The litigation in the first year of the goods and services tax stemmed from transition credit, uncertainty about tax and allegations of profiteering.
In the second part of the special series on GST litigation on BloombergQuint’s weekly law and policy series,The Fineprint, Badri Narayanan, partner at Lakshmikumaran & Sridharan, and MS Mani, partner at Deloitte India, explain the impact of the three key rulings by the Authority for Advance Rulings.
Slump Sale: Supply Of Goods Or Service?
In Rajashri Foods’ case, the Karnataka AAR was asked to determine whether sale of a business unit—on a going concern basis—would attract goods and services tax as sale of goods or supply of service. Going concern means a business that can sustain its operations in the near term and doesn’t face a threat of liquidation.
The authority pointed to the Central GST Act to say that transfer of a business on a going concern basis does not amount to supply of goods. But at the same time, such a sale is not listed in the activities that constitute supply of service either.
The AAR then considered a June notification that uses this language at one place—‘services by way of transfer of a going concern, ...would attract nil GST’. And so while the list of services doesn’t mention slump sales, based on this notification, the authority held sale of a business on a going concern basis as a supply of service that would attract a nil GST.
Once a slump sale is treated as supply attracting a nil GST, it would create problems on the credit front, Narayanan said.
If you treat this as a going concern business, then it is a continuation of what is happening in the old business and new business. The credits in old business will get transitioned automatically to this. The minute you will say it is service which is exempt, the question comes—is there any credit which is attributable to supply, common and otherwise, which needs to be reversed because it’s a supply which is exempt.Badri Narayanan, Partner, Lakshmikumaran & Sridharan
For instance, let’s say there’s a Rs 3,000-crore revenue company which is getting sold for Rs 10,000 crore. It has Rs 1,000 crore worth of credit on its books. And legal and banking services have been used for this sale. Is it only the credit with respect to legal services or investment bank services that needs to be reversed or the credit with respect to normal business needs to be reversed as well?
“So, the valuation provisions and credit provisions have not been explained and considered when this ruling has come. That can have an impact on the actual transaction,” Narayanan said.
Job Work Versus Manufacturing
In the second important ruling, the Maharashtra Appellate Authority for Advance Ruling overturned the AAR’s decision and ruled in favour of JSW Energy. The company had entered into a job work arrangement with JSW Steel. According to the agreement, JSW Steel would supply coal and other inputs to JSW Energy to convert them into power. For this JSW Energy will get job work charges.
The AAR had held that this transaction would amount to manufacturing and not a job work transaction, and thereby attract a higher GST. The appellate authority ruled otherwise and held that any processing undertaken by a person on the goods belonging to another registered person qualifies as job work even if it amounts to manufacture.
The authority has held that we don’t need to distinguish and draw very fine lines between a job work transaction and manufacturing, Mani said.
He explained the difference between the two by way of an example. Let’s say, ‘X’ has already manufactured a pen. But the branding sticker on it requires a special adhesive and a special machine that ‘Y’ has. After manufacturing a pen, ‘X’ sends it to ‘Y’ to put a sticker.
The question is what is the value on which I should be paying the GST? Should I pay it on the whole pen? To my mind, the answer is no because you have not sold the pen to ‘Y’. You have merely given it for job work, i.e. put a sticker. You remain the owner of the pen. ‘Y’ will get paid for the sticker. And so, it’s on that sticker that ‘Y’ should be paying an 18 percent GST and not the value of the pen.MS Mani, Partner, Deloitte India
This ruling will specially benefit small businesses, he said.
“At a broad level, people who do job work are SMEs. When SMEs do job work, their consideration is largely the processing fee. They pay the GST on processing fee and if they are asked to pay it on the value of final goods, it would be burdensome for them,” he said.
Liquidated Damages: Subject To GST?
In the third important ruling, the Maharashtra AAR has ruled liquidated damages to be a supply of service that would attract an 18 percent GST. Usually, liquidated damages or compensation has to be paid by a party that breaches the terms of a contract. The authority pointed to the Central GST Act that lists ‘agreeing to tolerate an act or situation…’ as a supply of service. It stated that a delay has taken place which is being tolerated by the power utility company in consideration for a price, i.e. liquidated damages. This, the AAR held, is to be treated as a supply of service taxable at 18 percent.
Traditionally, liquidated damages has not been considered as services because services always requires you to put some industry in doing something; passively not doing anything and getting a compensation was never considered to be supply of service, Narayanan said. The implications are huge, especially in cases where the output supply is exempt from the GST, he said.
In a power generation company, if the liquidated damages are triggered, there is no output supply at all because electricity is exempt from the GST. On one side, there is breach. I have not received anything and I’m getting compensation for it. If I pay tax on this compensation, I will also take credit on it. But what I do with that credit? I cannot take benefit as the output is zero. So, it creates an anomaly with respect to certain transactions.Badri Narayanan, Partner, Lakshmikumaran & Sridharan
Both these experts also said the majority of the AAR decisions, so far, have been in favour of the tax department. And though, they are only binding on the companies involved in the cases, their persuasive value can tilt the scales in favour of the tax department in other states as well.