Impact of Decisions of European Court of Justice on Concept of Composite Supply In India

CA. Srikantha Rao T

“Composite supply” under GST is a topic that is worth discussing considering the plethora of Advance Rulings that we have had ever since introduction of GST. Many of these advance rulings on the concept in question have also been contradictory leading to differing opinions on the subject. The issue of interpretation has been exacerbated by the fact that this is a concept which is fairly new to us in indirect taxes with the concept of “bundling” being first introduced in service tax only in 2012. Considering differing perceptions on the issue, it would be worthwhile for us to look at some of the cases that have come up before European Courts. The topics of “composite supply” and “principal supply” along with ancillary supply has seen plenty of litigation in Europe with the legal position that have been taken by Revenue authorities in those concerned countries, mirroring the view being taken by our own Revenue Authorities here in India. In this article we shall look at some of the cases that have come up for preliminary rulings before the European Court of Justice. Understanding these would help us in tacking similar or even identical issues when they come up before Indian courts in the years to follow.

While there are some differences in terms of drafting between the VAT laws of those countries as compared to GST law we have in India today, there are similarities in terms of the essence of the provisions under discussion. Before we move further it would be important for us to understand and appreciate the decision of the Kerala High Court in Abbott Healthcare Private Limited Vs The Commissioner of State Tax Kerala & Others (2020 (1) TMI 338 Kerala High Court) when called upon to decide on the issue of clubbing of supply of diagnostic instruments at hospitals without consideration with supply of reagents, calibrators and disposables for consideration through its distributors for use on those instruments. The Advance Ruling Authority at the lower level had held supply of instruments to be principal supply and tax rate applicable to composite supply of instruments with reagents being based on rate applicable to instrument.

The AAR had looked at utility or otherwise of instruments without reagents to arrive at the conclusion. The Court on the other hand, opined as follows – “The concept of enhancement of utility of the instrument through the supply of reagents/calibrators/disposables, while relevant for the purposes of valuation of the supply of instruments, cannot be imported into the concept of composite supply under the GST Act. A distinction has to be drawn between the nature of a supply and the valuation thereof. While clubbing of two independent supplies may be resorted to for the purposes of valuation of each of those supplies, there is no scope of clubbing of two independent supplies so as to notionally alter the very nature of each of those supplies as they existed in fact, at the relevant point in time. For a supply to be seen as a composite supply, it must answer to the definition of the term “composite supply” at the time of its supply.” Matter was consequently remanded back to AAR for a fresh decision.

Supply of software followed by customisation scenario

In a reference for preliminary Ruling in Levob Verzekeringen BV and OV Bank NV and The Secretary of State for Finance Netherlands, (Case C-41/04) (Judgment of The Court (First Chamber)) dated 27^th October 2005, the Court was required to look into the scenario of supply of standardised software followed by customisation thereof for the customer in the context of Articles 2(1) and 6(1) of Sixth Council Directive 77/388/EEC of 17 May 1977.

The Court opined that where two or more elements or acts supplied by a taxable person to a customer, being a typical consumer, are so closely linked that they form objectively, from an economic point of view, a whole transaction, which it would be artificial to split, all those elements or acts constitute a single supply for purposes of the application of VAT. This is true of a transaction by which a taxable person supplies to a consumer standard software previously developed, put on the market and recorded on a carrier and subsequently customises that software to that purchaser’s specific requirements, even where separate prices are paid;

Such a single supply is to be classified as a ‘supply of services’ where it is apparent that the customisation in question is neither minor nor ancillary but, on the contrary, predominates; such is the case in particular where in the light of factors such as its extent, cost or duration the customisation is of decisive importance in enabling the purchaser to use the customised software. This issue has been addressed in our GST law as software development and customisation services have been regarded as services along with transfer of right to use software unless in the latter, transfer of title is involved.

Possibility of threshold exemption being exceeded owing to clubbing of values & Price break up on a single contract

In The State Tax Inspectorate Under The Ministry of Finance of The Republic of Lithuania and Ms. Akvile Jarmuskiene (Case C-265/18) Judgment of The Court (Tenth Chamber) dated 2^nd May 2019, the Court was required to look into a reference for preliminary ruling (Under Art. 282 to 292 of Council Directive 2006/112/EC of 28 November 2006) on the matter of combined value of land and dwelling unit sold under a single contract to the same person exceeding threshold limit for small enterprise. This was when the contract indicated price for the two separately and taxability of transfer of right to dispose of tangible property as owner was involved.

The Court ruled that where a supply, to the same purchaser, comprises two items of immovable property, linked by their nature and coming under a single contract of sale, and the annual turnover limit serving as a reference for the purposes of applying the special scheme for small enterprises provided for by that directive is exceeded, the taxable person is required to pay tax on the basis of the value of the entire supply in question, that is to say, taking into account the value of both the items of property being supplied, even where taking into account the value of one of those items would not lead to that annual limit being exceeded. This could also impact composite supply scenarios under our GST law if similar view is taken here in the context of goods or services.

Another case relevant in this regard is that of Stadion Amsterdam CV and Secretary of State For Finance Netherlands (Judgment of The Court (Ninth Chamber)) dated 18^th January 2018 (Case C-463/16) in the context of the Sixth Council Directive 77/388/EEC of 17 May 1977 (old directive). The issue was regarding benefit of reduced rate on visit to AFC Ajax Museum which was possible only when an individual opted for comprehensive guided tour of the Amsterdam football stadium. There were two elements in the supply with one being visit to stadium while other was visit to museum with latter being entitled to lower rate of VAT. However, visit to museum without visiting stadium was not possible while rates for each were separately mentioned on record. The museum was located within the stadium complex.

The Court ruled that a single supply, comprised of two distinct elements, one principal, the other ancillary, (which, if they were supplied separately, would be subject to different rates of VAT), must be taxed solely at the rate of VAT applicable to that single supply, that rate being determined according to the principal element, even if the price of each element forming the full price paid by a consumer in order to be able to receive that supply can be identified. In other words, no reduced rate benefit was applicable where visit to museum was not the principal supply even if rate therefor was separately known.

This could pose problems where multiple rates are available on a contract based on number of items supplied but where a principal supply can be identified. Splitting of items for differential rate application could be questioned by Authorities where all items do not carry a single rate. One may not be able to justify applicability of individual tax rates just because price break up is separately available.

Reduced tax rate on certain element of composite supply but not on others & equal status of various elements

In The Appellate Tax Directorate, Czech Republic and Ms. Pavlina Bastova, (Case C-432/15) (Judgment of the Court (Fourth Chamber) dated 10^th Nov. 2016), the issue was regarding taxability of activity of providing horses for races to be conducted by organisers on one hand and income from operation of racing stables, training and feeding horses belonging to others. Reduced rate of VAT was applicable under Article 98 of the Directive 2006/112 with regard to usage of sporting facility and assessee wanted to take the view that operation of racing stable was entitled to this benefit.

The Court ruled that providing horse to the organisers would not be liable as a service unless there is presence of consideration irrespective of the fact whether or not the horse wins the race. With regard to the other activity of operation of racing stables, training and feeding the horses for the owners, the Court ruled that reduced rate of VAT cannot be applied where the contract for operation of racing stables, stabling, feeding and other care provided to the horses were in effect a single composite contract for supply of services made up of several components. This was more so where training of horses and use of facilities could be said to form two elements within the composite supply having equal status or where training of horses constituted the main component of the supply.

This would require careful review of tax impact at the time of finalising contracts as wrong elements clubbed together could result in assessee losing rate benefit. Luckily the first view regarding concept of consideration being absent where a horse is provided for races, has now been followed by the Appellate Authority for Advance Rulings in Maharashtra in Vijay Baburao Shirke’s case (2020 (10) TMI 48 Appellate Authority For Advance Ruling Maharashtra).

Leasing of immovable property with connected services – Termination clause and third party supplies

In Field Fisher Waterhouse LLP and the Commissioners for Her Majesty’s Revenue & Customs (Case C-392/11) (Judgment of The Court (Sixth Chamber)) dated 27^th September 2012, the issue was taxability of services like supply of water, heating of building, repair of structure and machinery, security of building and cleaning services in common areas provided to a tenant. The Court looked at the economic reason for concluding the lease which was not only to obtain the right to occupy the premises concerned, but also for the tenant to obtain a number of services.

However, obtaining the services concerned cannot be regarded as constituting an end in itself for an average tenant of premises, but constitutes rather a means of better enjoying the principal supply, namely the leasing of commercial premises. One notable feature here was landlord could terminate the arrangement if payments were not made towards other services. The Court consequently ruled that under Council Directive 2006/112/EC of 28 November 2006, leasing of immovable property and supply of services linked to the leasing may constitute a single supply.

The fact that the lease gives the landlord the right to terminate it if the tenant fails to pay the service charges supported the view that there was a single supply, but this did not necessarily constitute the decisive element for the purpose of assessing whether there is such a supply. The fact that services could be supplied by third party did not necessarily mean supply could not be regarded as composite supply.

In Mr Virgil Mailat, Mrs. Delia Elena Mailat and Apcom Select SA (Case C-17/18) (Judgment of The Court (Tenth Chamber)) dated 19^th December 2018, one of the issues was regarding treatment of letting out of building along with capital equipment used for running a restaurant and whether or not it would qualify as letting out of immovable property for Article 135(1)(l) of Directive 2006/112. The court observed that some of the movable property, such as the equipment and kitchen appliances, were incorporated in that immovable property and had to be considered to be an integral part of that property.

The movable property that was let, which was also used for the operation of the restaurant in the same way as that immovable property, could not be regarded as having its own purpose and had to be treated as a means of better enjoying the principal service supplied, viz., the letting of the immovable property. The letting of the immovable property had to be regarded as constituting the principal service supplied to which the other services, viz., the letting of capital equipment and inventory items, were merely ancillary.

Consequently the Court regarded the lease contract for an immovable property which was used for commercial purposes and for all capital equipment and inventory items necessary for that use as constituting a single supply in which the letting of the immovable property was the principal supply.

In between the aforementioned two cases we have the case of Minister For Finance and Military Housing Agency in Warsaw (Case C-42/14) (Judgment of The Court (Third Chamber)) dated 16^th April 2015. The issue here was once again regarding taxability of certain utilities like electricity, water, refuse collection provided by third parties and letting out of immovable property. So, while on one hand question was whether or not landlord could be said to have supplied utilities to tenant when these were provided by third parties, the other question involved was whether or not supply of utilities and letting out of property would be one single supply or several independent and distinct supplies.

The Court was clearly of the view with regard to the first question that in the context of the letting of immovable property, the provision of electricity, heating and water and refuse collection, provided by third-party suppliers for the tenant directly using those goods and services must be regarded as being supplied by the landlord where he has concluded agreements for the provision of those supplies and simply passes on the costs thereof to the tenant.

With regard to the second question, the Court tried to look at the contract to see if the tenant had the right to choose his suppliers and/or the terms of use of the goods or services at issue, so that the supplies relating to those goods or services could, in principle, be considered to be separate from the letting.

If the tenant could determine his own consumption of water, electricity or heating, which could be verified by the installation of individual meters and billed according to their consumption, supplies relating to those goods or services in principle, could be considered to be separate from the letting. As regards services, such as the cleaning of the common parts of a building under joint ownership, such services could be regarded as separate from the letting if they could be organised by each tenant individually or by the tenants collectively and if, in all cases, the supply of those goods and services were itemised separately from the rent on invoices addressed to the tenant.

In case of refuse collection Court was of the view that if the tenant had the choice of supplier or could conclude a contract directly with the supplier, even if, for reasons of convenience, he did not exercise that choice or option, but obtained the service from the supplier designated by the landlord on the basis of a contract concluded between the landlord and the supplier, that circumstance could point to the existence of a supply separate to the letting. The court consequently held the view that the letting of immovable property and the provision of water, electricity and heating as well as refuse collection accompanying that letting must, in principle, be regarded as constituting several distinct and independent supplies which need to be assessed separately for VAT purposes, unless the elements of the transaction, including those indicating the economic reason for concluding the contract, are so closely linked that they form, objectively, a single, indivisible economic supply which it would be artificial to split.

In an earlier case (B.G.Z Leasing and Director of The Warsaw Tax Chamber Case C-224/11 dated 17^th January 2013 (Judgment of the Court (Sixth Chamber))), on an issue of regarding recovery of insurance costs from tenant and whether these could be seen separately from the activity of letting out of immovable property, the Court has taken the view that insurance transaction where actual insurance costs are recovered by lessor from lessee will have to be seen independently. It is important to note here however, that insurance was taken at the option of the lessee where he required lessor to insure property rather than lessee himself insuring the same and such insurance service was not mandatorily bundled with leasing services. 

The aforesaid cases highlight the need for proper appreciation of likely tax impact at the time of concluding contracts for letting out of immovable property where certain other services or utilities are involved. While our law provides for pure agent route where there are reimbursements, whether recoveries for other services could be categorised as reimbursements at all or not is a question that could arise. The possibility of litigation for landlords cannot be ruled out as nature of supply could vary from case to case.

Disclosure of intention on standard terms and conditions of supplier vis-a-vis customer perspective

In Everything Everywhere Ltd and Commissioners for Her Majesty’s Revenue and Customs (Case C-276/09) (Judgment of The Court (Third Chamber)) dated 2^nd December 2010, the issue was regarding taxability of Separate Payment Handling Charges (SPHC) collected by mobile telephone service provider from consumers who had opted for certain modes of payment of mobile telephone bills viz., cheque payment, credit and/or debit card payments. The issue arose as the mobile service provider had sought exemption from payment handling charges distinguishing it from telecommunication service despite having provided for the charges in its terms and conditions, tariff and on its website with a view to communicating the same to its customers.

The Court observed that customers who pay their mobile telephone bills using one of the payment methods which incur the SPHC do not intend to purchase two distinct supplies, namely a supply of a mobile telephone service and a supply whose purpose is to handle their payments.

From the customer’s point of view, the supply of payment handling services supposedly provided by the telecommunications services provider to its customers at the time those services are paid for using certain payment methods must, in the circumstances such as those in present case, be regarded for VAT purposes, as being ancillary to the principal supply of those telecommunications services.

Consequently, the telecommunications service provider was not in a position to treat payment handling charges separately and distinctly from the main service i.e. telecommunications service going by customer perspective. This only highlights the importance of customer perspective irrespective of break-up of charges or disclosures as to intent to charge being provided on terms and conditions by service supplier.

Relevance of marketing/positioning of supply and pricing methodology

In Purple Parking Ltd and Airparks Services Ltd against The Commissioners for Her Majesty’s Revenue & Customs (Case C-117/11) (Order of the Court (Seventh Chamber)) dated 19^th January 2012, the issue was regarding treatment of transport of passengers in a motor vehicle between a car park and an airport passenger terminal where this was provided to passengers who were using car park facility. Customers used to drive their vehicles and park them in the 24 hour 7 days a week car park facility and then board the buses to reach the airport terminal. On their return they again used the transport facility to reach departure area where their vehicles or cars used to be made available.

The brochures provided by the appellants to customers emphasised the safety of the car park and the efficiency and simplicity of the parking operation. Reference was made in those brochures to ‘simply leaving your car, and moving yourself, your family and your luggage into one of our courtesy buses, with the driver of the vehicle helping with the luggage’.

The price charged by the appellants to their customers was entirely by reference to the time, calculated per day, that the vehicles were parked in the car park. The number of passengers was irrelevant and the transport was not charged separately. While tax was paid at standard rate by the operator, he claimed a refund at a later date on the grounds that transport services in vehicles designed to carry not less than ten passengers were actually zero rated. Refund was naturally refused by the Commissioners.

The Court observed that the pricing concept reflected the interests of the parties concerned. The customer sought, first and foremost, parking at an advantageous price. By contrast, the transport service was only the inevitable consequence of the fact that the car park was located at a certain distance from the airport, a location accepted by the customer given that the distance allowed him to pay less for the parking service. Secondly, the car park operator offered the transport service in order to be capable, in spite of that distance, of competing with the parking within the airport.

Moreover, the importance of the parking element followed from the measures adopted in order to guarantee the safety of the car park, which were also emphasised in the appellants’ brochures. Those measures were particularly important for the customers in the light of the fact that, on average, they parked their vehicles for several days.

Consequently, the Court was of the view that for the purpose of determining the rate of VAT applicable, services for the parking of a vehicle in an ‘off-airport’ car park and for the transport of the passengers of that vehicle between that car park and the airport terminal concerned had to be regarded as a single complex supply of services in which the parking service was predominant. This highlights the importance of marketing and pricing strategy as Courts could look at these to identify the principal element of a composite supply. Documents like brochures, catalogues or even website of the provider/supplier could be seen to understand essence of the supply.

Relevance of regular business practice of supplier and impact on cost and pricing

In The Commissioners of Customs & Excise and T.P Madgett & R.M Baldwin (Case C-308/96 joined with Case C-94/97) (Judgment of The Court (Fifth Chamber)) dated 22^nd October 1998 the issue was regarding application of scheme for travel agents under Article 26 of the Sixth Council Directive 77/388/EEC of 17May 1977 (Old directive) to a hotelier.

The Court while discussing the tax treatment held the view that where a hotelier habitually offers his customers, in addition to accommodation, services which go beyond the tasks traditionally entrusted to hoteliers, and which cannot be carried out without a substantial effect on the package price charged, such as travel to the hotel from distant pick-up points, such services are not to be equated with purely ancillary services.

Consequently, the scheme for travel agent was held to apply to a hotelier who, in return for a package price, habitually offered his customers, in addition to accommodation, return transport between certain distant pick-up points and the hotel. This would be the case even if coach excursion during their stay i.e., transport services were being bought in from third parties. This was different from a scenario where the bought in services were only ancillary to the principal service of the hotelier and where such bought in services did not constitute an aim in themselves for the customer.

The Flyer issued by CBEC on composite and mixed supply in essence seeks to capture the gist of the legal position emanating from these decisions discussed so far in a simple way requiring assessees to look at business and industry practice in the concerned field as well as perception of consumer in receiving the said services for the purpose of determining whether or not services would be of composite nature. One can only hope that Courts in India take note of the views taken by European Court of Justice (ECJ) on the subject matter in the last couple of years so that clear guidelines can be laid down for assessees to follow. Problems could be faced here due to the fact that even in Europe, there have been some contradictions in stance taken over the years leading to confusion.

Readers who are interested in accessing detailed case laws on the subject in the EU could do so on the website of the European Court of Justice at curia.europa.eu.

In case of any doubts on the article the author could be reached at srikantharaot@gmail.com