Indian Pharmaceutical Industry plays a prominent role in the Global Pharma Ecosystem. It is the world's largest provider of generic medicines by volume and is also the largest vaccine supplier in the world. The value of this sector is expected to reach USD 65 billion by 2024. Indian pharmaceutical products are exported to various overseas markets including the US, UK, European Union, etc.
With the advent of Goods and Services Tax (‘GST’) with effect from 1 July 2017, it has been a tough journey for the Indian Pharmaceutical Companies in terms of implementation of the same in the company’s operations, revamping its systems, understanding of the law, compliance with respect to various provisions of the law, claiming refunds, handling audits & investigations in the unsettled environment. With almost seven years of GST, though the Government made fair efforts for resolving the issues of the Industry based on the representations received, this Industry is still facing many challenges under the GST.
In this article, we will delve into certain key issues which are relevant for the Indian pharmaceutical industry from a classification, human resources & investigations perspective.
Points to ponder:
One major issue for the pharmaceutical industry in India has been the classification of the imported/final products which determines the Tax liability, Input Tax Credit eligibility and Export Incentives. Further, there are many issues from the Human Resources perspective such as taxability of benefits/perquisites provided to the employees. Considering the complexity of the issues involved, frequent investigations are being initiated by various Revenue agencies proposing tax recoveries, issuance of summons, requiring submission of voluminous data, making arrests etc., handling of which is a difficult task for the management and its officials, them being occupied with their regular roles and responsibilities.
1. Disputes relating to Classification of Goods:
Determining classification of pharma products is and has been a challenging task for the industry. Classification of the pharma products is complicated as compared to the other products since the same would depend on the constituent of the products, curative/prophylactic attributes of the constituents, composition of various elements, common parlance, industry perception, etc. While the majority of the products i.e., generics, bulk drugs, injectables, etc. might fall under Chapters 29 or 30, arriving at the classification at six digit and eight-digit levels has always been a challenging task for the industry. The pharma products majorly are liable to tax at the rate of 5% or 12%, while some of the products are exempted from payment of GST. Apart from Chapter 29/30 related products, there are other segments of products such as protein-based drinks/pre-mixes, energy drinks, etc. manufactured by the pharma companies and their classification also has been a challenging task as to whether they are food preparations or medicaments etc., which attracts different rates of GST.
Incorrect/wrong classification of the goods could result in an incorrect claim of exemptions, could lead to wrong/excess availment of Input Tax Credit, wrong/excess reversals of ITC, non-payment of GST etc. and could lead to recovery proceedings of such ITC/GST along with interest and penalties. Further, an incorrect classification of the export products may have a bearing on the incorrect claim of export incentives or loss of non-claiming of eligible export benefits such as drawback, RODTEP, refunds etc. These, therefore, would have a bearing on the finances of the companies. Further, these would have a chain of implications across the supply chain in the hands of the stockist, distributors, retailers etc. who follows the same classification as adopted by the manufacturing company. Further, an incorrect classification of import products may have a bearing on the correct GST payable by the companies, incorrect/loss of exemptions etc.
Thus, the classification of import products or final/export products may have a bearing on the survival of the company. Further, classification also plays a pivotal role in liquidation of accumulated ITC on account of inverted rated tax structure for pharma companies. Accordingly, it is crucial for the pharma companies to correctly determine and review classification of its import products or final/export products.
2. Human Resources – Employee Perquisites/Facilities/Benefits/Recoveries etc.
The Human Resources are very important for the Pharma Companies since their business would depend upon the well-being of its resources such as the scientists, biochemists, researchers, finance, etc. The Pharma Companies offer various perquisites and benefits to their employees in the course of their employment. The perquisites/facilities/benefits provided in addition to the salaries, could include provision of various facilities such as bus transportation, pick up and drop, canteen, mobile phones, etc. and benefits such as interest free loans, car purchase, ESOPs etc.
While the consideration/salary for employment services provided by the employees is not taxable in terms of Schedule III of the GST law, the other benefits/perquisites/facilities etc. provided to the employees remain an important area for taxation under GST in the hands of the companies/employers. It has been much discussed topic in all Industries. Taxability of any benefits/perquisites/facilities etc. provided to the employees as per the Human Resources policy of the companies continues to be a gray area under GST. Further, wherever the benefits/perquisites/facilities etc. are provided by the companies to the employees upon recovery of any amounts, such benefits/perquisites/facilities etc. may qualify as supplies made by the company to the employees and thus, GST might be payable on such benefits/perquisites/facilities. Also, valuation of such benefits/perquisites/facilities etc. is also an area to be looked into as the company and employees are treated as related parties under GST. Further, any such benefits/perquisites/facilities etc. for which recovery is made by the company from the employees merely as a pass-through for making payment to the vendors providing such benefits/perquisites/facilities etc., also continues to be a gray area for the industry to determine the taxability of such benefits/perquisites/facilities etc.
Even though the CBIC had tried to clarify the same vide press releases and circulars, the aforementioned scenarios still require further clarity as they had left room for varied interpretations. While the issues are subject to interpretation and need further clarifications, the practice adopted by the company for the past period may have a major bearing on the finances since such benefits/perquisites/facilities etc. may require payment of GST along with interest and penalties. Further, ITC eligibility with respect to these activities also continues to be an important area having financial implications for the pharma companies.
Thus, there is a need for the companies to list down all such benefits/perquisites/facilities etc. provided to the employees, examine the arrangements and analyze the implications with respect to each such benefits/perquisites/facilities etc., and take corrective actions needed if any, before the Department initiates audits & investigations.
- 3. Investigations
With seven years into GST, if we look back, the majority of investigations initiated by the Departmental agencies pertain to various issues which are commonly faced by the pharma companies such as refunds, export benefits, credit notes, payments made to/facilities provided to doctors/dealers, free samples, brand reminders etc. Further, there have been investigations even with respect to intra-company supplies for which clarifications have been issued recently in the month of July 2023.
The approach of the Departmental Agencies during Investigations has been summoning the Top Management of the companies, requiring the taxpayers to submit tremendous volume of data, seeking explanations etc. and also insisting payment of taxes along with interest and penalties based on their preliminary findings. At times, arrests of the management have also been made by the Departmental Agencies. The Government itself issued clarifications and the Courts have passed various orders regarding the Departmental Agencies summoning the top management, non-provision of sufficient time to the companies, not to insist on tax payments during investigations, etc.
Handling the Investigations is a difficult task for the management and the company as it requires digging into the voluminous data, providing explanations and submissions in respect of the queries raised by the Department, which needs to be undertaken by them besides the regular compliances and day-to-day business affairs. It is pertinent to note that any statements/data/explanations etc. submitted during such investigations could have a bearing on the merits of the case in future proceedings. Accordingly, the management and the company needs to adopt a planned approach and follow the best practices for handling investigations, which could have a major impact on the future of the company.
Conclusion
As we are into seven years of GST, there are still many issues unresolved and require various clarifications from the Government. Though some issues might need clarifications, other issues require actions of the Companies themselves based on the current legal position and would need to adopt the tax treatment to such issues to mitigate the risks of unwanted litigations which could have interest and penal implications. The initiation of investigations by the Departmental Agencies even before the issues are clarified by the Government based on their understanding of the GST law is another worrying area for the Pharma Companies.
It is therefore high time for the Pharma Industry & companies to analyze tax implications on various issues discussed above and adopt best practices for handling the departmental investigations.
[The authors are Associate Partner and Principal Associate, respectively, in Indirect Tax Practice at Lakshmikumaran & Sridharan Attorneys, Hyderabad]
