- CESTAT : 'Special Additional Duty' construable as customs-duty; Upholds interest-levy on short CVD payment
- HC : Managing investors' money under 'trust structure' by VCF not taxable: Reverses CESTAT-order
- Textile Ministry notifies extension of RoSCTL Scheme on export of Apparel/Garments till March 31, 2026
- HC: Directs MOF to consider request to exclude specialized Laser Marking Machines from ADD-levy; Disposes writ
- Himachal Pradesh HC declares ‘Water Cess’ levy on hydropower generation as ‘unconstitutional’
GST - Some practical aspects of Valuation : Part I
Shyamsunder Nori, Chartered Accountant
One of the important characteristic of a good indirect tax system is that the valuation rules should be simple and easy to understand and calculable with reasonable precision.
In this article, an attempt is being made to analyse the draft rules of ‘Determination of value of supply’ tentatively approved by GST Council which will be the basis for valuation in GST regime. Also we look at the requirement of payment of invoice within 180 days as a condition to take input tax credit vis-à-vis stock transfers. The provisions of Valuation as contained in the CGST Act and the Draft Rules cover the following situations that need to be distinctly considered for valuation purpose:
- Where supply of goods or services is made for a consideration not wholly in money.
- Where supply of goods or services or both is made between distinct persons (Stock & branch transfers)
- Where supply of goods or services or both is made between related persons
Before we deal with the specific valuation issues let us look at some of the provisions of Central Goods and Services Tax Act, 2017 (CGST Act) that are of relevance.
Section 7 (1) (c) of the CGST Act brings in certain activities specified in Schedule I to the CGST Act within the scope of supply. These activities in the absence of consideration would not fall within the frame work of taxable event – supply. Hence the deeming provision to bring them within the meaning of supply. One such activity enumerated in Schedule I is supply of goods or services or both between related persons or between distinct persons when made, in the course or furtherance of business, for no consideration.
Section 24 of the CGST Act requires a person having multiple places of business across States India to take registrations for each such State.
...Further Section 25 provides that in respect of each such registration the entity will be treated as a distinct person. Any supply of goods or services between these distinct persons would be an Inter-State Supply and chargeable to Integrated Goods and Services Tax under Integrated Goods & Services Tax Act, 2017 (IGST Act).
The provisions for determining the value of supply of goods or services made under different circumstances and on which tax has to be levied are contained in Section 15 of the CGST Act. Section 15(1) principally provides that value of supply of goods or services or both shall be the transaction value. i.e. price actually paid or payable. The twin conditions for application of transaction value are i) supplier and recipient are not related parties and ii) price is the sole consideration. Section 15(2) and 15(3) list out the inclusions and exclusions to a value of supply. Interestingly section 15(2) does not include reimbursements. Section 15(4) provides that where transaction value fails, the value of supply shall be determined in such manner as may be prescribed (valuation rules).
Determination of Value of Supply Rules (‘rules’) have been issued for public comment. These rules provide for open market value as the fundamental alternative where transaction value fails. Open market value like fair market value is essentially the value of a contemporaneous supply. Where open market value is not determinable then value of supply of like kind and quality can be the substitute value. Where there is neither open market value nor a value of supply of like kind and quality a residuary method of valuing on cost basis is provided.
The cost based valuation would be at 110% of the cost of the goods or services. There is no clarity as to what all will be considered as cost and whether a CAS 4 based valuation needs to be adopted or not.
...In a supply between related parties or distinct person a further relaxation is provided and a value declared on invoice would be simply accepted as the value of supply provided the recipient is eligible for full input tax credit. While such a relaxation looks very fair and industry friendly, the requirement that recipient should be eligible for full tax credit makes its impractical for transaction like supply of free samples.
We now look at the detailed valuation mechanism prescribed under the rules relating to the specific situations referred above and which is the subject matter of this article. We will deal with transaction value the inclusions and exclusions to ‘value of a supply’ in part 2 of this article.
Rule 1 |
Value of supply of goods or services where consideration is not wholly in money |
a) Open market value; b) If open market value is not available, value of supply shall be the sum total of consideration in money and money equivalent of any further consideration known at the time of supply; c) Not determinable under (a) or (b) above the value of supply shall be value of supply of goods or services or both of like kind and quality; d) Not determinable under (a) or (b) or (c) above, value of supply shall be the sum total of consideration in money and money equivalent of any further consideration as determined by application of rule 4 or rule 5 in that order. |
Rule 2 |
Value of supply of goods or services or both between distinct or related persons other than through an agent |
a) Open market value; b) If open market value is not available, value of supply of like kind and quality; c) Not determinable under (a) or (b) above the value of supply shall be as determined by application of rule 4 or rule 5 in that order Provided where recipient is eligible for full input tax credit, the value declared in the invoice shall be deemed to be the open market value. |
Rule 4 |
Value of supply of goods or services or both based on cost |
Value not determinable under rule 1 or 2, the value of supply shall be one hundred and ten percent of the cost of production or manufacture or cost of acquisition of such goods or cost of provision of such services. |
Rule 5
Residual method
Where value of supply not determinable under rule 1 or 2 or 4, the same shall be determined on reasonable basis and consistent with the principles of Section 15 and the rules.
Provided that in case of supply of services, the suppler may opt for this rule, disregarding rule 4
Explanation to rule 8 defines “open market value” and “supply of
goods of like kind and quality” as under:
Open market value |
Full value in money excluding GST payable by a person in a transaction of such similar supply being made at the same time, where the supplier and the recipient are not related and price is the sole consideration. |
Supply of goods or services or both of like kind and quality |
Any other supply of goods or services or both made under similar circumstances and is same as or closely or substantially resembles in respect of characteristics, quality, quantity, functional components, materials and reputation |
The above valuation principles dealing with situation where money
is not the only consideration or where Supply of Goods or Services
is between related parties or inter units of same entity are
applied to some practical scenarios below[1].
Illustration 1 : ‘X’ an individual buys car from a dealer ‘Y’ for Rs. 10 Lakhs along with exchange of his old car. The value of the old car as agreed between both the parties is Rs 1.5
...i) In terms of Rule 1, GST will be levied on sum total consideration of money and money equivalence of goods exchanged. Hence ‘Y’ will levy GST on Rs 11.5 lakhs.
ii) Where if the open market value of the car is Rs 12 lakhs, in terms of Rule 1, dealer ‘Y’ would charge GST on open market value i.e. Rs 12 lakhs. This is despite the sum total consideration of money and money equivalent of old car being Rs 11.5 lakhs only.
Illustration 2 : ‘X’ buys from ‘Y’ furniture for Rs 50,000 along with exchange of old furniture for Rs 15,000. ‘Y’ has sold furniture of like kind and quality at same time to ‘Z’ for Rs 70,000. On what value will ‘Y’ levy GST?
Open market value is not known, however there is a total of consideration of Rs 65,000 for this transaction - In money Rs 50,000 and money equivalent of other form of consideration i.e. exchange of old furniture for Rs. 15,000. The value of like kind and quality would only be considered if either the open market value or the sum total of consideration of money and money equivalent are not known. Hence here ‘Y’ will charge GST on a value of Rs 65,000 and not on a value of Rs 70,000.
Illustration 3 : Facts are same as in Illustration 2 above, except for there is no agreed price for the exchange of old furniture.
...i) Where either the open market value or the sum total of consideration is not determinable, then the value of goods of like kind and quality would be the substitute value for charging GST. Hence ‘Y’ will charge GST on a value of Rs 70,000.
ii) Now whether price of similar goods few months back can be the substitute price of goods of like kind and quality for a transaction currently under taken is a question of fact finding. If such price meets the parameters laid out in the Explanation to rule 8 then GST will be levied on Rs 70,000, else GST will be levied on a value that is hundred and ten percent of the cost of manufacturing the furniture.
Illustration 4 : ‘A Ltd’ intends to replace its old machinery. It agrees to buy from ‘B Ltd’ new machinery for Rs 10 lakhs along with exchange of its old machinery. the open market value of new machinery is not known as it is a customized machinery, however both A Ltd and B ltd agree that the value for old machinery is Rs 4 lakhs if A Ltd dismantles the old machinery and puts it in deliverable condition, else it would be Rs 2 lakhs if B Ltd has to dismantle on his own and take the old machinery. On what value will ‘B’ charge GST?
The total consideration is sum paid in money i.e.
...10 lakhs plus the value of the old machinery in money. The value of old machinery in exchange is only Rs 2 lakhs and hence ‘B Ltd’ will charge GST on a value of Rs 12 lakhs whether it takes the machinery in deliverable condition or incurs cost to bring it to deliverable condition.
Illustration 5 : Facts are same as in illustration 4 except that the open market of new machinery or the value of like kind and quality of new machinery are not available and as well there is no agreed exchange value for old machinery. However, the old machinery was originally acquired 5 years back at a cost of Rs 9 lakhs and the current the book value and WDV as per tax are Rs. 3 lakhs and 2 lakhs respectively. On what value will ‘B’ charge GST?
The exchange value of the old machinery in money nor the value of machinery of like kind and quality as the new machinery are known. What is known is an agreed value in money i.e. Rs 10 lakhs and an exchange of old machinery. The value of the old machinery has to be determined under Rule 4 i.e. hundred and ten percent of cost of acquisition of Rs 5 lakhs. The book value or WDV value has no relevance.
The application of cost based valuation (Rule 4) to an exchange of goods can in practice lead to absurd valuations and is impractical as no one would share the cost of acquisition of goods exchanged in a supply.
Illustration 6 : ‘A Ltd’ and ‘B Ltd’ are related persons. ‘A Ltd’ supplies raw material ‘X’ to ‘B Ltd’. ‘A Ltd’ supplied 100 Kgs of ‘X’ to ‘B’ in October for Rs.
...- Supply of 100 kgs to another related party ‘C’ for 850 per kg
- Supply of 500 kgs to an unrelated party for Rs. 800 per kg
On what value will ‘A Ltd’ charge GST?
A supply to related party cannot be considered as an open market value and hence the value of supply to ‘C’ cannot be considered as a value for levying GST. Similarly, a supply of different quantity (500 kgs) cannot be considered as a supply of goods of like kind and quality (100kgs).
The only option left to ‘A Ltd’ is to resort to cost based valuation under rule 4.
Illustration 7 : Facts are same as in Illustration 6. Further B Ltd can take full input tax credit for supply of ‘X’. On what value will ‘A Ltd’ charge GST?
The proviso to Rule 2 provides that where the recipient is eligible for full credit then value declared in the invoice will be the value on which GST will be levied. Hence ‘A Ltd’ can charge GST on supply value of Rs 800 per kg and need not resort to Rule 4.
Illustration 8 : ‘A Ltd’ and ‘B Ltd’ are related persons. ‘A Ltd’ supplies customized machinery to ‘B Ltd’ for a value of Rs 10 lakhs.
...Applying proviso to Rule 2 ‘A Ltd’ can charge GST on a value of Rs 10 lakhs. Even if there is an open market value for the supply (say Rs 15 lakhs) the value declared on the invoice will be considered as an open market value. The proviso is fair and logical for the simple reason that if the supplier declares a value higher than the fair value of the supply, the recipient has to pay for the increased input credit. It’s like paying extra cash and converting the same into an eligible credit. Conversely if the supplier declares a lower value than the fair value, it will have accumulated credit resulting in a cash blockage. Hence the system will automatically drive the declared value to be close to the fair value.
However, when we apply the proviso to stock transfers it could be interesting to see how the same can be applied for transfer and shifting of accumulated credit. Theoretically, the stock transfers would be close to fair value.
Illustration 9 : ‘A Ltd’ is an automobile manufacturer and has 5 manufacturing plants across India in different states. The corporate office in Mumbai houses all the senior management and strategic team. The plants operate as per their guidance. The overall payroll and administration cost incurred by the Corporate Office is Rs 10 lakhs per month. (i) How would the value of supply of Services by corporate office to the plants being distinct persons will be determined under GST? (ii) Can corporate office charge to each plant a fixed amount of Rs. 2 lakhs per month? (iii) Can corporate office charge to each plant considering the input credit requirement at each plant?
(i) There is no open market value or a value of supply of like kind and quality, ‘A Ltd’ has to determine the value on cost basis i.e.
...hundred and ten percent of cost of rendering such services. Using a reasonable and fair allocation methodology such value should be apportioned to all the plants.
(ii) A fixed charge of Rs 2 lakhs is a value declared in an invoice and hence applying proviso to Rule 2 ‘A Ltd’ can charge GST on Rs 2 lakhs.
(iii) Though proviso to Rule 2 allows to charge GST on value declared on invoice, this cannot be extended to as a planning mechanism and charge GST as per the credit requirement at the receiving units. For example, if one unit needs maximum credit then ‘A Ltd’ cannot declare a supply value of say Rs 8 lakhs to this unit and balance to other units. Further can a different methodology be followed next month?
Illustration 10 : Facts are same as in illustration 9 and additional fact for consideration is ‘A Ltd’ imported technology and know-how for a lump sum consideration USD 10 Million. What is the value of supply by corporate office to the plants?
Imported technology and know-how used by the plants in their manufacturing process is legally owned by the corporate office. Clearly when these units use the technology and manufacture there is a supply of technology by the corporate office to the manufacturing units. The open market value of the technology is USD 10 Million. Does this mean that the value of supply to each manufacturing unit is USD 10 million and in all there is a supply of service of USD 50 million by the corporate office? Nothing can be more preposterous than such a proposition.
Ideally ‘A Ltd’ should allocate the technology cost to each plant on a scientific basis (say no of cars that would be manufactured using the technology) and value the supply to each plant at hundred and ten percent of such allocation under rule 4.
...This is where proviso to rule 2 will make it simpler and easy. ‘A Ltd’ can on a reasonable basis allocate the USD 10 million to all plants.
‘A Ltd’ can alternatively consider allocation over the period for which it has the rights to use the technology rather than allocating to all plants the lump sum consideration of USD 10 million in one go.
Illustration 11 : Facts are same as in illustration 9 and additional fact for consideration is – ‘A ltd’ sets up a new manufacturing facility in Hyderabad. Prior to this ‘A Ltd’ had no operations in State of Telangana. Some of the existing employees from other plants in other states have been transferred to Hyderabad and new employees were recruited. The setting up of the new plant has been handled by a strategic team from Corporate office. This included right from land selection, procurement, construction, recruitment and induction. The new employees were trained at other plants on the proprietary manufacturing know-how developed over years. The strategic team also ensured that manuals, guidance, automobile designs and other technology is made fully available to the new plant. What is the value of supply of services by the corporate office?
The payroll and over heads cost of the strategic team on a reasonable basis should be identified. In the absence of an open market value for such services rule 4 would apply and hundred and ten percent of such cost determined would be the value of supply of service. There is no supply when employees are transferred and hence no valuation.
‘A Ltd’ is the economic and legal owner of manufacturing know-how and related good manufacturing practices. Hence the situs of such intangibles will be where the corporate office is situated i.e.
...State of Maharashtra. This know-how when made available to the new facility can result in a supply of service by Corporate office. Apparently there is no open market value and cost is also not determinable. The only option left to ‘A ltd’ is to apply proviso to Rule 2 and declare some value. In such complex issues proviso to rule 2 can be a savior.
A more complex issue could be what about the other plants where such know-how was developed years ago prior to GST and put to use by such plants on a continuous basis. Is there a supply of services by the corporate office on a continuous basis? One can understand the stock transfer of goods but bringing in the inter-unit services within GST can lead to lot of litigation.
Brand and trade-marks used for the first time in a state can be a classic litigation. Take an example of a food chain that has unique brand and operates under a trade name say ‘Pizza world’. When a new food chain is opened in a state for the first time, is there a supply of brand value and trade name? which State has given the economic value to the brand and which State has supplied?
Subjecting Inter-unit services to GST opens a Pandora’s box of valuation issues.
Illustration 12 : ‘I co’ is a company engaged in the development and sale of banking and financial software. It has its corporate office in Bangalore and has clients in India, Europe and US. It has plans for expansion in other countries. It acquires another company ‘F co’, for a consideration of USD 100 million, a company in Germany specializing in mobile applications for banks and operates in Europe.
...(i) ‘I Co’ and ‘F Co’ are unrelated parties prior to acquisition and the consideration for the acquisition is a market driven price. As a related party ‘I Co’ receives the technology and work force for a price agreed. There are two options available to ‘I Co’.
- Pay GST on the fee charged by ‘F Co’ – Proviso to Rule 2 or
- Pay GST on the hundred and ten percent value of the fee charged – Under rule 4
(ii) Where no fee is charged by ‘F Co’ for technology, the issue for consideration is what would be the open market value. Can it be said that USD 100 million being an open market value will be the value that ‘I Co’ has to pay, though being currently imported free for one market? The price of USD 100 million paid by ‘I Co’ is a price for the opportunities it sees in various countries and markets.
...The Indian market potential in such a calculation and premium paid would be the factors that need to be considered. If there is an agreement that ‘F Co’ would never charge for the technology, then USD 100 million paid for the technology could be the open market value. However, a question would arise on the time of supply when used for other markets than India. As pointed in other illustrations above, life is simpler in GST if there is a value declared in invoice and resort to proviso to rule 2.
Section 16(2) and stock transfers:
Proviso to the Explanation to Section 16(2) of CGST Act provides that:
“where a recipient fail to pay to the supplier of goods or services or both, other than the supplies on which tax is payable on reverse charge basis, the amount towards the value of supply along with tax payable thereon within a period of one hundred and eighty days from the date of issue of invoice by the supplier, an amount equal to the input tax credit availed by the recipient shall be added to his output tax liability, along with interest thereon, in such manner as may be prescribed ".
Now consider the case where there is a stock transfer of goods or services or both, should the unit receiving these goods or services transfer funds equivalent to invoice value to supplying unit or corporate office? A literal reading of the above proviso and applying it to inter-unit transactions would mean that there has to be funds transfer within 180 days, otherwise the receiving unit would have to pay interest for the 180 days and as well should treat such ineligible credit as its output tax in the immediate month following the period of 180 days.
...The linking of input tax credit to payment and extending it to stock transfers would put the industry to lot of harassment.
[1] In all illustrations GST is used for convenience and it refers to SGST and CGST or IGST as the case may be.