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July **** Legal & Compliance

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AMPLEXUS GST

An e-newsletter on GST

GST ON FOC SUPPLY

Kumar Akarshan, Manager-Legal (Taxation)

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ISSUE# 2

March 2017 Legal & Legal Compliance & Compliance

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1. Section 9 is the charging section of the CGST Act, 2017, which provides for levy of GST on intra-state supply of goods or services or both, on the value as determined under section 15 of the CGST Act. Similarly Section 5 of the IGST Act, 2017 provides for the levy of GST on inter- state supply of goods or services or both. For the sake of reference relevant portion of section 9 is reproduced below:

9. (1) Subject to the provisions of sub-section (2), there shall be levied a tax called the central goods and services tax on all intra-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 and at such rates, not exceeding twenty 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.

2. In the CGST Act, works contract is specifically defined in section 2(119). Furthermore, as per Schedule II to the CGST Act, the entire works contract is deemed to be supply of service. For the sake of reference section 2(119) and relevant portion of Schedule II are reproduced below: Section 2(119) w“orks contract” means a contract for building, construction, fabrication, completion, erection, installation, fitting out, improvement, modification, repair, maintenance, renovation, alteration or commissioning of any immovable property wherein transfer of property in goods (whether as goods or in some other form) is involved in the execution of such contract;

Schedule-II

6. Composite supply

The following composite supplies shall be treated as a supply of services, namely: works contract as defined in clause (119) of section 2;

3. Therefore when the entire works contract is deemed supply of service, GST on such supply of works contract service will be levied as per the rate applicable to works contract service on the transaction value of such supply as determined under Section 15 of the CGST/SGST Act. The total GST applicable, as per the Notification no. 8/2017-IT(Rate), on works contract service, is 18%. GST is payable on the transaction value determined as per the provisions of Section 15 of the CGST Act read with CGST Rules, 2017. For the sake of reference relevant portion of Section 15 are reproduced below:

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Section 15. (1) The value of a supply of goods or services or both shall be the transaction value, which is the price actually paid or payable for the said supply of goods or services or both where the supplier and the recipient of the supply are not related and the price is the sole consideration for the supply.

(2) The value of supply shall include–––

(a)

(b) any amount that the supplier is liable to pay in relation to such supply but which has been incurred by the recipient of the supply and not included in the price actually paid or payable for the goods or services or both;

(4) Where the value of the supply of goods or services or both cannot be determined under sub-section (1), the same shall be determined in such manner as may be prescribed.

4. Thus as per the provision of section 15 the transaction value of the works contract would be the price actually paid or payable for such works contract service, and where the price is the sole consideration. In the transactions of works contract w.r.t. construction of plant and machinery, it is not uncommon that the contractee supplies some materials free of charge (FOC) to the contractor who in turn uses the same for the purpose of executing works contract for the contractee. This note attempts to analyse the impact of GST on the supply of FOC materials in the following two situations:

Situation 1 - Where the contract itself stipulates supply of FOC materials over and above the contract price.

Situation 2 - Where there is no stipulation about FOC in the contract. The FOC materials are supplied by the Contractee and the Contractor issues the bill net of value of FOC materials.

5. The issues involved in the analysis are as follows: Issue-1-Whether or not the value of the FOC materials supplied by the contractee to the contractor for the purpose of executing works contract will form part of the transaction value of the service provided by the contractor?

Issue-2- Whether or not GST will be chargeable on such FOC materials supplied by the contractee to the contractor?

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ANALYSIS

Issue-1

6. As per Section 15 (1) of the CGST/SGST Act, the transaction value of the supply of goods or services shall be the price actually paid or payable for the said supply where the supply and recipient are not related and the price is the sole consideration for the supply. 7. Further Section 15 (4) provides that where the value of supply of goods or services cannot be determined under Section (1) then the same shall be determined in the manner prescribed i.e. as per the Valuation Rules. Rule 27 of the CGST Rules, 2017 provides for the mode of valuation where the consideration is not wholly in money i.e. where the suppliers receive the consideration partly in money and partly in kind or wholly in kind. 8. From the aforesaid it is evident that the valuation rules can be resorted to only where the supply is between related parties or/and the price is not the sole consideration as per Section 15(1). Situation-1

9. The first question which arises for consideration is whether the price paid by the recipient to the supplier can be treated to be sole consideration where the contractor receives FOC materials in addition to the monitory consideration as stipulated in the contract? Can it be said that the FOC materials are in the nature of additional consideration flowing from contractee to contractor? Here it would be relevant to consider the judgment of Larger Bench of CESTAT New Delhi in the case of Bhayana Builders (P) Ltd v. Commissioner of Service Tax, Delhi, 2013 (32) STR 49 (Tri-LB) whereby it has been held that value of FOC material cannot be treated to be part of the taxable value provided by the Works Contractor and as such service tax is not payable by the works contractor on the value of FOC material supplied by the contractee. It has been categorically held therein that free supplies incorporated into construction (cement or steel for instance), would not constitute non-monetary consideration remitted by the service recipient to the service provider for providing the service, particularly since no part of the goods and providing the service, particularly since no part of the goods and materials so supplied accrues to or is retained by the service provider. 4 of 10

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10. It can therefore be safely concluded that the FOC materials are not in the nature of “non- monetary consideration” flowing from the recipient to the supplier. If that be so, then price is the sole consideration in Situation 1, hence such price should be taken to be the transaction value of the services provided by the Works Contractor. Hence, there should not be any occasion to resort to the valuation rules.

11. It may be noted that Rule 27 of the CGST Rules, 2017 contains two illustrations to explain the role of Rule 1(a) and (b). The said Rule 27 reads as follows: CGST Rules, 2017

Rule 27 Value of supply of goods or services where the consideration is not wholly in money

Where the supply of goods or services is for a consideration not wholly in money, the value of the supply shall,

(a) be the open market value of such supply;

(b) if open market value is not available, be the sum total of consideration in money and any such further amount in money as is equivalent to the consideration not in money if such amount is known at the time of supply;

(c) if the value of supply is not determinable under clause (a) or clause (b), be the value of supply of goods or services or both of like kind and quality;

(d) if value is not determinable under clause (a) or clause (b) or clause (c), be the sum total of consideration in money and such further amount in money that is equivalent to consideration not in money as determined by application of rule 4 or rule 5 in that order.

Illustration:

(1) Where a new phone is supplied for Rs.20000 along with the exchange of an old phone and if the price of the new phone without exchange is Rs.24000, the open market value of the new phone is Rs 24000.

(2) Where a laptop is supplied for Rs.40000 along with a barter of printer that is manufactured by the recipient and the value of the printer known at the time of supply is Rs.4000 but the open market value of the laptop is not known, the value of the supply of laptop is Rs.44000.

12. From the bare perusal of the illustrations appended to Rule 27 it appears that even the value of FOC materials can be sought to be included in the value of Works Contract Service. However, neither the illustration nor the rule can be resorted to include the value of FOC material in the value of works contract service as long as such FOC material does not amount to non-monetary consideration flowing from recipient to the supplier. 5 of 10

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13. Further, it does not matter that the term “consideration” was not defined in the Finance Act 1994 and the same is defined in CGST/SGST Act, 2017. Even the basic spirit of the definition of consideration in the GST Laws is that it should be something which accrues to or is retained by the service provider.

14. Here it would be worth mentioning that in the cases pertaining to excise and customs, the value of FOC materials has been held to be includible in the value of manufactured/ imported goods. Further, the valuation principle contained in the excise and customs laws are also akin to Section 15 of the CGST/SGST Act. Like those laws, even the GST law contemplate the value of supply of goods or/and services to be the transaction value where supply is not between related parties and the price is the sole consideration. The issue which arises for the consideration is when the judgments pertaining to excise and customs which have held that FOC materials should be treated to be in the nature of additional consideration hence includible in the transaction value/assessable value of the goods manufactured/imported then whether the same principle will apply for the purpose of valuation of supply of services under GST also. 15. Here it is pertinent to mention that supply of goods and supply of service by their very nature are different from each other. Whereas when there is a supply of goods, the FOC supply received by the supplier necessarily gets incorporated/integrated/forms/becomes part and parcel of the goods supplied. Whereas in case of supply of service, the extent/scope of the service will depend upon the nature of contract entered into between the provider and the recipient of the service. Due to this basic difference in the nature of supply of goods and supply of service the orders/judgments which have been delivered with respect to FOC supply in respect to supply of goods will not be applicable to supply of service, even though now the same provisions of law applies to both the transactions. Therefore, with respect to supply of service, Bhayana Builders case is more appropriate case which would be applicable as the same deals with supply of service.

Situation-2

16. In Situation 2, the price agreed for contract is being partially borne by the recipient and when the contractor issues the invoice he is deducting from the total value of contract the value of free issue material. In this case, the supply of FOC materials will amount to sale of such material by the contractee to the contractor in view of Supreme Court judgment in N. M. Goel

& Co. v. Sales Tax Officer, AIR 1989 SC 285. Thus, here it can be said that the material supplied accrues to the contractor. Hence the same would form part of the transaction value of the works contract.

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Issue-2

17. With respect to the second issue in situation-2, there is clear supply of goods by the contractee to the contractor for which consideration is also received by the contractee in the form of commensurate reduction in the contract value, therefore GST will be payable on supply of such goods by the contractee to the contractor. In this regard reliance may also be placed in the Supreme Court decision in the N.M. Goel case (supra), wherein in similar fact situation the Court held that such transaction amounts to sale and therefore liable to sales tax. 18. In case of situation 1, where there is specific provision for issuance of FOC materials over and above the contract value, it must first be noted that for such issue of FOC material, no consideration is flowing from the contractor to the contractee or from any third person to the contractee. Now, Schedule 1 to the CGST Act enumerates activities which are to be treated as

SUPPLY even if made without consideration. The relevant Entry for our purpose is the Entry no 1 which says- “Permanent transfer or disposal of business assets where input tax credit has been availed on such assets”.

19. Therefore for such activity of FOC supply by the contractee to the contractor to be treated as Supply and thus liable to GST, such activity must result in permanent transfer or disposal of such FOC materials. The Black s Law Dictionary defines transfer as follows:

“transfer, n. 1. Any mode of disposing of or parting with an asset or an interest in an asset, including a gift, the payment of money, release, lease, or creation of a lien or other encumbrance. The term embraces every method- direct or indirect, absolute or conditional, voluntary or involuntary- of disposing of or parting with property or with an interest in property, including retention of title as a security interest and foreclosure of the debtor’s equity of redemption.”

As verb, transfer by the Black s Law Dictionary is defined as follows:

“transfer, vb. 1. To convey or remove from one place or one person to another; to pass or hand over from one to another, esp. to change over the possession or control of. 2. To sell or give.

20. Further Cambridge dictionary defines transfer as follows:

“to move someone or something from one place, vehicle, person or group to another” 7 of 10

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21. From the above definitions, what can be seen is that transfer means disposal of or parting with an asset or an interest in an asset from one person to another, especially where there is a changeover of the possession or control. However to be covered under the Schedule 1 such transfer needs to be permanent . The Oxford Dictionary defines permanent as: “Lasting or intended to last or remain unchanged indefinitely”. 22. In the present context, what the word transfer would entail is that there should be a movement of the said goods from the contractee to the contractor, i.e. there should be a change in possession/control from the contractee to the contractor. However, for such transfer to be covered under Schedule 1, such transfer must be permanent, i.e. there should be a permanent change in the possession or control of the goods. In a situation where there is an issue of FOC materials of the nature where the goods are merely issued to the contractor (and not transferred) however the effective control over the said goods are retained by the contractee and where the contractor merely uses the said goods as per the instruction and control of the contractee, it cannot be said that there is permanent transfer.

23. Further, the term “permanent transfer” of business assets connotes a transaction where the supplier intents to transfer the title in the business assets without any consideration. The supplier does not intent to receive back such business asset as such or in any other form and the recipient of such “permanent transfer” acquires the full right in such business assets. Attention is also invited to clause 4(a) of Schedule II which provides that where goods forming parts of the assets of a business are transferred or disposed of by or under the direction of the persons carrying on the business so as to no longer form part of those assets, whether or not for consideration, such transfer or disposal is supply of goods by the person. Therefore, permanent transfer of business asset as per clause 1 of Schedule shall be treated to be supply of goods as per clause 4(a) of Schedule II. Now the question arises whether issue of FOC materials by the contractee to the contractor will amount to “permanent transfer of business assets”. Where the terms of contract stipulates that the contractee will issue free material to the contractor with the following understanding that:

a. The ownership of such material shall remain with the contractee. b. The contractor shall use such materials only for the purpose of execution of contractor. c. The contractee shall have the right to recall such material at any time. 8 of 10

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d. Any such material left after execution of works contract shall be property of the contractor.

e. Any waste generated out of such material shall remain to be the property of the contractee.

f. The contractee is empowered to penalize the contractor for mis-use or non-optimal use of the materials so issued,

g. If the contract does not envisage any permanent transfer or right over the said goods apart from the use of the said goods for the required purpose; In such cases there is no permanent transfer of business assets in the form of FOC materials by the contractee to the contractors. Hence such transaction may not fall within the scope of Clause 1 of Schedule I. If that be so, no GST is payable by contractee on issue of FOC materials to the contractor.

24. Further, the Cambridge dictionary defines disposal as the act of getting rid of something, especially by throwing it away the act of getting rid of something, especially by throwing it away . The Oxford dictionary further goes on to add one more definition of disposal as the sale of shares, property or other assets . By a mere perusal of the above definitions of the term

disposal , it can be seen that in the present fact situation the FOC supplies cannot be said to be

the disposal of the FOC materials .

Availability of ITC on FOC materials to the contractee 25. Section 17(5)(d) provides that ITC shall not be available in respect of goods or services or both received by a taxable person for construction of an immovable property (other than plant and machinery) on his own account including when such goods or services or both are used in course or furtherance of business. In the case where a person is buying goods for the purpose of supplying the same as FOC material, it is possible to argue that such goods are not being used for construction of immovable property on his own account in as much as the said materials will be used by the contractor. Therefore there seems to be no bar on availing ITC by the contractee on FOC materials. Moreover if the supply of FOC material is for purpose of construction of plant and machinery, there is no iota of doubt that in such case contractee will be eligible to claim the ITC even under section 17(5)(d). 9 of 10

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CONCLUSION

26. In Situation 1 where there is a stipulation of FOC supply in the contract over and above the contracted price the value of the FOC supply will not be added to the value of the works contract service provided by the contractor, for charging of the GST. In this case FOC supply by the contractee to the contractor will also not be leviable to GST in the hands of the Contractee. 27. In Situation 2 where there is no stipulation about FOC in the contract and the FOC materials are supplied by the Contractee the contractor and the Contractor issues the bill net of value of FOC materials, the value of the FOC supply will be required to be included in the assessable value of the works contract service. Furthermore, in this case GST will also be leviable on the FOC supply made by the contractee to the contractor. The Contractor can avail ITC of such GST. 10 of 10

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