Free Issue Material and Valuation under Tax: A Never Ending Dispute

Introduction

The valuation of supply is an important aspect to consider for payment of taxes. Valuation can be challenged as it is based on multitude of factors such as involvement of related parties, barter transactions, free issue materials in terms of the contract and deemed valuation provisions. The provisions can play a pivotal role in determining the classification and GST rate. In this article, we will examine the inclusion of cost of free issue material in the value under GST law and its possible impact on classification and GST rate.

Before proceeding further, let’s have a look at the GST valuation provision. Under GST regime, the value for supply of goods and/or services is the transaction value.¹ Section 15(2)(b) of the Central Goods and Services Tax Act, 2017 (CGST Act) states that, the value shall inter alia include:

“Any amount that the supplier is liable to pay in relation to such supply but which has been incurred by the recipient of the supply and not included in the price actually paid or payable for the goods or services or both.”

The provision requires two elements for deemed inclusion of cost of free issue material in the value of supply:

1. Supplier is liable to pay the amount (for free issue material).

2. But the amount was incurred by the recipient.

Decision of High Court and Authority for Advance Ruling (AAR)

The Chhattisgarh High Court in Shree Jeet Transport v. Union of India² has made certain observation on free issue material. In the said case, the petitioner was providing transportation of goods by road Goods Transport Agency (GTA) service and issued consignment note to the recipients. It was agreed between the parties that the recipient will bear the cost of fuel. The matter has reached the High Court after chequered history of advance ruling and appellate advance ruling, on inclusion of value.

The High Court, while ignoring the contract between the parties, has observed that vehicles cannot run without fuel. GTA service is dependent on fuel as it is an important component for rendering service. The contract cannot override the plain language of GST law. The Court, while considering Section 15(2)(b) of the CGST Act read with the definition of consideration³, has held that the cost of fuel incurred by the recipient and provided free of cost to the petitioner should be included in the value of GTA service supplied by the petitioner.

The special leave petition (SLP)⁴ was filed by the assessee before the Supreme Court. The notice has been issued to Revenue in SLP filed against the decision.

There are divergent advance rulings under GST law on the similar issue. The Rajasthan Advance Ruling Authority⁵ has held that the value of diesel provided on free of cost basis by the recipient is not required to be included in the value for GTA service. Whereas, the Uttarakhand Advance Ruling Authority⁶ has held that input i.e. fuel provided free of cost by the service recipient for transportation of goods should be added in the value of GTA service.

For the present issue, the interpretation of the phrase, “supplier is liable to pay … but which has been incurred by the recipient …” used in Section 15(2)(b) of the CGST Act needs to be seen. Whether cost of free items provided by the recipient should be included in the value of goods/services supplied by the supplier where supplier is not even liable to pay for such items? Whether contractual terms can be preferred for arriving at the valuation where liability to incur the cost is of the recipient and supplier is not at all responsible for the cost.

Consideration

Under GST law, “consideration”⁷ inter alia includes any payment whether in money or otherwise made or to be made or monetary value of any act or forbearance for the inducement of the supply of goods/services.

A doubt can arise as to whether fuel, being an essential element for GTA service, can be said to be an additional consideration (non-monetary) from the recipient to the supplier.

The Supreme Court in CST v. Bhayana Builders (P) Ltd.⁸ has held that free supplies from the service recipient cannot be added to the taxable value where service provider receives free of cost goods/material from the service recipient and no amount is charged for such goods/material.

Reference is also made to the Circular⁹ issued by Central Board of Indirect Taxes and Customs (CBIC) which has clarified the following:

It is further clarified that while calculating the value of the supply made by the component manufacturer, the value of moulds and dies provided by the original equipment manufacturers (OEM) to the component manufacturer on FOC basis shall not be added to the value of such supply because the cost of moulds/dies was not to be incurred by the component manufacturer and thus, does not merit inclusion in the value of supply in terms of Section 15(2)(b) of the CGST Act.

Under the erstwhile regime as well, the courts have dealt with the similar issue. The CESTAT, New Delhi¹⁰ has ruled that the value of free of cost diesel provided by the recipient should not be included in the value of service rendered (transport or mining service). The department had appealed against the decision before the Supreme Court and the appeal was dismissed.

It is worthy to note that in such cases, it needs to be factually determined whether free issue material provided by the recipient to the supplier is an additional consideration (non-monetary) for the supply or a mere condition to the contract. Whether supplier has gained any economic benefit out of the free issue material provided by the recipient. GST is a transaction-based levy dependent on the terms/contract between the parties. The contractual terms should be strictly drafted to bifurcate the responsibilities of the supplier and the recipient. The list forming conditions to the contract should be separately identified from the items forming non-monetary or an additional consideration from the recipient.

On the concluding note, since GST is a contract-based levy, the freedom to structure the transaction and tax planning is available with the assessee as per the four corners of law. It is necessary for the GST Council to issue clarification to give rest to the long-standing issue of valuation of free issue material by the recipient to the supplier, in terms of Section 15 of the CGST Act. The decision of the Supreme Court may impact various contractual arrangements executed in manufacturing, oil & gas, job work, construction sector, etc. and therefore, the industry is eagerly awaiting the decision of the Supreme Court.