GST implementation in India piloted various new concepts of indirect taxation. The cause for the levy of indirect taxes shifted from the concept of manufacturing, service and sales to the concept of ‘supply’. The indirect tax system itself transitioned from an origin-based taxation to a largely destination / consumption-based taxation system. An important change under the GST regime is the treatment of inter-unit cross-charges. The service tax regime had the provision of centralized registration and even in cases where separate or decentralized registrations were obtained, all the registrations were part of the same person or entity and no deemed transaction arose between the registrations. However, this understanding has changed under GST leading to significant changes in treatment of transactions between GST registrations.
Section 25 (4) of the CGST Act, 2017 (‘Act’) provides that, “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”. So, two separate GST registrations, whether in the same state or in different states, under the same PAN number are distinct persons for the GST legislation. Further, clause 2 of Schedule I of the Act provide that “supply of goods or services or both between related persons or between distinct persons as specified in Section 25, when in the course of furtherance of business” shall be treated as supply even if made without consideration.
The above provisions lead to the understanding that, the third-party common costs at the entity level (say, the audit fee, software license, consultancy charges, etc.) are used or consumed across the entity and hence have to be allocated to all registrations, if the head office bears such expenses. This can be done either through a tax invoice involving cross-charge of both value of the service and GST or through the mechanism of the input service distributor (ISD) by transferring the input GST credit to other registrations.
However, it is debatable as to whether even the common employee costs (say Finance, Tax, HR, Admin, IT, etc.) also have to be shared by all the GST registered locations of an entity. Let us analyze some of the issues surrounding service cost cross-charge to other GST registered locations of an entity.
1. Employee cost cross charge is optional or mandatory – A question arises as to whether the common employee costs have to be mandatorily shared between GST registrations or is it optional. Assuming that the head office would be housing the central functions such as Finance, Tax, HR, Admin, IT, etc., would the head office be required to compute the value of services provided by these functions to the branch offices and charge the same to branch offices with GST?
This matter came up for discussion in the case of M/s. Columbia Asia Hospitals Pvt Limited before the Karnataka Appellate Authority for Advance Ruling (AAAR). The appellant explained that the employment relationship between the employee and the employer exists with the legal entity as a whole and is not confined to the registered location where the employee is based. Further, the appellant explained that in terms of Entry I of Schedule III of the Act, services by an employee to the employer in the course or in relation to his employment shall not be treated as supply of service. Hence, there is no transaction of supply of service between the corporate office and other offices.
The AAAR ruled that the employer-employee relationship is to be viewed separately for each registered location of the business entity (reaffirming the decision of the AAR and without clearly explaining why the employee relationship with the employer is not at an entity level) and in so far as the other units are benefiting from the services of the employees located at the corporate office, there is a supply of service from the corporate office to other offices. Therefore, the transaction (or a deemed transaction between the offices) is covered under supply and chargeable to GST.
Going by the above decision, the cross-charge of common employee costs from the head office to other offices or the other way (where employees sitting in branch offices also provide service to head office) is mandatory and the head office cannot retain or absorb all the common employee costs at its end.
2. Valuation – Rule 28 of the CGST Rules, 2017 (‘Rules’) provides the mechanism of valuation in the case of transactions between distinct persons under Section 25 (4) of the Act. The valuation shall be –
i. Open market value of such supply;
ii. If open market value is not available, then the value of goods or services of like kind and quality;
iii. If the value cannot be determined as per clause (a) or (b) above, then value shall be determined based on the cost of provision of service (Rule 30) or under residual value method (Rule 31).
The second proviso to Rule 28 provides that – where the recipient is eligible for full input tax credit, the value declared in the invoice shall be deemed to be the open market value of the goods or services.
In the case of services, availability of a comparable open market value or value of similar kind and quality can be almost ruled out. Hence, the internal cost of services becomes the yardstick for valuation. The above proviso to Rule 28 provides the flexibility to the taxpayer to choose any value for cross charge, preferably cost or cost + markup as the taxpayer deems fit. Further, the taxpayer can also have a standard factor/value of cross charge for the entire financial year instead of undertaking cross charge based on actual values month-on-month.
3. Cross Charge Pool and Allocation – The other issue that has to be addressed is the functions and cost centres that need to be included in the common employee cross-charge pool. While valuation of the services for cross charge is not a critical issue where the recipient GST registration is eligible for full credit, valuation becomes relevant where the receiving unit is not eligible for credit and the IGST charged accrues as revenue to the recipient State.
The legislation is silent on the mechanics of the cross-charge pool and allocation factors. Further, there are no guidelines on documentation and records management for such computation and allocation. It is upon the taxpayer to determine the cross-charge pool and the allocation factors.
4. Time of Supply – The common service functions in an organization may be engaged in supply of services at periodic intervals or on a continuous basis. Therefore, it would be extremely difficult though not impossible to determine the time of each supply for payment of GST. Hence, a question arises as to what should be the frequency of the cross charges, whether it should be monthly, quarterly or annually?
In terms of Section 13(2) of the CGST Act, 2017 the time of supply of service shall be earliest of the date of issue of invoice, date of provision of service or date of receipt of payment. The cross-charge between the GST registration would not involve any payment and it would be not possible to determine the date of provision of service for each such service and hence the time of supply would fall on the date of issue of invoice. Hence, the taxpayer is not bound to follow any periodic frequency for cross-charge to other units and the date of invoice (whenever issued) would be the time of supply. However, a monthly or a quarterly cross-charge could keep the taxpayer away from litigation.
5. Past Period Costs – The other question that emerges from point no. 4 is whether a taxpayer can now (in 2019-20), based on the above decision in the case of M/s. Columbia Asia Hospitals, undertake the cross-charge even for the period 2017-18 and 2018-19 and in doing so whether he would attract any interest or penalty given the delay in discharge of the applicable GST on the cross-charge. Going by the discussion in point no. 4 above, it appears that the taxpayer should be able to cross-charge even for the past periods and can adduce a line of argument that no interest or penalty is applicable for past period cross-charges as the time of supply is the date of issue of invoice which is in the current period. However, the question of interest and penalty is not free from litigation.
The decision of the AAAR is appropriate in the context of consumption-based tax principle with the GST accruing to the State to which services are provided. However, such cross-charges would lead to a plethora of transactions across the country without any incremental revenue to the Government where full credit is available to the recipient registration. Further, in the absence clear legislation on the credit eligibility at the recipient location, cost pool, allocation factors, the time of supply, etc. unnecessary litigation would crowd the courts.
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