Popularly known as Pharmacy of the World, Indian Pharmaceutical Industry plays a vital role in manufacturing and supplying of medicines around the globe. Industry has grown tremendously over the last few decades to became one of the biggest pharmaceutical exporters, exporting pharma products to over 200+ countries. In FY 2022-2023, the pharma industry has experienced $25.26 billion export of pharmaceuticals and is expected to reach $130 billion by FY 2030. To conform the expectation and to cater the world, the industry is engaging with various service providers from outside India frequently and establishing legal entities outside India to strengthen seamless flow of pharmaceutical supply.
To aid the industry and to ease and encourage domestic manufacturing, various Production Linked Incentive (PLI) Schemes and other incentives have been brought by the Government, introduction of Goods and Services Tax (GST) in 2017 has been one of the steps to achieve ease of doing business in India. Since 2017, the Central Goods and Services Tax Act, 2017 (here and after referred to as “the CGST Act”) and the rules thereunder have undergone various amendments. Due to lack of interpretative content on a few amendments, pharma sector has often experienced various challenges in import, export and availing services from outside India.
In this article, we will discuss such key challenges faced by the pharma industry in GST which may affect the industry in their global operations and exports, imports and refunds, which are aside from the issues being faced in marketing and supply chain, procurement and input tax credit, etc, covered separately in this link.
A few key challenges faced by the industry are as follows:
- Challenges in terms of support functions / services provided by holding companies to subsidiaries / branches:
Holding pharma company in India allow usage of its Intellectual Property Rights (IPR) such as logo, brand name to its foreign subsidiaries, branches outside India. Similarly, the foreign holding pharma companies allow usage of its brand name and logo to its Indian subsidiaries, branches.
Para 2 of Schedule I of the CGST Act specifies that supply of goods or services or both between related or distinct persons to be treated as supply even if made without consideration. In view of the same, if an Indian holding company allows usage of its IPR to its subsidiary outside India without consideration, a doubt could arise as to whether the said activity even when made without consideration would still qualify as a taxable supply and attract the valuation as per Rule 28 of the CGST Rules? Further, since consideration is required to qualify as export of service, a doubt could arise that tax needs to be paid in the absence of consideration from subsidiaries. Similarly, when the transaction is with branch, it may not qualify as export of service and may be considered exempt from GST in light of notification in this regard. Or whether the said supply of IPR would be considered as export of services or whether such supply is exempt from tax under the GST Acts?
Similarly, Para 4 of Schedule I of the CGST Act provides that any import of service by a person from a related or distinct person would be a taxable supply even when made without consideration. In view of the same, GST implications could arise by deeming fiction, by treating as import of service.
Such transactions and also transactions like support services, common expenses recovered from group companies abroad, expenses directly attributable to foreign companies but borne in India and reimbursed at full could attract the lens of taxmen. Thus, there is a need to examine these transactions and ensure adequate mechanisms to determine the taxability and accordingly discharge applicable tax thereon, including ITC reversal wherever required.
Further, such transactions will also have implications under Income Tax laws with respect to Transfer Pricing and FEMA implications with respect to payment realisation in convertible foreign exchange.
- Representative Office / liaison office set up outside India:
Various pharma companies establish representative offices / liaison offices outside India which primarily have employees of the Indian co. The intent behind the same is to ensure that the exported goods are received outside India after clearance and are provided to the end customers outside India. Further, such deployed employees also assist the pharmaceutical companies in India to engage with third-party service providers in the foreign market to explore and expand their business outside India.
Explanation 2 to Section 8 of the IGST Act provides that a person carrying on a business through a branch or an agency or a representative office in any territory shall be treated as establishments of distinct persons.
In view of the same, there arises question whether a few employees in a foreign country would amount to establishment of a representative office? If yes, whether the pharma companies are required to discharge tax on the services availed or services provided to such registered office?
Further, when a third-party service provider is engaged by the pharma company with the help of its employees deployed outside India, whether the said services will be construed to be directly provided by the third party to Indian company or will the same amount to supply of service to the representative office. A detailed examination of the contractual and factual understanding needs to be taken into consideration, to examine applicability of GST on reverse charge and applicability of provisions relating to intermediary services.
- Transfer pricing adjustments, product recall, expiry related payments to foreign companies, and Rule 96B:
Pharma sector is one of the very few sectors where the manufacturing entity bears the cost of expired medicines. Additionally, it also bears cost on account of price fluctuations (by way of transfer pricing adjustments with limited risk distributors outside India), cost of product recalls if any.
In such cases where the price charged by exporter for goods gets revised subsequently, applicable debit / credit notes are raised. Here considering the wording of Rule 96B of the CGST Rules which provides for recovery of refund of unutilised ITC or IGST paid on export where export proceeds are not realised, a relevant question arises that whether change in price to a lower amount afterwards would make the exporters ineligible to refund? Here, it is pertinent to note that the exporter has correctly paid tax and/ or availed refund of unutilized ITC/ IGST based on its export keeping all the relevant factors in sight. Whether subsequent adjustment in prices should be a factor for the purpose of granting refund? If refund amount is paid back, whether amount so paid will be re-credited back to electronic credit ledger?
Rule 96B further compels exporters to ponder whether they will be liable to pay IGST on the additional amount received pursuant to debit notes issued?
A clarification is required on Rule 96B with respect to the phrase ‘export proceeds not realised’ to ensure pharma industry does not get deprived of the refund they are otherwise eligible to under the GST law. This should also be in keeping with the mechanism in section 16 of the IGST Act, which only requires a supplier to export the goods without imposing any condition of realizing foreign currency, unlike in case of export of services where there is a compulsory requirement in law to realize the foreign currency.
- Export of goods on payment of Integrated Goods and Services Tax (IGST):
Section 16 of the IGST Act provides for export of goods without payment of IGST (and claim refund of ITC), or alternatively export goods on payment of IGST and claim refund thereof.
The CBIC has amended rule 96(10) of the CGST Rules from time to time. Rule 96(10) of the CGST Rules provides that the exporters who have availed the benefit of advance license, EOU Schemes or concessional rate during import or on inward supply, can export the goods by opting only the second option i.e., without payment of tax and under LUT. After the said amendment, various pharma companies who have either availed benefit during import or the exporters have domestically procured goods from a taxpayer who has availed any import benefit but have mistakenly opted for the option of export on payment of IGST, have faced various challenges with respect to refund.
Since the Rule strictly prohibits refund of IGST to such exporters, various pharma industries have faced this issue where they have paid IGST on export but were denied with the refund of IGST paid. With no relevant provisions under Rule 96(10) for refund of IGST paid on export or re-credit of ITC utilized by such companies while making tax payment during export, this issue has turned out to be dread for pharma industry.
One way of overcoming this mistake is to pay the IGST as applicable on import of such goods/ receipt of goods to fulfil the condition under Rule 96(10) and thereafter avail credit of such IGST paid on import of goods/ receipt of goods. This step would require amendment of Bill of Entry (BOE). However, it has been noticed that often customs department has rejected to amend the BOEs. Absence of amended BOEs raises question as to whether it is possible to avail ITC without amended BOEs in terms of Section 16 of the CGST Act? Further, after the payment of IGST on import/ receipt, whether the exporter will be able to avail refund of the IGST so paid on imports, or the same will lie as accumulated?
The Government can clarify a way forward for the pharma industries to rectify their mistakes without losing on the tax the exporters have deposited with the government exchequers.
Conclusion:
Implementation of GST in indirect taxes in itself is a big step forward towards ease of doing business. However, there still lie certain issues which need to be addressed, including challenges in terms of formula for inverted duty structure, limiting value of export to 1.5 times domestic turnover for refund of ITC, limiting refund on FOB value of exports, issues in relation to R&D sector in terms of refunds and availability of ITC, applicability of GST on out of court settlements and income tax deductibility of such expenses, etc..
This Government has shown its intent to reduce litigation by making amendments, granting clarifications wherever required from time to time. It is only hoped that these issues are also addressed sooner rather than later so as to resolve long pending disputes in relation to global operations, including exports and imports, as also refunds.
[The authors are Partner, Associate Director, and Senior Associate, respectively, in the corporate and Indirect Tax practice at Lakshmikumaran & Sridharan Attorneys, Mumbai]
