Applicability of GST on Cross ChargeNovember 20, 2019

Strictly for private circulation only

Developments on the issue of cross-charge

Karnataka AAAR in Columbia Asia Hospitals

• Ruling : The India Management Office (IMO) 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 employee working in the IMO, the outcome of which benefits all the other units and such activity is to be treated as a taxable supply

⎼ The employee-employer relationship is to be viewed separately for every registered unit of the business entity, cost of employees working in the IMO is an integral part of the cost of services rendered by IMO

• Distinction between ISD & cross-charge

⎼ Only ITC on input services which are attributable to other distinct entities are distributable : No element of service, but mere distribution

⎼ In a cross-charge mechanism, expenses incurred by a distinct person for the purpose of carrying out activities the outcome of which benefits other distinct persons is required to be cross charged

o There is an element of service

Draft cross-charge circular

Company HO (State A)

Office/Branch (State B)

Distinct persons

Software development

Client

Office/Branch (State C)

IT Services

Vendor

Common functions at HO

e.g. IT, HR, Admin, taxation

Software developmentDistinct persons

2

1

3

4

In the above diagram:

1 – Third party cost attributable to the multiple offices / branches

2 - Employee related expenses + other common expenses incurred for HO related activities

3 & 4 - Branches undertaking services for ultimate servicing to client

Third party services• Audit• Legal• Rent• IT support• Warranty • Market survey• Market research

Draft Circular

Draft cross-charge circular

• Is it mandatory to distribute ITC in respect of input services procured by HO but attributable to both HO and branches following the ISD procedure

⎼ Yes, ISD is mandatory• Will the input service procured by HO from a third party for use by the branches the

ITC of which is distributed in accordance with the ISD procedure, be treated as a supply by HO to the branches and will it be taxable in the hands of HO

⎼ No, services procured by HO from a third party for use at HO and branches, or exclusively for use by branches, the ITC of which is distributed in accordance with ISD, would not be separately treated as supply by HO to the branches

• HO expenses on procurement, distribution and management of common input services

⎼ Separate service provided by HO to branches – to be separately invoiced, it is for HO to value the services

Draft Circular

Draft cross-charge circular

• HO generated services such as common administration by maintaining common administration team for branches & HO or common IT maintenance team through a maintenance team at HO, where the team members are employee of the HO

⎼ Whether employees at HO are providing service to the branches is not the correct perspective to be determined

⎼ the correct perspective would be to determine whether the HO and branches are providing services to each other and not whether the employee of HO is providing services to the Branches

• Value of services – to be determined per Section 15(4) read with Rule 28

⎼ Open Market Value à the value of supply of service of like kind and qualityà110% of cost of provision of services / reasonable means consistent with the principles and general provisions

⎼ If full ITC available, value declared is deemed OMV

• Need to apportion expenses incurred by HO to another office – to be done based on information maintained in its normal course of work, only exception is ISD

Draft Circular

Press Note dt 15/11/2019*

• Services by an employee to the employer in the course of or in relation to his employment is outside the scope of GST

• Offices of an organization in different States are regarded as distinct persons, hence, what is taxable under GST is supply of goods and services by the HO to its branch office/s and vice versa

⎼ Any tax charged on such supplies is available to the recipient as input tax credit

⎼ Not any additional cost - it is a worldwide practice under the GST laws

• GST charged on prices / charges by any supplier of goods or services from his consumers does comprise of all costs including cost of raw material, capital goods, input services and employee costs, etc.

⎼ This does not mean that salaries paid to the employees by the employer are being taxed under GST

* Reported by Media, however, not on PIB website

International laws on self supply

Country Legal Provision/ Ratio emergingEuropean Union

• Transfers between different parts of the same legal entity not treated as supply for VAT [FCE Bank C-210/ 04 (2006)]

• Supplies, made by a VAT-grouped company (including a branch) to its overseas branch (or head office) are treated as supplies made by the VAT group to a third party and vice-versa [Skandia America Corp. (USA), filial Sverige (C-7/13)]

Singapore • Supplies made between the divisions or businesses of the same entity are disregarded for GST accounting purposes. Similarly, GST is not chargeable on allocation of expenses to the various divisions.

• Divisional registration does not alter the GST-registered person's GST liability. The parent body is still legally liable for the divisions.

Australia / New Zealand

• An entity cannot make a supply to itself – Goods and Service Tax Ruling 2006/9• Exception – Division 54 provides for obtaining separate registration for branches. In

such instances all transfers of anything by the parent entity to any GST branch of the parent entity, that would have been supplies made to the branch if it were an entity, were supplies made by the parent entity

• Test to satisfy is whether supply would have qualified as supply to independent third party

UAE • Self-supplies are not taxable. This includes instances where one member of a tax group provides services to another member of the same tax group

Legal Analysis

Legal points for discussion

1) Whether there is a ‘supply’ by HO to branches for common functions such as HR, IT, Taxation etc.?

2) Whether the value of such supplies will include employee cost?

3) The charging mechanism fails and therefore, no tax can be levied

Supply under GST• GST is leviable on ‘Supply’ of goods or services or both made for a consideration by

a person in the course or furtherance of business• Schedule I : Supply of goods or services between distinct persons when made in the

course or furtherance of business : Liable even if without consideration

⎼ Elements of ‘supply’ first need to be satisfied, ‘Supply’ not defined : In common parlance, ‘supply’ means “to provide”

⎼ Contractual arrangement / obligation ‘to provide’ services by a ‘supplier of services’ to a ‘recipient of services’ necessaryo No agreement / obligation ‘to provide’ any services to the branch(s)o Services received by HO and not distributed are consumed by HO / used

for own-self for performing its obligations as the HOo Mere incidental use by branches cannot be treated as an activity of ‘supply’

• Legislative intent for introducing the concept of ‘distinct persons’

⎼ Destination based consumption taxation : POS is the HO and not the branch

⎼ To ensure seamless transfer of credit in the economic chain so that the ‘tax sticks’ only to the last leg/ final consumption state – Avoids cascading effect

⎼ Probably the intent was taxing stock transfer of goods as under the VAT regime

Supply under GST – ‘employee to employer’

• ‘Supply’ excludes activities in Schedule III : Services by an employee to employerin the course of or in relation to his employment

• Employee is employed for carrying out duties under the employment contract for the legal entity as a whole & not for a specific location based on physical presence

⎼ Tech Mahindra Vs. CCE, Pune - 2016 (44) S.T.R. 71 (Tri. - Mumbai)

o “The activity of the head office and branch are thus inextricably enmeshed. Its employees are the employees of the organization itself. There is no independent existence of the overseas branch as a business.”

⎼ Agencia Commercial ... vs Custodian Of The Branches [1982 AIR 1268]

o It is settled law that a body corporate and its branches are not distinct and separate entities from each other, that the branches constitute mere components through which the corporate entity expresses itself and that all transactions entered into ostensibly with the branches are in legal reality transactions with the corporate body and that it is with the corporate body that a person must deal directly.

⎼ Costs incurred by the HO is towards fulfillment of its legal obligation and not any ‘supply’ of any service to the branch

Supply under GST – ‘employee to employer’

• Terms used are ‘employee to employer’ and not ‘employee to distinct person’, term ‘employer’ not defined, meaning to be understood in common parlance

⎼ Oxford Dictionary : “a person or organization that employs people.”

⎼ Employees’ Provident Funds Act : “employer” means…in relation to an any other establishment, the person who, or the authority, which has ultimate control over the affairs of the establishment

o establishment consisting of different departments or branches, whether situated in the same place or not treated as parts of same establishment

⎼ Payment of Gratuity Act, 1972 : the person, who, or the authority which, has the ultimate control over the affairs of the establishment,…company

• Services are provided by the ‘employees’ to the legal entity (employer) as a whole and there is no separate supply of service by HO to branch

• The concept of ‘distinct person’ cannot be stretched to tax something (salary cost) by deeming fiction, which is per se not taxable under the GST Law

Charging mechanism fails• Value of services – to be determined per Section 15(4) read with Rule 28

Valuation mechanism CommentsOpen Market Value (OMV) OMV for the services not available

The value of supply of service of like kind and quality

Not possible to identify like kind or quality as it is Company specific

110% of cost of provision of services Difficult to determine what would constitute cost. Exact allocation of cost for time spent by employee towards a specific branch may not possible e.g. it is not possible to identify how much time a Director would be spending on work related to HO, even not possible for department to establish

Reasonable means consistent with the principles and general provisions

Would still require allocation of employee cost which is difficult to determine. Also, methodology too vague

As the charging mechanism fails, tax cannot be levied even if ‘supply’ is assumed

Implications & Way forward

Implications for taxpayers

• Possible scenarios

⎼ Companies who have neither followed ISD nor cross-charge mechanism

⎼ Companies who have followed ISD mechanism, but not done cross-charge

⎼ Companies who have only done cross-charge, not levied GST on employee cost : either from the date of introduction of GST / subsequently

o Accepted the view that there is a ‘supply’ if not paid ‘under protest’ and hence, could result in demand of GST on attributable employee cost interest consequences

⎼ Companies who have done cross-charge, and levied GST on employee cost : however subsequently

o Interest exposure• The view of the Government as evident from the Draft Circular & the Press note

seems to be that GST applicable on common functions provided by HO to the branch

⎼ Could result in issuance of issuance of SCN and litigation

Way forward – Practical approach

• Companies may consider the following:

⎼ ISD registration for third-party expenses which are attributable to branches : All expenses at HO should be taken in ISD and then distributed

o Authorities questioning not taking of ISD registration, view also articulated by the Draft Circular that ISD is mandatory

⎼ Levying GST on cross-charge (HO to branch services or vice-versa) and pay the same under protest on a going forward basis

• Option to be evaluated after considering the following:

⎼ Availability of credit to the recipient locations

⎼ Cash outflow issues and possibility of utilization

⎼ Even if employee cost is not considered – cross charge a fixed amount under the deemed OMV concept

⎼ Could result in substantial compliance burden (a company having branches in 30 States may have to raise 900 GST invoices, all of which could be creditable) - however, would avoid unwarranted litigation

Way forward – Legal resolution

• Don’t file an application of Advance Ruling – if negative, would lead to a legal compulsion to charge GST

• File an immediate Representation on the issue with the GST Council/CBIC

⎼ Legal arguments as discussed aforesaid

⎼ Any levy would lead to substantial litigation across the taxpayers

⎼ Levy of tax leads to substantial impractical difficulties and is difficult to operate, any levy should justify costs incurred to administer such levy

o Increase in compliance burden and complicates the structure of GST, credit available in most cases and hence revenue neutral

o Artificial attribution / allocation of costs is in any event not in line with the concept of GST / destination-based consumption tax

⎼ Additional point on past practice of cross-charge vs. ISD / giving legal sanctity to cross charge

• Writ petition if negative Circular issued / Notices received – Petitions could be kept ready

Questions ?

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