Valuation of free of cost supplies under GST

Dear Friends,

We know that the value of a taxable supply is the taxable base on which the rate is applied. It is important to understand and calculate the value of supply for ascertaining GST liability. GST will be applicable in the value of the goods and services supplied. The valuation process of supply under GST is separate for related and unrelated purposes. Since main ingredient for GST related to any goods or services is the supply of those goods or services and hence first we have to understand, what is supply.

At the outset,it is necessary to understand that activity would qualify as a "Supply" under Section 7 of the GST Act, 2017 and would be taxable under Section 9, only if the said activity or transaction involves "consideration". However in certain instances a supply without "consideration" would qualify as supply according to the provisions of Section 7(1)(c) and taxable under Section 9 of the CGST Act,2017.

GST is chargeable on "ad valorem" basis i.e. it is charged as reference to a "Value" on all supplied of goods and services as provided under Section 9 as follows

"Section 9(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 the supply of alcoholic liquor for human consumption on the value determined under Section 15 and at suc rates, not exceeding 20% as may be notified by the Government on the commendations of the council and collected in such manner as may be prescribed and shall be paid by the taxable person."

Section 15 of Central Goods and Services Tax Act 2017 - Value of taxable supply

(1) 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.

(2)The value of supply shall include--

(a) any taxes, duties, cesses, fees and charges levied under any law for the time being in force other than this Act, the State Goods and Services Tax Act, the Union Territory Goods and Services Tax Act and the Goods and Services Tax (Compensation to States) Act, if charged separately by the supplier;

(b) any amount that the supplier is liable to pay in relation to such supply but which has been incurred by the recipient of the supply and not included in the price actually paid or payable for the goods or services or both;

(c) incidental expenses, including commission and packing, charged by the supplier to the recipient of a supply and any amount charged for anything done by the supplier in respect of the supply of goods or services or both at the time of, or before delivery of goods or supply of services;

(d)interest or late fee or penalty for delayed payment of any consideration for any supply; and

(e ) subsidies directly linked to the price excluding subsidies provided by the Central Government and State Governments.

Explanation.- For the purposes of this subsection, the amount of subsidy shall be included in the value of supply of the supplier who receives the subsidy.

(3) The value of the supply shall not include any discount which is given-

(a) before or at the time of the supply if such discount has been duly recorded in the invoice issued in respect of such supply; and

(b) after the supply has been effected, if-

(i) such discount is established in terms of an agreement entered into at or before the time of such supply and specifically linked to relevant invoices; and

(ii) input tax credit as is attributable to the discount on the basis of document issued by the supplier has been reversed by the recipient of the supply.

(4) Where the value of the supply of goods or services or both cannot be determined under sub-section (1), the same shall be determined in such manner as may be prescribed.

(5) Notwithstanding anything contained in sub-section (1) or sub-section (4), the value of such supplies as may be notified by the Government on the recommendations of the Council shall be determined in such manner as may be prescribed.

Explanation.- For the purposes of this Act,-

(a) persons shall be deemed to be "related persons" if-

(i) such persons are officers or directors of one another's businesses;
(ii) such persons are legally recognised partners in business;
(iii) such persons are employer and employee;
(iv) any person directly or indirectly owns, controls or holds twenty-five per cent. or more of the outstanding voting stock or shares of both of them;
(v) one of them directly or indirectly controls the other;
(vi) both of them are directly or indirectly controlled by a third person;
(vii) together they directly or indirectly control a third person; or
(viii) they are members of the same family;

(b) the term "person" also includes legal persons;

(c) persons who are associated in the business of one another in that one is the sole agent or sole distributor or sole concessionaire, howsoever described, of the other, shall be deemed to

LET'S UNDERSTAND PROVISIONS OF SECTION 15

From above we found that the below-mentioned items will be included while calculating or at the time of valuation of supply of Goods or services for levy of GST;

1. Taxes, cresses, fees, charges levied under any other laws being in force if charged separately by the supplier;
2. Any amount that thee supplier is liable to pay in relation to supply but has been incurred by the recipient and not included in the price actually paid or payable;
3. Incidental expenses charged by the supplier to the recipient or any amount charged for anything done by the supplier in respect of supply at the time or before the delivery of the Goods or supply of Services;
4. Interest or late fee or penalty for delayed payment of any consideration for any supply;
5. Subsidies directly linked to the price excluding subsidies provided by the Central Government and State Government.

Please Note That:- the value of supply however would exclude any discount which is given before or at the time of Supply or is given after the supply is made but emanates from the agreement entered into by the parties and where ITC, as is attributable to the discount, has been reversed by the recipient.

In GST regime the Free of Cost supplies to related parties or unrelated parties may have different implications.

LET'S DISCUSS -FREE OF COST SUPPLIES TO RELATED PERSON OR PARTIES

Sections 7(1)( c) of the CGST Act: Activities to be treated as supply even without a consideration

Para; 1 Permanent transfer or disposal of business assets (PTOBA) where input tax credit has been availed on such assets.

Here the following parameters are required to be satisfied to be attract under para-1

(a) There should be permanent transfer or disposal of business assets

(b) Transfer in kind of permanent in nature

(c) ITC has been availed on such business assets

• Business assets including non –current asset & current asset ( stock) also.
• Temporary transfer of business assets without considerations not covered under this clause.
• Registered person for any reason ITC though, eligible but not availed such business assets but person such permanent transfer or disposal of business assets made without consideration will not be attract any GST.

Note: only such assets permanent transfer or disposal of business assets but no further any processing on such assets ( minor) then this para not applicable.

LET'S CONSIDER SOME EXAMPLES

1. Suppose A Ltd., is manufacturing School uniform, it has taken ITC on various materials such as clothes, threads, buttons, Capital Goods etc., and has supplied or donated the lot of an orphanage. Now in this case since supply of goods are without consideration, but it would be deemed to be supply under GST, because ITC has been claimed on the input goods. The A Ltd., is required to reversed ITC taken on goods donated to orphanage.
2. Suppose a coaching class administrator purchases a Digital Screen of Rs. 3,00,000 plus GST of Rs. 54000/- for teaching of its students The coaching institute after some time suppose after one year from the date of purchase donated the Digital Screen to a Charitable Education Institute free of cost. In this case the donation of Digital Screen will be considered as supply,since ITC has been taken at the time of purchase of the screen and the donating coaching institute is required to reverse ITC claimed on Digital Screen to the extent as may be prescribed.
3. Mr. X is a trader of plywood & he made a chair out of plywood later donating to school but Mr. X is taken ITC at the time of purchase, this transaction will be qualify as a supply because Mr. X is donating of chair not a raw material ( plywood) even without considerations hence GST is applicable.

Note: if supply made a without considerations in the course or furtherance of business as a taxable persons ITC was taken at time of purchase. Then this clause covered ii) if supply made a with considerations in the course or furtherance of business as a taxable persons irrespective whether ITC was taken or not but GST is applicable.

4. Suppose Mr. X has purchased a car and after some time he has donated the car for charitable purposes. In this case the deeming provisions are not applicable since Mr. X has not taken ITC on car ( ITC is blocked on car u/s. 17(5)) an the car is his personal asset. The donation of car will not be considered as supply under GST.
5. Suppose Mr. X being proprietor of his mobile shop, has given a valuable mobile to his friend on his birthday as a gift. He has taken TC on gifted mobile at the time of purchase,in this case also the transaction will be deemed as supply free of cost. Since Mr. X is transferring his business asset to his friend on which ITC has been claimed and hence it is a supply.

Please note that

1. Clause 2 of Schedule I of CGST Act, provides that supply of Goods or Services between related parties or distinct persons made in the course or furtherance of business shall be treated as a supply even if made without consideration.
2. This all transactions made between related persons and district persons without any consideration would be liable to GST.
3. If goods or service are furnished free of cost by one person to another, then such free of cost furnishin of goods or services must first qualify as a "Supply"to attract GST liability.
4. Since GST is a "Destination Based Consumption Tax", it means that the burden is to be borne by the person consuming the goods/services so supplied. The consumption of Goods/services by the receipient is a collolary of term "Supply". It is presumed that the Goods/Services supplied by one person will be consumed by another ( i.e. the receipient). In the same way the Goods/Services provided by a customer to his contractor in real estate will be assumed to be consumed by the contractor and if these goods/services are not consumed by the contractor or the receipient then such type of transaction will not be covered under GST.

LET'S CONSIDER EXAMPLES TO UNDERSTAND ABOVE PROVISIONS

1. Suppose Mr X supplies stones, aggregates etc., on a free of cost basis to his work contractor Mr. Y for building Mr. X house. Such a free supply of stones, aggregators or other materials will qualify as a deliberate supply and may attract GST liability depending upon whether customer( Mr. X) and the work contractor (Mr. Y) are related or unrelated person.
2. Now lets' consider another examples Mr. A has provided a piece of unstitched cloath to Mr. B ( a tailor ) free of cost basis, the primary purpose of providing such unstitched cloth to tailor is carrying out of work on the same cloth. Mr. B is supplying of services of stitching on a material provided by the customer, thus such unstitched cloth effectively forms subject matter of Mr. B ( tailor) supply. In this case, there is no consumption of the cloth by the tailor but the same is being worked upon to provide supply by the tailor. Such free of cost supply of cloth by the customer to the tailor should not normally be treated as a free of cost supply, even though the customer Mr. A and the tailor Mr. B is related persons.

VALUATION OF FREE OF COST OF SUPPLY IN CASE OF RELATED PERSONS

In the event of the supplier and recipient of goods or services being related, the value of free supply is to be determined in the manner as prescribed under Rule 28 of CGST Rules.

The Rule 28 prescribed that in a related party transaction, the value of Supply would be either-

• The open market value of such supply; or
• The value of supply of goods or services of like kind and quality, where no open market value is available ; and
• If both the ave methods cannot adopted, then as per Rule 30 or Rule 31 of the CGST Rules.

FROM above ;

1. First option available for valuation between related person is the Open Market Value as per rule 28;
2. Second option is provided by way of proviso to Rule 28 where under the Goods are intended for further supplies, value can be 90% of the selling price of the recipient of supplies;
3. Third option is provided by way of second proviso to Rule 30 of the CGST Rule,whereby where the receipient is entitled to take full credit, the value declared in the Invoice shall be considered as open market value.

CGST Rule 28: Value of supply of Goods or Services or both between Distinct or Related Persons, other than through an Agent (Chapter-IV: Determination of Value of Supply)

The value of the supply of goods or services or both between distinct persons as specified in sub-section (4) and (5) of section 25 or where the supplier and recipient are related, other than where the supply is made through an agent, shall-

(a) be the open market value of such supply;

(b) if the open market value is not available, be the value of supply of goods or services of like kind and quality;

(c) if the value is not determinable under clause (a) or (b), be the value as determined by the application of rule 30 or rule 31, in that order:

Provided that where the goods are intended for further supply as such by the recipient, the value shall, at the option of the supplier, be an amount equivalent to ninety percent of the price charged for the supply of goods of like kind and quality by the recipient to his customer not being a related person:

Provided further that where the recipient is eligible for full input tax credit, the value declared in the invoice shall be deemed to be the open market value of the goods or services.

CGST Rule 30: Value of Supply of Goods or Services or both based on Cost (Chapter-IV: Determination of Value of Supply) 

Where the value of a supply of goods or services or both is not determinable by any of the preceding rules of this Chapter, the value shall be one hundred and ten percent of the cost of production or manufacture or the cost of acquisition of such goods or the cost of provision of such services.

CGST Rule 31: Residual Method for Determination of Value of Supply of Goods or Services or both (Chapter-IV: Determination of Value of Supply) 

Where the value of supply of goods or services or both cannot be determined under rules 27 to 30, the same shall be determined using reasonable means consistent with the principles and the general provisions of section 15 and the provisions of this Chapter:

Provided that in the case of a supply of services, the supplier may opt for this rule, ignoring rule 30.

Please Note That:  Section 15(2)(b) of the CGST Act, provides that the value of supply must include the mount that the supplier is liable to pay but has been incurred by the recipient. As per this sub-class the value of the goods/services,cost of which was original to be borne by the supplier, but instead, has been borne by the recipient, then the said cost has to be included in the transaction value of supplier. Consequently, the supplier would be liable to discharge its tax/GST liability on the transaction value plus the said cost borne by the recipient.

In the case of supply between related persons the same would be taxable under the GST laws, however the conclusion of inclusion of the value of the goods in the transaction value of supplier, would solely depend on the terms and conditions stipulated under the contract (entered into between the 'related parties') read with the provisions of Section 15(2)(b) of CGST Act,2017.

FREE OF COST SUPPLY TO UNRELATED PERSON

Generally a supply free of cost between unrelated persons is outside the purview of GST Act,2017. But in some cases the value of such supplies without consideration may have to be necessarily included within the transaction value of supply thus rendering such supplies without consideration attracts GST.

Since Section 15(2)(b) provides that; (b) any amount that the supplier is liable to pay in relation to such supply but which has been incurred by the recipient of the supply and not included in the price actually paid or payable for the goods or services or both.

It means the inclusion of the value of goods/services in the transaction value, the cost of which had to be originally borne by the supplier ( under the contract) but instead gets borne by the receipient of such supply. The provision would be applicable even if the parties are unrelated.

LET'S CONSIDER EXAMPLES

1. Suppose there is a contract between, Mr. A(customer) and Mr. B (contractor) for construction of home of Mr. A. The contract provides that the Mr. B will procure all materials for the purpose of construction of house. But Mr. A has supplied certain goods to Mr. B,regardless of the obligations stipulated under the contract, and the contract price is reduced to the extent of such supplies. In this case the contractor, Mr. B is liable to all goods, however irrespective of this obligation the customer,Mr. A has supplied certain goods to Mr. B and the cost of such goods has been deducted from the contract price. According to our discussion and applicable provisions of Section 15(2)(b) of CGST Act, 2017, the cost of supply of material by Mr. A (customer) to Mr. B (contractor) will be added in the transaction value of the supplier and Mr. B is liable to pay GST on such supply.
2. As per contract certain goods/services are to be made available by the service recipient, and the contract price does not include the value of such supplies. In this case, the supplier is not contractually liable to supply certain goods to the recipient, instead the recipient is obliged to make available to the supplier. Thus on the basis of legal provisions stated above, it can be stated that the value of the goods supplied by the recipient free of cost, will not be included in the transaction value of the supplier, and hence not liable to discharge GST on the same.

EXAMPLE

Suppose a company supplies goods and services on a free of cost basis to its subsidiary company and the two companies are related parties. As per scope of work of such contract, certain equipment in the nature of ambulance, cranes, patrol vehicles etc., are being supplied by the company to its subsidiary which shall be returned by the subsidiary on mpletion of the construction contract.

There are two scenarios

1. Such free of cost supplies by the holding company to its subsidiary would qualify as supply between related parties without consideration as per Schedule I and GST is liable on such free of cost supply;
2. However if such supplies by the holding company are agreed upon by both parties as an obligation of the holding company under the contract which would essentially required for the subsidiary to provide its services, then such free of cost supply may not be taxable. Accordingly the contract may be suitable reviewed in order to finalize GST liability on such supplies.

CONCLUSION

We know that the main taxable event under GST is the supply of goods /services. Being a destination base consumption tax, GST is payable by the recipient of supply. In some cases there may be supply of goos/services free of cost and same will be valued on the basis of relationship between the supplier and the recipient. The determination of inclusion of value of free of cost supplies in transaction value will depends on the terms and conditions of contract between the supplier and the recipient. So it is important to draft your contract after considering theses provisions in mind.

DISCLAIMER: The article produced here is only for information and knowledge of readers. The article has been prepared on the basis of available details and information available. The views expressed here are the personal views of the author and same should not be considered as professional advice. In case of necessity do consult with Tax Professional for more understanding and clarity on the subject matter.