The background
The GST Act has merged taxability of goods and services under one act. Under GST, the taxable event is “supply of goods or services” from one taxable person to another taxable person. Section 7 of the CGST Act, 2017 defines the term “supply”. As per the definition of “Supply” amongst other things, “consideration” is mandatory. However, there are certain types of transactions which are covered under the ambit of “supply” even though there is no consideration for such transactions. Schedule I of the CGST Act, 2017 provides the list of the transactions which are covered under the definition of “supply” even though there is no consideration for such transactions.
One of the transactions in Schedule I is “Supply of goods or services or both between related persons or between distinct persons as specified in section 25, when made in the course or furtherance of business”. The taxability of transaction between the head office and branches is covered under this entry. In other words, by virtue of this entry, the transactions between the “distinct persons” are covered under the ambit of GST. The words “distinct persons” has been defined under the CGST Act, 2017 which reads as follows:
Where a person who has obtained or is required to obtained registration in a state or union territory in respect of an establishment has an establishment in another state or union territory, then such establishments shall be treated as establishments of distinct persons for the purposes of this Act
With the above legal fiction, the transactions between the head office and branches or vice-a-versa or between branches are covered under the ambit of GST.
The intent of GST law to tax branch transfers was clear with the above provisions. However, as there was no consideration for these transactions, the valuation was the next issue to be addressed. To address the issues of valuation, Rule 28 under the CGST Rules, 2017 was inserted. The Rule 28 of the CGST Rules, 2017 states as under,
Rule 28 – Value of supply of goods or services or both between distinct or related persons, other than through an agent
The value of the supply of goods or services or both between distinct persons as specified in sub-section (4) and (5) of section 25 or where the supplier and recipient are related, other than where the supply is made through an agent, shall-
(a) be the open market value of such supply;
(b) if the open market value is not available, be the value of supply of goods or services of like kind and quality;
(c) if the value is not determinable under clause (a) or (b), be the value as determined by the application of rule 30 or rule 31, in that order:
Provided that where the goods are intended for further supply as such by the recipient, the value shall, at the option of the supplier, be an amount equivalent to ninety percent of the price charged for the supply of goods of like kind and quality by the recipient to his customer not being a related person:
Provided further that where the recipient is eligible for full input tax credit, the value declared in the invoice shall be deemed to be the open market value of the goods or services.
On careful consideration of above rule read with 2nd proviso, it can be appropriated that in case the recipient (branches in this case) is entitled to full input tax credit, the value declared by the supplier (in tis case HO) will be accepted as “open market value” for the purpose of payment of GST.
In other words, the rule provided flexibility for valuation of goods or services when the recipient is entitled for full input tax credit of such goods / services.
The dispute
The provision of the CGST Act, 2017 and Rules made thereunder were amply clear in terms of taxation of goods / services and valuation thereof. However, the department (particularly DRI) started issuing notices to the taxpayers demanding GST particularly on the services between Head office and branches commonly termed as “Cross Charge”. The department also raised notices challenging the valuation of cross charge services. Some of the taxpayers applied for Advance Rulings to get clarity on the cross charge i.e. its mandate and valuation. Some also appealed against the Advance Ruiling order on the matter. Few appellate advance rulings order which are important to note are as follows:
M/s. Columbia Asia Hospitals Pvt. Ltd (GST AAAR Karnataka) :
India Management Office (IMO) of the Appellant is providing a service to its other distinct units by way of carrying out activities such as accounting, administrative work, etc with the use of the services of the employees working in the IMO, the outcome of which benefits all the other units and such activity is to be treated as a taxable supply in terms of the entry 2 of Schedule I read with Section 7 of the CGST Act, 2017
Cummins India Limited (GST AAAR Maharashtra) :
- The activity of the HO availing ITC for common input supplies on behalf of the company’s branch offices/ units does qualify as supply and would attract the levy of GST.
- The HO is not entitled to avail the ITC of such common input supplies and thus needs to register itself as an ISD as per Section 24 of the CGST Act, 2017 and distribute such availed common ITC to the company’s branch offices/ units.
- The valuation should be determined as per the second proviso of Rule 28(c) of CGST Rules, which provides for adoption of invoice value as the open market value in case the recipient is able to avail full ITC of the GST so charged.
- As regards the salary of HO employees AAAR observed that since the supply is made by the HO to its branch offices/ units, salary of employees of HO should also be allocated.
The above two rulings have paved way for multiple litigations on taxability as well as valuation of services between head office and its branches.
Though the issue has been lingering since 2018, the GST council took note of the same in the year 2023. The aforesaid controversy was tabled before the GST Council in its 50th meeting wherein it was decided and recommended to clarify that ISD mechanism is not mandatory for distribution of input tax credit of common input services procured from third parties to the distinct persons and to clarify issues regarding taxability and valuation of cross charge i.e internally generated services.
The Resolution
Post 50th GST Council meeting, the CBIC has issued circular clarifying various issues related to taxability of services provided by an office of an organisation in one State to the office of that organisation in another State, both being distinct persons (Circular no: 199/05/2023-GST dated 17th July 2023).
The CBIC clarified its position in case of taxability of cross charges and valuation thereof by bifurcating the services of head office in two broad categories i.e.,
- Third party services (like services used by branches but billed at head office)
- Internally generated services (HO providing own services to branches)
Based on the above categorization, it has clarified as under,
The circular has brought some welcome clarifications like,
- ITC on common input services procured by the Head Office (HO) from a third party but attributable to both HO and Branch Office (BO) or exclusively to one or more BO, can be distributed through ISD or by raising tax invoice.
- In case of internally generated services, the value of supply of services made by a registered person to a distinct person needs to be determined as per rule 28 of CGST Rules.
- In case BO is eligible for full credit, value declared on the invoice including Nil value is acceptable.
- It is not mandatory to include cost of salary of employee of HO for calculating service provided by HO to BO.
The Way forward
“Better late than never”, the CBIC department follows this principal. However “late” … this is a welcome clarification and taxpayers will be able to address their open litigations based on these clarifications. The valuation flexibility provided as per Rule 28 can be used strategically to address the issues of blockage of ITC. However, taxpayers having exempt supplies will have to carefully value cross charge services.
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