JANUARY 05, 2021

By Dr G Gokul Kishore

OUTCOME of advance rulings under GST is, in most cases, not in favour of applicant-taxpayers. There is a general trend to avoid using such mechanism. As such rulings are binding on only the applicant and jurisdictional officer, there is no law laid down by these bodies. But the interpretation adopted raise eyebrows and sometimes, shakes common understanding of the provisions. This 94th part intends to touch upon such "jurisprudence" advanced in a few advance rulings.

Franchisees are related persons

As per Section 15(5)(c) of CGST Act, persons who are associated in the business of one another, in that one is the sole agent or sole distributor or sole concessionaire, howsoever described, of the other, shall be deemed to be related. Nomenclature is not relevant, but the role and responsibilities are of such nature that the other person is exclusively associated with the business of the supplier, then they will be deemed as related persons. The statute also uses the words "associated in the business of one another". This means, supplier should be associated in the business of distributor and vice versa i.e., relationship is mutual. Though issues on valuation arising out of such provisions were contested heavily under Central Excise, GST law carries forward the legacy provisions.

In a recent advance ruling involving the controversial issue of input tax credit on sales promotion items, the Authority for Advance Rulings (AAR) has expressed the view that franchisees are related persons of the supplier [Page Industries - 2020-TIOL-300-AAR-GST. Except a single sentence that franchisees and applicant are associated with the business of one another, the conclusion that franchisees are related persons has been rather abrupt.

Franchisees hold representational right and they carry on the business using the brand name, trade mark and trade dress of the supplier. A particular franchisee cannot represent multiple suppliers engaged in same business in the same territory. They are exclusive vis-à-vis particular line of business of the supplier, mostly on territorial basis. While a sole distributor may or may not hold out as a representative of the supplier, franchisees essentially act as the supplier to the outside world. Use of the word "sole" manifests the legislative intention of exclusivity and, therefore, the supplier is in a position to exercise control over such distributor. Because the statute uses the word "howsoever described", an interpretation may be adopted to treat franchisees as related persons of the supplier. Suppliers are in a position to exercise control over franchisees as they do in the case of sole distributors. However, the sole distributor of Product A may be a sole distributor for an altogether different Product B, but such position may not be available in franchise model. This does not mean franchisee of Product A cannot be a franchisee of Product B subject to the condition that these two products are completely different and are supplied from a different establishment.

Treating such franchisee as related person of the supplier needs to be judicially tested before it can be conclusively considered so. The advance ruling ought to have contained reasons for arriving at such conclusion that franchisees are related persons of the supplier. The industry having franchisees and taking ITC on materials given to them or placed in their establishment may have to take learnings from such ruling and implement measures to be both tax-efficient as well as tax-compliant.

Liaison office and head office are related persons

Liaison offices are barred from undertaking business of the company and they are permitted to act only as a communication channel as per the permission granted to them by Reserve Bank of India. Karnataka AAR held that the definition of business under GST law is relevant and not what FEMA or RBI says and such liaison offices in India are liable to take registration as they promote the business of the company located abroad [Fraunhofer-Gessellschaft Zur Forderung der angewwandten Forschung - 2020-TIOL-267-AAR-GST]. One of the reasonings adopted by AAR is legally not on a strong wicket. It held that persons who are associated with the business of one another are deemed to be related as per Section 15 of CGST Act and, since, liaison office promotes business of the company (head office), they are related persons.

The AAR appears to have ignored "one another" in the definition of related person as it conveys mutuality. It is a two-way relationship. There should be two parties - Party A should be associated with the business of Party B and Party B should also be associated with the business of Party A. Both may be in the same line of business but what is more important is that there should be two different parties and they should have mutual interest in business. Mere association cannot automatically lead to the conclusion that the parties are related. Even customers are associated with the business of supplier but Section 15 cannot be stretched to conclude that such customers are related persons of supplier.

Association in business is not somehow being in touch with the other person but mutuality of interest is the underlying test for determination of relationship. Despite voluminous jurisprudence on this subject in the pre-GST regime, the AAR has neither discussed nor considered the principles flowing from the same. The AAR, probably in its endeavour to discard the fact that liaison offices are not separate entities by themselves but merely an extension of the company, has opted to adopt such porous interpretation of concept of related person to sustain the ground of business of liaison office being one of promotion and the same is connected with the company as it is such company's business that is being promoted. Basis of liaison office is acting as a communication channel and not promotion per se. Expenses of liaison offices are met by the head office and there is no consideration paid for promotion or facilitation. Use of the wider definition of business in CGST Act to artificially widen the scope of liaison office and the concept of related person under Section 15 neither helps in proper appreciation of the provisions nor advances the cause of ease of doing business.

CBIC has an alternative to either compel taxpayers to litigate or proactively clarify such issues in their favour. It is hoped that the latter is opted, sooner.

[The author is an Advocate, Gokul & Subha Advocates, Chennai. Views expressed are personal.]

See Part 93.