Introduction of GST has definitely changed the way in which business is being done due to change in indirect tax structure and law. Levy of tax has been changed from the act of sale or manufacture to act of supply. GST is levied on supply of goods or services for consideration. There are few activities which would be treated as supply even in absence of consideration. For example, stock transfer of goods to branches in other states are treated as supply to levy GST. There are doubts among the tax payers with regard to treatment of free issues or free sample of goods in GST. In this article, we have analysed few of them with possible answers.
Issue of free goods or free samples by business entities to attract customers is very common in most businesses. There was good clarity on taxation of such goods in earlier indirect tax laws such as central excise and sales tax. Central excise levy was on the act of manufacturing and therefore, if there were free issue of manufactured goods, excise duty was attracted. The levy of sales tax attracted on sale of goods for consideration. As free samples or free issues did not have any consideration, there was no sales tax levy. There was restriction on availing input tax credit on inputs used in free issue goods or samples.
GST on free samples
Section 17(5) of CGST Act 2017 restricts credit on goods issued as free samples. It is very clear that when credit availed goods are issued as free samples, credit relating to same would be ineligible. However, the doubt which arises is whether the restriction is applicable on free sample of finished goods manufactured out of ITC availed inputs as well. The sectoral series on ‘Drugs and Pharmaceuticals’ released by CBEC clarifies that on physician samples, GST is not payable as value would be zero and credit is not to be availed. From this clarification, it could be understood that the reversal of credit is needed in case of finished goods as well.
Sometimes it could be difficult to identify the exact amount of credit on inputs used in finished goods. In such cases, option of claiming credit based on turnover ratio can be an alternative option. However, this may not be always feasible as Rule 42 of CGST Rules 2017 prescribes taking total input tax credit including input services for reversal when actual amount credit cannot be identified on non-taxable transactions.
Schedule II to CGST Act 2017 consists list of activities to be treated as supply of goods or services. Sl.no. 4(a) of the schedule prescribes that transfer or disposal of any business assets which no longer form part of business assets should be treated as supply of goods whether or not there is consideration. Even finished goods which are business assets issued as free samples could be considered supply of goods for payment of GST. Clarity is needed on this aspect as it results in reversals of credit as well as payment of GST.
GST on free supplies
Schemes such as ‘Buy 1 Get 1 free’ or ‘Buy 10 and Get 1 free extra’ are very common in fast moving consumer goods including pharma companies. In such cases, issue is if credit reversal or GST payment is needed on goods supplied as free under various schemes.
Free issue goods cannot be considered as a separate supply to levy GST. However, the main issue is requirement of credit reversal in accordance with Section 17(5) of CGST Act 2017. If one were to analyse the real nature, it is not difficult to understand that such free issue is in form of quantity discount. Discount need not be in cash form always. Even seller would have factored cost of free issue while fixing the price of first supply on which GST would be paid.
There have been few tribunal judgements in case of excise levy on free issue of goods. Many of them were in favour of suppliers. Delhi tribunal in case of Surya Food & Agro Limited Vs CCE 2003 (156) ELT 488 held that free supplies made by appellant are in nature of trade discount wherein cost of free issues would have been factored in price of non-free goods. Accordingly, extra excise duty levy was not levied on free goods. This analogy may hold good even in GST regime.
Even in European VAT laws, when the customer is required to pay a consideration in connection with goods, even if the supplier describes part of that goods as a ‘gift’ or ‘free’, (example "buy 1, get 1 free") it does not come within the terms of a gift for VAT purposes.
There is no need to reverse credit or pay VAT.
One is not clear if these views would be accepted by tax department without questioning. A simple change in terminology of schemes such as ‘Buy 2 for the price of 1’ instead of ‘Buy 1 Get 1 free’ could make lot of difference.
GST on free supplies from customers
There are occasions wherein goods such as tools, dies would be supplied by the customers for use by manufacturer supplier. Important question which is arising in such cases is treatment of such free supplies for valuation by supplier. Central Excise provisions had a specific provision on considering amortised value of such free supplies. Though model GST law had specific provision covering the aspect, the final GST Act or rules do not discuss this specifically.
Section 15(1) of the CGST Act provides that the value of a supply of goods or services or both would be the transaction value which is the price actually paid or payable for the said supply of goods or services or both where supplier and recipient of supply are not related and price is the sole consideration for the supply. Further Section 15(2) specifies that the value of supply shall include any amount that the supplier is liable but incurred by recipient which is not included in price of goods or services.
In case of contracts wherein the tools are not supplied by the customers, the supplier would incur the tools cost and add it to price of final goods. This price would get reduced when tools are supplied by customer. Therefore, such supply of tools could be held as additional consideration. This scenario would invite reference to valuation rules.
Rule 27 of CGST Rules states that the value of supply when consideration is wholly in money should be open market value (OMV). When such value is not available, then value would be total consideration in money plus money equivalent to consideration which is not in money. OMV means full value in money where supplier and recipient are unrelated and price is sole consideration. When tools are supplied, the supplier could ascertain the OMV and discharge the GST on such OMV. If there is no OMV, then the prorated ( total cost/ possible number of parts that can be manufactured) value of tools to be added to consideration received for supply of finished goods for payment of GST. Earlier central excise law stated that the value of tools and dies to be appropriately apportioned for valuation. Such clarity is absent in GST. However, adding entire value of tool at a time may not be logical. Therefore, the age old method of adding amortised value could be followed for valuation of freely supplied tools.
There is another school of thought that the tool supplied by customer is for his own use and it does not become consideration for the supplier for discharging GST. This could be a risky proposition as any view against this proposition could invite demand of tax including interest and penalties which are quite high in GST law.
The safer option could be to hire the tools from the customer for consideration with tax invoice instead of getting it free of cost. The tax amount could be claimed as credit as well.
Conclusion:
Many tax payers would be facing issues in taking decisions with respect to treatment of free samples or free issues. As discussed in one of the paragraphs earlier, it is not clear if one has a choice to reverse the credit on inputs contained in free samples or to treat such free sample as supply of goods in terms of Schedule II. Once an activity is supply, there should not be any option of treating it otherwise for reversing credit. A clarification by the CBEC on treatment of free samples and free issues could make the task of businessmen easier in taking right decision. Government could also consider allowing credit on goods as samples which ultimately results in increase in sale of goods on payment of GST.
This article has been adopted based on article published in KSCAA journal for the month of December 2017.
Authors could be reached at [email protected] and [email protected] for any further clarifications, suggestions or feedback.