Issues in GST- Intermediaries & Export of service?

Background

The scope, coverage and taxability of intermediary services has been a subject matter of litigation since service tax regime. Under service tax law, there had been disputes about the applicability of service tax levy on commission agency services by Indian service providers to foreign principals. The argument was that all services were provided by way of marketing /sales promotion to end customers in India, consequently taxable in India. The issue was more or less settled over period that services were exports. Thereafter a reversal in the entire concept had been made under negative list based ST taxation, whereby Indian commission agents earning valuable foreign exchange would be taxed wef 1.10.14.

It would do well to recollect that under earlier service tax regime, w.e.f. 01.7.2012, commission agent for services provided to foreign principal were under intermediary services and taxed to service tax.  In order to bring parity with the commission agent for services,  w.e.f. 01.10.2014, the commission agent for goods where such services provided to foreign principal were covered under intermediary services and taxed to ST under Rule 9 of Place of Provision of Service Rules (POPS). This change had led to service tax being demanded on commission agent services though booking of orders for goods with Indian customers was done for foreign principal and commission received in convertible foreign exchange. Under GST regime, intermediary services to foreign principals were continued to be taxed. 

In several countries, including our neighbours like Sri Lanka, Thailand as well as the European Union, the intermediary service whether for goods or services has been based on the place of the customer/ recipient. Destination principle was followed. Representations were done by industry/consultants that in line with international best practices all services which are B to B could have been given based on location of customer in 2014/15 and again in 2016/17 in GST. However though there was lot of talk, there was no relief given and the only option for commission agents was to factor the tax into costing.

In a significant development in post GST regime, the 139th Report on Impact of Goods and Service Tax by Dept related Parliamentary Standing Committee on Commerce, one of the main recommendations done by the Committee was that the Govt may cause amendment to section 13(8) of IGST Act to exclude intermediary services and make it subject to default section 13(2) so that the benefit of export of services would be available.  However unfortunately the said recommendation has not been made effective as on date.

This is also not in line with the EU best practice which seeks to avoid double taxation. Many shifted bases to Middle east, Hong Kong, Singapore etc. which leaded to loss of income tax and export of services from India even when consideration was received in CFE and it ended up that Indian service providers would be less competitive. 

Under ST regime, the decisions in Universal Services India Pvt. Ltd. reported in 2016 (42) STR 585 (AAR), GoDaddy India Web Services Pvt. Ltd.: 2016 (46) S.T.R. 806 (A.A.R.), CSG Systems International (India) Pvt. Ltd. [TS-125-CESTAT-2021-ST], Verizon India Pvt. Ltd. Vs CST, DELHI (2021 (45) G.S.T.L. 275 (Tri. - Del.), Lubrizol Advanced Materials India Pvt. Ltd. Vs C.C.E., Belapur(2019 (22) G.S.T.L. 355 (Tri. - Mumbai) , Sunrise Immigration Consultants Private Limited, Chandigarh Tribunal (2018-TIOL-1849-CESTAT-CHD) clearly settled the matter that support services, on principal to principal basis, would get covered under export of services.

In judicial developments in GST regime, in the case of Material Recycling Association of India [2020 (40) GSTL 289 (Guj.)], it was held that intermediary services would attract CGST and SGST.

Recently, in case of Dharmendra M. Jani Vs Union of India and others (Bombay High Court) [Dharmendra M Jani Vs UOI and Others (Writ Petition No 2031 of 2018)] [2021-TIOL-1297-HC-MUM-GST and [2021-TIOL-1326-HC-MUM-GST]]Justice Ujjal Bhuyan has held the provision of intermediary to be unconstitutional however Justice Abhay Ahuja dissented thereby gave a split verdict on the issue.

Also, the latest circular No.159/15/2021-GST dated 20th September, 2021 has been issued with the intention to clarify on intermediary concept.

In this background, the paper writer have examined concept of intermediary, GST applicability on intermediaries/commission agents and various models of working and way ahead.

Concept of intermediary vs supply on own account under GST  

The term “intermediary” is defined under section 2(13) of the IGST Act, 2017 to mean a broker, an agent or any other person, by whatever name called, who arranges or facilitates the supply of goods or services or both, or securities, between two or more persons, but does not include a person who supplies such goods or services or both or securities on his own account.

“Agent” is defined to mean a person, who carries on the business of supply or receipt of goods or services or both on behalf of another; While an agent includes a broker, it does not mean that every broker is an agent. The definition of intermediary does not limit its coverage to a ‘broker’ and ‘agent’ but brings within its ambit even ‘any other person, by whatever name called’.

It could be understood from the above that the nature of intermediary would be as under:

1. 1. An intermediary arranges or facilitates the supply of goods or services or both or securities between two more persons.
   2. Generally, two supplies are involved in the intermediary service arrangements:
      1. Supply between the principal and the third party and
      2. Supply of his own service to his principal – generally for a fee or commission. The value of a service provided by an intermediary is invariably identifiable from the main supply of goods/service that he is arranging.
      3. However, it may be noted that a person acting as an intermediary cannot change the nature/value of supply provided by person on whose behalf he is acting as an intermediary.
   3. The test of agency must be satisfied between the principal and the agent i.e. the intermediary.
   4. The Principal must know the value at which the goods/ service is supplied (or obtained) on his behalf.
   5. Excludes person who supplies on his own account

When supply is on own account?

1. He neither arranged nor facilitated goods/services provided to such customer by third person
2. On the other hand, person himself is providing such goods/services to his client’s customers
3. Agreement to work on principal to principal basis

In a relevant case of Principal Commr. Of CGST, Delhi South, New Delhi Vs Comparex India Pvt. Ltd. 2021 (47) G.S.T.L. 355 (Tri. - Del.) where the respondent purchased the software from Microsoft and thereafter, sells either in the same or customized condition to the customers. Goods supplied on its own account, no commission being paid by Microsoft and in fact independently sold the license to the overseas customers, after purchasing them from Microsoft. Agreement specifically mentions that there is no relationship of principal and an agent between Microsoft and the respondent and respondent is free to sell the product at any price to the customer, though the price to be paid by the respondent to Microsoft is fixed. Payment to Microsoft made by the respondent; not relatable to the payment received from the customer. Service being provided by respondent on its own account, respondent not to be regarded as ‘intermediary’ as defined in Rule 2(f) of Place of Provision of Services Rules, 2012.Affirmed in 2021 (50) GSTL J9 (Supreme Court)

Validity of GST levy on intermediary services done to foreign clients

For determining the place of supply of services by intermediary we need to go to IGST law. GST is applicable only on the supply of goods and or services in the taxable territory of India. Taxable territory is the territory of India to which the provisions of GST law apply.

The place of supply of service, whether within or outside India is determined by applying Section 13 of IGST. Section 13(1) shall apply to determine the place of supply of services where the location of the supplier of services or the location of the recipient of services is outside India.  

Default Section 13(2) states that the place of supply of service except the services specified in sub-sections (3) to (13) shall be the location of recipient of service.

Section 13(8) of IGST Act, 2017 provides that the place of supply of following services shall be the location of the supplier of service:

1. 1. …
   2. intermediary services,
   3.  …….

At present, the intermediary service is covered in Section 13(8), whereby the place of supply of intermediary services is location of service provider agent in India and liable to GST.

Therefore, such service to be treated as intermediary services, being services of commission agent for goods/services covered in section 13(8)(b), and the place of supply of service is location of supplier in India and liable to GST

As the place of supply of intermediary services to foreign principal is location of service provider in India and consequently condition (iii) of export of services as per S. 2(6) of IGST Act is not satisfied and GST needs to be paid by intermediary service provider which becomes a cost to the services provider.

Section 13(8)(b) of the IGST Act is evidently contrary to the fundamental principle of destination-based consumption tax. GST is a destination-based consumption tax. It is a value added tax; a tax on services provided and consumed within the territory of India. Therefore, it cannot have any extra-territorial operation or nexus.

Levy of GST on intermediary service is violative of Article 14 because the services of management consultants, marketing consultants, market research agents, professional advisers to foreign clients are treated as export.

Indian Constitution only grants power to the Parliament to frame laws for inter-state trade and commerce i.e., for determining inter-state trade or commerce. It does not permit imposition of tax on export of services out of the territory of India by treating the same as a local supply. Hence, section 13(8)(b) of the IGST Act is ultra vires Articles 246A and 269A of the Constitution

Article 286(1) provides that no law of a state shall impose or authorize the imposition of a tax on the supply of goods or services or both where such supply takes place outside the state or in the course of import of the goods or services or both into the territory of India or export of goods or services out of the territory of India. Article 286(2) provides that Parliament may by law formulate principles for determining a supply of goods or of services or both in any of the ways mentioned in clause (1). Thus, no state has authority to levy local tax on export of services. Section 13(8)(b) of the IGST Act has deemed an export to be a local supply. This is in violation of Article 286(1).

Notwithstanding the question of constitutional validity, the lawmakers in their wisdom have provided the place of supply of intermediary to be in India as an intra-state supply.

Going further next the paper writers have examined the business models in context of the services suppliers commonly nomenclated as “Commission agents”.

Various business models and tax implications

1. Supply of pre-sale/pre-procurement and post sale/order fulfilment services:

 These commission agents are doing presale/pre-procurement activities of nature of due diligence, recommending suitable suppliers, maintain supplier list, market research and post order activities such as supplier order status, guidance to manufacturers on trends/developments, communicate deviation in quality and delivery schedule, advise on international norms and standards covered in support services.

When the essential nature of services is that of outsourced support services being operational, administrative, or any other support comprising functions that entities carry out in ordinary course of operations themselves but may obtain as services by outsourcing from others, it would get covered in Section 13(2) of IGST Act, whereby place of supply is location of foreign principal outside India. If there is a fixed amount of fee with profit assured is paid to service provider and payment is not based on what is purchased by the ultimate clients. Then this supports the stance it is merely outsourced support services.

Further if all the conditions set out in Section 2(6) of IGST Act as extracted below are fulfilled by service provider, it would be treated as exported services. Therefore such service provider can avail eligible credits related to such exported services. Alternately go for refund.

Frequently the payments could be made to the supplier of the outsourced support services, based on the realization of monies from foreign party. We caution revenue could take stance the fact that the consideration is paid only based on value of goods, and could allege that the essential activity is facilitating selling of goods between two parties covered in intermediary service. Therefore, liable to GST.

However, in the view of paper writer such stance by dept is not correct. The methodology of arriving at the consideration for service does not have any legal implication on taxability of the service. When it is only a pre-sale/post-sale/procurement activity which is being done by the agent, with no link to sale, then it is clear it is outsourced support services covered in section 13(2) of IGST act, as per which the place of supply of service is location of foreign client outside India. This could be compensated on cost plus model.

2. Single agreement for providing both services namely support service + intermediary service:

ONLY IF there is clear cut segregation of the support services and a consideration for same, the said activities could be covered in Section 13(2) of IGST Act and place of supply of service is location of service receiver foreign principal outside India. Further if all conditions of export of services given further below are satisfied such services could be treated as exports. Tax to be paid on the intermediary service.

3. Separate agreements for providing support service and intermediary service:

There could be a separate agreement for supply of intermediary service. The services of enabling the sale/purchase of merchandise and its allied activities done to the foreign clients could be said to be facilitating the supply of goods to/by foreign clients and considered as intermediary to that extent. Such services are covered in section 13(8)(b). As per which the place of supply of service is location of supplier in India and taxable to GST.

The support service agreement is covered in section 13(2) of IGST Act whereby place of supply of service is location of recipient foreign client and is not liable to GST. Further if all conditions of export of services given below are satisfied such services could be treated as exports.

When considered as export of service?

When all the conditions set out in section 2(6) of IGST Act as extracted below is fulfilled by supplier of service, then he can avail eligible credits related to such exported services.

Alternately go for refund.

1. The supplier of Service is located in India – Yes supplier of service is located in India;
2. The recipient of Service is located outside India - Yes recipient of Service foreign client is located outside India
3. The place of supply of Service is outside India- Yes, the place of supply of service is location of recipient being the foreign client outside India.
4. The payment for such service has been received by the supplier of Services in convertible foreign exchange or INR wherever permitted by RBI-Yes that the payment for such services has been received by the supplier of services in CFE or INR as permitted; and 
5. The supplier of service and the recipient of service are not merely establishments of a distinct person -Yes, supplier and foreign client are distinct persons[separate legal entities].

When bond/LUT is not executed by Indian service provider in respect of the exported services, then he have to pay IGST at the rate of 18% on such exported services and claim refund of such IGST paid.

Implication of latest circular No.159/15/2021-GST

A supply to be termed as intermediary supply the following conditions are to be satisfied

• Minimum of three parties to be present in a supply. Two of them transacting in the supply of goods or services (the main supply) and one arranging or facilitating (the ancillary supply) the said main supply.
• Two distinct supplies: Intermediary supply consists of two supplies one is “Main Supply” and other is “Ancillary Supply”. The ancillary supply is supply of intermediary service and is clearly identifiable and distinguished from the main supply.
• Intermediary service provider to have the character of an agent, broker or any other similar person: Role of intermediary is supportive
• No Supply of goods or service or both or securities on his own account. In cases where the person supplies the main supply, either fully or partly, on principal to principal basis, the said supply cannot be covered under the scope of “intermediary”.
• Service provider to have the character of an agent, broker or any other similar person.

Note: These aspects if clear in the agreement, then there maybe no dispute going forward.

Subcontracting of a supply to another supplier is excluded from the term intermediary supply as provision of such supply amounts to supply of service on his own account.

Invoking of provisions of Sec 13 of IGST Act 2017 for intermediary service for place of supply requires either the location of supplier or location of the recipient is outside India. It is also clarified that services outsourced to India or carried out in the country for foreign entities will not be treated as intermediary services, and hence not face 18% goods and services tax. Such outsourced services would be treated as export of services subject to satisfying the other conditions specified.

Comments: The circular seems to be merely a reproduction of the provisions with generic illustrations and circular absolves by stating whether or not, a specific service would fall under intermediary services would depend upon the facts of the specific case.

It would do well to recollect that in past the Circular no. 107/26/2019-GST dated 18^th July 2019 provided clarification w.r.t. intermediary services was withdrawn thereafter

In paper writer view, the latest circular maybe used as a supporting hand when the facts are very clear that it is outsourced services or sub-contracted services done under contract to foreign clients.

Way ahead under GST

Some service providers have been splitting the activity into technical, consultancy and business support services arrangement. It is suggested that caution is exercised as the interest and penalty could lead to enhanced demands.

1. Outsourced Support services model: The understanding is that it is business support service of nature of technical support service management consultancy service. The intimation to be given to department by RPAD letter and seek confirmation of understanding on non applicability of GST as well as entitlement to treat as export of services.

2. When there are 2 agreements: Explain in detail type of work done fact that these two agreements are distinct and separate activities having fixed amount or cost plus for support[not taxable-exported service] and percentages for the enabling- intermediary services [taxable]could be suggested.

3. For those where main activity it involves enabling supplies of goods/services and incidental support are in single agreement/ based on actual export or percentage thereof: It maybe preferable to pay GST.

As of now the preferred option for commission agents would be to make diligent representation through the Trade Bodies/ Associations. Representation may include:

1. Fact that the amount of commission would go to increase the cost of exports and is against the Make in India policy focus.
2. International best practice is that all services which are B to B could be based on location of customer (EU).
3. These types of services result in valuable CFE for India.
4. In light of this it should be made clear to the GST Council, Commerce Ministry, Ministry of Finance and PMO.

Conclusion

The levy of tax on intermediary services is an example of revenue augmentation measure keeping aside all the basic tenets of taxation one of which is that activities earning CFE for India are to be kept out of tax levy. Higher officers have been saying that this is due to the fact that they are following “best practices” across the world. However, in the European Union the intermediary service whether for goods of services has always been based on the place of the customer/ recipient. To close, to achieve ease of doing business, leg up for exporters of services and goods there is urgent need to move the “intermediary” from supplier based to recipient based as is the international best practice. 

For any further clarifications do get back to m[email protected] or [email protected]

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