Maharashtra Appellate Authority for Advance Ruling ("AAAR") has recently passed on order in the matter of Cummins India which has intensified the already existing confusion between the concepts of 'Input Service Distributor' ("ISD") and Cross Charge. While ISD and cross charge are two different concepts, they have been confused as alternatives to each other from time and again because both these concepts essentially entail ITC of common input services and apportionment of the same across branch offices located in different states. Before discussing the facts of the Cummins India case and analysing the implications arising out of the MH AAAR decision, let us first understand how GST law defines these two concepts.
Input Service Distributor
Section 2(61) of the CGST Act defines ISD as an office of a company (normally the head office / HO), which receives input services that are either exclusive to some other state unit of the same company or is common to various state units of the same company.
Under GST law, different state branches/ units, have their own GST registration and are referred to as "distinct persons".
In a typical business structure of a company, the HO handles a lot of common activities on a centralised basis. If the input service received by the HO is exclusive for a particular branch office/unit, then the entire input tax credit ("ITC") should be passed on to that specific branch office/unit. However, if the input services are common to two or more branch offices/units, the law prescribes ISD mechanism to distribute the input credit basis the turnover of each branch office/unit and for the same obtaining an ISD registration is necessary.
Head Office Cross charge
Cross Charge can be understood by reading Entry 2 of Schedule 1 which states that when expenses are incurred by a distinct person to carry out activities the outcome of which benefits other distinct persons is deemed to be supply.
It is relatively simpler to determine the value of supply of goods by way of stock transfer, either from the factory location to the warehouse or from a warehouse to other sales locations of the company qualifying as distinct person. The valuation rules prescribed under GST law guide on how to go about valuating the supplies.
Complexity seeps in when it comes to supply of services by a HO to its branch offices/units. First, we need to determine what are the typical services that are "deemed" to be supplied by a HO to its distinct persons? Once an answer to this question is found, then the valuation of such supply of service is another challenge.
From the above discussion it seems that while ISD mechanism is a simple pass-through mechanism on the other hand cross charge requires valuation of services deemed to be provided by one state to other state branches.
Brief facts of Cummins India case
Cummins India approached the Authority for Advance Ruling ("AAR") requesting for a ruling on three questions – (i) whether availing ITC of common input supplies on behalf of other units/units registered as distinct persons and further allocation of the cost incurred to such other units qualifies as supply and attracts GST, (ii) whether a nominal value can be adopted for charging the GST and (iii) whether obtaining ISD registration is mandatory?
The MH AAR held the activity of availing ITC of common input supplies on behalf of other state branches qualifies as a supply; obtaining registration is mandatory; and the valuation should be done basis 110% of the cost under Rule 30 of CGST Rules. Cummins India also made some additional submissions during the proceedings regarding exclusion of salary of employees based at HO for the purpose of valuation, but the AAR did not touch upon this aspect in its order.
Cummins India filed an appeal before the AAAR challenging the order on the grounds that AAR should have clarified on the non-inclusion of employee's salary for computing the valuation under the 110% rule. Further, some new queries were raised like whether the HO can avail the ITC of GST paid in such common input services.
Order of the AAAR
The AAAR held that the activity of the HO availing ITC for common input supplies on behalf of the company's branch offices/ units does qualify as supply and would attract the levy of GST. The AAAR also held that the HO is not entitled to avail the ITC of such common input supplies and thus needs to register itself as an ISD as per Section 24 of the CGST Act, 2017 and distribute such availed common ITC to the company's branch offices/ units. On the aspect of valuation and inclusion of salary of employees, the AAAR held that the valuation should be determined as per the second proviso of Rule 28(c) of CGST Rules, which provides for adoption of invoice value as the open market value in case the recipient is able to avail full ITC of the GST so charged. As regards the salary of HO employees AAAR observed that since the supply is made by the HO to its branch offices/ units, salary of employees of HO should also be allocated.
Our comments
The AAAR while passing its order has practically merged two different concepts. This approach taken by the AAAR will have far-reaching implications on almost all types of businesses and could lead to demand notices by department on these grounds.
ISD is purely a pass-through mechanism and is not a supply of any service from the HO and hence it should not be subject to GST. Accordingly, there is no requirement of determining value of such an activity.
HO Cross charge under Schedule I, on the other hand, provides to tax the inter-state supply of goods and services. The observation of the AAAR that employees of the HO are not working for the company but at the behest of the HO and thus their salaries should also be allocated to the branch offices/units is an upsetting observation.
Schedule III to the CGST Act provides that the employer-employee relationship is beyond the scope of GST. However, the observation of the AAAR regarding allocation of salary of HO employees to different state units as part of valuation could lead to different interpretations and would possibly result in unwanted queries on valuation of HO cross charges.
Although the AAAR has held that the valuation can be done under the second proviso to the Rule 28(c), which provides for accepting the value as mentioned in the tax invoice if the recipient location is entitled to avail full ITC, this will have practical difficulties in situations where recipient has exempt turnover and is unable to avail full ITC.
Till such time the Government steps in and issue necessary clarification on this vital issue to save time and money being wasted on avoidable litigation in future, companies should revisit the tax positions adopted in respect of the ISD and cross charge and prepare defense for any potential queries from department officers.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.