Circular Trading is not a new concept in India, it has been ever existing in the Indian Market, but many tend to believe that it only takes place in the stock market. However, that is not the case, Circular Trading can also take place into companies or trading businesses. Before we further get into the depth and analysis of circular trading, let’s start with the basics and try to understand the following aspects.
Circular trading refers to issuing of invoices in transactions among multiple companies without actual supply of goods. This is done to use input tax credit in the GST regime, meaning Circular Trading is a type of cycle that takes place when a company tries to create a flow of fake sales transaction with its collusioned parties by producing fake invoices.
This type of cycle basically creates a huge financial impact on companies’ accounts. This approach of fraud helps companies to inflate their turnover, gain larger loans from financial institutions or banks and also avail GST credits on every lap of transactions done, ultimately raising the black money.
There is no clear definition of Circular trading in GST , we will try to understand the concept under different circumstances and try to seek the answer whether in the below examples, Circular trading happens or not?
Example 1: Let’s say Company A is into trading of Gold and supplies, and sells goods to Company B, and Company B sells the same goods to Company C, Company C sells the same goods to Company D and Company D sells to Company E and finally E sells the goods to company A. or Company A purchases the exact goods from Company E, hence completing the cycle.
Here before deciding whether the above flow of transaction in example 1 is a circular transaction or not we have to answer the following unanswered question
1) Whether the company A was having the physical goods in his inventory before he sells to Company B?
2) Whether in the journey of flow of transaction from Company A to Company E, whether any third party Logistic services provider are deployed to collect and deliver the goods to Company B, C, D, or E?
3) Whether in reality the goods are moved from one company to another?
Example 2 : Suppose Company A sells goods to company B -100 Kgs, Company B sells goods to Company C – 85 Kgs, Company C sells goods to Company D -70 Kgs , and Company D sells to Company E -65 Kgs, and Company E sells goods to Company A – 65 Kgs . Now the unanswered question
1) The same goods came back to A but the quantity is not the same, so whether this can be treated as circular trading?
2) Simlarly, out of the total purchases of Company A, the purchases from Company E is only 10 to 20 %, and the remaining purchases of Company A are from other institutions such as banks, Exchange and imports from abroad so whether this transactions falls under the ambit of Circular Trading and can be treated as circular trading?
Example 3 : Suppose Company A sells goods to company B at Rs 1000, Company B sells goods to Company C at Rs 1010 , Company C sells goods to Company D at Rs 1070 and Company D sells to Company E at Rs 990 and Company E sells goods to Company A at Rs 1000.
1) From the above example it is imperative that there is a value addition at each level, but if the item of trade is such (like gold) where the price is determined on the basis of cost plus small margin or market price which level is low, so whether this tantamount to Circular trading?
In all the three examples, sale of goods has taken place and the title in the goods are transferred in the hands of the buyer . As per section 4 of Sale of Goods Act , ‘A contract of sale of goods is a contract whereby the seller either transfers or agrees to transfer the property in goods to the buyer for a decided price.
Consequence: Since the provision of GST for circular trading are very harsh and are covered under serious offense as non-bailable and cognizable offense, where a police department has the authority to arrest without a warrant and can begin an investigation without any permission of a court if the amount surpasses beyond INR 5 Crs.
In February and April, 2019, the Indirect tax department has raided in different states to unearth the transaction of circular trading. It is said that some companies prepared doctored invoices of INR 25,000 crore to avail advantage of GST credit or input tax credit.
Input Tax Credit is a mechanism where a company at the time of paying tax on output, can claim the tax that have already paid on inputs. For instance, a company A has a tax payable on output (Final product) is INR 5000 and tax paid on inputs (Purchases) is INR 4000. Here, this company can claim input credit of INR 4000 and will be taxed only the difference amount that is INR 1000.
Conclusion : In the absences of the clear cut definition of circular trading there is lot of confusion in the trade and industry. The government (GST Council) should come out with the clear policy, FAQs and DO and DON’T as when the transactions are to be treated as Circular Trading.
When there are no clear guidelines on Circular Trading , the harsh provisions of imprisonment cannot be left at the discretionary of the GST officers, which has a very big and direct impact on the reputation of the businessman in particular and the business community at large, and such provisions should be either diluted or deleted from the act.