Treatment of Supply without consideration under GST
The proposed Goods and Services Tax (GST) draft model law has been released by Empowered Committee of State Finance Ministers in June 2016 which proposes to subsume various taxes from the present indirect taxes structure.
Unlike present regime where taxable event for Central Excise is “manufacturing”, for Service Tax is “provision of service” and for Value Added Tax is “Transfer of property”, under the proposed regime, all the taxable events will be replaced with only one incidence which will be known as “Supply”.
Section 3 of the Model GST Law define Supply as –
(a) all forms of supply of goods and/or services such as sale, transfer, barter, exchange, license, rental, lease or disposal made or agreed to be made for a consideration by a person in the course or furtherance of business,
(b) importation of service, whether or not for a consideration and whether or not in the course or furtherance of business, and
(c) a supply specified in Schedule I, made or agreed to be made without a consideration.
Part (c) in above as given in schedule – I have been re-produced below –
MATTERS TO BE TREATED AS SUPPLY WITHOUT CONSIDERATION
Permanent transfer/disposal of business assets.
Temporary application of business assets to a private or non-business use.
Services put to a private or non-business use.
Assets retained after deregistration.
Supply of goods and / or services by a taxable person to another taxable or non-taxable person in the course or furtherance of business.
Provided that the supply of goods by a registered taxable person to a job-worker in terms of section 43A shall not be treated as supply of goods.”
Herein in this article we will focus on the fifth clause of schedule – I, i.e. Supply of goods/service by a taxable person without consideration.
Let’s start with an example of the same which can be goods as free samples which are supplied in the course or furtherance of business to any person by a taxable person will attract GST under the new regime. Although, normal trade discounts or cash discounts reflected on invoice won’t be covered under such clause.
To understand who is a taxable person, we may refer Section 9 of the Model GST Law which provides that “any person who is doing business in India and liable to be registered as per the provisions is a taxable person”. Although there are some exceptions to this definition which are –
Any person having aggregate turnover less than Rs. 10 lakhs;
Any person carrying on business in North Eastern States including Sikkim having aggregate turnover less than Rs. 5 lakhs;
Services of employee to employer;
Person engaged in supplying goods/services which are not liable to GST; or,
Any person liable to pay tax under Reverse Charge who is receiving services in a year for personal use till certain amount.
Prima facie, it can be seen that there are some cases which are not covered under this limb, although they might be covered elsewhere under the Model GST law. Such cases are given as below –
Supply of goods/services by a non-taxable person irrespective of the fact that whether supplied to a taxable person or another non-taxable person; and,
Goods/services are supplied by a taxable person not in the course or furtherance of business, i.e. for personal purposes.
Valuation of goods/services supplied without consideration under present regime vis-à-vis proposed regime
The concept of supply without consideration under GST seems to be a deviation from the existing provisions contained either in Service tax where service without consideration is kept outside the purview or VAT where sale without consideration is also not chargeable to VAT. It seeks to broaden the tax base under the proposed tax structure.
Analysis: Position of free Supply under present tax structure
Under the present tax structure, only Excise law covers the valuation mechanism under Rule 4 for goods cleared as free samples which are liable to payment of Central Excise Duty.
Circular No. 813/10/2005-CX seeks to clarify that Rule 4 of Central Excise Valuation (Determination of Price of Excisable Goods) Rules, 2000 shall be referred for valuation of samples which are distributed free, as part of marketing strategy, or as gifts or donations, i.e. without consideration. Further, Circular No. 915/05/2010-CX also clarify the same proposition along with various judicial decisions.
Rule 4 of Central Excise (Determination of Price of Excisable Goods) Rules, 2000 states that the value of goods supplied free of cost to be taken for the purpose of charging Excise duty is the value of goods sold by the assessee nearest to the time when such free goods are removed. However, some adjustments may be done in case of difference in the dates of delivery of goods sold and goods given away as free gift. Therefore, goods removed even without any consideration are chargeable to central excise duty on such value to be determined as above under the present regime.
With regard to rendition of Services without any consideration under present Service tax structure, such activities have been kept outside the ambit of Service tax by specifically providing in the definition of Service as given under Section 65B (44) of Finance Act, 1994. Therefore, service provided without any consideration or complimentary services for which no fees is charged is not taxable as per present regime.
Proposed GST regime
To understand provisions contained in GST Model Law regarding valuation of supply without any consideration we need to refer Section 15(4) of Model GST Law.
Since, there is no transaction value of the supply made without consideration, (transaction value is the basis of valuation wherever consideration is there under Rule 3) Rule 4 or Rule 5 shall determine the value of such supply. Rule 4 is somewhat similar to the present valuation mechanism as given in the Excise Law mentioned above with much more clarity on the same.
Rule 4 provides that where the value of supply cannot be calculated as per the general Rule 3, the value to be taken for taxing such transaction shall be the value of similar goods/services of same type or quantity supplied at or nearest to the time of such free supply to some other customer subject to some adjustments in the value so arrived mentioned in the said Rule to be made by officer like difference in the dates of supply, quantity levels, quality, design.
For example, if a dealer is giving free chocolate fruit bars as their promotional activity, the value of such chocolate fruit bars chargeable to tax under GST as per Rule 4 shall be the value of the other similar chocolate bar of same type (like, fruit in our case) or quantity (say 50 gms) which is sold by the company nearest to the supply of free chocolate bar, say Rs. 10/-. Yes, some adjustments can be made in the value so arrived, i.e. Rs. 10/- in this case based on the difference in quantity or quality.
Further Rule 5 says that in case Rule 4 cannot apply i.e. similar kind and quality products are not available to compare, then we may follow the ‘computed value’ method in which value can be derived by arriving
Cost of production, manufacturing or processing and in case of supply of services, cost of provisioning of such services; and,
Charges for brand or designing in regard with such supply; and,
Amount generally charged as profit and general expenses while rendering similar services or supplying similar goods.
Status of taxability of supply without consideration in International VAT (GST) Laws
Supply of goods
European Union – Council Directive 2006/112/EC issued by European Union contains the common provisions of VAT for the members of the European Union. Article 16 of Chapter 1 of Title IV of such directive provides that supply of goods for business purposes like free samples or gifts of ‘small value’ shall not be considered as supply of goods for consideration. In other words, if goods are supplied for more than “small value” for business purposes, it shall be considered as supply with consideration and taxable under such law. Now such amount of “small value” has been provided differently under laws of each member country of European Union.
Ireland VAT – VAT Consolidation Act 2010 along with VAT Regulations 2010 issued by Irish Government provides that any goods supplied in the course or furtherance of business, cost of which excluding VAT to the donor is exceeding €20* (excluding VAT) whole value shall be deemed to have supplied for consideration which is chargeable to VAT under Irish Laws.
Further, in case repeated gifts had been made to the same person concession limit of €20 shall not be allowed to the person making such gift.
U.K. VAT – Value Added Tax Act, 1994 governs the provisions relating to regarding taxability of free supplies and clarifies that gifts made in the course or furtherance of business is chargeable to VAT provided cost to the donor for acquiring or producing such goods is more than £50.
Although, such limit of £50 is to be calculated taking into consideration the total cost of such gifts made to the same person in any 12-month period. Also, any supply made by an employer in respect of catering of food or beverages or accommodation in a hotel, inn, boarding house or similar establishment to his employee is not chargeable to VAT and its value shall be taken as nil.
Supply of services
Supply of Services without consideration in the course or furtherance of business has not been covered anywhere under the definition of ‘supply’ under neither Ireland VAT nor U.K. VAT. However, self-consumption of service or service without consideration for private purposes like, for own self or for staff are covered under the definition provided in these laws and thus, taxable.
Critical Issues under Valuation Mechanism contained in Model GST Law
Based on the analysis of the draft provisions of Model GST Law and international practice, there are certain issues which will require clarification for better compliance:-
No monetary threshold limit for exemption – As mentioned above, under International VAT laws, both the Irish Laws as well as U.K. Laws relating to VAT contains a limit for taxing the supply without consideration, i.e. €20 in case of Irish VAT and £50 in case of U.K. VAT. Whereas no such monetary limit has been given under the draft GST Law and even a small supply of negligible value shall be taxable under proposed GST regime. Introduction of such monetary threshold limit for taxing a supply might provide an ease to the taxpayers as it will provide that transactions made free of cost above such limit will only be taxable.
No provisions for repeated supply of gifts/free samples – Although, in case threshold limit is prescribed on a later date or under the final GST law, still there will be a need of a provision for repeated supply to a same person to avoid tax evasion. In other words, as can be seen from above, Irish VAT as well U.K. VAT contains provisions in case repeated gifts has been made by a person to the same person, provision of such cases will also be required but only in case if threshold limit is prescribed later. For example, let say the limit for taxing a certain free supply is Rs. 2000/- up to which no tax will be levied under GST. In order to avoid tax, a person who has to send goods worth Rs. 5,500/- may send his goods in instalments repeatedly to the same person valuing less Rs. 2,000/- in a single transaction. Therefore, provision for repeated supply to same person will also be required in case threshold limit for tax is prescribed under GST laws.
Value of similar services under Rule 4 will be a challenge– Under Rule 4 of GST Valuation Rules, value to be adopted for services supplied free of charge, i.e. without consideration is to be taken based on the transaction value of ‘services of like kind and quality’ which are supplied nearest to such free supply. However, definition of ‘services of like kind and quality’ given under Rule 2(1)(c) of the Rules which among other things, also provides for services which are similar in quality and reputation. Now the problem arises as to how to determine the quality of the services so supplied free of cost and compare it with the services supplied at the same time for consideration for taking its value. Quality of goods can be determined but in case of services which are intangible in nature, it is difficult to determine and compare the quality of two services. Also, a clarification is needed as to what is referred by the term ‘reputation’ of similar services. Therefore, it will cause hardships to the taxpayer in some instances while comparing other taxable services for determining the value of free supply of services.
Value of similar services/goods under Rule 5 – Under Rule 5 of GST Valuation Rules, value to be adopted for services supplied free of charge, i.e. without consideration is to be taken after summing up certain amounts which is already discussed above. One of the amount is on account of “charges for design or brand”. Here, the problem arises as to how the value of brand incorporated in goods/services shall be determined. For example, Tropicana supplies a free pack of juice to one of its customers which it usually sells for Rs. 50/- and while determining its value for tax purposes and referring to Rule 5 for such purposes, how it will determine as to what is the brand value of Tropicana incorporated in that Rs. 50/-. Therefore, proper costing methods and a better clarity is further required for valuation of goods/services supplied without any consideration in order to avoid litigations on valuation issue.
Other Instances of “supply without consideration”
Some of the other instances of supply without consideration can be “Buy one get one offer and industrial samples”. Let’s us review them one by one.
Buy one get one offer – This method is very commonly followed by market for promotion of their products wherein they are giving away second product free of cost with the product which buyer is purchasing like, buy one pack of juice and get another one of same quantity or lesser quantity free. What consumer ultimately paying is for one product only and manufacturer is giving away second product free of cost to the consumer. This is appropriately covered under the fifth clause of Schedule-I of Model GST Law wherein the second product is supplied without any consideration by a taxable manufacturer/dealer in the course or furtherance of his business.
Following this proportion, it can be visualized that such transaction will be covered under definition of supply and taxable under proposed regime. In case answer is Yes, then issue will arise as to what will be the value of second product given away under ‘buy one get one’ type of schemes to be taken for the purposes of levying tax on such supply?
Valuation Method – For valuation method of article supplied free of cost under ‘buy one get one offer’, we may compare the provisions contained under Model GST Law as well as contained under one of the member country of European Union, say Irish Laws.
Ireland VAT law covers such transactions of ‘buy one get one’ under Mixed Supply of Goods and Services given under Section 47 of the VAT Consolidation Act, 2010. There are two types of transaction under Irish VAT which are Multiple Supply and Composite Supply given under the said section wherein Multiple Supply includes those transactions where two or more supplies are made and which are capable of being differentiated as an individual supply and composite supply includes a principal supply and ancillary supplies.
Valuation mechanism of multiple supplies under Section 47 is given as consideration for the total supply should be apportioned among each constituents of the transaction on a reasonable basis like, splitting the consideration on the basis of proportion of cost or market value of the constituents and every constituent shall be taxed in their individual capacity as per the rates in force. Therefore, under ‘buy one get one offer’, consideration charged for one product should be apportioned among the other product given away without consideration and both such products shall be taxed in their individual capacities on the value so apportioned.
E.g. a free bar of chocolate will be given with the purchase of coffee jar, value of which is Rs. 1,500/-. As per Irish VAT laws, Rs. 1,500/- is for both chocolate as well as coffee jar and it should be allocated on any reasonable basis among them, say, Rs. 1000/- for coffee jar and Rs. 500/- for chocolate bar. Now, such coffee jar shall be taxable at Rs. 1,000/- at the rates in force in respect of its taxability and similarly, chocolate bar at Rs. 500/- at the rates in force. It might be possible that one of the item is non-taxable or exempt in their individual capacity. What is to be seen is their individual taxability after splitting.
Model GST Law
There is no specific provision prescribed under Model GST law. Only inference we can take from Rule 4 and Rule 5 which can be used in case law permits to split such supply i.e. buy one get one.
Industrial Samples/Free Samples – These are the samples which are given away free of cost by the company manufacturing that product for testing purposes in order to procure bulk orders of such product. For example, pharmaceutical companies supply their medicines free of cost to doctors/hospitals/clinics so that they may test their product for quality and its uses and can order in bulk quantities in case of hospitals/clinics.
Such free samples/industrial samples are adequately covered under “supply made without consideration in the course or furtherance of business” and proposed to be taxable under Model GST Law.
Ireland VAT law specifically provides that industrial samples are exempt under their law provided some conditions are fulfilled which are listed as below –
Gift should be of industrial samples;
in a form which is not ordinarily available to the general public;
made in reasonable quantities;
to an actual/potential customer.
Present tax structure in India-
Such products are also taxable under present Excise law. There are various case laws which covers issues relating to valuation of products supplied as free samples by pharmaceutical companies
Indian Drugs Manufacturer’s Association vs. Union of India 2008 (222) E.L.T. 22 (Bom.) seeks to clarify that the valuation in respect of physician samples cleared for free distribution is to be made in accordance with Rule 4 of the Valuation Rules, 2000, i.e. general rule of valuation instead of making it under Rule 8 or Rule 11 of the Rules.
Blue Cross Laboratories Limited vs. Commissioner of Central Excise, Mumbai 2006 (202) E.L.T. 182 (Tri.-LB) also provides for same valuation rule in respect of free physician samples. In relation to adjustments to be made in case of comparable goods, it was observed that “No straight-jacket formula can be laid down for indicating the types of adjustments which are required to be made; but the guidelines provided by the said proviso indicate the nexus between the adjustments and the difference in the characteristics of the goods excisable not sold and the comparable goods. If the value of the excisable goods under assessment cannot be determined under sub-clause of clause (b) of Rule 6, meaning thereby that where there is no value of comparable goods available and therefore no scope for the proper officer to make adjustments as per the proviso to sub-clause (i) of sub-clause (b) of Rule 6, then only the costing method can be resorted to under sub-clause (ii) of sub-clause (b) of Rule 6, but not otherwise.”
Aforementioned decision of Blue Cross Laboratories was also followed by larger bench of Hon’ble Ahmedabad CESTAT in the matter of Cadila Pharmaceuticals Ltd. vs. Commr. of C. Ex., Ahmedabad-II 2008 (232) E.L.T. 245 (Tri.-LB).
Model GST Law
As already mentioned above, valuation of such transactions will be made in accordance with provisions contained in Rule 4 or Rule 5 of Valuation Rules, as the case may be, i.e. either by taking the value of the similar product sold for consideration nearest to such offer after making some adjustments or by taking cost of such product given away free of cost after adding cost of brand or design along with profit margin which the dealer usually charges on such product.
With the inclusion of Schedule I in the Model GST Law, the intention of the law is to expand the scope of levy of indirect taxation up to the supplies which are taking place even without consideration which is not in consistence with the present structure. Supplies without consideration will have larger ramification with real life situations. We have analyzed only three situations to start as food for thought. As per analysis provided above to avoid any litigations and ease of doing business there are well defined provisions internationally for the taxation of free supplies based on experience. Apart from handling valuation, there will remain an ambiguity as to what constitutes adjustments under Rule 4 and 5 of the proposed law? The taxability of free supplies will remain an issue of hiccups until specific valuation rules will not be issued or there will be more clarification on the proposed GST Valuation Rules.
Atul Kumar Gupta
B Com (Hons) FCA, FCMA, LLB, MIMA, CIQA, PGDEMM
Central Council Member of ICAI (2016-2019)
Former Chairman NIRC of Institute of Chartered Accountants of India
Former Chairman NIRC of Institute of Cost Accountants of India
Author of “Comprehensive Guide to Service Tax”
& “GST Concept & Roadmap”