A common method of business reorganization is where an entity transfers its business vertical on a going concern basis to another entity which will continue its operations. It may partake different forms such as demerger, slump sale etc. The concept of "going concern" is a fundamental assumption required for accounting purposes - according to which - an enterprise is viewed as continuing in operation for the foreseeable future. A business can be said to be transferred as a going concern when an entire business as a whole or at least a business vertical is being transferred and is capable of being run independently for the foreseeable future. It is different from transfer of individual assets. It ordinarily entails transfer of assets and liabilities, contracts, employees, good will, legal proceedings etc. In this article we discuss GST implications on transfer of business as a going concern qua input tax credit ("ITC").
Taxability under GST
Section 7 of the Central Goods and Services Tax Act, 2017 ("CGST Act") defines the taxable event under GST, namely "supply" to cover all forms of supply of goods or services, including transfer made for a consideration by a person in the course or furtherance of business. Section 2(52) and 2(102) of CGST Act defines "goods" and "services" respectively.
Transfer of business cannot be said to be a transfer of movable property and hence, it will not qualify as supply of goods as there are no identifiable movable properties which are getting transferred. On the other hand, it can be said to be covered within the ambit of definition of service since definition of "service" under GST is wide enough to cover anything other than goods. Further, Notification No. 12/2017- Central Tax (Rate) dated 28.06.2017 specifically exempts "services by way of transfer of a going concern, as a whole or an independent part thereof."
Requirement to reverse ITC
Once transfer of business as a going concern is regarded as an exempt supply of service, it is pertinent to analyze whether reversal of ITC under Section 17(2) of the CGST Act read with Rule 42 of the Central Goods and Services Tax Rules, 2017 ("CGST Rules") will be applicable.
Inputs and input services which are solely used for undertaking the proposed transfer of business
On a conjoint reading of Section 17(2) of the CGST Act read with Rule 42 of the CGST Rules, ITC of inputs and input services used exclusively for effecting exempt supplies is ineligible at the outset itself. Therefore, inputs and input services which are solely used for undertaking the proposed transfer of business, viz. legal services, due diligence services, consultancy services etc. may be said to be ineligible for availing ITC.
Proportionate reversal of credit on account of transfer of business being an exempt supply
ITC of inputs and input services used for effecting taxable supply and exempt supply ("termed as common credit") is eligible to the extent provided under Rule 42 of the CGST Rules. As per the said rule, the proportion arrived by dividing aggregate value of exempt supplies (numerator) and total turnover (denominator) will be applied on the common credit and the said ITC shall be reversed as pertaining to exempt supplies. The reversal is required to be done during every tax period and aggregately at the end of the financial year.
In view of the above provision, the pertinent question is whether common credit attributable to transfer of a going concern will be required to be proportionately reversed. In other words, whether value of transfer of going concern will be includable in the numerator of the above formula for calculating the reversal ratio. On a strict reading of the provisions, it may be said that the value of the transfer of business needs to be included for the purpose of reversal of credit in the month of such transfer and cumulatively at the end of the financial year.
However, in this regard, it is also pertinent to refer to Section 18(3) of the CGST Act which provides that where there is a transfer of business with the specific provisions for transfer of liabilities, the registered person is allowed to transfer the ITC which remains unutilized in his electronic credit ledger to such transferred business in the manner prescribed under Rule 41. Rule 41 of the CGST Rules provides that the registered person shall, in the event transfer of business, furnish the details of transfer of business in FORM GST ITC-02, electronically on the common portal and will be able to transfer it to the transferee. The ITC shall be apportioned in the ratio of the value of assets transferred as explained vide Circular No.133 03/2020-GST dated 23.03.2020.
Once ITC pertaining to the business which is transferred as a going concern is also transferred to the transferee unit as above, it may be said that there will be no ITC pertaining to the transferred unit in the credit ledger of the transferor unit. It is a cardinal rule of interpretation of statute that if strict interpretation of statute leads to absurd and otiose results, then it must be avoided, and a contextual and purposive interpretation must be given. Therefore, it may be said that upon transfer of credit to the transferee unit under Section 18(3) of the CGST Act, there is no question of further reversing the credit on account of such transfer of business. Further, it is also an established rule of interpretation that a specific provision prevails over general provision. Therefore, it may be said that there is no requirement to reverse ITC attributable to transfer of going concern under Section 17(2) of the CGST Act read with Rule 42 of the CGST Rules in view of specific provision for transfer of credit under Section 18(3) of the CGST Act.
The possible interpretation that credit reversal is not required however goes against express the language of Section 17(2) of the CGST Act and Rule 42 of the CGST Rules and may lead to interpretational issues and consequent litigations.
Requirement of credit reversal may result in huge financial burden on the taxpayers especially those engaged in making other exempt supplies because including value of business transfer in the aggregate value of exempt supplies in the Rule 42 formula may result in a very high percentage of reversal requirement in the case of common credits for the entire business.
Certain other ITC related issues which may arise in the case of transfer of business as a going concern are outlined below:
- Whether transferor or transferee is eligible to avail ITC in respect of "goods in transit" on the date of transfer of business?
- Whether issue / receipt of credit notes / debit notes by transferee on behalf of transferor is possible?
- Whether transferee unit can re-avail the ITC reversed by transferor unit?
- Whether condition of payment to vendor within 180 days from invoice date and corresponding availment / re-availment of ITC to be evaluated qua transferor or transferee?
- Whether ITC can be availed in respect of invoices received belatedly post transfer of credit from transferor to transferee?
In the case of transfer of business as a going concern, the business vertical is hived off from the transferor unit and it is continued by the transferee unit. Denial of credit in this situation when there is no break in the credit chain will lead to cascading effect. It will hence be unjustified, and contrary to the object and scheme of the GST law to provide for seamless flow of credit. Therefore, it is important that the ITC related issues are addressed, and certainty is achieved by amending the CGST Act or CGST Rules to exclude transfer as a going concern from the requirement of reversal of ITC under Section 17(2) of the CGST Act, and also issue necessary clarifications pertaining to other ITC related issues.
- The article has been published in TIOL
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