It is quite common to make free supplies in business to business transactions. This happens when the recipient/buyer is in a position to procure quality material at the cheaper rate in the market. This gives leverage to the recipient to keep the cost of the manufactured product or the cost of service at lower levels. During the Pre-GST regime, there has been huge amount of litigation as to whether Central Excise Duty/ customs duty/service tax is chargeable on the value of free supply of goods/services. The courts generally, have been reluctant to allow addition of the value of free supplies unless there is specific provision in law to that effect. During the Pre-GST regime, tax was chargeable on the value of free supplied goods/services as mentioned below:
- Under Central Excise Law, the duty was chargeable on the value of free supply of goods by the buyer to the manufacturer. This was ensured under Explanation 1 to Rule 6 of the Valuation Rules.
- Under Customs Act, the customs duty was chargeable on the import of free supplied goods to the importer. This was ensured under Rule 10(1) of Customs Valuation Rules.
- Under Finance Act, 1994, service tax was chargeable on the value of free supply of services to the recipient. This was ensured under notification 11/2012 - ST dated 17.03.2012 with regard to Works Contract Services as defined in the Act.
The Model GST Law also had a provision in section 15(2) in this regard which is reproduced below:
'Section 15(2) The transaction value under sub-section (1) shall include-
The value, apportioned as appropriate, of such goods and/or services as are supplied directly or indirectly by the recipient of the supply free of charge or at reduced cost for use in connection with the supply of goods and/or services being valued, to the extent that such value has not been included in the price actually paid or payable.'
From the above, it is clear that the legislature/Govt. introduced specific provision in law wherever it was intended to add the value of free supplies in the transaction value for the purposes of charging appropriate tax.
Now on examination of section 15 of the CGST Act and the CGST Rules on Valuation (Chapter IV), it is seen that the legislature has consciously omitted to add the provision contained in GST model law (as stated above) on free supply. That means the GST law does not lay down any situation where the value of free supply of goods/services to the recipient in the course or in furtherance of business, can be taxed.
ITC Reversal on Free supplies:
Before analyzing the question, it must be understood that charging section and section related to ITC credit are independent of each other, and one must not be used to curtail the ambit of other. Both the provisions play in their own trajectory. It is an established position in law that unless there is specific provision in law, the right of the supplier to avail credit of tax paid, cannot be curtailed.
Section 16(1) of the CGST Act provides the general principle that every registered person shall be entitled to take credit of input tax charged on any supply of goods or services or both to him which are used or intended to be used in the course or furtherance of his business. A person is entitled for credit if the inputs or input services supplied is used 'in course or in furtherance of business'. Thus, there is no requirement in law that inputs of inputs services must be used for making taxable supplies only, mere use in course or furtherance of business is enough. In view of this a person is entitled to avail ITC on all supplies, which are being used in making free supplies, as such free supplies are being made in course or in furtherance of business.
Where the goods or services or both are used for the purposes of business, as a matter of principle, ITC is admissible. However, there are certain exceptions to this general principle and all these exceptions have been incorporated in section 17. Therefore, if the Revenue has to deny or ask for reversal of credit, it has to be established that the ITC availed falls within any of the exceptions of section 17. In case, the Revenue fails to establish, the courts are bound to uphold the right of revenue availment of the recipient. If the matter is covered by section 17, then the recipient is liable to reverse the credit. For example, if free samples are supplied or goods are lost, stolen or destroyed, then credit has to be reversed since section 17(5)(h) covers the denial of credit.
Further, no supplier distributes anything for free. The cost of everything distributed free is already built in price of taxable supplies, on which tax is being paid by the supplier.
In view of the above, no reversal of credit is required for inputs/input services used in making free supplies, since there is no specific provision in law to reverse the credit of tax suffered on free supplied goods.
Payment of GST on free supplies:
When the goods are supplied free, no consideration is involved and therefore, the supply would not amount to taxable supply in terms of section 7 of the CGST Act.
Free supplies and Works Contract:
When free supplies of goods/services are made to the recipient, the ownership remains with the supplier. Therefore, the free supply of goods and services, does not fall within the definition of 'works contract' in section 2(119), since no transfer of property in goods, is involved.
Disclaimer: The views expressed in this article are strictly personal. The content of this document are solely for informational purpose. It doesn't constitute professional advice or recommendation. The Author does not accept any liabilities for any loss or damage of any kind arising out of information in this article and for any actions taken in reliance thereon.