Sale of goods & services in a fixed exchange rate contract and its implications under GST

Key Issues

• Valuation in Sales Contract denominated in foreign currency.
• Fixed Exchange rate Sales contract –
  • Determination of value of supply
  • Invoicing under GST
  • Accounting in books & adjustment of forex. Diff.
  • Availment of ITC by recipient

Introduction

Let us take a look at the genesis of GST, the charging section, which creates a levy of a consumption-based indirect tax on supply of goods or services or both.

"Extract from Section 9(1) of the CGST Act, 2017 -

(1) Subject to the provisions of sub-section (2), there shall be levied a tax called the central goods and services tax on all intra-State supplies of goods or services or both, except on the supply of alcoholic liquor for human consumption, on the value determined under section 15 and at such rates, not exceeding twenty per cent., as may be notified by the Government on the recommendations of the Council and collected in such manner as may be prescribed and shall be paid by the taxable person."

From above, we can observe the whole levy of GST is dependent on the three most fundamental elements – (1) Supply, (2) Value of Supply and (3) Rate of tax.

Unless all these fundamental elements are determined, the assessment of the GST cannot be made.

One of these elements is Value of Supply and the manner for determining the value of supply has been prescribed in Section 15 of the CGST Act read with various rules made thereunder in CGST Rules, 2017.

Key Issues

A. Valuation in Sales Contract denominated in foreign currency

Section 15(1) of the CGST Act, 2017 provides that the value of a supply of goods or services or both shall be the transaction value, which is the price actually paid or payable for the said supply of goods or services or both where the supplier and the recipient of the supply are not related, and the price is the sole consideration for the supply.

Therefore, the transaction value of the contract will be considered as the value of supply.

But issue with the Sales Contract denominated in foreign currency is that the assessment of GST has to be made in Indian Currency (INR) but the transaction value is not available in INR. Thus, the value cannot be determined under the provisions of this sub-section.

For resolving this issue, Section 15(4) ibid further provides that where the value of the supply of goods or services or both cannot be determined under sub-section (1), the same shall be determined as per rules prescribed.

For determining value of supply of a contract denominated in foreign currency, Rate of exchange between foreign currency and Indian currency is a pre-requisite. But the next issue arises as to which Exchange rate shall be taken to convert foreign currency into INR to determine the value of supply since there are various exchange rates available, i.e., spot rate, forward rate, future rate, CBIC rate, RBI reference rate.

For determination of such exchange rate, Rule 34 has been prescribed under CGST Rules, 2017 which has been extracted as below –

"34. Rate of exchange of currency, other than Indian rupees, for determination of value.

(1) The rate of exchange for determination of value of taxable goods shall be the applicable rate of exchange as notified by the Board under section 14 of the Customs Act, 1962 for the date of time of supply of such goods in terms of section 12 of the Act.

(2) The rate of exchange for determination of value of taxable services shall be the applicable rate of exchange determined as per the generally accepted accounting principles for the date of time of supply of such services in terms of section 13 of the Act."

Thus, the Rate of exchange to be taken for determination of value of supply is summarized as follows:

For Supply of Goods – CBIC rate

For Supply of Services – Rate as per GAAP

Therefore, we can determine value of supply in a Sales Contract denominated in foreign currency as follows:

Value of supply = Transaction value × Exchange Rate as determined from above

B. Valuation in Fixed Exchange rate Sales contract

Now, let's discuss about Sales contract in which a fixed rate of exchange has been stipulated in the Contract, Master Service Agreement (MSA) or Statement of work (SOW) itself.

The manner of determination of value of supply remains same as discussed in above Part-A. The key issues that come here is w.r.t. to GST Compliant Invoicing and accounting of Revenue & settlement of dues.

Let us take an example to understand the key issues & the practical approach to deal with the issues.

Suppose Sam Fintech Ltd., an Indian company has entered into a contract with a major client Infinity Solutions India Ltd., an Indian Branch of a US Company to supply services with below details:

Fixed Price contract rate: $100 million

Fixed Forex conversion rate: USD/INR = 80

GAAP Rate on billing date: USD/INR = 82

Now in this contract the key issues are as follows:

1. What shall be the value of Tax Invoice under GST- Rs. 8000 million or Rs. 8200 million?
2. Revenue to be recognized in books.
3. What is the actual receivable amount from client?
4. How to deal with the difference between actual amount receivable and the invoice amount?
5. Journal Entries for recording the transaction.
6. Amount of Input tax credit (ITC) that can be claimed by the recipient.

Let's discuss all the issues one by one:

1. Value of Tax Invoice

The relevant provisions pertaining to Invoicing has been extracted below-

"Section 31(2) of the CGST Act, 2017 provides that a registered person supplying taxable services shall, before or after the provision of service but within a prescribed period, issue a tax invoice, showing the description, value, tax charged thereon, and such other particulars as may be prescribed."

"Rule 46 of the CGST Rules, 2017 provides as below-

Subject to rule 54, a tax invoice referred to in section 31 shall be issued by the registered person containing the following particulars, namely-

……..

(j) total value of supply of goods or services or both;"

From above, it can be concluded that Value of Supply shall be mentioned on the Invoice and the definition and manner of determination of value has been defined in Section 15 read with Rule 34 as discussed above.

So, the Taxable Value will be Rs. 8200 million i.e. (@ Rs. 82/$ GAAP rate) and the same shall be mentioned in the Tax Invoice. The Invoice Value will be Rs. 9476 million with 18% GST.

2. Revenue to be recognized in the books

Let's first understand the nature of the contract. The contract consists of two Performance obligations, one for supply for services & other one is a Forward rate derivative contract.

Ind AS 109 classifies such type of contract as an Embedded derivative contract and provides for separation of the contract into two contracts- one revenue contract for supply of services and one derivative contract.

Ind AS 109 provides that an embedded derivative is a component of a hybrid contract that also includes a non-derivative host—with the effect that some of the cashflows of the combined instrument vary in a way similar to a standalone derivative. An embedded derivative causes some or all of the cash flows that otherwise would be required by the contract to be modified according to a specified interest rate, financial instrument price, commodity price, foreign exchange rate, index of prices or rates, credit rating or credit index, or other variable, provided in the case of a non-financial variable that the variable is not specific to a party to the contract.

It provides that the following steps should be applied to identify an embedded derivative in a foreign currency contract which has a feature of forward derivative but It is not availed by the entity: -

Step I: Recognise Sales at forward rate which prevails on inception date.

Step II: Difference between spot rate at settlement date & forward rate on inception date will be considered as embedded Derivative & ultimate Profit/ Loss from such derivative contract will be adjusted with Carrying Amount of Debtor.

So, the revenue to be recognized in the books will be the Forward Rate (Contracted Fixed Price) i.e., Rs. 8000 million. (@ Rs. 80/$)

3. Actual receivable amount from the client

Since, the conversion rate was fixed in the contract itself, the actual receivable amount from the client will be Rs. 9440 million i.e., 8000 million (@ Rs. 80/$) + 18% GST

4. Dealing with the difference between actual amount receivable and the invoice amount

As it can be observed from above that there is a difference of Rs. 36 million between the Invoice amount & actual amount receivable due to Forward Derivate Contract, the difference needs to be dealt with.

Let's take a look at some key definitions:

The definition of "Goods" & "Services" as per Section 2 ibid has been reproduced as below-

"goods means every kind of movable property other than money and securities but includes actionable claim, growing crops, grass and things attached to or forming part of the land which are agreed to be severed before supply or under a contract of supply"

"services means anything other than goods, money and securities but includes activities relating to the use of money or its conversion by cash or by any other mode, from one form, currency or denomination, to another form, currency or denomination for which a separate consideration is charged"

As per section 2(h)(ia) of Securities Contract (Regulation) Act, 1956 the definition of "Securities" includes Derivatives.

Since, Derivative contract, being a securities contract, is neither Goods nor Services, it will be out of purview of the GST and GST shall not be leviable on it and a Financial Credit Note can be issued.

The practical remedy to deal with the difference is to issue a Financial Credit Note to the client to the extent of Rs. 36 million to settle the client receivable account.

5. The transaction shall be accounted as follows

6. Amount of Input tax credit (ITC) that can be claimed by the recipient

The receipt can claim full ITC as mentioned in the Invoice i.e., Rs. 1476 million subject to fulfillment of all conditions for availing ITC.