act

The IT Act, of course, does not look kindly at the CSR expenses mandated under Section 135 of the Companies Act, 2013. As per Explanation 2 to Section 37(1), any expenditure incurred by an assessee on the activities relating to corporate social responsibility referred to in Section 135 of the Companies Act, 2013 will not be deemed to be an expenditure for the purpose of business. This may be understandable since, the amount mandated to be spent is a percentage of profits or income of the business and hence the same would not qualify as an expenditure made to earn business income.

However, in the case of CSR which is not mandatory, expense may be allowed as deduction as held in Assistant Commissioner of Income-tax, Circle 1(1), Bilaspur v. Jindal Power Ltd, - 2016-TIOL-1231-ITAT-RAIPUR. The Tribunal opined that it is not necessary that "every expense that could be allowed as a deduction should be such as a hardnosed and perhaps devoid of senses of compassion, businessman alone would incur in furtherance of his business pursuits." The assessee, therein had incurred certain expenses in construction of school building, devasthan/ temple, drainage, barbed wire fencing, educational schemes and distribution of clothes voluntarily and such expenses were held to be deductible.

Another argument in favour of allowing expenses which may be in nature of charity was put forth in Kanhaiyalal Dudheria v. Joint Commissioner of Income-tax, [2020] 113 taxmann.com 217 (Karnataka), wherein the assessee - dealing in iron ore incurred expenses for building houses for flood victims. The expenditure was incurred at the instance of the government which was one of its major customers and hence the High Court held that the expenditure was incurred to maintain good relations with its customer (government) and was allowable as a business expense. The judgment of the Supreme Court in Sri Venkata Satyanarayana Rice Mill Contractors Co. v. Commissioner of Income-tax, - 2002-TIOL-2567-SC-IT, that any expense made to secure a benefit for the business, whether voluntarily or at instance of an authority, would be allowable as an expense, was followed.

CSR and GST law

Section 17(5)(h) of CGST Act, 2017 restricts Input Tax Credit (ITC) on "goods disposed of by way of gift or free samples". Thus, use of the words 'gift' and 'free samples' is likely to lead to an interpretation where an expenditure on CSR activity - distributing food, medicine or PPE kits during Covid-19 times or other goods during normal times might very well not qualify for ITC credit if it centres only around gift. It is essential to note that the said section reads as below:

"(h) goods lost, stolen, destroyed, written off or disposed of by way of gift or free samples"

Thus, credit is sought to be denied in case of goods lost or stolen or destroyed or written off - that is, they are severed from the business or if they are 'disposed of' by way of gift or free samples. It can be seen even on a plain reading that the nature of goods gifted or given as free sample cannot be equated with writing off. It is understandable that goods which are not used in the business or for furtherance of business are denied credit like those used for personal consumption. The rationale for including gift in the exclusion bucket could be that goods may be diverted to close relatives or directors without any commercial reasons like compensation for services etc. However, use of the words 'disposed of' after the initial part indicating destruction etc, calls for a deeper examination of the meaning of the same.

'Disposed of' is a verb which means to get rid of, to settle conclusively or transfer control. The Supreme Court in Goodyear India Ltd. v. State of Haryana & Anr., 1990 AIR 781 upheld the judgement of the High Court of Punjab & Haryana [Civil Writ Petition No. 1138/1982, Judgment dated 4-12-1982], wherein the phrase 'dispose of' was interpreted. The High Court referred to the Webster's Third New International Dictionary as per which 'dispose of' means to relinquish, bestow, discard or destroy. In the facts of the case it was held that goods despatched to branch office could not be said to disposed of by a manner otherwise than by sale since there was no loss of control or title.

For purposes of interpreting 'dispose of' in the context of GST, it may be noted that while gifting away may be to settle or bestow the goods to another, it is not in the same league as writing off or destroying. The words have been used in the sense of discarding or goods becoming unfit for business use. The principle of Noscitur a sociis may be applied to decipher "disposed of" as discard.

In the context of CSR, goods are being used for a business purpose - that is for complying with statutory obligation besides building goodwill, brand recognition etc. Thus, applying the judgment of High Court of Karnataka in Kanhaiyalal Dudheria (supra) as well as the judgement of Supreme Court in Sri Venkata Satyanarayana Rice Mill Contractors Co.(supra) the goods used for both mandatory and non-mandatory CSR activity should be considered to be used in the course of business. They are not being discarded or destroyed.

Disposal versus use in business

Section 7 of CGST Act defining scope of supply uses the word 'disposal'. Schedule-I of CGST Act (Entry 1) uses the word 'disposal' along with business assets. In both these places, the statute refers to the act of removing or taking away of goods from the business of the supplier. In supply, when goods are disposed, they are not in the business for use by the supplier anymore. As per Schedule-I also, permanent transfer or disposal of business assets denotes that the goods are taken out of business.

In respect of goods used in CSR activities, the person concerned is not acting in the capacity of supplier and is not disposing them per se, rather he is using them for a particular activity. This activity is to ensure compliance with certain statutory obligation. If a public road is laid by a company as part of CSR activity, goods like cement or other materials are used in such activity and they are not 'disposed of' by the company. If the principle laid down by the High Court in Goodyear case is applied, it cannot be said that goods used for the purpose of CSR are discarded or destroyed or even relinquished. Neither the goods used in CSR activities are disowned nor are they discarded. They may not remain within the core business of the taxpayer i.e. that of providing outward taxable supplies but they are used for the purpose of or by reason of business.

Even in Modvat era, when credit was very restricted and use within the factory was emphasised, the definition of input contained the phrase "in relation to" so as to extend credit to those inputs which may not get converted into final product i.e. not directly involved in the production process but nevertheless contribute to such process. GST, as a tax law, professes and seeks to practise far more liberal credits and to argue under such progressive law that goods used for CSR activities are not goods used for business will be to deny the obvious. The CESTAT in Essel Propack v. Commissioner - 2018-TIOL-3257-CESTAT-MUM] held that CSR is not a charity anymore and it is related to manufacturing / business activity.

CSR activity is also business activity

This may lead to the question - Can it be said that CSR activity is a business activity? Had the company not been in business, CSR obligations would not have arisen in the first place. CSR obligations are fastened on entities because they are not only in business but also do well in business - earning good amount of profit. CGST Act also does not characterise CSR activity as not related to business since Section 17(5) listing the ineligible items or activities does not expressly include the same unlike Income Tax Act whereby mandatory CSR as per Companies Act is mentioned explicitly so as to effectively disallow such expenditure.

An argument could be that undertaking CSR activity is not the taxpayer's business activity but if one were to deny credit on such reasoning then the words "in the course" and "furtherance" will be rendered redundant and such interpretation should be avoided. CSR activity may not promote business but they are in the course of business activity. Such activities certainly help business to earn goodwill - an intangible asset. It may be an obligation under a different law but it remains a fact that it is a statutory obligation on the business and industry.

The provision to bar credit on gifts should be applied strictly only to gifts i.e. where there is no quid pro quo or consideration. However, scope of this article is restricted to deciphering "disposal" under GST law and dwell on rationale for disallowing expenses under IT Act for mandatory CSR and allowing the same in other cases. Discussion on whether goods used for CSR activity are "gifts" being transfers without consideration merits another article. The ruling in Polycab Wires Pvt. Ltd. - 2019-TIOL-107-AAR-GST holding ITC as not available on CSR items has not been cited in this article as the same does not deal with this issue at length.

[The authors are Advocates practising independently and the views are strictly personal.]