Cross charges are nothing but a supply between:

– Two or more offices/establishments of an entity or

– Related companies enjoying common facilities.

These charges may also be termed as a mechanism to allocate the value, as per the valuation rules and charge GST from the distinct/related persons.

To emphasize, this concept ascended from the deeming fiction created under the GST law by way of Entry Number 2 stipulated in the Schedule 1 (Activities to be treated as supply even if made without consideration)

“Supply of goods or services or both between related persons or distinct persons as specified in Section 25 of the CGST Act, 2017, when made in course or furtherance of business”

If supply against consideration alone are to be treated as supplies, stock transfers from one unit to another in another state would not tantamount to supply and ITC chain would have been disrupted. GST law has been designed in a way that there are no cascading effects of the taxes and ITC chain is maintained. The creation of this deeming fiction (supply between distinct and related persons) has been done, so the Input ITC chain is maintained intact.

Legal provisions relevant to the chargeability/taxability/levy/valuation of Cross charge:

1. Section 25(4) of the CGST Act, 2017 (hereinafter referred as “Act”): 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 person for the purpose of this act.

2. Section 25(5) of the Act: 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 purpose of this act.

3. Entry Number 2 of Schedule 1 of the Act (Activities to be treated as supply even if made without consideration): Supply of goods or services or both between related persons or distinct persons as specified in Section 25 of Act, when made in course or furtherance of business

4. Entry Number 1 of Schedule III of the Act (Activities or Transactions which shall be treated neither as a supply of service, nor supply of goods: Service of an employee to the employer in the course or in relation to his employment

5. Section 15 of the Act: Value of supply, in case of distinct person, shall be determined as per Rule 28 of CGST Rules which prescribes the methods to determine the value.

6. Rule 28 of the CGST Rules: The value of the supply of goods or services or both between distinct persons as specified in sub-section (4) and (5) of section 25 or where the supplier and recipient are related, other than where the supply is made through an agent, shall-

a. be the open market value of such supply;

b. if the open market value is not available, be the value of supply of goods or services of like kind and quality;

c. if the value is not determinable under clause (a) or (b), be the value as determined by the application of rule 30 or rule 31, in that order.

Provided that where the recipient is eligible for full input tax credit, the value declared in the invoice shall be deemed to be open market value of the goods or services.

7. Rule 30 of the CGST Rules: provides for value as 110% of the cost of production or manufacture or the cost of acquisition of such goods or the cost of provision of such services.

8. Rule 31 of the CGST Rules: provides value shall be determined using reasonable means consistent with the principles and the general provisions of section 15 and the provisions of this Chapter.

This issue pertaining to cross charge became the headlight when the Authority for Advanced Rulings (AAR) in the case of Columbia Asia Hospitals Pvt. Ltd-2018-TIOL-113-AAR-GST held that the services by Head Office (HO) to branches, vis-à-vis in-house service functions such as human resources and payrolls, if carried out from a centre in one state for offices in other states will be treated as “supply” in terms of Entry number 2 of the Schedule II of the Act. HO and Branch being in different states shall be considered as distinct persons as per Section 25 of the Act. Assuming that an entity is having 3 units in 3 different states and a corporate office, the employee cost has to be shared among the three units, by raising a GST invoice. The issue which is still unanswered by the AAR is the valuation of these services provided by the HO to its Branches.

It is pertinent to highlight the proviso stipulated in Rule 28 of the CGST Rules, where in it has been mentioned that where the recipient is eligible for full input tax credit, the value declared in the invoice shall be deemed to be open market value of the goods or services. Rule 28 specifically is for valuation of the supply between distinct persons as defined in Section 25(4).

Recently in the case of Kansai Nerolac Paints Ltd [2019] 106 taxmann.com 288 (AAR-Maharshtra), the applicant sought clarification on the valuation of supplies between various depots and factories. The facts of the case are highlighted as under:

1. Factories and depots of the company having same permanent account number (PAN) under Income Tax Act but bearing distinct registration number under GST law will be considered as distinct persons under section 25(4) of the Act.

2. Thus inputs, capital goods and outputs that are supplied by one distinct entity to another distinct entity will be valued as per CGST Rules 2017.

3. Since transactions undertaken by the company under discussion are amongst the distinct entities, valuation of the said transactions will be duly covered under Rule 28 of the CGST Rules.

4. Therefore Rule 30 of the said rules will not be applicable on the company and as per second proviso to the Rule 28, the price which will be declared on the invoice will be considered as Open Market Value (OMV) for the purpose of determining the value of goods.

 In the stipulated case above, AAR-Maharashtra held as follows:

Rule 28 deals with valuation of supply when it is made between the distinct or related persons. If a person obtains or is required to obtain more than one registrations in more than one state then in accordance to the provisions under Section 25 of the Act, each registration shall be treated as ‘distinct persons’ for the purpose of the CGST Act. Thus, supplies to the depots from factory/manufacturing units or from depot to depot, qualifies as supply made between distinct persons and provisions to Rule 28 shall apply for the valuation of such supply. And if any dealer is eligible for ITC, the applicant is eligible to value these goods by applying the terms contained in second proviso to the Rule 28. Accordingly, the value declared in the invoice shall be considered as OMV in respect of goods supplied by one distinct entity to another, where recipient is eligible to claim full ITC.

Drawing the conclusions from above ruling, valuation of the supplies between distinct entities is to be done on the basis of the value declared in the invoice. It is important to highlight that, in case of transfer of goods between distinct entities can be done on a reasonable basis. In the aforementioned case, the invoice value declared by the entity was basis the cost of production. Cost of production depends mainly on cost of inputs and input services. The issue which is still unanswered pertains to valuation of services between the distinct persons, especially the supply of services by employees of HO to its branch offices. The proviso contained in the Rule 28 is of significance where it is the recipient, who are entitled to the full credit, the value declared in the invoice is deemed to be OMV. In other words, in a case of supply eligible by this rule-related or distinct persons-the supplier is entitled to unquestioned admittance of ‘any price’ that may be charged. This provision appears to accommodate internal preferences of the parties where the tax paid is revenue neutral. However, caution is advised in taking recourse of this provision and charging a price lower than the cost. A quick reference to Rule 31, makes it clear that section 15 provides the boundaries within which every exercise of the valuation must operate. As stated by AAR in the case of Columbia Asia Hospitals Pvt. Ltd, HO and the other units are in the different states, the supply of human resources from HO to the other units will be considered as if the manpower recruitment services are provided by the HO to its branches. For valuation purposes, one needs to go through the hierarchy provided in Rule 28. As mentioned above, a nominal value for the purpose of billing should not be taken. There should be a reasonably justifiable method of valuation that prevails within the provisions contained in Section 15 of the Act.

It may be noted that any legal fiction created by a statue is for a specific purpose and the above deeming fiction is only “for the purpose of this Act”. Otherwise, the fact remains that different units of an entity situated in different states are part of the same entity and hence constitute a single person only. Employment is a contract between the employer and employee and is governed by the Contract Act as well as by any other special enactments relating to such employment. By all means the employees of an entity are employees of the entity as a whole as the entity is a single entity. So, when the employees of HO are catering services to other units, they are imparting the services only in their capacity of employees of the entity as a whole. Hence, these services should be covered under Entry 1 of the Schedule III i.e. neither a supply of goods nor a supply of services.

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4 Comments

  1. T R Rustagi says:

    In the context of resorting to the second proviso to rule 28 you have advised upon using the ‘reasonably justified’ method for declaring the price. On that, there could be disputes as to what is reasonably justified. The department might take a different view. What happens if the Department says that you have not declared the invoice value correctly? Can it ask the taxpayer to pay for the shrtfall in tax payable?

  2. Sakul mehra says:

    Very nicely written. You have covered all aspects and this article is really helpful to me and would also help others to understand the concept in depth
    Keep writing, best wishes
    Thanks

  3. SHAKTI SINGH CHAUHAN says:

    Enjoyed reading the article above , really explains everything in detail,the article is very interesting and effective. Thank you and good luck for the upcoming articles Mam

  4. Shakti Singh Chauhan says:

    Usually I never comment on Blog but your article is so convincing that I never stop myself to say something about it. You’re doing a great job Mam,Keep it up.

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