GST

Yin-Yang Nature of ITC and Supplier-Purchaser Obligations

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In a recent decision, the Kerala High Court upheld constitutionality of Section 16, CGST, 2017, specifically Section 16(2)(c) which restricts the ITC of a purchasing dealer (‘purchaser’) if the supplier has not remitted tax collected from the purchaser to the Government. The decision examines validity of the conditions to claim ITC under Section 16(2)(c) and Section 16(4). In this article, I examine the only the former by headlining two under-examined aspects of ITC: first, nature of ITC as a right/concession; second, the reliance of purchaser on supplier to claim ITC. Both aspects influence each other and in turn the success or otherwise of claims related to ITC. The issue relating to time limit for claiming ITC under Section 16(4) – though an influential part of the judgment – will be subject of a separate post.   

ITC: Right or a Concession? 

One of petitioner’s contention before the Kerala High Court was that ITC is a right of the purchaser and not a concession given by the Government. And since ITC is a property of the purchaser, denying the same for supplier’s default to remit tax is violative of purchaser’s right to property under Article 300A of the Constitution. The State countered the purchaser’s argument and argued that ITC is a concession granted by the State to avoid cascading effect of taxes, and the State can impose such restrictions as it deems fit to restrict taxpayer’s claim for ITC.

In deciding the true nature of ITC, and whether it is a right or a concession, the Kerala High Court gave an unambiguous conclusion that: 

The Input Tax Credit is in the nature of a benefit or concession extended to the dealer under the statutory scheme. Even if it is held to be an entitlement, this entitlement is subject to the restrictions as provided under the Scheme or the Statute. The claim to Input Tax Credit is not an absolute right, but it can be said that it is an entitlement subject to the conditions and restrictions as envisaged in Sections 16(2) to 16(4), Section 43, and Rules made thereunder. (para 71) (emphasis added)

The Kerala High Court cited a slew of precedents that aligned with its conclusion. The language here is noteworthy: the High Court is clearly leaning in favor of ITC being a concession and not a right, though it says it is not an ‘absolute right’. What does it mean? It can imply that either ITC is a limited right and can be subject to certain conditions by the State. Or that ITC is not a right but a concession. The latter seems more likely, but it is not clear. But does the distinction matter? If ITC is a taxpayer’s right, then it imposes a greater burden on the State before curtailing it. While conceptualizing ITC as a concession provides the State a comparatively wide leeway to impose conditions before allowing a taxpayer to claim ITC. If the policy decision of providing taxpayers of claiming ITC is a concession from inception, then even onerous restrictions on such claims are within the State’s remit. And a taxpayer needs to fulfil the conditions – onerous or otherwise – to successfully claim ITC since there is no vested right to claim ITC. The State has extended a concession on certain conditions and to avail the concession, the taxpayer needs to fulfil the prescribed conditions.  

In abstract, there are no easy answers if ITC is a concession or a right, though I’ve suggested elsewhere that if we bifurcate the stages of ITC: first stage involving claim of ITC and then the latter stage of utilizing ITC, there is room to suggest that ITC should be understood as one or the other depending on which stage is relevant to the case at hand. But a broad approach that ITC is a concession, irrespective of whether it is the stage of claiming of ITC or its utilization may not be the best way to answer this dilemma. The Kerala High Court does mention that GST laws contemplate four stages vis-à-vis ITC but didn’t co-relate it to the issue of nature of ITC. (para 11)  

Finally, it never was the purchaser’s claim that ITC is an absolute right. The purchaser’s claim was that if the conditions prescribed under the statutory provisions and rules have been fulfilled by the purchaser, then ITC transforms into its right, and denial of the same amounts to violation of right to property. By dismissing the argument by characterizing it as a claim for an absolute right, the Kerala High Court did not to do justice to the petitioner’s claim. Also, the core question before the High Court was whether the onerous conditions such as those prescribed under Section 16(2)(c) and Section 16(4), place all purchasers – bona fide and those colluding with suppliers – in a similar category and thereby violate Article 14 of the Constitution. The High Court’s analysis of the arguments relating to Article 14 was bereft of a comprehensive analysis as I elaborate in the section below.      

Purchaser’s Reliance on Supplier 

Section 16(2)(c) states that no person shall be entitled to claim ITC unless the tax charged in respect of such supply has been actually paid to the Government either in cash or utilization of ITC admissible in respect of such supply. This condition translates into the supplier filing their monthly return – GSTR-1 – indicating its outward supplies for the month. The information in the said return will auto-populate a return of the purchaser – GSTR-2A – which will indicate the inward supplies of the purchaser. The latter informs the purchaser’s claim for ITC. As is understandable, the purchaser is dependent on the supplier filing GSTR-1 accurately and in a timely fashion to enable it to claim ITC.

The purchaser’s argument was that GSTR-2A is a dynamic, read-only document, and is merely a facilitation document. And if certain purchases are not reflected in GSTR-2A, then it cannot be the basis of denial of ITC. The purchaser argued that if it possesses all the documents listed in Rule 36, CGST Rules, 2017, i.e., tax invoice, proof payment, actual receipt of goods then it should be presumed to have discharged the burden of genuineness of its ITC claim. Also, the purchaser cannot be burdened to ensure that the supplier has remitted the tax as it an impossible condition to fulfil for the purchaser. In the absence of purchaser lacking the resources to force a supplier to remit the tax, the doctrine of impossibility should be applicable. And since Section 16(2)(c) prescribes an impossible condition, it should be held as unconstitutional.  

The purchaser’s final argument vis-à-vis Section 16(2)(c) was that the provision treats bona fide purchasers similarly as purchasers that collude with suppliers to fraudulently claim ITC thereby being violative of Art 14. The purchaser’s claim was that denial of ITC to bona fide purchaser for supplier’s default in tax payment was arbitrary and irrational exercise of power. The purchaser also made an alternative argument that Section 16(2)(c) should restrict its ITC only if mala fide on its part was established. And that purchaser’s ITC should not be blocked if it has all the documentary evidence and by extension a prima facie proof of its bona fide intent and transaction.   

State’s defence of making the purchaser’s claim of ITC dependent on supplier’s payment of tax was as follows: the State argued that ITC ‘crosses State borders’. The supplier in originating State USES SGST/CGST credits of IGST collected from the purchaser and the latter will discharge output liability by claiming SGST/CGST credits of the IGST paid to the supplier. The originating State and the Union are under an obligation under Section 53, CGST Act, 2017 to transfer the CGST/SGST component utilized by the supplier and make it available to the destination State, since GST is a destination-based tax. The State’s claim was that if the supplier defaults in remitting the tax, but purchaser it allowed to claim ITC based on invoice, the originating State would have transferred tax to destination State without the former having received the tax. 

The purchaser raised some important and vital Constitutional arguments, but the Kerala High Court’s summary analysis was a complete endorsement and replication of the State’s argument and it concluded that: 

Considering the aforesaid scenario, without Section 16(2)(c) where the inter-state supplier’s supplier in the originating State defaults payment of tax (SGST+CGST collected) and the inter-state supplier is allowed to take credit based on their invoice, the originating State Government will have to transfer the amounts it never received in the tax period in a financial year to the destination States, causing loss to the tune of several crores in each tax period. (para 83)

The Kerala High Court added that: 

… this renders the whole GST laws and schemes unworkable. Therefore, as contended, the conditions cannot be said to be onerous or in violation of the Constitution, and Section 16(2)(c) is neither unconstitutional nor onerous on the taxpayer. (para 84)

The Kerala High Court dismissed the Constitution and fundamental rights-based arguments by agreeing to the State’s argument about administrative workability of the GST. But the High Court never seriously engaged with the argument if Section 16(2)(c) places a bona fide purchaser in the same category as a purchaser who colludes with a supplier to claim ITC fraudulently. The two categories of purchasers, prima facie, constitute two different categories. Neither was the ‘doctrine of impossibility’ squarely addressed by the High Court. How can a purchaser ensure that the supplier remits GST to the State? The purchaser can, ordinarily speaking, pay the tax to the supplier and ensure it has adequate proof of the payment. Persuading or forcing the supplier to remit the tax to the State in a timely and proper fashion isn’t or shouldn’t be the purchaser’ task. 

There is precedent – in pre-GST laws – that mandates payment of tax by the supplier before the purchaser can claim ITC. Legality apart, what is the policy driving enactment of such provisions? State wants to be secure about its revenue. State’s objective is to obtain tax from the supplier before it provides purchaser ITC on tax paid to the supplier. Documentary evidence of the supply of goods/services and payment of tax is insufficient to provide ITC. The reason is that, at times, the purchaser and supplier collude to make bogus transactions and claim ITC fraudulently. The fear or perhaps experience of allowing bogus ITC claims has resulted in making a statutory provision that places an onerous burden on the bona fide purchasers too. But the Courts have – until now – not engaged in a serious analysis if this similar treatment of all kinds of taxpayers violates Article 14 and whether it amounts to reasonable restriction under Article 19(6).    

Conclusion The Kerala High Court’s decision follows a burgeoning body of judicial precedents that have termed ITC as a concession and subject to statutory conditions. And yet Courts have not been able to cogently analyze as to why ITC cannot, under certain conditions, be termed as a right and not a concession. Neither have the Constitutional arguments based on Fundamental Rights been examined in any methodological fashion. While one may – and it seems to be increasingly the case – may become familiar with provisions imposing onerous demands on taxpayers to successfully claim ITC, it not a certificate of their constitutionality. Neither do the legality of such provisions provide them a stamp of good tax policy. Securing revenues for itself is certainly one of the goals of the State, but tax laws cannot and should not be so designed that they impose increasingly burdensome conditions on the taxpayers before they can claim ITC or similar such benefits under a tax statute.    

Powers of Arrest under GST: Unravelling the Phrase ‘Committed an Offence’

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CGST Act, 2017 provides the Commissioner power to arrest under specific circumstances. Section 69, CGST Act, 2017 states that: 

Where the Commissioner has reasons to believe that a person committed any offence specified in clause (a) or clause (b) or clause (c) or clause (d) of sub-section (1) of section 132 which is punishable under clause (i) or (ii) of sub-section (1), or sub-section (2) of the said section, he may, by order, authorise any officer or central tax to arrest such person. (emphasis added)   

There are several aspects of the power to arrest under GST that were and are under scrutiny of courts. For example, scope and meaning of the phrase ‘reason to believe’ remains open-ended even though the same phrase has a long standing presence under the IT Act, 1961. In this post, I will focus on judicial understanding of the phrase ‘committed an offence’ and its implication. Similar phrase and powers of arrest were provided in pre-GST laws as well, e.g., under Finance Act, 1994 which implemented service tax in India. Section 91, Finance Act, 1994 provided that: 

If the Commissioner of Central Excise has reason to believe that any person has committed any offencespecified in clause (i) or clause (ii) of section 89, he may, by general or special order, authorise any officer of Central Excise, not below the rank of Superintendent of Central Excise, to arrest such person. (emphasis added)     

The tenor and intent of both the above cited provisions is similar. The power to arrest has been entrusted to a relatively senior officer, who must have a ‘reason to believe’ that the person in question has ‘committed an offence’. Courts have made divergent observations on the meaning of the phrase ‘committed an offence’. Typically, a person is said to have committed an offence under a tax statute once the adjudication proceedings are completed and the quantum of tax evaded/not deposited is determined by the relevant tax authority after receiving a statement from the accused. In some cases, the tax officers have been found wanting in patience and have initiated arrests without completing the adjudication proceedings of establishing commission of an offence. Courts have made certain observations on the validity and permissibility of such a course of action.  

Pre-GST Interpretation 

There are two broad ways to interpret the above arrest-related provisions vis-à-vis commission of offence. First, the officer in question is in possession of credible material which provides it a ‘reason to believe’ that a taxpayer or other person has committed the offence(s) in question. In such a situation, the officer can authorise arrest of such person without completing the adjudication proceedings. Second, the officer’s reason to believe cannot – by itself – trigger powers of arrest, but the adjudication proceedings need to be completed to ascertain the amount of tax payable. The adjudication proceedings typically require issuance of a showcause notice to the taxpayer, and on receiving representation from the taxpayer the proceedings are completed by issuance of an order/assessment determining the tax payable by such person. Arrests can only happen once the adjudication proceedings have been completed and quantum of tax payable has been determined. The Delhi High Court – interpreting the relevant provisions of Finance Act, 1994 – in MakemyTrip case affirmed that the latter constituted the position of law and stated that authorities cannot without issuance of a showcause notice or enquiry or investigation arrest a person merely on the suspicion of evasion of service tax or failure to deposit the service tax collected. The High Court added: 

Therefore, while the prosecution for the purposes of determining the commission of an offence under Section 89 (1) (d)of the FA and adjudication proceedings for penalty under Section 83 A of the FA can go on simultaneously, both will have to be preceded by the adjudication for the purposes of determining the evasion of service tax. The Petitioners are, therefore, right that without any such determination, to straightaway conclude that the Petitioners had collected and not deposited service tax in excess of Rs. 50 lakhs and thereby had committed a cognizable offence would be putting the cart before the horse. This is all the more so because one consequence of such determination is the triggering of the power to arrest under Section 90 (1) of the FA. (para 78)

The only exceptions to the above rule as per the High Court was that if the taxpayer is a habitual offender, doesn’t file the tax returns on time and has a repeated history of defaults. The Supreme Court, in a short order, upheld and endorsed the Delhi High Court’s interpretation of the law. Various other courts, such as the Bombay High Court in ICICI Bank Ltd case, also took the view that adjudication proceedings should precede any coercive actions by tax officers.       

Courts in the above cases seem to be guided by at least two things: first, that the powers of arrest and recovery of tax are coercive actions and shouldn’t be resorted to in a whimsical fashion; second, establishing the ‘commission of an offence’ can only happen through adjudication proceedings and not based on opinion of the relevant officer, even if the opinion satisfies the threshold of ‘reason to believe’. Insisting on completion of adjudication proceedings also ensures that the ingredient of ‘commission of an offence’ prescribed in the provision is satisfied. Again, this is for the simple reason that an officer’s reason to believe that an offence has been committed is not the same as establishing that an offence has been committed in adjudication proceedings. The latter also provides the accused an opportunity to respond and make their representation instead of directly facing coercive action. 

Rapidly Swinging Pendulum under GST

Similar question has repeatedly arisen under GST, with no satisfactory answer one way or the other. While some High Courts have relied on the MakemyTrip case, others have suggested otherwise. The contradictory opinions can be highlighted by two cases. In Raj Punj case, the Rajasthan High Court deciding a case involving false invoices and fake ITC held that the petitioner’s contention that tax should be first determined under Sections 73 and 74 of CGST Act, 2017 does not have any force and the Department can proceed straightaway by issuing summons or if reasonable grounds are available by arresting the offender. (para 21) The High Court curiously added that determination of tax is not required if an offence is committed under Section 132, CGST Act, 2017. The observation is curious because Section 132(l), CGST Act, 2017 clearly links the penalty and imprisonment to the amount of tax evaded or amount of ITC wrongfully availed.  

The Madras High Court in M/s Jayachandran Alloys (P) Ltd case though had a different opinion. The High Court held that use of the word ‘commits’ in Section 132, CGST Act, 2017 made it clear that an act of committal of an offence had to be fixed before punishment was imposed. And that recovery of excess ITC claimed can only be initiated once it has been quantified by way of procedure set out in Sections 73 and 74 of the CGST Act, 2017. The High Court endorsed the approach and interpretation adopted in the MakemyTrip case and added that its view was similar in that an exception to the procedure of assessement is available in case of habitual offenders. 

What is the reason for invoking arrest powers before completing adjudication proceedings? Various. First, the Supreme Court’s observations in Radheshyam Kejriwal case that criminal prosecution and adjudication proceedings can be launched simultaneously, and both are independent of each other. While the Supreme Court was right in noting that both proceedings are independent of each other, it did not specifically opine on the inter-relation of adjudication proceedings and arrest. Second, if there is reason to believe that a large amount of tax has been evaded, arrests are justified by tax officers by arguing that they are necessary for protection of revenue’s interest. Third, evidentiary or other reasons can be invoked as failure to arrest the suspects may lead to destruction of evidence of tax evasion. And various other reasons that can be clubbed under the broader umbrella of expediency and revenue’s interest. The exceptions will always be recognized – as in the MakemyTrip case – the question is the boundary and scope of such exceptions tends to be malleable and there is little that can be done to address the issue.     

Way Forward 

The Supreme Court is currently seized of the matter involving scope of the powers of arrest under GST. While I’m unaware of the precise grounds of appeal before the Supreme Court, the issues broadly involve the scope of powers of arrest, pre-conditions for invoking the powers of arrest, the exceptions, and possibility of the misuse of powers of arrest. The latter have been indirectly acknowledged and ‘Guidelines’ have been issued, exhorting officers not invoke powers of arrest in a routine and mechanical manner. And only make arrest where ‘palpable’ guilty mind is involved. There is empirical data – yet – that can establish the efficacy or otherwise of the guidelines. And Supreme Court may enunciate its own set of guidelines in its judgment. But, as the cliché goes, the proof pudding is in its eating. Powers of arrest are necessary to create the necessary deterrent effect: minimize and detect tax evasion. At the same time, frequent resort to coercive powers under a tax statute adversely affects business freedoms. The balancing act is tough to achieve. I’ve written elsewhereabout the uncertainty that bedevils this area of law, and I suspect little is going to change in the instantly. Supreme Court’s judgment may provide a guiding light, but one should temper one’s expectations and not hope for a magic wand that may, at once, resolve a tricky issue.    

Tax Treatment of Mandatory CSR: Alignment of CGST Act, 2017 and IT Act, 1961

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In this article, I elaborate on one of the several changes introduced by Finance Act, 2023 to CGST Act, 2017. Section 17, CGST Act, 2017 was amended via Finance Act, 2023 to clarify that the goods or services or both used to comply with mandatory CSR obligations, i.e., CSR obligations under Section 135, Companies Act, 2013, would not be eligible for Input Tax Credit (‘ITC’). The amendment sought to achieve two objectives: first, it clarified law on a point which attracted contradictory opinions by authorities for advance rulings (‘AARs’); second, it tried to ensure that the tax treatment of mandatory CSR activities under CGST Act, 2017 aligns with that of IT Act, 1961. I suggest that while the former objective may have been fulfilled, the latter remains questionable since the tax policy vis-à-vis mandatory CSR is itself confusing under IT Act, 1961.  

Confusion to Clarity: ITC on Mandatory CSR Activities

Section 16, CGST Act, 2017 states that a registered person shall be entitled to ITC charged on any supply of goods or services or both ‘which are used or intended to be used in the course or furtherance of his business’ and the said amount shall be credited to the electronic ledger of the person. As regards CSR, AARs were confronted with the question if CSR activities undertaken by a registered person should be understood ‘in the course of business’.   

In Re: M/s Dwarikesh Sugar Industries Limited the applicant wished to know if it can claim ITC on expenses incurred to fulfil its mandatory CSR obligations. AAR endorsed the interpretation adopted in a pre-GST case, i.e., Essel Propack case and noted that since the applicant was ‘compulsorily required to undertake CSR activities in order to run its business’, CSR activities should be treated as incurred ‘in the course of business.’ (para 12) AAR emphasised the compulsory nature of CSR and reasoned that it should not be equated with gift, since the latter had a voluntary element.

In Re: M/s Adama India Pvt Limited the applicant relied on Re: M/s Dwarikesh Sugar Industries Limited and Essel Propack case to support the contention that ITC on its mandatory CSR activities should not be blocked. Curiously, AAR did not examine scope of the term ‘business’ or ‘in the course of business’ used in CGST Act, 2017, but instead relied on the Companies (CSR Policy) Rules, 2014 which defined CSR activities undertaken by a company to not include activities undertaken in pursuance of the normal course of business. But the definition of CSR under these Rules has a different purpose and context. And reliance on Companies (CSR Policy) Rules, 2014 would be understandable if the term ‘business’ was not defined or was unclear under CGST Act, 2017. Section 2(17), CGST Act, 2017 contains an elaborate definition of business to which AAR paid no attention.  

In Re: M/s Adama India Pvt Limited, AAR also refused to refer to Essel Propack case reasoning that it was decided under pre-GST laws, but strangely it considered Companies (CSR Policy) Rules, 2014 as relevant to GST. While it may be reasonable to suggest that cases decided under pre-GST regime (in this case excise law regime) need not always be applicable in the GST regime; but, such a line of argument would only be persuasive if there was a marked difference in the applicable provisions in pre-GST and GST laws, which wasn’t the case as far the impugned issue was concerned. Even so, AAR should have examined the scope of ‘business’ under CGST Act, 2017 and the nature of mandatory CSR activities instead of referring to other legislative sources.   

In Re: M/s Polycab Wires Private Limited, Kerala AAR held that goods distributed by the applicant for free – and shown as CSR expenses – were not eligible for ITC under Section 17(5)(h), CGST Act, 2017. While AAR did not state it expressly, it seemed to equate the applicant’s free distribution of goods – as part of its CSR Activities – to gift or free samples. While for the latter, ITC is expressly blocked under Section 17(5)(h), CGST Act, 2017, it was an error to equate gifts and free samples with goods distributed under the CSR initiative. The applicant distributed goods at the request of Kerala State Electricity Board and thus, it was not entirely out of the applicant’s volition nor was it a compulsory CSR activity under Companies Act, 2013. AAR avoided the tough question on how to best classify the impugned CSR activity.

Thus, as is evident, AARs were struggling to adopt convincing reasoning and were arriving at different conclusions regarding eligibility of taxable persons to claim ITC on their CSR activities. Nor were they meaningfully distinguishing between mandatory and voluntary CSR activities.  

Ostensibly, to clear the confusion caused by contradictory advance rulings, Section 139, Finance Act, 2023 introduced the following clause to Section 17(5), CGST Act, 2017:

(fa) goods or services or both received by a taxable person, which are used or intended to be used for activities relating to his obligations under corporate social responsibility referred to in section 135 of the Companies Act,2013; 

Section 17(5), CGST Act, 2017 enumerates the situations in which ITC is blocked, and the insertion of above clause in Section 17(5), CGST Act, 2017 means that goods or services or both used to fulfil mandatory CSR obligations will not be eligible for ITC.. And to this extent, the law on ITC vis-à-vis mandatory CSR activities is sufficiently clear post the enactment of Finance Act, 2023. 

Clarity to Confusion: Mandatory CSR under IT Act, 1961

Blocking ITC for mandatory CSR via Section 17(5)(fa), CGST Act, 2017 superficially aligns with the tax treatment of mandatory CSR under IT Act, 1961. Section 37, IT Act, 1961 states that any expenditure – not being an expenditure of the nature described in Sections 30 to 36 – laid out or expended wholly and exclusively for the purpose of business or professions shall be allowed in computing the income chargeable under the head ‘Profits and gains of business or profession’. Section 37, IT Act, 1961 is a residual provision and allows an assessee to claim expenditure if some of the expenditure does not meet the requirements under specific heads, from Sections 30 to 36 of IT Act, 1961. The primary requirement under Section 37, IT Act, 1961 being that the expenditure should be for the purpose of business or profession. However, Explanation 2 to Section 37 clarifies that:

For the removal of doubts, it is hereby declared that for the purposes of sub-section (1), any expenditure incurred by an assessee on the activities relating to corporate social responsibility referred to in section 135 of the Companies Act, 2013 (18 of 2013) shall not be deemed to be an expenditure incurred by the assessee for the purposes of the business or profession. 

The above Explanation to Section 37 expressly disallows an assessee from claiming deductions on expenses incurred in fulfiling mandatory CSR obligations. 

However, the confusion on mandatory CSR expenses and IT Act, 1961 is two-fold: first, if mandatory CSR expenses satisfy the requirements of Sections 30 to 36, an assessee can claim deductions. This implies that there is no across the board bar on claiming mandatory CSR expenses under the IT Act, 1961 but the prohibition is only under Section 37 resulting in an uneven tax treatment of mandatory CSR IT Act, 1961; second, Section 80G states that an assessee cannot claim deductions if the mandatory CSR money is contributed to the Clean Ganga Fund or the Swach Bharat Kosh Fund. There is no express prohibition against mandatory CSR money contributions to any other fund listed under Section 80G creating a confusion about the objective of partial disallowance for only two funds.   

Conclusion

It is evident that the State does not view mandatory CSR activities as integral to or in the course or furtherance of business for tax purposes. The introduction of Section 17(5)(fa), CGST Act, 2017 reinforces the deeming fiction previously incorporated under Explanation 2, Section 37, IT Act, 1961. As far as these two provisions are concerned, mandatory CSR is not treated as an activity in the course or furtherance of business. The issue is partial bar against mandatory CSR expenses under IT Act, 1961. The limited scope of bar under both provisions – Section 80G and Section 37 only – raises the question as to why mandatory CSR is treated as business expense under other provisions. Reflection of a confused tax policy as far as IT Act, 1961 is concerned. 

Finally, the reasons for denying tax benefits for mandatory CSR activities seem to be rooted in the State’s conception of CSR activities as a backstop to its own welfare measures. And since the denial of tax benefits is limited only to mandatory CSR activities, there is room to suggest that the State does not wish to ‘subsidise’ only some CSR activities, as tax benefits are not denied to voluntary CSR activities. ITC is not blocked for voluntary CSR activity neither is deduction of expenses barred – even partially – for voluntary CSR. Creating a ‘two-track’ tax policy vis-à-vis CSR expenses.      

No Service Tax on Carried Interest: GST Applicability Remains an Open Question

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In a recent decision the Karnataka High Court has held that a Venture Capital Fund (‘VCF’) is not liable for service tax on carried interest. The decision reversed Customs, Excise & Service Tax Appellate Tribunal’s (‘CESAT’) ruling which was under appeal. CESAT had held that service tax was payable by the VCF primarily on the grounds that a VCF constituted as trust can be considered a person and that the doctrine of mutuality was not applicable to it since it further invests the money of its contributors with third parties, breaching the mutuality. The High Court viewed the VCF as a pass-through entity and viewed the asset management company appointed by trustee as the service provider. The decisions take contrary stands on whether VCF constituted as a trust is a person, its role, and the applicability of doctrine of mutuality. And while we do seem to have some answers about the taxability of carried interest under service tax regime, the same issue under GST regime remains an open question. I focus on the role of trusts and doctrine of mutuality in this article.  

Role of VCFs and Investment Managers

The appellants before the Karnataka High Court were established as a trust under the Indian Trusts Act, 1882 and registered as a VCF with Securities and Exchange Board of India (‘SEBI’). The appellants were managed and represented by a trustee. The terms and conditions in the formation of the appellant’s trust were contained in the Indenture of Trust, an offer document inviting subscribers and contributors to be part of the trust. The trust in turn appointed an investment manager to handle the funds of contributors. The Revenue Department demanded service tax on the expenses incurred by the trust – which they argued should have been characterized as service income as well as service tax on disbursement of carried interest to Class C unit holders in the VCF, i.e., typically the investment manager itself, among other trust expenses which were sought to be characterized as income of the VCF. Service was demanded under the head of ‘banking and financial services’ under Sec 65, Finance Act ,1994.   

Returns on investments are termed as carried interest, and as per the Indenture of Trust, the contributors receive the same as per the terms stated in the trust. Since the investment manager can and does invest alongiwth the contributors, it becomes entitled to carried interest on its investment in addition to the performance fee charged by it for its services. The former money is paid to it in its capacity as an investor and the Revenue’s case was that it should be subjected to service tax, though the applicability of service tax on the latter was not in dispute. CESAT’s understanding of the arrangement was that the trust was engaged in asset management and was responsible for managing the funds of contributors until delegated to the investment manager. (para 40.2) The Karnataka High Court, on the other hand, observed that VCF does not make any profit or provide any service and merely acts as a ‘pass through’ wherein funds from contributors are consolidated and invested by investment managers. VCF acts a trustee holding the money on behalf of the contributors and invests the money as per advice of the investment manager. (para 21) The latter understanding is proximate to the real nature of transaction and it was influential in the High Court’s conclusion that no service tax was payable by VCF. However, CESAT in overemphasizing the role of trust in the entire transaction arrived at the questionable conclusion that trust was providing banking and financial services by indulging in asset management of its contributors. CESAT was persuaded by the Revenue’s argument that carried interest paid to investment manager was a disguised performance fee and should be subject to service tax, an argument that – if one reads the two decisions – is not entirely proven by facts.       

Trust as a Person and Doctrine of Mutuality 

The appellant’s argued that trust was not recognized as a person and thus cannot be held liable to tax. The appellant’s further argument was that VCF, constituted as trust, was not providing any service to the contributors, and expenses incurred by the trust cannot be considered as consideration for ‘services’. Also, the appellant added, assuming but conceding, that the trust was providing a service – no service tax was payable due to the doctrine of mutuality. There was complete identity between the trusts and its contributors. The appellants relied on the jurisprudence of doctrine of mutuality, with the Calcutta Club case being the focal point of reference. The doctrine of mutuality postulates that when persons contributed to a common fund in pursuance of a scheme for their mutual benefit, having no dealings or relations with any outside body, they cannot be said to have traded or made profit from such mutual undertaking since there the identity of the persons and the mutual undertaking is the same. 

CESAT rejected all the above appellant’s arguments. CESAT noted that VCF is registered as a fund under the SEBI VCF Regulations and under the Regulations it is treated as a body corporate and it should be treated as such for tax purposes too. CESAT held that: 

As the Trusts are treated as juridical persons for the purposes of SEBI Regulations, we do not find any reason as to why they should not be treated so for the purpose of taxation. (para 37.4)

On the same issue, the Karnataka High Court took an opposite view and held that while SEBI and other legislations may treat a trust as a juridical person, the relevant statute for the purpose of service tax liability is Finance Act, 1994 and the latter does not treat trust as a juridical person. The High Court held that definitions of each statute must be read with the object and purpose of that statute as intended by the legislature and accordingly refused to treat trust as juridical person for the purpose of Finance Act, 1994. (para 15)

The Karnataka High Court’s emphasis on the intent and context of each legislation is vital. It is important to note that courts should be circumspect before importing definitions of one statute into another, unless there is complete silence on the issue in the latter. In the context of tax, the issue is even more vital as the general rule of construction of tax statutes is that a burden cannot be imposed on an assessee, unless expressly stated in the statute. It thus follows that if an entity is not expressly regarded as an assessee, it cannot be subjected to tax.  

As regards the applicability of doctrine of mutuality, the Karnataka High Court gave a succinct  and correctfinding. The High Court observed that the trust and its contributors cannot be dissected into two distinct entities because the contributors investment is held in trust by the fund and investments the money on the advice of investment manager. Thus, the trust cannot be held liable for providing service to itself. CESAT had a different opinion and noted the doctrine of mutuality as applied in various cases in India was in the context of member clubs where the contributions were made by members and the clubs were not pursuing profits. While in the impugned case the main purpose of VCF was to earn profits. The CESAT observed that VCF had violated the principle of mutuality by engaging itself in commercial activity and using its discretionary powers over funds to benefit a certain class of investors. Relying on the Calcutta Club case, the CESAT rejected the applicability of the doctrine of mutuality. 

While attributing profit to VCF was not incorrect, CESAT’s understanding of the scope of discretion VCF possessed over the funds of its contributors and the importance placed to profit motive is perhaps misplaced. Profit motive of an entity that collects funds does not per se rule out the applicability of the doctrine of mutuality. And if the trust in this case was retaining some money as expenses for holding the money, it was per the terms of trust and that factor also is relevant but not determinative in ruling out the doctrine of mutuality. While it is important to understand the context of previous decisions, the scope and applicability of the doctrine needed a better articulation in the CESAT’s decision.  

Finally, CESAT relied on ‘common parlance’ to state that no common man would consider VCF trusts like clubs. Here again, the reliance on a common man’s view of the role, object, and relevance of VCF is inaccurate as the tribunals are bound to consider the statutory definitions and not rely on an elastic and ambiguous understanding of entities as adopted in common usage.      

GST and Doctrine of Mutuality 

The doctrine of mutuality already has a small history under the GST regime. In reaction to the Supreme Court’s decision in Calcutta Club case, the definition of supply was amended – with retrospective effect – and the following clause was added via Finance Act, 2021:

(aa) the activities or transactions, by a person, other than an individual, to its members or constituents or vice-versa, for cash, deferred payment or other valuable consideration. 

The Explanation stated that notwithstanding anything contrary contained in any judgment or decree, the person and its members or constituents shall be deemed to be two separate persons and the supply of activities or transactions inter se shall be deemed to take place from one person to another. While the above clause, does signal to a significant extent that doctrine of mutuality is truly buried, and has not survived the 46th Constitutional Amendment, despite the Supreme Court holding otherwise, its applicability to the specific context of VCFs and carried interest remains uncertain and untested. This also because trust is included in the definition of a person under Section 2(84)(m), CGST Act, 2017 meaning that arguments relevant in the impugned case may not be entirely transferable to similar demands of tax under GST.    

Conclusion

CESAT’s decision created turmoil as VCFs have never been understood to be service providers, but only conduits for channeling the investments and holding the money in trust. The actual investment advice is provided to the contributors by the investment management company. CESAT overemphasized the role of trust, to some extent misunderstood the nature of payments, and decided that trust was acting as a service provider. The Karnataka High Court has corrected this position, but its applicability and relevance is for service tax levied under the Finance Act, 1994. We yet do not know if similar demands will made under GST and their likely fate. 

Unfamiliar Terrain of Loyalty Points and GST

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Levying GST on atypical forms of consideration is a familiar problem under GST regime. One such problem relates to the levy of GST on vouchers issued by a supplier. While we have a modicum of certainty on the interface of vouchers and GST, on another form of consideration, i.e., loyalty points, applicability of GST remain a source of intrigue. In this article, I elaborate on some of the challenges posed by issuance of loyalty points and the unanswered questions about the levy of GST on their issuance, cancellation, among other aspects. 

Identity of Loyalty Points

The first challenge is accurately identifying loyalty points. It is unclear if loyalty points can be classified as actionable claims, vouchers, or a form of money. One advance ruling relating loyalty points has stated that loyalty points, until they are valid, constitute as actionable claims. However, after their expiry period, they cease to be actionable claims. AAR’s reasoning was that after the expiry date of the loyalty points, the customer can no longer redeem them and loses any right over them. Since the customer loses the right to initiate legal action in relation to their loyalty points after their expiry, they cease to be actionable claims. AAR however, stopped short of identifying the nature of loyalty points after their expiry period. AAAR, in an appealagainst the ruling, took the same view.  

During the hearing before AAR, the Revenue Department commented that loyalty points do not amount to actionable claims but chose in possession. The Department emphasized that actionable claims comprise of two kinds of claims: (a) claim to unsecured debt; and (b) claim to beneficial interest in a movable property. And argued that since the beneficial interest in movable property was in the possession of customers the loyalty points cannot be termed as actionable claims but instead should be characterized as chose in possession. 

It is difficult to buy the distinction between actionable claims and chose in possession articulated by the Revenue Department. Actionable claims rarely cease to be such merely because the beneficial interest in the movable property is in the possession of the customer. Chose in possession tends to be broader concept encompassing a bundle of rights over an object, and the possession of the object is not determinative of its character. Further, the identity of loyalty points also overlaps with the definition of vouchers. Section 2(118), CGST Act, 2017 defines voucher as an instrument where there is an obligation to accept it as consideration or part consideration for a supply of goods or services or both and where the goods or services to be supplied or identities of potential suppliers are indicated on the instrument itself. It is difficult to argue that loyalty points constitute as an ‘instrument’ and can strictly speaking, be considered as vouchers as defined under CGST Act, 2017 even though loyalty points would typically fulfil remaining ingredients enlisted in definition of the voucher. 

While High Courts have termed gift vouchers as actionable claims, money, and vouchers as defined under CGST Act, 2017, it is difficult to state if loyalty points can be satisfactorily included in any one of the three categories even if they are analogous with gift vouchers often issued by suppliers to retain and cultivate loyal customers. The context and facts would require examination to accurately determine the identity of loyalty points as it is possible that they are identified in different categories depending on their nature and purpose of use.

Prima facie, it does seem that loyalty points satisfy the definition of an actionable claim. Though, if loyalty points are used in consideration or part consideration of a supply of goods or services, they can be considered as vouchers provided one adopts a broad view of what constitutes as an ‘instrument’ in the definition of vouchers. Irrespective, the identity of loyalty points under the GST regime remains an open question.    

Taxation of Loyalty Points 

The GST consequences of issuance, use, redemption, and expiration of loyalty points remains an equally open-ended question partially, if not substantially, because the identity of loyalty points is not established. The levy of GST in respect of loyalty points has multiple dimensions: their effect on the value of supply, time of supply, and whether the expiry of loyalty points constitutes an independent supply. The last question was the subject of attention in an advance ruling. 

In the advance ruling, the applicant was responsible for managing loyalty points issued by one of its clients to its customers. The applicant charged GST on the service fee it charged its clients for managing their loyalty point program. The client used to pay the applicant Rs 0.25 per loyalty point as issuance charge. If the customer redeemed the loyalty points, the applicant would Rs 0.25 per loyalty point redeemed by the customer to the client. If the customer did not redeem the loyalty points and/or if the loyalty points expired, the applicant would forfeit and retain the amount equivalent to Rs 0.25 per loyalty point. AAR had to answer the question whether the forfeiture of amounts equivalent to expired loyalty points was consideration for actionable claims and whether it would be subject to GST? As mentioned above, AAR held that loyalty points were actionable claims until they expired but ceased to actionable claims after their expiry. AAAR held the same. The other related question was the issue of consideration. AAR held that the forfeiture of amount equivalent to expired loyalty points constituted as revenue for the applicant was issuance fee for the services it provided to its clients for managing their loyalty point programs. The forfeiture amount was consideration for supply of services to its clients in the normal course of business and was part of their remuneration. The forfeiture of expired loyalty points was termed as a supply, and their value was held part of the value of supply. AAAR similarly took the view that consideration for expired loyalty points had flown to the applicant and was its revenue for managing its loyalty point program.  

The advance ruling mentioned above, dealt with specific facts where the loyalty point program of a supplier was managed by a third party. And the taxability of forfeited amount was the specific issue before the advance ruling authority. However, in case, the loyalty point program is managed in-house by a supplier would some of the answers be different? Perhaps. The answers would depend on the terms and conditions underlying the loyalty point program relating to their issuance, redemption, and expiry. Forfeiture of the loyalty points in case of in-house management would not ordinarily amount to a supply, since a third party would not be involved. Neither would any question of consideration arise in such a scenario. 

In another scenario, what if the value of loyalty points reduces at stipulated dates. For example, after 24 months, each loyalty point, instead of being worth Rs 0.25 would be worth Rs 0.10. Would the difference, i.e., Rs 0.15 be treated as consideration? In case of third party managing the loyalty point program, the reduced value is likely to be forfeited by the third party, making it a supply to the extent of the reduced value. In case of in-house management of loyalty point program, the reduced value is unlikely to invite any GST consequences. But, again these are tentative answers and would require scrutiny depending on the terms and conditions of the loyalty program offered by a supplier.     

Conclusion 

This article is a preliminary attempt to highlight some of the GST implications and issues that may arise from the issuance, redemption, and expiry of loyalty points. The aim is to highlight a couple of issues and how the answers are not – currently – straightforward under the GST laws. A parallel aim of the article was also to highlight that loyalty points while comparable are not completely analogous to gift vouchers issued by suppliers and may require customized answers. Though gift vouchers and loyalty points may also intersect in certain circumstances. And further loyalty point programs also differ – third party managed and in-house – and may invite different interpretations and inevitably varied answers.    

Can Cash be Seized During GST Inspections? 

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Section 67 of the CGST Act, 2017 deals with powers of inspection, search, and seizure of officers and Section 67(2) specifically empowers the officers carrying out an inspection to seize goods and documents. Courts have arrived at divergent interpretations as to whether the power to seize goods and documents includes the power to seize cash – unaccounted or otherwise. Relying on the interpretive principle of ejusdem generis and the objective of GST laws, some Courts have held that power to seize goods includes power to seize cash while some Courts – relying on similar factors – have concluded otherwise. 

Short Profile of Section 67

Section 67, CGST Act, 2017 states that where a proper officer not below the rank of Joint Commissioner has reasons to believe that a taxable person has suppressed any transaction in relation to supply of goods or services, or has claimed ITC more than his entitlement or has engaged in the business of transporting of goods in a manner that has caused or is likely to cause tax evasion, he may authorize any officer of central tax to inspect places of business of such taxable person. Section 67(2) along with the two Provisos states as follows: 

Where the proper officer, not below the rank of Joint Commissioner, either pursuant to an inspection carried out under sub-section (1) or otherwise, has reasons to believe that any goods liable to confiscation or any documents or books or things, which in his opinion shall be useful for or relevant to any proceedings under this Act, are secreted in any place, he may authorise in writing any other officer of central tax to search and seize or may himself search and seize such goods, documents or books or things: 

Provided that where it is not practicable to seize any such goods, the proper officer, or any officer authorised by him, may serve on the owner or the custodian of the goods an order that he shall not remove, part with, or otherwise deal with the goods except with the previous permission of such officer: 

Provided further that the documents or books or things so seized shall be retained by such officer only for so long as may be necessary for their examination and for any inquiry or proceedings under this Act. (emphasis added)

The specific question that Courts have have faced is: whether cash is a ‘thing’ and can be seized by officers while carrying out inspections under Section 67? The text of Section 67 does not provide any definitive answer as it does not mention the word ‘money’ and the only way to include money in the scope of Section 67 is through a process of interpretation. While some Courts have relied on the definition of money, as included in CGST Act, 2017, this interpretive approach has not provided a definitive answer to the scope of Section 67 and the power of officers under the said provision.  

Cash is a ‘Thing’ 

The Madhya Pradesh High Court referred to the definitions of ‘consideration’, ‘business’, ‘money’ among others to hold that the term ‘thing’ used in Section 67 includes money. The High Court’s reasoning was that definitions are the key to unlock the objective of CGST Act, 2017. The High Court though never specifically articulated as to what objective of GST laws was served by allowing officers to seize cash belonging to a taxable person. The High Court further tried to reason that a statute must be interpreted in a manner that suppresses the mischief and advances the remedy. Again, here the High Court did not clearly state the mischief and remedy in question. Is the mischief tax evasion? And if so, is it warranted to rely on inconclusive definitions to interpret a provision which provides invasive powers to tax officers?   

The Kerala High Court akin to the Madhya Pradesh High Court also opined that Section 67(2) allows for seizure of cash including things under certain circumstances. However, the Kerala High Court took a different view of the objective of GST and observed that: 

The power of any authority to seize any ‘thing’ while functioning under the provisions of a taxing statute must be guided and informed in its exercise by the object of the statute concerned. In an investigation aimed at detecting tax evasion under the GST Act, we fail to see how cash can be seized especially when it is the admitted case that the cash did not form part of the stock in trade of the appellant’s business.          

The Kerala High Court added that the intelligence officer’s argument that there was huge amount of idle cash at the petitioner’s premises and it wasn’t deposited in the bank reveals the misgivings that officers have of their powers under GST laws. The High Court added that such arguments were only valid if the officer was attached to the Income Tax Department.

The above two decisions show how two High Courts are at odds as to their understanding of the objective of GST. While the Madhya Pradesh High Court reasoned that seizure of cash would serve the object of GST, the Kerala High Court opined that seizure of cash will not serve the purpose of detecting GST evasion especially if it is not part of stock in trade of the taxable person. Both High Courts are at fault in not specifically articulating the object of GST laws. Invoking the ‘object’ of GST laws in abstract and in general terms is not the best interpretive approach and is in fact erroneous. It is not prudent to assume that GST laws have only one objective. One could perhaps argue that inspection and seizure have one overarching objective, i.e., to ensure collection of the tax due and compliance with statutory provisions. But, surely, that is not the ‘only’ object of GST. To argue or even pre-suppose that the only object of GST is to facilitate maximum tax collection is a reductive view of tax laws.  

Further, it is important to highlight that the Kerala High Court casually concluded that Section 67 allows seizure of things including cash without specifically examining the text of the provision and its scope. The principles of strict interpretation of tax statutes were given a complete bypass by the Kerala High Court in observing that cash can be seized under Section 67.  

Cash is Not a ‘Thing’ 

At the other end of spectrum are two decisions of the Delhi High Court. The first case, also discussed here, relied on three major factors to conclude that cash is not included in the term ‘thing’ used in Section 67. The Delhi High Court observed that while Section 67 uses the term ‘goods’ which was a wide term, the caveat in the provision was that they should be liable for confiscation. Goods should be the subject matter or suspected to be subject matter of evasion of tax. Similarly, documents, books or things can be confiscated if in the opinion of the officer they shall be used or are relevant to any proceedings under the Act. 

The Delhi High Court highlighted the drastic nature of the powers of search and seizure and the need to adopt purposive interpretation. The High Court observed that powers under Section 67 have only been given to aid proceedings under CGST Act, 2017 and cash cannot be seized in exercise of powers under Section 67 on the ground that it represents unaccounted wealth. And that unaccounted wealth is the subject matter of IT Act, 1961. 

In the second case, the Delhi High Court also made similar observations and held that if there is no evidence that cash represents sale proceeds of unaccounted goods it cannot be seized under Section 67 of CGST Act, 2017. And that CGST Act does not permit the coercive action of forcibly taking cash from the premises of another person. 

The Delhi High Court’s approach is founded on sounder reasoning as it not only highlights the drastic and intrusive nature of powers of inspection, but also specifically identifies the purpose of these powers. To aid investigation under CGST Act, 2017 cash can be seized but only if represents the sale of unaccounted goods or a related offence under the statute. Cash cannot be seized merely because it is unaccounted income or wealth, which is the subject matter of IT Act ,1961.  

Way Forward 

The Madhya Pradesh High Court’s reasoning to support its conclusion that ‘thing’ includes ‘money’ lacks potency especially because of the High Court’s ignorance of the dictum that tax laws need to be interpreted strictly. By relying on definitions and other provisions, the High Court interpreted the scope of Section 67 which is not ideal. And unlike the Delhi High Court, the Madhya Pradesh High Court did not acknowledge the drastic nature of inspection and seizure powers and how in trying to suppress the mischief of tax evasion it is empowering tax officers beyond what the law specifically states. And any reliance on purposive interpretation is only defensible if the purpose of the statute and/or provision is clearly articulated and the interpretation is to suit that purpose. Reference to abstract objective of the statute is not helpful and leaves a lot to be desired. On balance, the approach adopted by the Delhi High Court – in both its decisions on the issue – is well-reasoned, pragmatic and hopefully will form the bedrock of jurisprudence in future.  

JDAs Not Exempt from GST: Telangana HC

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The Telangana High Court in a recent judgment clarified that Joint Development Agreements (‘JDA’) between developer and landowner do not transfer ownership rights but only grant development rights to developer. The petitioner’s case, in summary, was that JDA results in transfer of ownership in land and the GST exemption for ‘sale of land’ under Entry 5, Schedule III, CGST Act, 2017 will be applicable to JDAs. The State’s case for bringing JDA within the fold of GST relied on Entry 5(b), Schedule II, CGST Act, 2017 which inter alia makes construction services amenable to GST.  The High Court clarified that transfer of ownership only takes place via a conveyance deed after the developer has completed the obligations under JDA, and JDA itself does not transfer title in the land.  

Facts and Arguments 

The petitioner claimed that the transfer of development rights in its favor by the landowner via JDA should be treated as sale of land by the landowners and the execution of JDA should not be subjected to GST. 

The petitioner’s arguments were that the execution of JDA was ‘almost like a sale of land’ and that JDA needs to be considered holistically without focus on individual clauses as it enabled the landowner to transfer the land to the petitioner. The petitioner’s case was that by execution of JDA itself there is substantive transfer of development rights in favor of the petitioner which results in sale of land proportionate to the amount of investment made by the developer. And since JDA gives rise to an element of sale of land the statutory embargo on levy of GST on sale of land would be applicable. 

The petitioner’s ancillary argument was that Notification via which GST was imposed on transfer of development rights should be declared as ultra vires the Constitution. The petitioner’s argued that the Notification traversed beyond the four corners of the law. The absence, in CGST Act, 2017, of any specific provision, mechanism or machinery to determine the quantum of tax payable on JDA was emphasised to argue that the Notification being a delegated legislation traversed beyond the parent legislation.  

The State contended that the petitioner’s entire case lacked any foundation. The State referred to the clauses of JDA to argue that ownership, title rights on the land were retained by the owner and the petitioner was only granted the development rights on the land which belonged to the landowner. The State added that none of the clauses of JDA indicate that the JDA which gives petitioner right to develop the property also effectuates an outright sale of land from the landowner to the petitioner. 

Telangana High Court Decides 

The Telangana High Court correctly rejected the petitioner’s arguments and concluded that execution of JDA does not result in an outright sale of land. The High Court’s conclusion was primarily dependent on its examination of the terms/clauses of JDA and their implication.  

The Telangana High Court opined that an owner of immovable property has a bundle of rights one of which is to get the property developed by an agent of its choice on the terms and conditions that they deem fit. The High Court noted that under the JDA, the petitioner would get the licence/permission to enter the landowners’ property for execution of its development activities. And after the petitioner develops the entire property, the landowner would grant to the petitioner a share in the land proportionate to the built-up area for which petitioner is entitled. (paras 24 and 25) 

The Telangana High Court also noted that the JDA clearly stipulated that in event of default on the petitioner’s part, all the rights on the property remained with the landowner. This stipulation in favor of the landowner, as per the High Court, was an indication that the title over the property on the date of execution of JDA remained with the landowner and not with the petitioner. (para 26) 

The Telangana High Court referred to another clause of JDA which stipulated that on completion of development, the petitioner was to transfer possession of the completed units to the landowner. Thereafter, the landowner would sign conveyance deed with the petitioner to transfer the undivided share of land towards investment, efforts, cost of construction incurred by the petitioner in developing the land. The High Court correctly interpreted the terms of JDA to note that under a JDA, the petitioner offered construction services to the landowner. And for the said services the landowner transferred development rights to the petitioner and the same cannot be equated with outright sale of land. Based on the above reading of the various clauses of JDA, the High Court concluded that:    

From plain reading of the JDA that was entered into between the two parties, what is apparently visible is that, there was no outright sale of land being effectuated and the JDA per se cannot be considered merely as a medium adopted by the landowner selling his land and the JDA does not lead to sale of land by itself. After the entire development activities are carried out for the investment made by the petitioner for realizing what he has invested, he would be permitted to sell/dispose of certain developed properties constructed in execution of the JDA. (para 29)

The High Court further reinforced its conclusion by observing that the transfer of undivided land in favor of the petitioner only happens after issuance of the completion certificate indicating that the services rendered by the petitioner in execution of JDA were supplied prior to issuance of competition certificate and were amenable to GST. The High Court was here impliedly referring to Entry 5(b), Schedule II, CGST Act, 2017 which makes construction services amenable to GST when they are provided before issuance of completion certificate. 

As regards the petitioner’s challenge to the validity of Notification, the High Court noted that Notification does not create a charge but only states the time at which the GST is payable is when the developed area is transferred by the petitioner to the landowner and not at the time of execution of JDA. And the Notification did not suffer from the vice of excessive delegation.  

Conclusion 

The Telangana High Court’s interpretation and understanding of JDA is correct. The petitioner’s contention that execution of JDA itself transfers ownership rights was incorrect as the various stipulations in JDA made it evident that the transfer in title only happens once the developer has fulfilled the obligations of developing the land in question. The petitioner erroneously equated the right to receive a part of the land on completing the development of land with the actual transfer of land. 

Lessons from NAA: Parameters of a Fair Dispute Resolution Body 

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The experience of transitioning from retail sales tax to VAT laws in 2002-03 provided a learning that a similar transition to GST may be used as a pretext by suppliers to artificially increase the prices of goods and services and profiteer at the expense of retail consumers. To protect consumer interest, an anti-profiteering provision was included in Section 171 of the CGST Act, 2017 which mandates that any reduction in tax rate or the benefit of ITC shall be passed on to the consumer by way of commensurate reduction in prices. And under the same provision the Central Government was empowered to either notify an existing authority or create a new authority to implement the mandate. And a new body in the form of National Anti-Profiteering Authority (‘NAA’) was duly constituted to implement the mandate of Section 171.  

NAA’s constitution via delegated legislation, opaqueness about its methodology to determine profiteering, absence of an appellate remedy, and the rhetoric filled nature of its orders created fertile grounds for arguments that it was an unconstitutional body. Recently, the Delhi High Court upheld the constitutionality of NAA though it provided the petitioners the liberty to challenge the individual orders of NAA on merits. I’ve previously examined the limitations and flaws in the judgment. In this article, I rely on NAA’s working and the Delhi High Court’s judgment to extrapolate some parameters which should be the touchstone to examine the efficacy and fairness of a tax dispute resolution body. 

Providing Appropriate Policy Guidance  

A crucial issue that characterises the administration of tax laws in India is the nature and extent of delegated legislation. Statutory provisions are consistently interpreted, re-interpreted by the executive via Circulars, Notifications, and Press Releases which are also constantly issuing instructions that require attention and compliance by taxpayers. The content of several such secondary legislative instruments is not only far removed from the parent statute, but the policy is also rarely encoded in the statute. The issue of delegated legislation, and its legal scope, becomes even more acute when the statute does not provide adequate policy guidance to the decision-making body creating a danger of the body interpreting its mandate beyond the confines of the parent statute. And more crucially, leaving the stakeholders clueless about the scope of jurisdiction of the decision-making body and the nature of disputes that it can adjudicate. 

The fact that NAA did not contain adequate policy guidance was one of the petitioner’s main contentions before the Delhi High Court and rightly so. While Section 171 does state the broad compliance that suppliers need to adhere, it provides no insight into the nature and scope of of the body that is empowered to implement the mandate. NAA’s and the Delhi High Court’s opinion was that Section 171 is a ‘self-contained code’; but, interpreting the broad mandate of Section 171 as an adequate policy direction is not ideal. Certainly not from the perspective of taxpayers. The jurisdiction and mandate of the decision-making body needs to be prescribed more precisely and preferably by the legislature or executive. The body in question should not have the authority to determine its own jurisdiction and procedure which it can interpret in a self-serving manner. 

Creating an Accountability Mechanism

Creating accountability mechanisms for judicial or quasi-judicial bodies has been a tough road in India. For example, we are yet to determine the appropriate method and manner of determining the accountability of judges of High Courts and the Supreme Court. One way the accountability invariably gets attached to judicial or quasi-judicial bodies is through the process of appeals against their orders. It allows the petitioner an opportunity to make additional or better arguments, at the same time another body can scrutinize the order on the touchstone of fairness, interpretive coherence, and other similar parameters. In the absence of a statutory right to appeal for the parties, the risk of perverse orders and opaque functioning increases dramatically. For example, in NAA’s case the parties were not provided a statutory right to appeal against its orders and could only approach the High Court via writ petitions which is accompanied with its own limitations. NAA could only be supervised by the GST Council, which if the minutes of its meetings as anything to go by, treated its job of supervising NAA superficially.  

One consistent and oft-repeated theme in NAA’s orders was the taxpayers demanding that NAA makes its methodology for calculating profiteering public and NAA replying that it had issued a document – which actually did not state the methodology – and regardless, calculating amount of benefits that needs to be passed to customers wasn’t a tough or complex task and taxpayers could do it themselves. And yet when taxpayers challenged NAA’s constitutionality on the ground that it lacked a judicial member, etc., NAA replied that it was an ‘expert body’ involved in complex work of determining profiteering and need not be compared to quasi-judicial or judicial bodies. Opaqueness and inconsistencies in NAA’s orders were abound but there was no superior or appellate authority that could scrutinize its decisions and present and alternate or a modified view of the facts and dispute in question. It is one thing to say that the constitutionality of a body cannot be challenged on the ground that there is no right to appeal against its orders, but the implications of the absence of such a right extend beyond the constitutionality argument and tax administration needs to be mindful of them.    

Defined Identity as an Adjudicatory Body or a Regulator  

Taxation law primarily concerns itself with the relationship of State with its residents with the former exercising its coercive power to extract financial resources for its sustenance. The disputes about the scope of the State’s powers are typically adjudicated by classical dispute resolution bodies, mostly successfully. In mediating the relationship of the State and its residents qua their tax obligations, the need for a regulator rarely presents itself. Thus, while sectoral regulators in other spheres such as banking law, securities law, etc. is relatively common, we do not witness similar bodies in tax law universe. Irrespective, when novel or ‘atypical’ bodies are created for administration of tax laws, it is incumbent on the legislature to be precise in stating the rationale and need for the body. Else, not only are the stakeholders confused, but the ‘atypical’ body itself suffers from an identity crisis and looks to fulfil the mandate of both a traditional dispute resolution body and a sectoral regulator and is frequently unable to do justice to neither.

In the case of NAA, it is still unclear if it was intended to be a dispute resolution body or a regulator. But one thing we do know that NAA fancied itself as an expert body and a sectoral regulator and frequently drew analogy of its mandate with SEBI. The analogy was always flawed because SEBI is creation of a dedicated statute, has a Board, and separate dispute resolution bodies while NAA, created via delegated legislation, was a coalesced body consisting of a few technical members which adjudicated on disputes and complaints relating to profiteering. The investigate arm of NAA, DGAP, was answerable and bound by all directions of NAA removing all and any pretence of checks and balances in its operation. There was no clear identification of its role beyond the general mandate contained in Section 171 and NAA itself did not satisfactorily fulfil the role of either a regulator or a dispute resolution body.    

De Minimis Requirement of Reasoned Orders 

In respect of taxation law, the absence of well-reasoned orders is a widespread symptom that affects advance ruling authorities, tribunals and to some extent even High Courts and the Supreme Court. While speaking orders are a minimum requirement or at least an expectation from any judicial or quasi-judicial or for that matter any administrative body, there is a need to ensure that the orders satisfy the minimum standards of a reasoned order. This can be done through careful selection of personnel and/or ensuring accountability mechanisms in form of an appellate body as suggested above. 

While people like me and more skilled than me examine and critique the various such orders, there was something fundamental amiss in the NAA’s orders: skill of writing a judgment. The Delhi High Court in its recent judgment has incorrectly noted that NAA was only a fact-finding body and did not adjudicate on rights and liabilities. NAA not only heard arguments of the taxpayers who were defending their conduct, but also of complainants, and adjudicated on their rights and obligations. But in most of its orders, one found a lack of engagement with the various arguments that the parties raised and instead a generous dose of rhetoric, stonewalling, and sidestepping with substantive arguments. NAA interpreted the relevant statutory provisions were interpreted pedantically and did not even acknowledge important arguments when arriving at its conclusions, violating basic tenets of judgment writing. It is important that vital tax law matters are not decided in a whimsical fashion with disregard to taxpayer rights and a well reasoned judgment is provided by the authorities in question.  

Conclusion 

The above are by no means exhaustive or even necessary conditions to design a fair and transparent tax dispute resolution body. I’ve only picked cues from the working of NAA and the arguments presented by petitioners before the Delhi High Court to make a tentative case for designing dispute resolution bodies under the tax law umbrella. I’ve highlighted some of the above parameters based on my own previous assessment and observation of the NAA’s working and how, in my view, there was a wide bridge between the laudable objectives of setting up an anti-profiteering regime under GST and the NAA implementing the said mandate in an opaque manner via questionable orders that barely met the minimum requirements of respecting taxpayer rights and administering tax justice.  

Penalties for e-way bills cannot be imposed in absence of Mens Rea: Allahabad HC

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The Allahabad High Court in a recent judgment took the view that the GST Department cannot impose a penalty on taxpayers – under Section 129(3), CGST Act, 2017  – for not possessing e-way bills in the absence of an intention to evade tax. The High Court held that the essence of any penal imposition is linked to the presence of mens rea which was clearly absent as revealed from the facts and records of the impugned case. In stating so, the High Court aligned with an emerging jurisprudence on Section 129 that requires intent to evade tax as an essential requirement for passing orders under Section 129(3). 

Facts  

The petitioner, an authorized dealer of Steel Authority of India Ltd (‘SAIL’) purchased a bar of TMT on 19.02.2021. Tax invoices were issued by SAIL to the petitioner, and they contained the registration number of the transportation vehicle. The petitioner claimed that the e-way bills could not be generated at the onset of transportation since there were glitches in the e-way bill system of the Department. The e-way bills were generated on 20.02.2019 and 21.02.2019. The petitioner’s claim was that the e-way bills were presented at the time of interception of goods before the issuance of showcause notice and before passing the detention order. Aggrieved by the orders of detention passed on 21.02.2019 and 20.10.2019 by the Assistant and Additional Commissioner respectively, the petitioner approached the Allahabad High Court. 

Allahabad High Court Quashes Orders of Detention 

The Allahabad High Court noted that the relevant question was: despite the petitioner failing to generate the e-way bills on time, did it have an actual intent to evade payment of tax? The High Court cited relevant precedents to note that for proceedings under Section 129(3) intent to evade tax is mandatory and that even in the absence of an e-way bill if there is no discrepancy in the accompanying documents and no intent to evade tax, then penalty cannot be levied. Courts have also held that not generating Part B of the e-way bill is a mere technical error, and if the accompanying invoice has the vehicle details, then it can be reasonably concluded that the taxpayer has no intent to evade tax. Based on an examination of the relevant precedents, the High Court’s summation of the current legal position was: 

What emerges from a perusal of the aforesaid judgments is that, if penalty is imposed, in the presence of all the valid documents, even if e-Way Bill has not been generated, and in the absence of any determination to evade tax, it cannot be sustained. (para 15) 

As per the facts of the impugned case, the petitioner had generated both the e-way bills, one before detention and one after detention, but both before the order under Section 129(3) was passed. The Allahabad High Court noted, neither of the two orders contained a reasoning as to how and why an intention to evade tax was established. The High Court noted that the petitioner was made to suffer due to a technical error without there being an intent to evade tax on petitioner’s behalf. Elaborating on the importance of establishing intent to evade tax before imposing penalties under Section 129(3), CGST Act, 2017, the High Court observed: 

A penal action devoid of mens rea not only lacks a solid legal foundation but also raises concerns about the proportionality and reasonableness of the penalties imposed. The imposition of penalties without a clear indication of intent may result in an arbitrary exercise of authority, undermining the principles of justice. Tax evasion is a serious allegation that necessitates a robust evidentiary basis to withstand legal scrutiny. The mere rejection of post-detention e-Way Bills, without a cogent nexus to intention to evade tax, is fallacious. (para 18) 

The Allahabad High Court further added that it was incumbent on the tax authorities to distinguish technical errors from deliberate attempts to avoid tax. And that mere technical errors that do not have financial implications should not lead to imposition of penalties. 

Conclusion 

The Allahabad High Court through its judgment in the impugned case follows a line of judicial precedents – and the High Court duly cited some of them – that underline the need to establish or indicate the presence of intent to evade tax before tax authorities pass an order under Section 129(3) of CGST Act, 2017. Either the officers are not understanding the scope and objective of the provision or are deliberately ignoring the requisite conditions of the provision before passing orders under Section 129(3). Irrespective, the burgeoning no. of cases by taxpayers claiming violation of Section 129(3) indicates a lack of adherence to the law laid down by Courts in an increasing no. of cases.  

Post-Supply Discounts Cannot be Included in Transaction Value: Madras HC

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The Madras High Court recently observed that post-supply discounts offered by a supplier to the recipient cannot be included in the transaction value/value of supply for levying GST. The High Court distinguished between subsidy offered by a third party and a discount and noted that a discount by itself cannot qualify as subsidy.  

Introduction to Taxability of Discounts under GST  

Before discussing the case, I think it is important to provide contest of the type of discounts envisaged under CGST Act, 2017 and their manner of inclusion and exclusion from the value of supply. 

Section 15, CGST Act, 2017 contains stipulations as to which amounts can or cannot be included in the value of a taxable supply, where both the recipient and supplier are not related, and price paid or payable is the sole consideration for supply. Section 15(3)(a) states that discounts offered at the time of or before a supply shall not be included in the value of supply in such discount has been duly recorded in the invoice in respect of such supply. Section 15(3)(b), which was in focus in the impugned case, states that a discount after a supply has been effected shall not be part of value of supply if: (i) such discount is established in terms of agreement entered into at or before the time of such supply and specifically linked to relevant invoices; (ii) ITC as is attributable to the discount on the basis of the document issued by the supplier has been reversed by the recipient of the supply. 

Typically, discounts offered before or at the time of supply are excluded from the value at the time of generation of invoice itself. While discounts offered after the supply cannot, due to their nature be reflected in the invoice per se, but the value can be reduced by filing credit notes thereafter and linking it to the supply in question. It is the latter kind of discount that was the Madras High Court’s focus in the impugned case.  

Facts and Arguments  

The facts of the impugned case were not clearly stated by the Madras High Court in its judgment, but from what one can gather it seems: the petitioner challenged the inclusion of volume discount in the value of supply and the Revenue Department’s stance that the discount was a ‘private’ subsidy. Under Section 15(2)(e) subsidies directly linked to the price are included in the value of supply except subsidies provided by the Central and State Governments. The petitioner’s case was that it paid GST on the transaction value in the invoice which includes the volume discount, and the Revenue Department cannot add the volume discount over and above the invoice amount as it would to double taxation on the same amount. The petitioner contended a manufacturer would incentivize the distributors to sell mobile phones on a discount and such discount cannot be construed as a subsidy under Section 15(2)(e). 

The Revenue Department seems to have added the discount value to the invoice by claiming that the discount is a subsidy by a third party and amounts to consideration under Section 2(31)(b), CGST Act, 2017. The Revenue Department’s order under challenge before the High Court also mentioned that the after-supply discount must be as per the terms agreed and based on certain parameters and workable criteria. And a discount cannot be offered at the complete discretion of the supplier. The Madras High Court held that the order was unsustainable in law and liable to be quashed. 

Madras High Court Decides 

The Madras High Court made three observations that were vital to the dispute and are our understanding of when post-supply discounts can or cannot be included in the value of supply: 

First, the High Court observed that Section 15(2)(e) of CGST Act, 2017 will only come into play when a part of the consideration payable for the supply is subsidized by third party other than the Central Government or the State Government. While this is a straightforward interpretation of the impugned provision, it is a necessary clarification for frequently some basic and obvious things need to be made clear to the Revenue Department. (para 45)

Second, the High Court observed that a subsidy will be embedded in the transaction value only if it disguised as a discount. However, a discount by itself will not qualify as a subsidy. (para 48) A discount will only be part of the transaction value if it is on account of a subsidy offered by a third party. The High Court was trying to distinguish the discount offered by a supplier on their own account and a discount offered due to contribution by a third party; the latter being a ‘private’ subsidy that was liable to be included in the value of supply and the former being a discount that as per Section 15(3)(a) and/or Section 15(3)(b), whichever is applicable, not being part of the value of supply. While this an important distinction, it still leaves open the question of how a discount is to identified and distinguished from a ‘private’ subsidy. We do know that a discount does not by itself become a subsidy, but we don’t know when they transform into a subsidy. 

Third, the High Court stated the discount can only impact the transaction value of the supplier and its recipient. And there is no scope for confusing the further supply made by the recipient and the sale it effected to its customers and the discount it offered. (paras 51-52) 

As I stated above, the High Court did not narrate the facts clearly, so it is difficult to understand some of its observations especially the third observation listed above. But, after reading the judgment, it does seem that in this case this is what transpired: 

A supplied goods to B, which included the price of volume discounts and GST was calculated by including the value of volume discounts. When B further supplied those goods to C on a discounted value, the Revenue Department included the discount value offered by B in the transaction value of supply made from A to B contending that the discount offered by B to C was a subsidy provided by A to B. This not only caused the possibility of double taxation of the discount, but also inter-relating two different supplies and not treating them independent of each other. The value of supply from A to B was calculated in reference to the value of supply from B to C and the High Court frowned on the same. 

Conclusion 

The Madras High Court’s judgment is succinct on its findings on law and almost equally precise on the facts, though the latter lack clarity which is an impediment to completely understanding its approach to the underlying dispute. Despite the hiccups in comprehension, the High Court’s findings on law are welcome and clarify an important aspect on the GST implications of discounts and their impact on the value of supply.             

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