Cross Charge and ISD under GST-Some fresh thoughts

Concept of cross charge is invention in GST regime. This concept did not exist in old regime. Following are extracts from Statute giving birth to this novel concept.

Relevant extracts of Section 25 of CGST Act which reads as under:

(4) 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.

(5) Where a person who has obtained or is required to obtain registration in a State or Union territory in respect of an establishment, has an establishment in another State or Union territory, then such establishments shall be treated as establishments of distinct persons for the purposes of this Act. 

Relevant extracts of Schedule I to CGST Act reading as under:

2. Supply of goods or services or both between related persons or between distinct persons as specified in section 25, when made in the course or furtherance of business: 

Extract of explanation 1 to Section 8 of IGST Act reading as under:

Explanation 1. —For the purposes of this Act, where a person has, —

(i)		an establishment in India and any other establishment outside India;
(ii)		an establishment in a State or Union territory and any other establishment outside that State or Union territory; or
(iii)		an establishment in a State or Union territory and any other establishment registered within that State or Union territory,

then such establishments shall be treated as establishments of distinct persons. 

Section 25 of CGST Act read with explanation 1 to Section 8 of IGST Act lay lays down that following will be treated as distinct persons for the limited purpose of GST law.

1.Each Registration obtained whether in same state or in different states shall be treated as distinct persons.

2. Registered (under GST law) establishment in one state and unregistered establishment in other state shall be treated as distinct persons.

3. An establishment in India and other establishment outside India shall be distinct persons.

4. An establishments in different states even though unregistered shall be treated as distinct persons.

5. Establishment registered in one state and another unregistered establishment within same state shall be distinct persons.

The term establishment has not been defined in GST law. Dictionary meaning of same is any office or manufacturing unit or outlet or service provider or depo or branch.

Thus, we can observe that though under common law above establishments or registrations are part of same entity but for the limited purpose of GST law, they are to be regarded as different entities or persons.

It is common practice that supply of goods or services takes place among these establishments or registrations and that is too without any consideration.

The taxman (Government) has put fingers on these interbranch or inter office transactions and treated them as supply liable to GST even though transactions are without any consideration by virtue of Schedule 1 to CGST Act which is extracted above.

Consequently, if any unregistered establishment (since it is not engaged in any supply to outsiders) is engaged in supply of goods or services to another establishment in other state, it would be required to obtain compulsory registration u/s 24 of CGST Act.

Similarly, if any unregistered establishment (since not engaged in any supply to outsiders) is engaged in supply of goods or services or both to other establishment in same state, it would be required to obtain registration on crossing threshold limit of turnover laid down by section 22 of CGST Act.

Thus, cross charge becomes mandatory once it is proved that two establishments are distinct persons and transactions of supply of goods or services are taking place between them even though without consideration.

Valuation under cross charge

Under section 15 of CGST Act, value of supply is price actually paid or payable for such supply provided parties are not related and price is sole consideration for such transaction. Since in case of inter establishment transactions, no price is charged, we have to take recourse of Valuation Rules (Chapter IV of CGST Rules) in accordance with section 15 (4) of CGST Act.

Valuation in case of distinct persons covered by 25(4) and 25 (5) of CGST Act

 Rule 28 of CGST rules will be applicable for transactions between distinct persons under section 25 (4) and 25 (5) of CGST Act. It lays down as follows:

1.Value of supply will be open market value of goods or services

2.If open market value is not available, value of supply will be value of supply of goods or services of like kind and quality by same establishment.

3.If value cannot be determined by above methods, it will be determined by application of Rule 30 which lays down that value will be   110% of either cost of acquisition or manufacturing of goods OR110% of  cost of provision of such service

4. If value cannot be determined by above methods, it will be determined by application of Rule 31 which lays down that value will be determined using reasonable methods consistent with provisions of Act and Valuation Rules.

It further lays down that in case of provision of service, Rule 31 can be applied ignoring Rule 30.

Fist Proviso to Rule 28 lays down that in case of supply of goods which are supposed to be further supplied by recipient as it is, supplier may adopt value being equivalent to 90% of price charged by recipient to his customer not being related person.

Second Proviso to Rule 28 lays down that in case recipient is entitled for full ITC of tax charged by supplier, value of supply mentioned in invoice issued by supplier will be treated as open market value of goods or services.

Thus, as result of second proviso to Rule 28,in case of distinct persons covered by section 25 (4) and 25(5), valuation is not cumbersome provided recipient is entitled to full ITC.

Valuation in case of distinct persons as per explanation to section 8 of IGST Act

Valuation will be made in accordance with Rule 30 or Rule 31 of CGST Rules.

Rule 28 is not applicable in this case.

Issues in valuation in cross charge

Valuation of supply of goods

Generally, valuation of supply of goods does not pose any major issues since cost of acquisition or manufacturing of goods will be available with supplier and even open market value of those goods can also be found out. Accordingly rule 28 (in case of distinct persons covered by section 25) or directly rule 30 and rule 31(in case of other distinct persons) may be applied.

Valuation of supply of services

Real challenge is in case of supply of services since open market value of service supplied by one establishment to other establishment as per rule 28 cannot be available. Similarly, value of services of like kind or quality as per rule 28 also cannot be available since services of like kind and quality are not supplied by establishment to any outsider.

 In case of supply of services by both categories of distinct persons, recourse has to be taken to rule 30 and 31.

Cost of provision of services can be determined after considering all expenses incurred in providing those services i.e., cost of running office such as rent, electricity, telephone, food and beverages, salaries of staff etc.

Here another twist comes into picture. Since employees working in establishment providing services are employees of entity as a whole under common law, how can services provided by such employees be considered for cross charge taking into consideration schedule 3 to CGST act which specially excludes services provided by employee to employer in course of employment from purview of GST.

Here we have to understand and accept that services are not provided by employees of servicer provider establishment to recipient establishment but services are provided by one establishment to other establishment.

Moreover, for limited purpose of GST and as a result of deeming fiction created under GST law, employees working in service provider establishment are to be treated as employee of that establishment only and not of the entity as a whole.

Thus, value of services can be arrived at by summation of all relevant expenses for relevant period. Mark up on such cost may not be made in case of applicability of rule 28 but otherwise reasonable mark up on cost will be required.

When services are provided to more than one establishment, value of services arrived at has to be apportioned or allocated among all such establishments using some reasonable basis. One such basis is turnover of establishments during relevant period. In case of supply of HR related services, basis of apportionment can be number of employees in each establishment.

Input services distribution or ISD

This concept has been borrowed from service tax regime with certain variations.

Input services distributor has been defined u/s 2(61) of CGST Act as under:

“Input Service Distributor” means an office of the supplier of goods or services or both which receives tax invoices issued under section 31 towards the receipt of input services and issues a prescribed¹⁷ document for the purposes of distributing the credit of central tax, State tax, integrated tax or Union territory tax paid on the said services to a supplier of taxable goods or services or both having the same Permanent Account Number as that of the said office 

 It is facility given by Statute to ensure distribution of common or exclusive input tax credit of inputs services acquired centrally to relevant recipients/recipient by adopting method laid down under the Act.

As already mentioned, only ITC of services can be distributed using this facility.

Generally, any organisation undertakes centralised procurement of  major goods and  major services in order to ensure:

a. Administrative convenience

b. Better and strong negotiations with supplier in case of bulk procurement

c. Better supervision and monitoring over supply of goods or services by supplier or vendor.

ISD registration can be obtained by any office of entity such as head office/regional/zonal/divisional office or even by any branch. This registration can be obtained even by office or establishment already having regular registration under GST law as supplier of goods or services.

Tax Invoices by vendor of services are issued in favour of this ISD registration who in turn can distribute input tax credit of tax so paid (to supplier) to various other establishments of same entity by compulsorily adopting method laid down by section 20 of CGST Act.

We are not going into details of method of distribution.

It is to be noted that services being intangible, point of time of receipt of services and also actual receiver of beneficiary of services are very difficult to determine.

Input tax credit of all services which are procured centrally on behalf of various other establishments or offices must be distributed via ISD route. Reason is as follows:

Section 16 (1) of CGST Act which deals with conditions for availing input tax credit, beside other things, provide that input tax credit of only those input services shall be available which are used or intended to be used in the course or furtherance of business of registered person.

As in case of centralised acquisition by any registered person, services are used or intended to be used in course of business of other establishments or registrations, the registered person procuring the same centrally will not be entitled to avail input tax credit either wholly(if services are not used by him at all) or partially (if services are used for his business to certain extent.)

Even though office procuring services centrally satisfies definition of recipient as laid down by section 2(93) of CGST Act since it is liable to pay the consideration, it does not satisfy  requirements of section 16(1).

Issue of cross charge of centrally acquired services.

Moreover, if any objection is raised by department saying that such services should be cross charged since office acquiring the services centrally is actual recipient of those services and it is supplying those services to other offices or establishments, justification of distribution thru ISD route can be as follows:

1.Office acquiring the services satisfies the definition of recipient, but it does not satisfy requirements of section 16(1) as already explained above.

2.Moreover, office acquiring services centrally is already making cross charge for services provided by it (in form of negotiation with vendor, selection of vendor, supervision of supply of serviced by vendor) to other establishments for which services are acquired.

3.Value of this cross charge will not include expenditure for services acquired centrally or at the most it may include only that part of such centrally acquired services as is actually used by centralised office.

Thus, ISD registration will be involved in exclusive distribution of ITC on services, cross charge in respect of provision of services in relation to centralised procurement will be done by regular registration of that office.