Background

Indirect taxes, as with any other industry, play a pivotal role as a catalyst in the growth of the mobile handset industry. Current regime the Indian mobile manufacturing players are reeling under cost pressures and low margins especially with Chinese players providing stiff competition.

At present, majority of the mobile handset companies have started their manufacturing facility in India, though import still continues to be the major way of managing the supply chain distribution. Currently, Customs duty, Countervailing Duty (in lieu of Excise), NCCD, Entry tax and Service tax (paid on procurement of services), all go in the costing of mobile handsets. With no offset available inter se few duties and taxes, margins have eroded as mobile handset companies find it difficult to reduce prices in this price sensitive Indian economy.

Obviously, the position of taxes under GST seems to be different. However, how different or helpful they will be to a mobile handset player is something we have tried to analyze in this article.

Imports – Expensive mechanism

Currently, following duties are imposed on import of mobile phones:

  • Basic Customs Duty (‘BCD’) – 0%
  • Countervailing Duty (‘CVD’) – 12.5%
  • Special Additional Duty (‘SAD’) – 0%
  • National Calamity Contingent Duty (‘NCCD’) – 1%

With the introduction of Goods and Services Tax (‘GST’), all taxes except BCD would be subsumed. The rate of GST hopefully should be 18% and thus, the duty payable by the importer will drastically increase.

Under the Model GST law, all import of goods will classify as inter-state transaction subject to Integrated Goods and Services Tax (‘IGST’). Credit of IGST will be available against output IGST, Central Goods and Services Tax (‘CGST’) and State Goods and Services Tax (‘SGST’) (in that sequential order).

Though credit of IGST will be available, following issues may require some consideration:

  • Increase in working capital due to increase in the duty amount. In order to understand the increase, please have a look at the table mentioned below:
Pre GSTAmountPost GSTAmount
CIF value of goods100CIF value of goods100
MRP of the goods150MRP of the goods*
BCD0BCD0
CVD (12.5% on 65% of MRP due to abatement)12.2IGST18
SAD0NCCD**
NCCD1
Total Duty Cost13.2Total Duty18

* Under proposed GST regime, there would be no concept of MRP based assessment and thus duty/ tax shall be charged at transaction value.

** Assuming that NCCD would also be subsumed in GST.

  • Credit of IGST will be available at the time of import which is a cost under the present regime, since CVD is not creditable for traders;
  • Duty will be paid on import, whereas credit could be adjusted only on supply. Thus, there may be a difference between time of actual payment of duty and its off-setting.
  • In order to avoid accumulation of IGST and transportation costs, Companies may explore the possibility of companies importing goods at different locations rather than at a central place and then supplying them (subject to commercial feasibility).

Make in India – Ambiguity on IGCR Rules

The import provisions also impact the ‘Make in India’ concept which can be understood with the help of the above example. Under the current regime, a mobile handset company import handset and pays duty of INR 13.2. Let us assume the company is purely into trading and is not eligible to avail credit of any duty paid. Thus the total cost of the product becomes INR 113.2. Under the proposed GST model, credit of entire IGST will be available. Thus there will be a sudden reduction in the cost of the product for the importer which would adversely impact the Indian manufacturers.

Further, with an intent to promote ‘Make in India’ concept, the government is providing all possible benefits and duty concessions. One such benefit is provided under Import of Goods at Concessional Rate of Duty for Manufacture of Excisable Goods Rules 1996 (‘IGCR’). Under the concept of IGCR, a manufacturer is entitled to import goods at a concessional rate of duty subject to the condition that these goods are put into manufacture. Mobile phones qualify for this benefit.

Under the proposed GST regime all taxes except BCD would be subsumed. For manufacturers in India, issues should be addressed:

  • What is the benefit of manufacturing in India when it would be cheaper to import?
  • Whether benefit of IGCR would be available;
  • If IGCR or similar benefit is not provided, what is the benefit of manufacturing in India; and
  • If IGCR would continue, how would it not defeat the purpose of GST?

Stock transfer – Taxable, yet cost effective

Currently, majority mobile handset companies operate from warehouses in every state via stock transfer (through statutory forms) and thereafter sell goods locally to the distributors. This is done with the intention to avoid payment of non-creditable CST and in order to pass the creditable VAT to their distributors. Post GST, inter-state stock transfers will attract IGST. As credit of IGST will be available (read above), there may not be any requirement of stock transfer. Following points would merit consideration:

  • The tax considerations for maintaining regional warehouses may have to be re-examined;
  • Cost of warehousing and other ancillary costs such as employees at each location, compliance cost, etc. may reduce;
  • No hassle on collection of statutory forms and thus, no liability upon their non-submission;
  • The current business model is exposed to VAT for scenarios classified as ‘pre-determined sale’, whereas under GST no such exposure should exist;
  • In order to avoid exposure on ‘pre-determined sale’, the company often sends more stock than required at the receiving warehouse. In such cases, the stock invariably lies at warehouse. Under GST, every supply shall be taxable, thus not warranting any excess stock to be sent. Consequently, helping reduce logistics and other costs.

Tax on Handsets to increase

Currently most states classify mobile handsets in the lower tax slab i.e. 5%. Under GST, the rate of tax would drastically increase to 18-20% (in case there are no multiple tax rates).

The Hon’ble Supreme Court of India in the case of State of Punjab and Others v/s Nokia India Private Limited held that the battery charger sold along with mobile phone in a composite package, should be considered as an accessory and subject to higher rate of VAT. This ruling resulted in nationwide litigations with handset companies facing ire of Revenue Department and demands running into crores. The reason of such demand was battery charger being classified as ‘accessories’ to mobile phones, which is subject to higher rate of VAT. It is not yet clear whether GST would have multiple tax rates or a uniform tax rate. In case of multiple tax rates, the pending list of litigations would continue if such issues are not addressed.

Mobile Phone Barter – May loose its charm

Mobile handset companies keep introducing promotional schemes allowing old mobile phones to be exchanged with a new one (post paying the differential value). Value of old mobile phone is determined according to various conditions and eventually reduced from the value of new mobile phone. Currently, the amount reduced on exchange or barter is outside the ambit of VAT (except states such as Gujarat which have specific inclusion).

The Model GST law has included ‘barter’ in the definition of ‘supply’. Consequently, every transaction involving an exchange of mobile phone will be subject to GST. The important aspect to be seen is the computation of the value of the old mobile phone in light of the proposed valuation mechanism.

Let us understand the difference with the help of below mentioned example:

Pre GSTAmountPost GSTAmount
New phone cost (A)10,000New phone cost (A)10,000
Old phone value (B)1,000Old phone value (B)1,000
Net Value (C)9,000Net Value (A-B) = C9,000
VAT (on 9,000 @5%) (D)450GST (18% on 10,000) (D)1,800
Total amount paidC+D9,450Total amount paid to be paidA+D11,800

 CENVAT Credit – Not to be reversed

At present, mobile companies are required to reverse majority of CENVAT Credit (assuming they render certain taxable services). The reversed CENVAT Credit becomes a cost to the Company. Under GST, entire credit of services would be allowed to the Company. Though, procurement of service/ goods would become expensive (due to increase in tax rate), however the total input GST credit would be available with the Company to discharge its output GST liability. This would provide great benefit to the Company and should impact the pricing of the product.

Valuation Mechanism – Copying is Dreadful

Since inception of mobile handset companies in India, they have been subject to valuation on the basis of MRP (for Customs). However, domestic transactions are mostly carried out at transaction value. Under GST Model law the concept of MRP is proposed to be replaced with the ‘transaction value’ method (scope of which is enlarged).

While going through the provision, it is difficult to ignore the ‘inspiration’ from Excise and Customs Law. While the latter laws were formulated with different intention, the ‘inspiration’ may have its own ramifications. However, it would be interesting to see, how GST officers would consider the transactional value especially when the gambit of transaction value is enlarged. At the same time, it is important to understand whether the GST officers are well equipped to determine the true spirit of transaction value especially when similar issues under Customs and Excise laws have resulted in a plethora of litigations. There may be a possibility that similar litigations are initiated basis under the proposed model without considering the fact that the erstwhile rulings were in respect to a different statute with different objective.

Section 15 of the Model GST law enlarges the scope of ‘transaction value’ by compulsorily adding few items to compute the transaction value. We have attempted to capture few impact areas:

15(2)(a) any amount that the supplier is liable to pay in relation to such supply but which has

been incurred by the recipient of the supply and not included in the price actually paid or

payable for the goods and/or services;

Warranty Expenses

The defective component is replaced by the Authorized Service Centre (‘ASC’) and charges are borne by the handset mobile companies. Under the proposed GST regime, it is imperative to examine:

  • Whether faulty component replaced by Authorized Service Centre (‘ASC’) would be considered as an expense incurred by ASC on behalf of the Company;
  • What would be the transaction value under such circumstances especially when there is no consideration flowing from the ultimate customer?

15(2)(b) the value, apportioned as appropriate, of such goods and/ or services as are supplied directly or indirectly by the recipient of the supply free of charge or at reduced cost for use in connection with the supply of goods and/ or services being valued, to the extent that such value has not been included in the price actually paid or payable;

Dead On Arrival (‘DOA’) – Dead yet costly

The DOA mobile handset is replaced by the ASC and cost is ultimately replaced by handset companies. Currently, it is done by issuing a Free of Cost (‘FOC’) invoice. Under the proposed regime, it is imperative to examine:

  • Whether mobile handset provided to the customer FOC basis will be considered a supply subject to GST;
  • If yes, what would be the transaction value of the supply; and
  • Who would be liable to pay tax and who would take the credit considering the supply is intra-state (between the ASC and the customer), whereas the mobile handset company is not receiving the goods in the first leg.
  • At the time of returning the DOA phone, whether it would be considered as a ‘supply’ by the customer and whether this transaction would come under taxability under reverse charge mechanism.

Free of Cost (‘FOC’) – No free lunches

Mobile handset companies often distribute handsets at events/ promotions for which no consideration is charged. Following issues may require some clarification:

  • Handsets distributed free of charge to public for promotion would be considered as a supply?
  • What would be the transaction value in such case where no consideration is being received; and
  • How would the credit mechanism flow in such transaction which would depend upon the fact the who is the recipient of the mobile phone, entity organizing the event or the ultimate recipient of the handset?

15(2)(c) royalties and licence fees related to the supply of goods and/or services being valued that the recipient of supply must pay, either directly or indirectly, as a condition of the said supply, to the extent that such royalties and fees are not included in the price actually paid or payable;

Royalty – May be painful

Currently, few mobile handset companies are engaged in a legal tussle with few oversea Android technology providers for use of such technology in their mobile phones. The matter is sub judice at the Delhi High Court and the Hon’ble Supreme Court. It is only a matter of time that future of such litigations would get decided. Under GST regime, following aspects may require some clarification:

  • Whether importer of the handset (not the manufacturer) would directly or indirectly be liable to pay the royalty amount? Whether this chain would extend to the distributor and thus royalty amount being added in every chain of transaction?
  • Whether these transactions would come under the purview of condition of sale?

(e) incidental expenses, such as, commission and packing, charged by the supplier to the recipient of a supply, including any amount charged for anything done by the supplier in respect of the supply of goods and/or services at the time of, or before delivery of the goods or, as the case may be, supply of the services;

All expenses to be included?

Under proposed GST regime, ‘any amount charged for anything done by the supplier’ is required to be added in the transaction value. Basis this provision following may be introspected:

  • Whether costs such as transportation, freight would be required to be added in transaction value? The same is added under current regime under Entry tax laws.
  • What shall be the future of common expenses incurred by the company such as advertisement, audit expenses, rent of head office, etc. because such expenses are typically booked at head office and recovered through sale of goods. Thus it may be interpreted that the branch would ultimately be paying for common expenses as well.
  • Though the net result of including such expenses would be tax neutral for the company (as credit would be admissible at receiving location), this aspect sooner or later will surely invite litigation.

15(2)(h) any discount or incentive that may be allowed after the supply has been effected:

Provided that such post-supply discount which is established as per the agreement and is known at or before the time of supply and specifically linked to relevant invoices shall not be included in the transaction value.

Year-end sales incentives still litigious

Under the current regime, many states do not allow ‘post sales discount’. Under the GST regime, it is clearly worded that any discounts post supply would be added to the ‘transaction value’. However, the addition comes with an exception i.e. if any post supply discount is as per the agreement known at the time of the supply and linked to specific invoices, the same shall be removed from transaction value. Consequently, the discount amount would not attract GST.

For a better clarity, let’s take following example. A distributor of mobile phones is able to procure 10,000 units from the company during a particular year. As per the agreement, post supply of 9,000 units, distributor shall be entitled to turnover discount. Both the entities are aware of the discount amount at the time of agreement. In addition, both are aware that the target is reasonable and quite achievable. In such cases:

  • Would discount be attributable to few invoices or all the invoices?
  • If yes, which ones specially if goods are supplied in lots throughout the year?
  • This aspect is ambiguous and might result in litigation

To top it up, as per Section 15(4)(iii) of the Model GST law, the transaction value shall not be accepted if there is a reason to doubt regarding the truth or accuracy of the transaction value declared by the supplier. The word ‘reason to doubt’ has been highly litigious and would open a pandora’s box of litigation.

Conclusion

The above mentioned are an indicative list of issues that would impact the mobile handset companies. The mobile handset companies are going to benefit in certain area (such as import duty being creditable and CENVAT Credit being available) and adversely impact in certain areas (such as transaction value or rate of tax). This it is imperative that such companies not only spend time on transaction structuring, warehousing, supply chain, IT system, contracts renegotiating but also spend ample focus on determining the current value of handsets that will be subject to the transaction value. Though implementation of GST with effect from April 01, 2017 looks ambitious, the mobile handset companies should gear up and leave no stone un-turned.

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Authored by Nimish Goel, Partner and Head of Indirect Tax/GST at International Business Advisors (www.ibadvisors.co). Nimish has a vast experience of more than 13 years in Customs, Excise, Service tax and VAT. Nimish has been a part of EY India and then with KPMG in Europe where he learnt the nuances of GST and is a regular author of articles on issues related to indirect taxes including GST. For any professional assistance, he can be reached on nimish.goel@ibadvisors.co. Uday Mehta, Article Trainee assisted him in this article.

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