Convergence - Divergence? The Evolving Relationship Between Direct and Indirect Taxes in India - Part 1

Illustrative Line Parties

Direct Tax Regime

Indirect Tax Regime

Subsidy

Income - Section 2(24) (xviii) states -

xviii. assistance in the form of a subsidy or grant or cash incentive or duty drawback or waiver or concession or reimbursement (by whatever name called) by the Central Government or a State Government or any authority or body or agency in cash or kind to the assessee other than, -

(a) the subsidy or grant or reimbursement which is taken into account for determination of the actual cost of the asset in accordance with the provisions of Explanation 10 to clause (1) of section 43 or

(b) the subsidy or grant by the Central Government for the purpose of the corpus of a trust or institution established by the Central Government or a State Government, as the case may be

The subsidy can be received from the Govt. or any other persons by the Assessee/Taxpayer.

Thus, the subsidy received by the Assessee/Taxpayer is termed income under section 2(14)(xviii) of the ITA.

The subsidy may be linked to capital investment receipts or revenue receipts. If linked to capital investment, the subsidy's value is reduced from the value of the capital expenditure, whereas revenue subsidy is offered as income in the profit and loss account, forming part of income from other sources.

The subsidy can be received from the Govt. or any other persons by the Assessee/Taxpayer.

If the Subsidy is received by the Assessee/Taxpayer from the Government, then it is considered consideration as per section 2(31) of the CGST Act, 2017, thus not subject to GST levy even though it is in the nature of goods or services or both.

If a subsidy is linked to capital investment and is reduced from the value of such capital expenditure, the tax treatment remains unchanged under the Indirect Tax regime.

Whereas, if a revenue subsidy is received from the government, it does not form part of consideration. Otherwise, such a subsidy would be treated as consideration and become liable to GST, forming part of the taxable value, as per Section 15(2)(e) of the CGST Act, 2017, which states that such subsidies (except those provided by the government) shall be included in the valuation of goods or services.

Bad Debts Recovery

U/s 36(1)(vii) of the Income Tax Act, 1961, any income which is offered to tax forming part of Income from Operations which is irrecoverable and the same is written of Bad Debts is allowed as deductible expenditure for determination of total income u/s 28 of the ITA and often reported as "Bad Debts written off" and disclosed appropriately wherever required. Such write-off is permissible irrespective of time limits and does not expire under any allied laws to recover dues.

In the future, when Bad Debts are recovered due to persistent follow-up by the owners even though the same was recognised as expenses considering the principles of conservatism, such monies recovered are reflected as Bad Debt Recovery in the profit and loss account. Then, such recovery is subject to tax, and it has to be considered income u/s 2(14) for the determination of total income u/s 28 r.w.s 41 of the ITA.

When amounts are written off as bad debts in an enterprise's profit and loss account, as they are deemed irrecoverable in the ordinary course of business, a registered person cannot claim a refund of levies paid under Section 54 of the CGST Act, 2017. Credit notes cannot be issued under Section 34 of the CGST Act, 2017, as the conditions prescribed for issuing credit notes are not satisfied.

In the future, if bad debts are recovered due to persistent follow-up by the business owners, even though they were previously recognised as an expense based on the principle of conservatism, such recovered amounts are recorded as 'Bad Debts Recovery' in the profit and loss account. However, the credit entry appearing in the profit and loss account does not constitute 'consideration' as per Section 2(31) read with Section 7 of the CGST Act, 2017. Therefore, it does not qualify as a supply. Consequently, no GST is payable on the amount recorded as 'Bad Debts Recovery', and such recovery also does not form part of the aggregate turnover under Section 2(6) of the CGST Act, 2017.

Amenities and Benefits

Income - Section 2(24) (iv)/(iva) states -

(iv). the value of any benefit or perquisite, whether convertible into money or not, obtained from a company either by a director or by a person who has a substantial interest in the company, or by a relative of the director or such person, and any sum paid by any such company in respect of any obligation which, but for such payment, would have been payable by the director or other person aforesaid;

(iva). the value of any benefit or perquisite, whether convertible into money or not, obtained by any representative assessee mentioned in clause (iii) or clause (iv) of sub-section (1) of Section 160 or by any person on whose behalf or for whose benefit any income is receivable by the representative assessee (such person being hereafter in this sub-clause referred to as the "beneficiary") and any sum paid by the representative assessee in respect of any obligation which, but for such payment, would have been payable by the beneficiary ;

Profits and Gains of Business or Profession

Section 28(iv) of the Income Tax Act, 1961 provides the value of any benefit or perquisite arising from business or the exercise of a profession, whether -

a. convertible into money or not; or

b. in cash or in kind or partly in cash and partly in kind

Furthermore, Section 56(1) of the ITA provides-

Income of every kind which is not to be excluded from the total income under this Act shall be chargeable to income-tax under the head "Income from other sources", if it is not chargeable to income-tax under any of the heads specified in section 14, items A to E

Furthermore, 194R(1) of the ITA provides -

Any person responsible for providing to a resident, any benefit or perquisite, whether convertible into money or not, arising from business or the exercise of a profession, by such resident, shall, before providing such benefit or perquisite, as the case may be, to such resident, ensure that tax has been deducted in respect of such benefit or perquisite at the rate of ten per cent of the value or aggregate of value of such benefit or perquisite:

Provided that in a case where the benefit or perquisite, as the case may be, is wholly in kind or partly in cash and partly in kind but such part in cash is not sufficient to meet the liability of deduction of tax in respect of whole of such benefit or perquisite, the person responsible for providing such benefit or perquisite shall, before releasing the benefit or perquisite, ensure that tax required to be deducted has been paid in respect of the benefit or perquisite:

Provided further that the provisions of this section shall not apply in case of a resident where the value or aggregate of value of the benefit or perquisite provided or likely to be provided to such resident during the financial year does not exceed twenty thousand rupees:

Provided also that the provisions of this section shall not apply to a person being an individual or a Hindu undivided family, whose total sales, gross receipts or turnover does not exceed one crore rupees in case of business or fifty lakh rupees in case of profession, during the financial year immediately preceding the financial year in which such benefit or perquisite, as the case may be, is provided by such person.

Thus, in view of the above, any kind of amenities or benefits would be considered as Income (if taxable) chargeable to tax either as profits and gains of business u/s 28 of the ITA or income from other sources u/s 56 of the ITA.

Specified person/s u/s 194R may also deduct TDS at the specified rates from time to time, and such TDS deducted is often reflected in the taxpayer's PAN Number in Form 26AS and AIS/TIS statements, too.

Section 2(31) defines consideration as -

"consideration" in relation to the supply of goods or services or both includes-

a. any payment made or to be made, whether in money or otherwise (comment -to include in kind in the form of amenities or benefits), in respect of, in response to, or for the inducement of, the supply of goods or services or both, whether by the recipient or by any other person but shall not include any subsidy given by the Central Government or a State Government;

b. the monetary value of any act or forbearance, in respect of, in response to, or for the inducement of, the supply of goods or services or both, whether by the recipient or by any other person but shall not include any subsidy given by the Central Government or a State Government:

Provided that a deposit given in respect of the supply of goods or services or both shall not be considered as payment made for such supply unless the supplier applies such deposit as consideration for the said supply;

Moot question to examine considering the definition of consideration u/s 2(31) to include benefit or amenities received in kind on which TDS is deducted u/s 194R of the Income Tax Act, 1961, whether it should be considered as supply as per section 7 of the CGST Act, 2017? Answer to the above question depends upon on the following aspects: -

1. If such amenities or benefits are received by way of furtherance of business of the person, then, they would be considered as supply whereby such transactions is subject to levies under GST Acts and Rules thereunder and person is required to comply with provisions of Section 31 of the CGST Act, 2017;

2. Whereas if such amenities or benefits are received are not received because of furtherance of business of the person, they would not be considered as supply and thus, no levies are payable under GST Acts and Rules even though TDS is deducted u/s 194R of the ITA.

The complete transactions need to be evaluated holistically, considering all relevant facts and circumstances in general.

Liquidated Damages

Section 56(1) of the ITA provides-

Income of every kind which is not to be excluded from the total income under this Act shall be chargeable to income-tax under the head "Income from other sources", if it is not chargeable to income-tax under any of the heads specified in section 14 items A to E.

Thus, if compensation is received or deemed to be received or accrued or deemed to accrue or arise or deemed to arise by way of Liquidated Damages because of contractual arrangements between the parties to the agreement, then it would be termed as income as per section 2(24). Such income may be taxable as profits and gains of business or profession or income from other sources or any other section if related stipulations governing such income head are satisfied.

In a nutshell, liquidated damages are taxable as income, and tax is payable as per rates in force notified by the respective Finance Act for each year.

Vide Circular No CIRCULAR NO. 178/10/2022-GST dated 03.08.2022 in para 7, which has been reproduced below:

There has to be an express or implied agreement, oral or written, to do or abstain from doing something against payment of consideration for doing or abstaining from such actfor a taxable supply to exist. An agreement to do an act or abstain from doing an act, or to tolerate an act or a situation cannot be imagined or presumed to exist just because there is a flow of money from one party to another. Unless there is an express or implied promise by the recipient of money to agree to do or abstain from doing something in return for the money paid to him, it cannot be assumed that such payment was for doing an act or for refraining from an act or for tolerating an act or situation. Payments such as liquidated damages for breach of contract, penalties under the mining act for excess stock found with the mining company, forfeiture of salary or payment of amount as per the employment bond for leaving the employment before the minimum agreed period, penalty for cheque dishonour etc. are not a consideration for tolerating an act or situation. They are rather amounts recovered for not tolerating an act or situation and to deter such acts; such amounts are for preventing breach of contract or non-performance and are thus mere 'events' in a contract. Further, such amounts do not constitute payment (or consideration) for tolerating an act, because there cannot be any contract: (a) for breach thereof, or (b) for holding more stock than permitted under the mining contract, or (c) for leaving the employment before the agreed minimum period or (d) for doing something leading to the dishonour of a cheque. As has already been stated, unless payment has been made for an independent activity of tolerating an act under an independent arrangement entered into for such activity of tolerating an act, such payments will not constitute 'consideration' [Section 2(31)]. Hence, such activities will not constitute "supply" [Section 7] within the meaning of the Act.

In summary, liquidated damages are not considered a supply. Thus, no GST is payable under the GST Acts if they are expressly or implicitly stated in the contractual arrangements between the parties.

Sundry Balances written back.

U/s 37 of the ITA, any expenditure which is claimed as deductible subsequently if the expenditure is not payable because of transactions settlement and considering accounting principles, the same is reported as "Sundry Balances written back" in the profit and loss drawn up for the applicable reporting period, such transaction is considered as Income u/s 2(14) and offered to tax as income while determining total income u/s 28 of the ITA.

The moot question to examine here is whether credit in the profit and loss account as "Sundry Balances written back" would be termed as consideration and consequently supply u/s 7, whereby GST levies are payable. In my opinion, it is neither consideration nor supply; thus, no GST levies are payable.

GST levies would be payable only when Input Tax credit is claimed by Section 16 and Section 17 of the CGST Act, 2017, and considering the provisions of Rule 37/37A of the CGST Rules ifthe said person does not reverse ITC on or before the time limits provided under the provisions of the Act and Rules. Then, such ITC is subject to recovery under the provisions of the Act and Rules framed thereunder.

If a person has not claimed any ITC credit u/s 16 and 17, then such credit reflected in the profit and loss won't be exposed to GST levies under the governing act and rules framed thereunder.

Unexplained Cash Credit u/s 68

Section 68 states that where any sum is found credited in the books of an assessee maintained for any previous year, and the assessee offers no explanation about the nature and source thereof or the explanation offered by him is not, in the opinion of the Assessing Officer, satisfactory, the sum so credited maybe charged to income-tax as the income of the assessee of that previous year:

Thus, if such additions are made to the income tax assessments, the taxpayer is liable to pay tax at 60%, plus a surcharge of 25%, cess of 4%, and a penalty under Section 271BBE at 10%

To my understanding, the GST Act does not provide for taxing such unexplained cash credit, which is added to the person's regular income tax assessments.

However, if such unexplained cash credit is termed the concealed supply of goods or services or both, GST levies will be payable as per the earlier provisions of Sections 73 and 74 and now Section 74A of the GST Act, 2017.

Consequently, all the demands and recovery proceedings would be initiated, and GST levies would be determined accordingly.

Unexplained Investments u/s 69

Section 69 states that

Where in the financial year immediately preceding the assessment year,the assessee has made investments which are not recorded in the books of account, if any, maintained by him for any source of income, and the assessee offers no explanation about the nature and source of the investments or the explanation offered by him is not, in the opinion of the Assessing Officer, satisfactory, the value of the investments may be deemed to be the income of the assessee of such financial year.

Thus, if such additions are made to the income tax assessments, the taxpayer is liable to pay tax at 60%, plus a surcharge of 25%, cess of 4%, and a penalty under Section 271BBE at 10%

To my understanding, the GST Act does not allow for the taxation of unexplained investments, which are added to a person's regular income tax assessments.

Unexplained Money, Bullion etc. u/s 69A

Section 69A states that -

Where in any financial year the assessee is found to be the owner of any money, bullion, jewellery or other valuable article and such money, bullion, jewellery or valuable article is not recorded in the books of account, if any, maintained by him for any source of income. The assessee offers no explanation about the nature and source of acquisition of the money, bullion, jewellery or other valuable article, or the explanation offered by him is not, in the opinion of the Assessing Officer, satisfactory, the money and the value of the bullion, jewellery or other valuable article may be deemed to be the income of the assessee for such financial year.

Thus, if such additions are made to the income tax assessments, the taxpayer is liable to pay tax at 60%, plus a surcharge of 25%, cess of 4%, and a penalty under Section 271BBE at 10%

To my understanding, the GST Act does not allow for the taxation of unexplained money, bullion, etc., which are added to a person's regular income tax assessments.

Distinct persons transactions& Branch Transfers

Under the Income Tax regime, each person is subject to tax based on PAN Number. PAN numbers are unique to each person, and now, with the advent of tech developments, the same person can't have multiple PAN Numbers.

Technically, nothing is called a distinct person under the direct tax regime.

Further, it is a well-known, established jurisprudence that one can't make transactions with himself/herselfviz. No one makes a profit out of himself. That's why when filing revenue returns under the Direct Tax, all incomes earned by the person based on his/her PAN Number are clubbed together based on the person's residential status as per section 6 of the ITA, and tax liability is determined as per the rates in force.

Thus, a person under the income tax will always file single-income tax returns and/or audit reports based on the PAN Number.

Further, income tax assessments would be applicable based on the person's PAN number and its registered address.

Whereas under the Indirect Tax regime, a distinct person is specified under explanation 1 to section 8 of the IGST Act, which defines the distinct person as under:

Explanation 1. -For the purposes of this Act, where a person has -

i. an establishment in India and any other establishment outside India;

ii. an establishment in a State or Union territory and any other establishment outside that State or Union territory; or

iii. an establishment in a State or Union territory and any otherestablishment registered within that State or Union territory,

then such establishments shall be treated as establishments of distinct persons.

Thus, transactions executed between distinct persons are subject to GST levy either as intra-state supply u/s 8 or inter-state supply u/s 7 of the IGST Act, 2017.

Each distinct person is supposed to comply with all regulatory provisions as applicable to any registered person under the provisions of the Act and Rules framed thereunder.

Thus, under the GST Act, a person will always file GST returns based on each GSTIN Number, including regular returns, annual returns, self-reconciliation statements, etc.

Further, GST assessments would be applicable based on each GSTIN number, considering the definition of distinct persons, persons' Places of Business, and Additional Places of Business as registered under the provisions of the Act.

Principal and Agent Transactions

Suppose a person acts as an agent, intermediary, commission agent and/or broker, etc. In that case, he merely acts as a facilitator between two persons for the supply of goods or services or both. In such a scenario, both the parties viz. Seller and Buyer report such transactions as transactions forming part of their operations under the provisions of the ITA and comply with applicable provisions. Essentially, such an agent has no legal authority to conclude the transactions as per the Indian Contract Act of 1872. In contrast, the transaction of supply between the buyer and seller has to be concluded based on the provisions of the Indian Contract Act of 1872 and the Sale of Goods Act of 1930 for the purpose of reporting in the financial statements based on the event of a transfer of title and ownership of supply amongst the parties.

However, under either law, an Agent can determine the price, terms, and conditions of the sale and supply.

The agent only discharges income tax on its commission income as per the provisions of the ITA, and the Buyer/Seller discharges taxes on the transaction values bythe applicable allied laws.

Transactions between Buyers and Sellers with an agent are termed P TO A transactions, not P to P Transactions.

If transactions executed by the Agent don't satisfy the stipulations of the agency provisions as provided under the Indian Contract Act, 1872, then such transactions are termed P-to-P transactions instead of P-to-Atransactions.

If a person acts as an agent, intermediary, commission agent, broker, etc., then he merely acts as a facilitator between two persons for the supply of goods or services or both. In such a scenario, both parties, viz. Seller discharges GST levies on the supplies, and Buyer claims input tax credit on such supplies per the provisions of sections 16 and 17 of the CGST Act, 2017.

The agent only discharges GST on its commission income under the GST Act based on his registered place of business, whereas the Buyer/Seller discharges their GST levies based on whether the transaction is an intra-state supply or an inter-state supply, taking into consideration the concepts of Composite and mixed supply.

Transactions between Buyers and Sellers with an agent are termed P TO A transactions, not P to P Transactions.

If transactions executed by the Agent don't satisfy the stipulations of the agency provisions as provided under the Indian Contract Act, 1872, then such transactions are termed P-to-P transactions instead of P to A transactions, in such scenario, the agent will discharge GST levies based on the characterization of the transaction as intra-state supply or inter-state supply by taking into consideration the concept of Composite and mixed supply.

However, under either law, an Agent can determine the price, terms, and conditions of the sale and supply.

Schedule III transactions r.w.s Section 7(2)

Transactions deemed neither supply of goods nor services under the GST Act (refer to the explanation provided under the indirect tax regime) are termed revenue from operations to report under the provisions of ITA practically for all purposes.

Such transactions are taxed under the ITA Act based on Sections 4, 5 and 6 of the Act read with DTAA and MLI provisions considering the registered place of business, source, permanent establishment, business connection, marketplace place, etc.

Under Income Tax, Income Tax is payable on net earnings after considering all incomes, expenses, and transaction values, which are considered only for reporting purposes of underlying economic transactions.

Schedule III under the CGST Act. 2017 lists transactions that are neither treated as a supply of goods nor services. Thus, such transactions are not subject to GST levy because they are not termed as supplies. Examples include high Seas Sales, out-and-out Sales, Sales of Land or Buildings or both, etc.

Under the indirect tax regime, GST levies are determined based on the consumption of the supply.

Under GST, levies are payable on the transaction values irrespective of margins involved in the underlying economic transactions.

Advances

Any advance received either for the supply of goods or services, or both cannot be recognised as Income from Operations unless title to the supply of such goods or services of both is transferred to the buyer/recipient by the Sale of Goods Act, 1930, Indian Contract Act, 1872 or any other ancillary laws applicable to the underlying transactions.

The above recognition is aligned to GAAP, AS 9 - Revenue Recognition, Ind AS 115 - Revenue Recognition and/or any other accounting and legal prudence applicable to the transaction basis of the documentation.

Considering the withholding taxes (TDS/TCS) deducted /collected, reporting such revenue as income from operations isn't mandatory. Readers, please note that TDS/TCS deduction/collection has to be seen only as procedural compliance of the Payers to mitigate the hardship arising due to non-compliance under the respective laws. Most of the TDS can be carried forward to claim an offset against the tax liabilities payable in the year in which such revenue is offered to tax by the taxpayer.

Most of us are aware that initially, all advances, either for goods or services or both, were subject to GST levy.

Now, only GST levies are payable on the advance received for services but not for goods.

Thus, variations may arise when reconciling income from operations reported in the financial statements with aggregate turnover reported in GST annual returns under Section 44 due to advances received at the beginning and end of the financial year.

Voucher Sales - Future sale of goods or services or both

Taxpayers depending upon the nature of the business model may issue the voucher for the future sale of goods or services or both with the time limit of expiry provided.

Revenues received on account of the sale of vouchers can be accounted as per the tax treatment provided to the advances(supra).

Readers should note that on the expiry of the time limits provided in such vouchers, taxpayers are duty-bound to recognise the revenue as operations whereas Advances can be carried forward in the books of accounts for longer durations or there may not be any time limits applicable to advances unless documentation otherwise.

If taxpayers are acting as agents to facilitate the sale of vouchers, then, tax treatment as discussed in the case of Principal and Agent Transactions (supra) shall apply appropriately.

Revenues received on account of the sale of vouchers can be accounted as per the tax treatment provided to the advances(supra).

Similarly, if on the expiry of the time limits provided in such vouchers, when taxpayers recognise the revenue as operations, then, GST levies will be payable on such transactions.

If taxpayers are acting as agents to facilitate the sale of vouchers, then, tax treatment as discussed in the case of Principal and Agent Transactions (supra) shall apply appropriately.

Readers, please kindly note that Finance Bill 2025, has omitted the Time of Supply provisions relating to the voucher which may determine the tax treatment from the date on which the assent of the President of India is received.

Unbilled Revenue

Unbilled Revenue refers to revenue that has not yet been billed by the entity but is recognised as income in the accounting period based on supporting documentation, such as agreements and contracts.

Unbilled Revenue is merely an accounting entry in the books of accounts and is pari materia to the concept of provisions, which is well understood in accounting practices.

This revenue, once accounted for in the books, is subsequently reversed in the following financial year once a valid invoice is issued.

Under the direct tax regime, taxes are payable on the recognition of such unbilled revenue in the year of accrual. However, in the subsequent year, when the revenue is reversed against actual billed income, the tax impact is neutralized, ensuring that taxpayers do not end up paying taxes twice on the same revenue.

Readers should note that no TDS should be claimed in the Income Tax Return (ITR) for revenues that have been offered to tax as Unbilled Revenue in the financial statements.

If unbilled revenue is recognised in the financial statements, then, as explained under the direct tax regime, no invoices are issued for booking such revenues. This implies that no tax invoices are issued under Section 31 of the CGST Act, 2017. Since GST liability arises only upon the issuance of a tax invoice, no GST levies are payable on recognising revenue as unbilled revenue.

Thus, variations may arise due to the presence of unbilled revenue at the beginning and end of the financial year when reconciling income from operations as reported in the financial statements with aggregate turnover reported in GST annual returns under Section 44.