In our previous article published in the 82nd issue of Tax Amicus in April 2018 (https://www.lakshmisri.com/News-and-Publications/Publications/Articles/Tax/relevance-of-amortization-for-valuation-under-gst-law), we highlighted the inconsistency arising out of a joint reading of Section 15(1) of the CGST Act and Circular No. 38/12/2018, dated 26-3-2018, regarding inclusion of amortized value of mould in job work charges for payment of GST by the job worker. Various representations were made by trade and industry in this regard and it was expected that CBIC would clarify the position to end the anomaly.
CBIC has been proactive in clarifying various issues under GST law. It has recently clarified certain issues by way of Circular No. 47/21/2018-GST, dated 8-6-2018. One of the issues addressed in this circular pertains to tax implications on free of cost (FOC) supplies and the need for reversal of input tax credit (ITC) in such cases. In addition to providing clarification on the above issues, this circular also tries to throw some light (or rather add to the anomaly) on the un-posed query on valuation and amortization.
The transaction addressed in the latest circular is very common in the automobile industry, wherein Original Equipment Manufacturers (OEM) place order on Component Manufacturers (CM) for manufacture and supply of components, and the mould and dies owned by the OEM are given to CM for free.
As the transaction under consideration contemplates payment of tax and reversal of ITC in certain circumstances, it would be relevant to keep in mind a recent amendment by way of insertion of second proviso to Rule 37(1) of the CGST Rules by Notification No. 26/2018-Central Tax dated 13-6-2018. The amendment allows the recipient to retain the ITC on the amount added in terms of Section 15(2)(b) of the CGST Act, even when the payment towards the value of supply and tax thereon is not made to the supplier within 180 days from the date of his invoice.
We would now proceed to analyze the circular dated 8-6-2018 under two broad scenarios. As per para 1.1 of the circular, the mould owned by the OEM, provided to the CM, does not constitute a supply as there is no consideration involved (say, Scenario 1). On the other hand, as per para 1.3 of the circular, the mould which was required to be procured by the CM, but supplied by OEM on FOC basis, is required to be added to the value of components by way of amortization (say, Scenario 2). The circular seems to take two different positions on the liability to pay tax by the OEM based on his terms of contract with the CM.
In our understanding, the transaction between unrelated persons is generally regulated by market forces. If the contract specifically requires CM to procure mould and the same is given to him by OEM for free, then the CM would readily agree for OEM to deduct payment towards the value of the mould from his invoice. The question of amortizing the value of mould in the value of component arises only if the price of the component is suppressed, resulting in short payment of tax by CM, taking into account the entire contract.
In so far as the eligibility of ITC of GST on the mould is concerned, the recent circular clarifies that the OEM can take such ITC under Scenario 1 as the same is provided in the course or furtherance of his business. It is also clarified that under Scenario 2, the ITC is not eligible in the hands of OEM as the mould is not considered to be provided to CM in the course or furtherance of OEM’s business. This contention in the circular may have to be agitated as it intends to narrow down the scope of ITC under GST law.
It is interesting to note that the OEM has procured the mould by himself in both the scenarios; however, he is allowed to take ITC only under Scenario 1. As per the circular, the mould is not used in the course or furtherance of business of OEM under Scenario 2. It therefore follows that the mould is used in the course or furtherance of CM’s business and hence he should be eligible to take ITC of GST paid on such mould, subject to the satisfaction of other conditions under Section 16(2) of the CGST Act.
One primary condition for taking ITC relating receipt of goods is already met by the CM. Another important condition, for retaining the ITC, as prescribed under the second proviso to Section 16(2) is that the amount towards the value of supply along with tax should be paid to the supplier within 180 days from the date of his invoice. As per the circular, the mould is “supplied” by OEM to CM on FOC basis, so no payment of consideration can be expected for such transaction. However, insertion of second proviso to Rule 37(1) of the CGST Rules would allow the CM to take ITC even when the payment towards the value of supply and tax thereon on account of the amount being added in terms of Section 15(2)(b) of the CGST Act, i.e., the value of the mould, is not paid to the OEM within 180 days from the date of his invoice.
The Departmental Authorities may however contend that the amendment to Rule 37(1) is only meant to allow ITC of GST on the amortized value of mould in the component, in the hands of the OEM and not to allow the CM to take ITC of GST on the mould. Also, unlike the amendment to Rule 96(10) of the CGST Rules, relating to restriction in claiming refund of GST paid on export of goods right from 1-7-2017, the amendment to Rule 37(1) seems to be prospective. Therefore, retaining ITC on the amount added in terms of Section 15(2)(b) of the CGST Act, even when payment for such amount is not made within 180 days from the date of invoice, for the period prior to 13-6-2018 may act as a hanging sword of ‘tax liability’ along with continuously ticking ‘interest’ meter.
In our view, the artificial restriction of barring ITC under Scenario 2 is contrary to the general principles under which the GST operates and the same needs to be deliberated further by the authorities. If a particular contract requires CM to procure the mould, but the same has been “supplied” by the OEM, then one way to overcome the ITC restriction as per the circular would be for the OEM to generate a tax invoice for supply of mould to CM. This would be equivalent to reversal of ITC by OEM as contemplated in the circular.
As per the Westminster Principle, based upon the observations of Lord Tomlin in the case of Inland Revenue Commissioners v. Duke of Westminster [(1936) AC 1],tax planning may be legitimate provided it is within the framework of law. Payment of tax will satisfy the requirement of ITC reversal as contemplated in the circular and the CM can in-turn take ITC of GST on the mould and utilize such ITC towards payment of GST on supply of component, including the amortized value of the mould in the transaction value, in terms of Section 15(2)(b) of the CGST Act. This would ensure effective utilization of the ITC rather than it being lost in the process of reversal.
[The authors are Principal Associate and Associate, respectively, in GST Practice in Lakshmikumaran & Sridharan, Bangalore]