Cross Charge in GST – The Mystery Continues!

¹Introduction

Recent media reports suggest that two giant FMCG companies have paid a substantial amount of GST on account of ‘cross charge’. Controversial Advance rulings have also generated a good amount of traction for this topic. GST authorities have issued show cause notices to many taxpayers demanding GST on account of cross charge and very soon the matter will come up for judicial scrutiny. An attempt has been made in this article to understand the nuances of cross charge.

Related Legal provisions

The term ‘Cross Charge’ has not been defined in the ²Act. However, one can trace the genesis of cross charge to Section 7(1)(c) of the Act. In terms of said section, the activities specified in Schedule I made or agreed to be made without consideration shall be treated as supply. Entry No. 2 to Schedule I to the Act states that the supply of goods or services or both between ³related persons or between distinct persons as specified in section 25, when made in the course or furtherance of business to be treated as supply even if made without consideration. Section 25(4) of the Act states that a person who has obtained or is required to obtain more than one registration, whether in one State or Union territory or more than one State or Union territory shall, in respect of each such registration, be treated as distinct persons for the purposes of this Act.

A bare reading of the above provisions suggests that the supply of goods and/or services between related persons or distinct persons even though made without consideration is deemed as supply.

Scope of Schedule I

On a cursory glance at Schedule I to the Act one may take a prima facie view that all transactions between related persons or distinct persons would be treated as a supply. However, on a fine reading of provisions, it transpires that the following two conditions must be fulfilled before a transaction of activity is deemed as a supply:

First there should be the existence of supply between related persons or distinct persons
Secondly, such supply must be in the course or furtherance of business.

Unless the above two conditions are fulfilled activities/transactions can’t be deemed as a supply. Further, as of now, there is a great amount of confusion as to the scope of Schedule I to the Act. Scope of deeming fiction created by Section 7(1)(c) read with entry no. 2 to Schedule I continues to remain one of the grey areas of GST regime. Consequently, the department may try to bring each and every transaction between related persons and/or distinct persons if made without consideration within the scope of deeming provision. Examples that immediately come to my mind are the applicability of GST on corporate guarantees, brands, and logos, etc. As such, these questions are highly debatable and would have to be settled only after ⁴CBIC or Court’s intervention.

Few examples of activities necessitating cross charge

Stock/Branch transfer of goods is the simplest and most common example of cross charge.
Another example would be taxpayers having an establishment in more than one state/union territory i.e. the existence of head office (‘HO’) in addition to other interstate units/branches(‘BO’). For ease of accounting, convenience, and commercial expediency it is quite possible that many ⁵common services might be rendered by HO and consumed by various BO. Considering the spirit of the destination-based tax cost of such common services should be cross charged to other BO and such BO subject to fulfillment of conditions may be eligible to avail ⁶ITC for the same.
Another example that comes to mind is a business conglomerate having many group companies operating under one roof. Further, presume all these companies are operating from single premises taken on lease by one of the group companies. In such a set up there might be certain common expenditures in addition to Rent of common premises say House Keeping, Electricity, Staff Refreshment expenses, Maintenance, Telecommunication services, etc. In a given situation aforesaid common cost should ideally be cross charged to other entities on some rationale basis say area occupied or number of employees etc.

Whether cross charge is necessitated for Employee cost?

Though in the above examples, GST levy on account cross charge appears to be the most logical., however, all hell breaks loose when taxpayers are confronted with the question of whether employee costs should also be cross charged. This question is of paramount importance as the salary paid to employees in relation to terms of employment is neither a supply of goods nor services and therefore falls outside the ambit of the GST levy.

Few arguments advanced against cross charge of employee cost are briefly summarised as under:

Employees are appointed for the entity as a whole and not for a distinct person.
When an employee renders any service to other distinct persons of the same entity, the nature of activity still retains the character of services by an employee to the employer in the course of or in relation to his employment as he is an employee for the entity as a whole and not for any distinct person.
Multiple GST Registration is a mere procedural formality.
Inclusion of salary in cross charge will indirectly result in taxing salary which has been specifically excluded from the ambit of GST by virtue of Entry No 1 of Schedule III of the Act.

Further, it is to be noted that the department can’t simply presume cross charge. The burden of proving the existence of such a supply lies on the department.

Draft Board Circular on cross charge

A draft CBIC Circular for clarifying the taxability of services provided by an office of an organization in one state to the office of that organization in another state, both being distinct persons was attached to the detailed Agenda of 35^th GST Council Meeting. Considering the sensitivity of this issue and lack of consensus amongst states, GST Council even today has not come out with a final version of the Circular. Though the draft circular has no legal validity it would be prudent to refer to this draft to understand the thought process running in the department on cross charge. Important points coming out from the above draft circular are reproduced hereunder:

Where a taxpayer, registered in different States, is a distinct person, then –

(i) An employee of a HO (registered as a separate entity) does not provide any services to a BO, rather it is the HO which provides service to the BO.

(ii) There is a need to apportion expenses incurred by one office for the provision of output services to another office by any reasonable means consistent with the principles of valuation in the GST law and the generally accepted accounting principles.

(iii) Such apportionment/valuation of supply shall be done on the basis of information maintained by a company in its normal course of working. There is no need to maintain additional records of activities undertaken by individual employees.

CBIC press release dated 15th November 2019

Key highlights of the CBIC press release dated 15^th November 2019 are as under:

(i) GST charged on the prices/charges by any supplier of goods or services from his consumers does comprise all costs including cost of raw material, capital goods, input services, and employee costs, etc. But this does not mean that salaries paid to the employees by the employer are being taxed under GST

(ii) It must also be made clear that offices of an organisation in different States are regarded as distinct persons under Section 25 of the Act. Hence, what is taxable under GST is supply of goods and services by the HO to its BO(s) and vice versa. Any tax charged on such supplies is available to the recipient as ITC. This is not any additional cost to the organization. Also, it is a worldwide practice under GST laws.

Though the press release has no legal sanctity as such but on a conjoint reading of the aforesaid CBIC draft circular and press release taxpayer can guesstimate the stand of the department on cross charge.

Advance Rulings – a shocker

The ⁷Karnataka AAAR has stirred a hornet’s nest by ruling that the services rendered by the employees of the head office in so far as they are benefiting the other distinct persons of the appellant are to be considered as supply by virtue of Entry 2 of Schedule I to the Act. Further authority observed that such services of employees to other distinct person, when rendered in the course of their employment are not considered as a supply of service in terms of Entry 1 to Schedule III to the Act.

Further, ⁸AAAR Maharashtra held that HO using all its human resources to facilitate the operational requirements of the BO(s) by way of procuring common input services on behalf of the branch offices/units thereby, providing the services, therefore, allocation and recovery of any amount including its employee’s salary cost from the BO(s) will be subject to GST.

The above two appellate advance rulings expressing the view that salary cost should also be considered for cross charge can be said as a setback for the taxpayers as the quantum of cross charge would swell to a much higher amount and may lead to blocking of working capital in many cases and a permanent loss of ITC in few cases. Working outing cross charging of employee cost/establishment cost would be a herculean task and in few cases may be subject to rigors of GST Valuation Rules. In few cases, taxpayers may be required to value such services at 110% of the cost to avoid any future disputes.

Second Proviso to Rule 28 of the GST Rules – A Saviour

The second Proviso to Rule 28 of GST rules reads as under:

“ Provided further that where the recipient is eligible for full input tax credit, the value declared in the invoice shall be deemed to be the open market value of the goods or services”

Simply speaking second proviso to Rule 28 of the GST Rules expressly permits taxpayers to adopt any value if the recipient is eligible to claim full ITC. Further, it has also been held that ⁹when the recipient is eligible for full ITC, as per the second proviso to rule 28 of the GST Rules, the invoice value shall be deemed as ‘Open Market Value’ and the supplier need not determine ‘Open Market Value’ or adopt amount equivalent to 90% of the price charged by the recipient to the unrelated buyer

Interpretation of term ‘where the recipient is eligible for full ITC’

It is pertinent to note that the second proviso to Rule 28 can be pressed into action only if ‘full ITC’ is available to the recipient. Therefore, another question arises whether such full ITC condition should be satisfied at the invoice level or at the respective ¹⁰GSTIN level. It has been held that ¹¹the expression ‘where the recipient is eligible for full input tax credit’ as used in the second Proviso to Rule 28 of GST Rules, means that the recipient will be eligible to take full ITC of the amount of tax paid by the supplier as mentioned in the respective invoice or any other document valid under Section 16(2)(a) of the Act.

Whether cross charge for lumpsum amount is in compliance with Second Proviso to Rule 28?

At this juncture, the next question that surfaces for our consideration is whether the supplier (HO) can charge a lump sum amount where the recipient (BO) is eligible for full ITC for such supply. This question is relevant as the concept of revenue neutrality for supplies between related persons and distinct persons has been given statutory effect through the second proviso to Rule 28(supra).

In this regard, attention is invited to ¹²Maharashtra Advance Ruling wherein the applicant has raised following identical issue before the authorities:

“ Question 3: If the aforesaid activities (Managerial and leadership services) are treated as “supply of service” between distinct and related persons and GST thereon is held to be payable, whether the Applicant can continue to charge a certain lump sum amount, as has been done in the past, in terms of second proviso to rule 28 of GST Rules, 2017, as most of the recipients of such services are eligible for full credit, barring one or two related persons, who would comply with the provisions of section 17 of GST Act, 2017, at their respective ends?”

In response to the aforesaid question, Advance Ruling Authority has replied in the affirmative. It appears that authority has rightly given due recognition to the principle of revenue neutrality while arriving at the conclusion.

Whether cross charge is required even for SEZ units?

Now, the moot question arises whether SEZ units should also be cross charged. In the opinion of the paper writer in terms of the ¹³IGST Act, supply to SEZ unit is treated as ‘zero-rated supply’ and therefore cross charge to SEZ unit shall qualify for the benefit of zero rating.

Whether ITC can be availed on cross charge Invoices issued belatedly?

The next question to consider is if HO in the current year has raised invoices for cross charge for the past years whether recipient BO can claim ITC on such invoices. Whether Section 16(4) of the Act will pause a major hurdle for the recipient BO to claim ITC?

To answer this vexed question let us first go through section 16(4) of the Act which reads as under:

“ A registered person shall not be entitled to take input tax credit in respect of any invoice or debit note for supply of goods or services or both after the due date of furnishing of the return under section 39 for the month of September following the end of financial year to which such invoice or debit note pertains or furnishing of the relevant annual, whichever is earlier”

It is worthwhile to note that Section 16(4) of the Act refers to the date of the Invoice/Debit Note. Section 16(4) as such does not refer to the period in which supply was rendered. In the opinion of the paper writer therefore even if there is any delay in the issuance of invoice by the supplier, action for such violation lies by way of collecting interest for delayed payment of tax or imposing a penalty for violation of the provisions of Sec 31(2) of the Act read with Rule 47 of GST Rules. In the personal opinion of the paper writer delayed issuance of an invoice cannot be a ground to deny the credit to the recipient. However, it is quite likely that the department may contest such a view.

However, attention of readers is invited to the Ruling delivered by AAAR ¹⁴Andhra Pradesh wherein the authority had occasion to decide whether the applicant is eligible to claim ITC on an invoice dated 1st April 2020 (current year) that was issued covering the supply of services pertaining to the period from 1-4-2018 to 31-3-2019 (past years). Authority observed that the Invoice will have two principal aspects which are:

The period to which the supply pertains to and
The period to which the invoice pertains to

Authority held that irrespective of the date of Invoice eligibility of ITC would be guided by the period during which supplies were made and therefore came to the conclusion that the appellant is not eligible to claim ITC on the disputed invoice dated 1-4-2020 that was issued covering the supply of services pertaining to the period from 1-4-2018 to 31-3-2019.

Whether an annual cross charge is sufficient compliance?

One of the most common questions asked by many taxpayers is whether a year-end invoice for cross charge is sufficient compliance with the law. In the opinion of the paper writer, it is certainly possible to take a view that cross charge is a ¹⁵’Continuous supply of services’ and therefore ¹⁶periodic invoice for cross charge appears to be sufficient compliance with the GST law.

Scenario where the recipient is providing exempt supply

If a BO/unit/interstate branch receiving cross charge supply is using such supply for providing any exempt/non-GST supply then safe passage granted by the 2nd proviso to Rule 28 would not be available and therefore in such a situation cross charge shall be made at ¹⁷open market value or at ¹⁸110 % of the cost or any other ¹⁹reasonable method. Needless to say, in such a situation cross charge would certainly result in ITC loss in the hands of the recipient.

Way forward

It appears that this vexed issue of cross charge of salary cost will settle only with the intervention of Hon’ble Courts. Till then taxpayers need to take an informed call, considering their risk appetite. It would not be a bad idea to cross charge a lump sum amount if the recipient is eligible for full ITC. However, where the condition of eligibility for full ITC is not satisfied, HO may consider paying it under protest to explore the possibility of a refund in case of a favourable judgment, without any retrospective amendment though!

Disclaimer

The views expressed herein are strictly personal to the author and should not be construed as advice/ legal opinion. The contents of this article are based on the interpretation of the facts, relevant legislation, rules, notifications, circulars, judgments/rulings, etc. on the date of publishing of this article. One should not act upon the information in this article without obtaining specific professional advice. Author of this blog is not responsible or liable for any loss or damage caused to anyone due to any interpretation, error, omission pertaining to this article. Further, the said article is only for information and guidance purposes and should not be construed as any kind of advertisement or solicitation of work.

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This paper was also published in GST Review April 2023, a monthly magazine published by the Goods and Services Tax Practioner’s Association of Maharashtra (GSTPAM).
CGST/SGST/UTGST Act.
Refer to Section 15 of CGST/SGST/UTGST Act for the definition of Related Party.
Central Board of Indirect Taxes and Customs.
Auditing, Payroll, Human Resource Management, Research and Development, Financing, IT maintenance, Administrative work etc.
Input Tax Credits.
Columbia Asia Hospitals Pvt Ltd.) reported in [2018] 100 taxmann.com 501 (AAAR – Kar.).
Cummins India Ltd [2022] 134 taxmann.com 342.
Specmakers Opticians Private Limited 2020(1)TMI 63 (AAAR -Tamilnadu).
Goods and Services Taxpayer Identification Number.
GKB Lens Pvt Ltd 2018 (9) TMI 1768 – (AAAR- West Bengal).
B. G. Shrike Construction Technology (P.) Ltd [2021] 132 taxmann.com 124 (AAR – Maharashtra).
Section 16(1) of the IGST Act.
Vishnu Chemicals Ltd [2022] 139 taxmann.com 500 (AAAR – Andhra Pradesh).
As defined in Section 2(33) of the Act.
In terms of section 31(5) of the Act.
As per Rule 28 of CGST/SGST/UTGST Rules.
Refer to Rule 30 of CGST/SGST/UTGST Rules.
Refer to Rule 31 of CGST/SGST/UTGST Rules.

Cross Charge in GST – The Mystery Continues!

DISCLAIMER