Input services distributor and cross charge- a step towards legitimate allocation of GST (Comparison, limitations and Suitability)

Jitender Kumar Arora

Input services distributor and cross charge- a step towards legitimate allocation of GST (Comparison, limitations and Suitability)

It should be understand first that GST is tax leviable on supply of Good and Services both. It is consumption / destination based tax which against the previous principle of origin based taxation. Tax is charged on Value Added System (VAT) but business to business supply get credit of tax, with framework of law, and at the end tax goes in the hands of the state where consumption is made. If this basic principal is not followed then states would not get their share of legitimate revenue. The concepts of both Input Services Distributor (ISD) and Cross charge are based on this principle.

First Step towards allocation of tax is classification of supply as first Supply within a state i.e. Intrastate supply  and second Supply outside a state i.e. Interstate supply, which is summarized in table given below :-

Intrastate transactions: Intra state transactions are those where the location of supplier and place of supply are in same state and there will be a levy of Central goods and Services Tax (CGST) and the State goods and services Tax Act (SGST) of the state in which the supplier is located.

Interstate transactions: Interstate transactions are those where the location of supplier and place of supply are in different states or transactions of cross border (supplier is located in India and recipient located outside India or vice versa). In case of inter-state transactions, Integrated Goods and Services Tax (IGST) will be levied and place of Supply shall be determined in accordance with sections 10 to 14 of the Integrated Goods and Services Tax Act, 2017.

INPUT TAX CREDIT

As name suggest Input Tax Credit is credit of tax paid for acquiring/procuring goods and services. Since business purpose, including furtherance thereof, is a precondition for levy of GST, similarly in case Input Tax Credit it should also be noted that business purpose including furtherance thereof, should mandatorily be exist.

The term Input Tax has been defined under section 2(62) of Central Goods and Services Tax Act, 2017. Therefore Input Tax in context of registered person                                     includes

• CGST
• SGST / UTGST
• INTERGRATED TAX

Charged / paid under forward charge or reverse charge (RCM) and includes IGST paid on import of goods

Not to include

Composition levy

Input Tax Credit as per section 2(63) of the Central Goods and Services Tax, 2017 means the Credit of Input Tax.

Barrier in seamless flow of Tax Credit – Against GST basic principles 

Although it is mentioned under the input tax credit definition that the state tax is eligible for credit, but reality it is not that and state tax paid in one state can’t be utilized in the other state for payment of tax. The entire GSTN system is based on this scheme. State Tax is defined under Section 2(104) of Central Goods and Services Tax Act, 2017 as the tax levied under any State Goods and Services Tax Act, 2017.

Example

A registered person located in Delhi visits Mumbai for official tour and stayed there in Hotel and incurred the accommodation expenses. As per the place of supply rules place of supply will be Mumbai. In such a case he can’t claim input of CGST and SGST paid in Mumbai against CGST and SGST of Delhi State and vice-versa.

How to cross this barrier?  

This barrier can be crossed through first INPUT SERVICES DISTRIBUTOR (ISD)   and CROSS CHARGE MECHANISM which are discussed as follows:-

Input Service Distributor (ISD)

Definition :-

The term ‘Input Service Distributor’ has been defined under section 2(61) of the Central Goods and Services Tax Act, 2017 which is 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 prescribed 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.

As per above definition of input service distributor,

An office of a taxable person can act as Input Service Distributor (ISD) by way of accumulating the input tax credit on various services received by the taxable person

and

transferring the credit to other registered units under same PAN.

This concept is as it is borrowed from earlier service tax regime. This concept has inherent limitation that input tax credit relating to goods cannot be distributed under the concept of input service.

Distribution of ITC – Conditions Section 20(2) of CGST Act

Input service distributor may distribute the credit subject to the following conditions:-

1. Prescribed Document :- While distributing the credit, input service distributor shall issue a prescribed document (ISD Invoice (Rule 54(1) of CGST Rules)) to the recipient branch indicating that it is issued only for distribution of input tax credit;

2. Credit receipt can’t be more than distributed :- The amount of the credit distributed shall not exceed the amount of credit available for distribution;

3. Specific Credit will go to specific branch only: – If any specific credit is attributable to only a particular branch, then the same shall be distributed only to that branch.

4. Pro-rata distribution: – If the credit is attributable to more than one branch, then the same shall be distributed on pro rata based on the turnover in the relevant period in a state or union territory to the aggregate of the total turnover of all branches to whom the input tax is attributable.

Relevant Period: The term relevant period means:-

1. If the recipient branches of the credit have any turnover during the preceding financial year then the turnover of the preceding financial year is to be considered, or

2. If any of the recipient branches doesn’t have any turnover in the previous financial year then the turnover of the preceding quarter in which details of all the recipient branches are available, is to be considered.

Manner of Distribution of Credit (Rule 39 CGST Rules)

Rule 39 prescribe the procedure and manner for distribution of input tax credit by input service distributor. This rule provide that how tax nature (below referred as Color Change) by way of filing GSTR-6 (return by ISD) for distribution of credit which is to be filed monthly. There are three main things to be remembered in this regard:-

1. IGST Credit shall be distributed as IGST to every recipient (No color change)

2. CGST credit and SGST credit on account of central tax and state tax shall be distributed in the following manner;

Now understanding by way of a case study given below:-

1. A company is having office in Haryana, Delhi and UP which are registered in GST. The office in Delhi has obtained registration under Input Service Distributor (ISD). The office in Uttar Pradesh has incurred a location/place specific expenditure say Hotel Expenses in Delhi on which CGST and SGST was paid in Delhi. In such a situation The Delhi office (Input Service Distributor) can take credit of the said expenditure and distribute the same as Integrated GST to Uttar Pradesh through ISD. In this way we can see that tax paid on input of UP was utilized in UP only, although it was through ISD mechanism.

2. In the above case study, if the said expenditure would have been incurred in Haryana then the hotel would have charge Central Tax and State Tax of Haryana. In such situation case, neither the office in Uttar Pradesh nor the Haryana office could take input tax credit of the same.

Limitations of Input Service Distributor System

1. ITC on GOODS :-  As the name suggest it is the system of distribution of Credit of Input services and relating to goods cannot be distributed under this concept,

2. ITC without route of ISD State :- In this scheme  of  ISD  there  is  technical and legal limitation that stops input tax paid by one state  in another state without routing it to ISD Office. The same has been discussed in case study 2 earlier.

CROSS CHARGE MECHANISM

Before understanding cross charge it is pertinent to understand

(i) What is supply

(ii) What is Place of supply

(iii) What will be Value of supply

SUPPLY

GST is a levy on supply of goods and services or both. The word ‘Supply’ is defined under Section 7 of Central Goods and Services Tax Act, 2017 which is under,

For the purposes of this Act, the expression “supply” includes––

All forms of supply of goods or services or both such as sale, transfer, barter, exchange, licence, rental, lease or disposal made or agreed to be made for a consideration by a person in the course or furtherance of business; Import of services for a consideration whether or not in the course or furtherance of business and;

Includes Schedule I – activities made or agreed to be made without a consideration;

Schedule II – Classify that what is Sale and what is Service

Essential elements of Supply

(i) Business Purpose (in the course or furtherance of business) which means that transaction other than business are not supply hence no GST liability arise. For example Mr. Naitik is doing business of toys & registered in GST. He sold his personal Car then it will not be subject to GST as it is out of ambit of supply. 

If we observe the above definition of Supply, it is defined in an inclusive manner which includes all kinds of supply of goods or services taken and received in the course or furtherance of business for a consideration. It also includes activities listed in schedule I even without consideration.

Schedule I item 2, in this context is reproduced as under;

‘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

Transaction between distinct Persons and their valuation

It means that any supply of goods or services or both between branches of same organization in different states/UT in the course or furtherance of business is treated as supply and the transaction shall be valued as per the valuation rules 28, 30 and 31. This entry no 2 in Schedule II has been inserted in order to satisfy the destination or consumption based tax system i.e., the tax shall go to the state in which the goods or services are consumed. If the same is not treated as supply, then the state in which the supplier is located will not get its legitimate share of revenue. Therefore this system tax will flow along with goods and services in the state of supply.

SCHEDULE I
[See section 7]

ACTIVITIES TO BE TREATED AS SUPPLY EVEN IF MADE WITHOUT CONSIDERATION

1. Permanent transfer or disposal of business assets where input tax credit has been availed on such assets.

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: Provided that gifts not exceeding fifty thousand rupees in value in a financial year by an employer to an employee shall not be treated as supply of goods or services or both.

3. Supply of goods—

(a) by a principal to his agent where the agent undertakes to supply such goods on behalf of the principal; or

(b) by an agent to his principal where the agent undertakes to receive such goods on behalf of the principal.

4. Import of services by a person from a related person or from any of his other establishments outside India, in the course or furtherance of business.

SCHEDULE II

[See section 7]

ACTIVITIES OR TRANSACTIONS TO BE TREATED AS SUPPLY OF GOODS OR SUPPLY OF SERVICES

1. Transfer

(a) any transfer of the title in goods is a supply of goods;

(b) any transfer of right in goods or of undivided share in goods without the transfer of title thereof, is a supply of services;

(c) any transfer of title in goods under an agreement which stipulates that property in goods shall pass at a future date upon payment of full consideration as agreed, is a supply of goods

2. Land and Building

(a) any lease, tenancy, easement, licence to occupy land is a supply of services;

(b) any lease or letting out of the building including a commercial, industrial or residential complex for business or commerce, either wholly or partly, is a supply of services.

3. Treatment or process

Any treatment or process which is applied to another person’s goods is a supply of services.

4. Transfer of business assets

(a) where goods forming part of the assets of a business are transferred or disposed of by or under the directions of the person carrying on the business so as no longer to form part of those assets, whether or not for a consideration, such transfer or disposal is a supply of goods by the person;

(b) where, by or under the direction of a person carrying on a business, goods held or used for the purposes of the business are put to any private use or are used, or made available to any person for use, for any purpose other than a purpose of the business, whether or not for a consideration, the usage or making available of such goods is a supply of services;

(c) where any person ceases to be a taxable person, any goods forming part of the assets of any business carried on by him shall be deemed to be supplied by him in the course or furtherance of his business immediately before he ceases to be a taxable person, unless— (i) the business is transferred as a going concern to another person; or

(ii) the business is carried on by a personal representative who is deemed to be a taxable person.

5. Supply of services

The following shall be treated as supply of services, namely:—

(a) renting of immovable property;

(b) construction of a complex, building, civil structure or a part thereof, including a complex or building intended for sale to a buyer, wholly or partly, except where the entire consideration has been received after issuance of completion certificate, where required, by the competent authority or after its first occupation, whichever is earlier.

Explanation.—For the purposes of this clause—

(1) the expression “competent authority” means the Government or any authority authorised to issue completion certificate under any law for the time being in force and in case of non- requirement of such certificate from such authority, from any of the following, namely:—

(i) an architect registered with the Council of Architecture constituted under the Architects Act, 1972; or

(ii) a chartered engineer registered with the Institution of Engineers (India); or

(iii) a licensed surveyor of the respective local body of the city or town or village or development or planning authority;

(2) the expression “construction” includes additions, alterations, replacements or remodelling of any existing civil structure;

(c) temporary transfer or permitting the use or enjoyment of any intellectual property right;

(d) development, design, programming, customisation, adaptation, upgradation, enhancement, implementation of information technology software;

(e)agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act; and

(f) transfer of the right to use any goods for any purpose (whether or not for a specified period) for cash, deferred payment or other valuable consideration.

6. Composite supply

The following composite supplies shall be treated as a supply of services, namely:—

(a) works contract as defined in clause (119) of section 2; and

(b) supply, by way of or as part of any service or in any other manner whatsoever, of goods, being food or any other article for human consumption or any drink (other than alcoholic liquor for human consumption), where such supply or service is for cash, deferred payment or other valuable consideration.

7. Supply of Goods

The following shall be treated as supply of goods, namely:—

Supply of goods by any unincorporated association or body of persons to a member thereof for cash, deferred payment or other valuable consideration.

Cross Charge Mechanism- understand by example

A company having three branches in India say Delhi, Haryana and UP, if  a branch (Delhi)  is supplying goods and services  to other branches (Haryana and UP)  other state then supplying branch should charge GST from the receiving branch against Invoice subject to CGST Rule 28, 30 and 31.  In this way tax will reach in the state of consumption and conditions of availing ITC section 16(2) will get satisfied without violation. When in normal course of business transfer of goods take place, then it goes along with Tax Invoice & e-way bill but care should be taken in case of ITC related to common service if,  ISD registration is not obtained.

Cross Charge- a solution to barrier in seamless flow of Tax Credit

Cross charge mechanism can overcome the barrier of credit relating to goods and can be applied for goods as well as services. If one state`s branch of an entity have incurred expenses of business function in some other state then it would have paid CGST and SGST of the other state, which it cannot utilize as such as input tax credit, but the branch in other state shall first utilize this ITC thereafter pass on it to the state who have incurred the expenses by issuing Tax Invoice in respect nature of Business Support Services and IGST will be charged. But it should be noted that conditions of section 20 must be complied with if the services are related to/ consumed in more than one branch.

Case Study

A company having head office at Delhi and branches in Mumbai, Kolkata & Chennai. Branch at Mumbai incurred hotel expenses for official seminar in Kolkata and paid West Bengal CGST and SGST. The ITC credit relating to the transaction will not be available in Mumbai. Hence, under this situation Kolkata branch shall issue invoice to Mumbai branch under ‘Business support services’ head and transfer the equal credit to the Mumbai branch, Mumbai branch shall utilize the credit  and there will not be any ITC loss at all. Not this practice can followed in every branch level without any discrimination. In cross charge there will not be any centralized office like ISD

Choice in accordance with and Suitability

Anyone can choose any system which is suitable having regard to following facts:-

1. When a company having multiple registrations in various states but purchases / procurement of input service is centralized then it will beneficial to have ISD registration.

2. When a company having multiple registrations in various states and purchases / procurement of input and input services is made in each state then Cross Valuation is beneficial.