GST on High Seas Sales

Recent Ruling of AAR of Maharashtra in case of M/s. BASF India Ltd has discussed the applicability of GST on High Seas sales transactions and the reversal of ITC in case of such transactions. This article is a discussion on that ruling.

“There ain’t no such thing as a free lunch.” All of us have heard this idiom being used time and again over the years in different contexts. The essential meaning of the phrase is that you can not get something by giving nothing in return. Based on a recent ruling by the Authority for Advance Rulings of Maharashtra, one would think that the Revenue Department is taking this saying a tad too literally.

The Maharashtra Authority for Advance Ruling (hereinafter referred to as “the Authority”) issued an order dated 21^st May, 2018 on an Advance Ruling request raised by M/s. BASF India Limited (hereinafter referred to as “the Applicant”). The Applicant sought an Advance Ruling on the applicability of GST on “High Seas” sales and the implication thereof on the Input Tax Credit (ITC) of the Applicant. A brief nature activity of the Applicant, as stated in the Ruling, includes manufacturing and trading of chemicals and allied products. The Applicant imports certain goods and sells them to its customers located in India based on pre-orders received from such customers. The crux of the transaction is that the goods are sold to the customers before they are entered for Customs clearance. This practice is known as a “High Seas” sales transaction in the common trade parlance.

Before we analyse the Ruling by the Authority, let us briefly have a look at the submissions and interpretations provided by the Applicant –

The Applicant submitted that as per Section 5 and its provisions read with Section 7 of the IGST Act, the transaction is one of import of goods and the person clearing the goods is liable to pay IGST along with the Customs Duty under the Customs Act, 1962. However, since the duties and taxes are liable to be paid on the clearance of goods from the Customs by the Applicant’s customer, any transaction that takes place before such clearance should not be taxable. This would amount to double taxation of the same transaction. In fact, the Central Board of Indirect Taxes and Customs (CBIC) has also issued a Circular no. 33/2017 – Cus dated 1^st August, 2017, clarifying that the GST Council had considered the issue of High Seas sales and concluded that such transactions shall be dutiable only at the last stage of customs clearance. This view has been further strengthened vide Circular no. 3/1/2018-IGST dated 25^th May, 2018, wherein the CBIC has clarified that the IGST shall not be levied on goods which are sold or transferred while being deposited in a bonded warehouse. The reasoning behind both the Circulars points to the same concept of duty and IGST being payable at the time of final clearance of goods for home consumption.

On the issue of reversal of ITC, the Applicant has, somewhat contradictorily, submitted that High Seas sales are not exempt supplies. Relying on Section 17 read with Section 2 of the CGST Act, the Applicant has submitted that the High Seas sale transaction is ultimately being subjected to tax at the time of final clearance of goods from the Customs area and duty and IGST is being levied on the value derived after considering the High Seas sales contract value. In view of this, the High Seas sales transactions can not be considered to be “exempt supplies” under the CGST Act. Therefore, there should not be any reversal of ITC as envisaged in Section 17 of the CGST Act.

The Concerned Officer to the hearing has, in his submissions, accepted the interpretation of the Applicant regarding the inapplicability of IGST on the High Seas sales transactions. However, he has contended that since the tax is not being levied on such transactions, they would qualify as “exempt supplies” under the CGST Act.

The Authority heard the matter and the arguments and submissions put forth by the Applicant and the Concerned Officer. After referring to the various provisions of the IGST Act and the CGST Act read with the relevant provisions of the Customs Act, the Authority ordered as under –

• In the case of taxability of High Seas sales, the Authority accepted that the transaction shall not be exigible to levy of IGST.
• In the case of reversal of ITC, the Authority has ordered that the High Seas sales transaction shall be considered as “non-taxable supply as no tax is leviable on them till the customs clearance in accordance with and compliance of Section 12 of the Customs Act, 1962 and Section 3 of the Customs Tariff Act”. This would make such transactions subject to reversal of ITC as per Section 17 of the CGST Act.

This Ruling of the Authority is binding on the Applicant and the Concerned Officer, unless an Appeal against the Ruling is preferred by the Applicant. Let’s analyse the reasoning of the Authority while arriving at the Ruling as given in this case.

Chapter VI of the IGST Act deals with the Determination of Nature of Supply. The provisions of Section 7 of the IGST Act which are relevant to our discussion are reproduced below for reference –

“7. (1) Subject to the provisions of section 10, supply of goods, where the location of the supplier and the place of supply are in –

(a) two different States;

(b) two different Union territories; or

(c) a State and a Union territory,

shall be treated as a supply of goods in the course of inter-State trade or commerce.

(2) Supply of goods imported into the territory of India, till they cross the customs frontiers of India, shall be treated to be a supply of goods in the course of inter-State trade or commerce.

….”

It is clear from the reading of the above provisions that the goods supplied by way of High Seas transaction shall fall under Section 7(2) above as they are supplied before crossing the customs frontiers of India. Further, such supplies shall be treated as supply in the course of Inter-state trade or commerce. Although the definition of “customs frontiers of India” warrants a discussion for determining the nature of supply in our discussion, for the sake of brevity, let us presume that the transaction meets all the criteria of section 7(2) and can, without a doubt, be considered as a High Seas sales transaction.

Since we have determined that the High Seas sales transactions shall be considered to be in the course of inter-state trade or commerce, we further refer to Section 5 contained in Chapter III of the IGST Act to determine the taxability of such transactions. The relevant provisions are reproduced below –

“5. (1) Subject to the provisions of sub-section (2), there shall be levied a tax called the integrated goods and services tax on all inter-State supplies of goods or services or both except on the supply of alcoholic liquor for human consumption, on the value determined under section 15 of the Central Goods and Services Tax Act and at such rates, not exceeding forty per cent., as may be notified by the Government on the recommendations of the Council and collected in such manner as may be prescribed and shall be paid by the taxable person:

Provided that the integrated tax on goods imported into India shall be levied and collected in accordance with the provisions of section 3 of the Customs Tariff Act, 1975 on the value as determined under the said Act at the point when duties of customs are levied on the said goods under section 12 of the Customs Act, 1962.

….”

The proviso to Section 5(1) above provides that the IGST on goods “imported” into India shall be levied and collected as per the provisions of the Customs Tariff Act, 1975 and the Customs Act, 1962. As per Section 2(10) of the IGST Act, “import of goods” has been defined as “import of goods” with its grammatical variations and cognate expressions, means bringing goods into India from a place outside India;”. The complete transaction of High Seas sales involves getting goods into India from a place outside India. Therefore, the taxability of this transaction should be decided as per Section 3 of the Customs Tariff Act, 1975 at the point of levy of duty as per Section 12 of the Customs Act, 1962.

The CBIC, while deciding the applicability of Section 12 of the Customs Act, 1962 in Circular no. 33/2017 – Cus dated 1^st August, 2017, has observed that –

“4. GST council has deliberated the levy of Integrated Goods and Services Tax on high sea sales in the case of imported goods. The council has decided that IGST on high sea sale (s) transactions of imported goods, whether one or multiple, shall be levied and collected only at the time of importation i.e. when the import declarations are filed before the Customs authorities for the customs clearance purposes for the first time. Further, value addition accruing in each such high sea sale shall form part of the value on which IGST is collected at the time of clearance.

5. The above decision of the GST council is already envisioned in the provisions of subsection (12) of section 3 of Customs Tariff Act, 1975 inasmuch as in respect of imported goods, all duties, taxes, cesses etc shall be collected at the time of importation i.e. when the import declarations are filed before the customs authorities for the customs clearance purposes. The importer (last buyer in the chain) would be required to furnish the entire chain of documents, such as original Invoice, high-seas-sales-contract, details of service charges/commission paid etc, to establish a link between the first contracted price of the goods and the last transaction. In case of a doubt regarding the truth or accuracy of the declared value, the department may reject the declared transaction value and determination the price of the imported goods as provided in the Customs Valuation rules.”

Since the IGST Act shifts the burden of taxability of imports of goods to the Customs Act and the circular under Customs Act has clarified that the point of taxation shall be the point of clearance of goods, we can safely assume that the High Seas sales shall not be subject to levy of IGST at the time of such sales. This is also the stand taken by the Authority while Ruling in the case of M/s. BASF India Limited. Hence, I believe the first question of the Applicant has been answered satisfactorily by the Authority in the Ruling.

The second question relates to Section 17 of the CGST Act. This section provides for ineligibility or reversal of ITC in respect of exempt supplies. Section 17(2) of the CGST Act provides that where the goods or services or both are procured partly for providing taxable supplies and partly for providing exempt supplies, the ITC in respect of the exempt supplies shall be restricted / unavailable to the taxpayer. The calculation to determine the quantum of this unavailability or ineligibility of ITC has been laid down vide Rule 42 and Rule 43 of the CGST Rules, 2017. For the sake of brevity, we shall restrict ourselves to the text of Section 17(2) to determine the applicability of this section to High Seas Sales transactions. The text reads as under –

“17. ….

(2) Where the goods or services or both are used by the registered person partly for effecting taxable supplies including zero-rated supplies under this Act or under the Integrated Goods and Services Tax Act and partly for effecting exempt supplies under the said Acts, the amount of credit shall be restricted to so much of the input tax as is attributable to the said taxable supplies including zero-rated supplies.

….”

The Authority has further observed in the Ruling that since “no duty is leviable on them (High Seas Sales) except in accordance with proviso to Section 5(1) of the IGST Act”, High Seas sales transactions shall fall under the category of “exempt supply”. I feel this is a contentious issue in the Ruling.

“Exempt Supply” has been defined under the CGST Act in Section 2(47) as – ““exempt supply” means supply of any goods or services or both which attracts nil rate of tax or which may be wholly exempt from tax under section 11, or under section 6 of the Integrated Goods and Services Tax Act, and includes non-taxable supply;”

Let us break down the definition to understand the scope of exempt supplies under the CGST Act. The definition starts with “exempt supply means”. The word “means” has restricted the definition to be an exhaustive one, which implies that the scope of the definition is limited to the text contained therein. As we read further, the definition contains three distinct kinds of supplies that shall be considered as “exempt supply”. The first is the “supply of goods or services or both which attracts nil rate of tax”. The tax rates of goods and services have been released by the Government in various Schedules vide Notification No. 1/2017 – CT (Rate) and 11/2017 – CT (Rate) respectively, as amended from time to time. However, these notifications have so far not provided for any goods to be nil rated. Even for services, only one service has been notified under the nil rate of tax which has no relevance to our topic of discussion. The next category is goods or services or both “which may be wholly exempt from tax under section 11, or under section 6 of the Integrated Goods and Services Tax Act”. Multiple notifications have been issued and amended under Section 11 of CGST Act and Section 6 of IGST Act to exempt goods and services from the tax incidence. However, in none of these notifications is there a mention of any transactions resembling or related to High Seas sales. The third part of the notification is “and includes non-taxable supply”. The scope of “Non-taxable supply” has been defined in Section 2(78) as follows – “(78) “non-taxable supply” means a supply of goods or services or both which is not leviable to tax under this Act or under the Integrated Goods and Services Tax Act;”. The Authority has liberally interpreted the words “not leviable to tax” and included High Seas sales transactions under this clause. Consequently, High Seas sales have been made part of “exempt supply” and the Authority has Ruled that owing to this, the ITC shall be restricted under Section 17.

The moot question that arises is whether High Seas sales are actually “not leviable to tax” under the CGST or the IGST Act? Section 7(2) of the IGST Act lays down that the supply of goods imported into India, till they cross the customs frontier of India, are considered to be supplied in the course of inter-state trade or commerce. Section 5(1) of the IGST Act states that IGST shall be levied on all inter-state supplies of goods or services. Therefore, the leviability of IGST has been established in the IGST Act itself. However, the proviso to Section 5(1) states that the IGST on goods imported into India shall be levied and collected as per the provisions of the Customs Act. The incidence of IGST under the Customs Act, in case of High Seas sales, has been placed upon final clearance of goods. This tax is to be paid on the value arrived after value addition on account of High Seas sales, as clarified in the Circular no. 33/2017. This means that the High Seas sales are in fact being subjected to the levy of IGST. Only the incidence of tax has been moved from the time of entering into the agreement for High Seas sales to the time of clearance of goods from the Customs. This makes it clear that the High Seas sales transactions can not be classified as “not leviable to tax” as observed by the Authority.

The above implication, in turn, renders the second response of the Order issued by the Authority invalid. Since the High Seas sales transactions are leviable to tax, the common ITC shall not be restricted under Section 17 of the CGST Act on account of such transactions. This is my interpretation based on the strict reading of the law.

For the sake of prudency, let us deliberate the reasoning behind introducing Section 17 – (1), (2) and (3) of the CGST Act. These sub-sections and the rules made thereunder are similar to the provisions of Rule 6 of the CENVAT Credit Rules, 2004. The logic behind introduction of these provisions was to restrict the ITC of goods and services to the proportionate value of taxable supplies, in case the taxpayer is dealing in taxable as well as exempt supplies. In case of taxpayers dealing exclusively or primarily in exempt supplies, the Government loses revenue as the input credit will usually be more than the output liability. To overcome this, the Government came up with the logic that if the taxpayer is not paying tax on the entire income, the ITC should also not be granted on goods or services used to earn exempt income or commonly used for earning exempt and taxable income. Hence, by virtue of Section 17 and the rules made thereunder, the ITC of input goods or services used exclusively for exempt supplies can not be availed and common ITC on the goods or services used for both taxable as well as exempt supplies shall be restricted to the proportion of taxable income to total income.

Keeping the above in view, one might argue that by making High Seas sales, the seller is earning an income on which he is not paying GST. Emphasis is to be given to the usage of the word “seller”. The seller is using common goods or services like consultancy, banking, stationery, telephone, internet etc. to earn this income. If that is the case, going by the logic behind Section 17, why should ITC be allowed in full on such goods or services?

Interestingly, the GST Council has approved the amendments for adding high seas sales and out-and-out sales (where the goods do not enter the territory of India) to Schedule III of the CGST Act, which classifies transactions as neither supply of goods nor supply of services. These amendments to the law have also been tabled in the Lok Sabha. This would entail that high seas and out-and-out transactions shall not be subjected to reversal of ITC under Section 17 of CGST Act. However, these proposals are not being put into effect retrospectively, as can be interpreted from the CGST Amendment Bill. This will keep the argument, as discussed in this article, alive for the period prior to the amendments coming into effect.

In conclusion, the Ruling by the Authority in the case of M/s. BASF India Limited may be correct in the first question asked by the Applicant in the Advance Ruling application. But the reasoning behind the complete Ruling may be flawed. Some experts argue that the Ruling may be incorrect completely and has been made to favour the interest of the Revenue. In any case, I personally believe the interpretation adopted by the Authority seems to be very liberal and could have been deliberated further. Also, with the proposed amendments to the Act, one can argue that the intention of the Government was to keep such transactions outside the scope of GST from the very beginning and the entire discussion on the Ruling is moot. Counter-views and discussions are most welcome, and in fact, solicited.