The pharmaceutical sector in India plays a seminal position in the domestic and international economy. It provides more than 50 per cent of global demand for several vaccines, 40 percent of generic demand in the US and 25 percent of all medicines in UK. The value of this sector has been estimated at $42 billion in 2021, and it is expected to reach $65 billion by 2024[1].
India saw a monumental alteration in its tax regime on July 1, 2017, when the government implemented GST that effectively replaced a range of taxes including excise duty, service tax, sales tax etc. The implementation of GST has resulted in mixed reactions from the pharmaceutical sector on whether the reform has brought about positive changes in the economy. In addition to issues arising under GST, some challenges are being faced by the pharmaceutical sector from Income Tax perspective which have interplay with GST as well.
In this article, we will delve into the key issues which are relevant for the Indian pharmaceutical industry from a marketing and supply chain perspective.
Issues to ponder
Historically one common issue for the pharmaceutical industry in India has been the deduction claimed on various sales promotion expenses and their legitimacy as business expense. With the advent of GST & implementation of Section 194R under the Income Tax Act, the classification of these expenses for taxation purpose have become over complicated. Though a number of Circulars have been issued by CBDT & CBIC to address these issues in the past, a few of the issues impacting the pharmaceutical industry which remain unresolved till date, are briefly touched upon.
1. Credit notes issued in respect of promotion schemes
There are a number of promotional schemes run by the pharmaceutical sector with an objective to boost their sales. It includes temporary price reductions, volume discounts, cash discount, target linked payouts, other incentives for the distributors or retailers, which are offered post sale.
The CBIC vide Circular No. 92/11/2019-GST dated 07.03.2019, has clarified that secondary discounts which are not known at the time of supply shall not be excluded while determining the value of supply as the conditions laid down in clause (b) of sub-section (3) of section 15 of the CGST Act are not satisfied. In such cases, financial / commercial credit note(s) can be issued by the supplier as a commercial transaction between the two contracting parties.
Even though it has been clarified that commercial credit notes can be issued for payouts for which deduction cannot be claimed under Sec 15 of CGST Act, there may yet arise the following disputes,
- Whether such payouts qualify as a discount or a service consideration for the supply of marketing promotion service from distributors /retailers?
- Whether such payouts can be considered as third-party consideration, where such payouts are given in respect of price reduction offered by the distributors for further sales made by them to retailers or any target-based incentive offered by distributor to retailers?
- Whether distributor can avail full credit on the GST charged on initial supply, when a portion of consideration is not paid due to issuance of commercial credit note by the supplier?
2. Implications on post sales discounts under Section 194R of Income Tax
The CBDT vide Circular Number 12 of 2022 dated 16.06.2022 has clarified that no tax is required to be deducted under Section 194R on sales discount, cash discount and rebates allowed to customers. Thus, a discount passed on by a seller to a customer in respect of a sale, irrespective of the form, will not be treated as a benefit or perquisite for the purpose of tax deduction under Section 194R.
While the said clarification seems to take care of situations where the discounts are given by a manufacturer to distributors, no explicit clarity has been provided for cases where any payment is made by the manufacturer directly to the retailer or stockist. There is confusion in the industry if such payment can be said to be discount in the absence of buyer and seller relationship, even though it leads to reduction in price offered by retailer to the ultimate customers. Further, the Circular does not discuss the treatment of sales-target linked discounts which are given to distributors with an obligation to pass on such a discount to the retailers. In such cases, a question which comes up for consideration is whether such payment is in the nature of a discount offered to the distributor or an incentive given to the retailer on achievement of purchase target.
Therefore, the manufacturers are continuously struggling with classification of the various payouts as discount or sales incentive, with no clarity even after a year of implementation of Sec 194R.
3. Expired goods and product recalls
The CBIC has clarified the procedure in respect of return of time expired drugs or medicines vide Circular No. 72/46/2018- GST dated 26.10.2018. While two options have been given for returning such goods i.e., return as fresh supply or via a credit note, the circular has raised disputes with regards to reversal of credit, where a commercial credit note is issued by the supplier for the expired goods which are ultimately destroyed.
In such a case, the Circular contemplates reversal of ITC by the manufacturer on the inputs & input services used in the manufacture of such goods. However, the department has failed to appreciate that when a commercial credit note is issued by the manufacturer, no ITC is availed at the time of return of goods and no adjustment is claimed towards the GST paid earlier at the time of original supply. Therefore, one may contend that Section 17(5) does not apply at all, and reversal of credit only amounts to additional cost for the manufacturer.
The lack of clarification on the above issue has left room for varied interpretation and opened up a number of investigations by DGGI & Audit authorities.
4. Point of Sale Material supplied for business promotion
The industry has resorted to varied models for providing point of sale materials to retailers for the purpose of business promotion. These materials are usually provided free of cost to the retailers and are consumed at the premises of such retailers.
In respect of such materials, a common dispute which has arisen for the industry is regarding the eligibility to avail credit on such material since the same is provided as free of cost to the retailers and thus, can be considered to be covered under the purview of ‘gifts’ provided under Section 17(5) of CGST Act. Even if we keep aside the issue of eligibility to avail ITC, another issue which arises qua these materials is regarding the exigibility of such free of cost supply to GST in terms of Entry no. 1 of Schedule I of CGST Act which covers ‘Permanent transfer or disposal of business assets’. In respect of the aforesaid issues, the CBIC has not issued any explicit clarifications or guidelines and the same has resulted in dispute on these issues between the industry and the GST Authorities.
Conclusion
Before concluding, the hard work of the Government and GST Council must be appreciated. Considering the need of hour, various steps like providing clarifications / FAQs, helpdesk for technical grievance redressal etc. have been taken to address the concerns of the industry.
Nonetheless, with a GST crossing period of over half a decade, the Government should have a relook at the fundamentals of the GST vis-à-vis the present landscape of GST and the practices being followed in the industry. The above discussed issues should be on the top of the agenda of the Government and suitable clarifications should be issued to prevent dispute between the industry and Tax Authorities.
[The authors are Partner and Principal Associate, respectively, in Indirect Tax practice at Lakshmikumaran & Sridharan Attorneys, New Delhi]
[1] Pharamaceuticals Industry Report, May 2023 – India Brand Equity Foundation
