Implications of Various Discount and Promotion Schemes

This article features in the monthly journal of the Chamber of Tax Consultants - Apr ’20 issue.

It is inevitable for any business to have a discount, business promotion or incentive schemes being offered to its distribution channel or the end customer. These schemes take different avatars depending on business needs. This being a typical and a critical expenditure for many industries, innovation is the stress whereby business promotion schemes could take the form of free goods or reward points or free trips being offered, etc. With respect to the discount and incentive schemes, there could be purchase-related or sale volume-related incentives, dealer discounts, manufacturer discounts, combo offers, etc. In this article, we would try to analyse the following kinds of schemes or discounts to see what is the implication under GST and finally also look at the points that need to be kept in mind while rolling out any discount or incentive scheme in light of the implications under GST.

1. Discount offered by the manufacturer to its  distributors with the condition of it being passed on to the end customer,
2. Incentives in the form of free  goods and services,

Distributor discount with a precondition of passing it to customer

Say, for instance, a manufacturer has sent certain goods to the distributor at Rs. 75 per unit to be sold to the customer at Rs. 100. However, due to technological advancements, the said product is worth not more than Rs. 90 in the market and thereby the manufacturer states that the product be sold at Rs. 90 to the customer and this additional Rs. 10 discount offered to the customer would be reimbursed by the manufacturer by way of a commercial credit note. Now the question that arises here is whether the distributor would be liable to pay GST on sale made to the customer on Rs. 90 or entire Rs. 100?

For a similar set of facts, the Kerala AAR in the case of M/s. Santosh Distributors has ruled that the distributor would be liable to pay GST on entire Rs. 100 as the discount offered by the manufacturer is in the nature of consideration for the supply made to the customers.

However, a contrary conclusion emanates from the examination of the provisions of the Central Goods and Services Tax Act, 2017 (hereinafter referred to as the Act), as discussed below. In this case, the question that arises is whether reimbursement of the discount by the manufacturer to the distributor is “consideration” received by the distributor for the sale made to the customer and thereby such distributor is liable to pay GST on such reimbursed amount as well?

Section 15 of the Act: Value of taxable supply in terms of section 15(1) of the Act would be the transaction value, which is the price actually paid or payable for the said supply and where

1. The price is the sole consideration, and
2. The supplier and recipient are not related parties.

In the event of non-satisfaction of any of the above two conditions, a reference to the CGST Rules, 2017(hereinafter referred to as ‘Rules’) would have to be made in terms section 15(4) of the Act to identify the value of the supply.

In the present case, the supply for which valuation is being examined is the supply between the distributor and the customer. Assuming that the distributor and the customer are not related persons, the value of supply would be the price actually paid or payable i.e., transaction value, for the said sale.

Further, w.r.t. the question of whether the other condition of the price being the sole consideration is satisfied or not, it is to be noted that the term ‘price’ is not defined under the Act. Further, the term ‘sole consideration’ used in the above-referred provision is an adjective qualifying the term ‘price’ rather than a noun and thereby no relevance of the definition of ‘consideration’ as defined in section 2(31) of the Act for the purposes of this provision (whereas it is to be noted that the advance ruling referred to above has arrived at its conclusion only on the basis of the definition of ‘consideration’).

Price

The term ‘price’ as per the Black’s Law Dictionary:

“The amount of money or other consideration asked for or given in exchange for something else, the cost at which is something brought or sold”.

From the above definition, it can be seen that price is something given in return for something. In the instant case, the amount paid by the customer would be the price which is actually the amount paid in exchange for the product. The discount received by the distributor from the manufacturer cannot be considered as the price for the product sold to the customer. It is very important to note in this regard  that there are 2 transactions involved in the present case:

1. Sale of goods by the manufacturer to the distributor, and
2. Sale of goods by the distributor to the customer.

The discount offered by the manufacturer is in relation to the first supply referred above and it cannot be mixed with the second supply and taxed in the hands of the distributor. Hence, it can be said that the proposition to add the discount received from the manufacturer, by treating it as a consideration received from any person to the value of supply is not founded in the law and thereby not correct.

Sole consideration

Now let us examine what ‘sole consideration’ means to check if the condition of section 15(1) ibid is violated requiring identifying the value as per the rules. Since there is no legal precedent under GST reference to earlier law could give some insight. Under section 4 of the Central Excise Act, the goods are sold by the assessee, for delivery at the time and place of removal, the assessee and the buyer are not related and the price is the sole consideration then such price would be the transaction value for valuation purpose. As this provision relating to valuation is similarly worded to the corresponding GST provision, we would look at some precedent under the CE Act. From the analysis, it can be said, whether the price is the sole consideration or not has to be seen only looking at whether any other amounts are flowing between the supplier and recipient. Amounts flowing from any other person will not affect this position. Similar is the view held in the case of Coramandel International Ltd. Versus C.C.E., CUS. & S.T., Vishakhapatnam -2015 (319) E.L.T. 526 (Tri. - Bang.).

However, there are contrary judgments in the following cases which have not attained finality as they are pending before the Supreme Court:

1. Kochi Refineries Ltd Vs Commissioner of Central Excise, Cochin 2017(347) E.L.T 163(Tri. Bang.)

2. Hindustan Insecticides Ltd Vs Commissioner of C.Ex., Delhi-I 2017 (6) G.S.T.L 218 (Tri.- Del)

Redundancy

This is a kind of discount flowing from the manufacturer for the sale made to the customer with an intention to augment sales. If the intention of the law makers was not to treat the price to be a sole consideration if there is existence of discount, incentive or any other amount flowing from anyone other than the customer himself, say similar to what happens in case of a subsidy (though the present discount is not a subsidy as discussed in the next paragraph but is flowing similar to how a subsidy would flow from a Government to a manufacturer in respect of sale made to a customer, say a farmer), then this would mean that the clause e) in section 15(2) of the Act, which states that the value of supply would include “subsidies directly linked to the price excluding subsidies provided by the Central Government and State Governments.”, would become redundant. This is for the reason that in case of a subsidy being given (assuming it would amount to price not being sole consideration), the condition in section 15(1) of the Act would automatically be violated thereby leading to determining the value as per the Rules in terms of section 15(4) of the Act. However, that is not the intention for the reason that even in case of a supply being made where a subsidy flows from a third party, the price between the supplier and recipient would be the sole consideration and the value of subsidy gets added as per section 15(2)(e) of the Act,  and any other interpretation would lead to redundancy of the said provision. Therefore, it can fairly be concluded that any other amounts flowing from third parties to the supplier would not negate the condition of a price being the sole consideration between the supplier and recipient.

Hence, the valuation for the sale made by the distributor to the customer would be as per section 15(1)   of the Act i.e. transaction value only, being only the price paid or payable by the customer in respect of the sale in question.

Subsidy

Another aspect to be looked into is whether the discount given by the manufacturer is in the nature of a ‘subsidy’ requiring an addition to the price in terms of section 15(2)(e) ibid? The said term is not defined under GST.

However, in general parlance, it can be understood that subsidy would mean the benefit flowing from a third party which leads to a fall in price. In general, it is not provided by the person supplying the product itself but by an unrelated person who wishes the welfare of the customer. In the instant case, the discount is flowing from the manufacturer who has supplied the product to the distributor. Hence it cannot be in the nature of subsidy but would be treated as a part of the transaction that has already occurred between the manufacturer and the Distributor i.e., it is not a separate activity but a part of the sale that has already taken place between the manufacturer and the distributor. Thereby valuation for the sale made by the distributor to the customer would be unaffected.

Thus, only the amount paid or payable by the customer to the distributor should be included in the value of supply and not the discount offered by the manufacturer as it does not violate the conditions specified in section 15(1) of the Act and also that the same is not in the nature of a subsidy.

Treatment of discount in the hands of the manufacturer

Generally, this kind of a discount is a post-sale discount as it is given considering the prevailing market conditions, in which case the manufacturer will not be able to issue a GST credit note and take a deduction of the GST already paid at the time of supply unless the agreement with the distributor has a clause intimating the advancement of such market-related discounts. Further, where the manufacturer does not issue a GST credit note but only a financial credit note to pass on this discount, there should not be any requirement of credit reversal by the distributor as the conditions of section 16 are not violated.

Incentives in the form of free goods and services

Incentive schemes could be in the form of free goods being offered, either own manufactured or bought out goods, and free services like foreign or local trips being given. These could be given either by way of a pre-decided scheme at the beginning of the financial year or may be formulated at the end of the financial year considering the boom in the sales and the need for rewarding the distributors. These schemes could be either based on the volumes picked up by the distributor or the sales volume achieved by the distributor, during a given period. However, for the purposes of GST (section 15(3) of the Act) what is relevant is whether the scheme is known before the supply is made by the manufacturer to the distributor or after.

The transaction between the manufacturer and its distributor is on principal to principal basis wherein the goods are sold to the distributor on an invoice, which is then sold by him to his customers. In such a case, it is to be understood that any incentive given by way of free goods (being own manufactured) would not partake the character of a separate supply or service as was always being held under the earlier laws, like in the case of Commissioner v. AIA Engineering Ltd. - 2016 (41) S.T.R. J262 (S.C.), Commissioner Of Service Tax, Mumbai-I Versus Sai Service Station Ltd. 2014 (35) S.T.R. 625 (Tri. - Mumbai) and a host of other decisions. Further, it cannot be treated as another supply being made by the manufacturer to the distributor, though these could be treated as discounts (non-monetary in nature) as per the discussion below.

1. It is squarely clarified in para of B and C of the circular No. 92/11/2019 – GST dated 07.03.2019:
   • Discounts including ‘Buy one get one’ offer: It may appear at first glance that in case of offers like “Buy One, Get One Free”, one item is being “supplied free of cost” without any consideration. In fact, it is not an individual supply of free goods but a case of two or more individual supplies where a single price is being charged for the entire supply. It can at best be treated as supplying two goods for the price of… - This indicates that there is no separate supply and that the consideration in respect of the goods that are given subsequently (the so-called ‘free’ goods) is actually collected at the time of the sale of the goods initially.
   • Discounts including ‘Buy more, save more’ offers: (i) Sometimes, the supplier offers a staggered discount to his customers (increase in discount rate with the increase in purchase volume)…… (ii) Some suppliers also offer periodic / year ending discounts to their stockists, etc. For example- Get an additional discount  of 1% if you purchase 10000 pieces in a year, get an additional discount  of 2% if you purchase 15000 pieces in a year.
2. As per the above clarifications, it can be said that the free goods delivered to the distributors are actually not free but the price collected initially at the time of sale of goods to them includes the price of the goods given free (applying the clarification given in respect of ‘Buy one get one’ offer). Similar was the view of the AAR in case of In Re : Golden Tobacco Ltd. 2019 (27) G.S.T.L. 61 (A.A.R. - GST)
3. Another way of looking at it could be that the free goods are in the nature of discount where the number of free goods given increases with the increase in the volume of goods purchased by the retailers (as clarified for the ‘Buy more get more’ offers). Further, the circulars issued by CBIC

would be binding on the department as was held by the Supreme Court in the case of Commissioner of C. Ex., Bolpur Vs Ratan Melting Wires & Industries 2008 (231) E.L.T. 22 (S.C).

4. The same analogy can be applied for the bought out goods given free or the services given free which are in the nature of discount and not a separate supply more so for the reason that there   is no consideration being received by the manufacturer from the distributor for these goods or services given free which also draws support from the judicial pronouncements given under earlier tax regimes i.e. under service tax that the incentive or trade discount offered is not a separate activity or service to be leviable to ST separately Sai Service Station supra and My Car Pvt. Ltd Versus Commissioner of central excise, Kanpur - 2015 (40) S.T.R. 1018 (Tri. - Del.). These free goods or services are a continuation of the initial transaction between the manufacturer and distributor of sale of goods.
5. Also, it is to be noted that there is no further obligation or task that the recipient of discount i.e. the distributor is required to do in order to be eligible for the free supplies other than the purchase of the products. Hence it cannot be considered as a separate supply and it is to be looked like something which is intrinsically connected with the initial goods sold to him.

Now let us have a look at the implication of credit with respect to these discounts or incentives.

As seen above, these incentives, discounts can be given either in monetary terms or in kind. Let us examine the following incentives offered:

1. Free gifts being goods,
2. Gold coins given as per the terms of the agreement between the distributor and the manufacturer on reaching the target volumes, and
3. Free trips being given, which are in the nature of free services.

The relevant provision under section 17(5) ibid restricting credit reads as below:

…… input tax credit shall not be available in respect of the following, namely:   (h) goods lost, stolen,

destroyed, written off or disposed of by way of gift or free samples;

From the above, it is clear that for the credit to be restricted

1. There should be a gift given, and
2. Such a gift should be that of goods.

In this regard, the following could be the possible interpretations to enable credit:

1. The provision restricts credit in respect of goods are to be DISPOSED OF by way of gifts. The said phrase means getting rid of something that you no longer want or need. Thereby, unless anything useless is gifted (i.e. something no longer required), the restriction under section 17(5) ibid will not apply.
2. It can be said that the so-called free goods are given in place of a monetary discount, in which case there can be no credit restriction as these discounts are not for any separate activity or given free, but are in relation to the supply already made by the manufacturer (the original supply of goods by the manufacturer to the distributor) which has already suffered tax.

These are the extreme views that will have to be judicially tested.

Another aspect to be considered is whether giving the goods free can be treated to be a barter transaction, i.e. whether it can be said that the distributor is providing business promotion/marketing service in return for the goods, being the consideration?  The answer to that can be in negative, for the reason that the said goods are not given for anything in return from the recipient, but it is in continuation of the sale transaction already made by the manufacturer to the distributor (as concluded in the earlier sections of this article). Hence, may not satisfy to be a barter also.

Coming to the present case analysis regarding ITC, following can be noted to enable credit w.r.t. the incentives given:

1. Gold coins: If given as part of the incentive agreement (i.e. gold coins to be given on achievement of a certain target), it cannot be considered as a gift as there is an obligation on part of the manufacturer to give such gold coins on fulfillment of the conditions stated. In this regard, important to note the press release dated 10.07.2017 wherein it was mentioned

“Gift has not been defined in the GST law. In common parlance, gift is made without consideration, is voluntary in nature and is made occasionally. It cannot  be demanded as a matter of right by the employee and the employee cannot move a court of law for obtaining a gift”

Further, it can be considered that the value of these gold coins is already included in the value of the goods purchased in respect of which these gold coins are given (as it is known that nothing is free in business and is more like a quantity discount). On this count, it can be stated that the credit relating to the gold coins given, which is an obligation of the manufacturer, would be eligible as it does not partake the nature of a gift.

2. Other free goods without any obligation: If it cannot be shown that the other free goods given are an obligation, credit may not be eligible.
3. Free trips: These are not goods and the restriction under section 17(5) ibid being only for the goods, a credit will be eligible on the count that the said services are used in the course or furtherance of business. ‘Business’ is a very wide term as was held in a  host of decisions under the earlier laws for the CENVAT eligibility before 01.04.2011. The free trips given could fall under the ambit of usage for business as it leads to an increase in sales and thereby credit being eligible. However a contrary view emanates from the ruling given by the Karnataka Authority for Advance Ruling (AAR) in the case of Surfa Coats (India) Private Limited dated 12.09.2019 [2019 (10) TMI 568].

Further, the circular 92/11/2019-GST dated 07.03.2019 referred to in the ruling does not mention that credit will not be available on free services, but only mentions that the ITC of the goods and services used in relation to the gifts i.e. goods being given as gifts, as contained in section 17(5) ibid, would not be eligible. Thereby, reliance on the said circular is also not correct to restrict the credit on the free services given.

“input tax credit shall not be available to the supplier on the inputs, input services and capital goods to the extent they are used in relation to the gifts or free samples distributed without any consideration”

Further, as far as the mention in the ruling that since the free goods are given without consideration and there is no supply, credit is not eligible, it can be said that when the inputs and input services satisfy the condition of being used for business (being in relation to taxable supplies), it does not matter whether their transfer per-se is a supply or not. Hence restriction of credit in relation to any free goods which are used for business though not supplied is not founded in the law and thereby the circular may not be correct to that extent as “use for business” is the condition for availing credit and “not use for making the supply”.