Taxation
GST: Providing guarantee to related persons is like stepping on a land mine

Related party transactions always follow the presumption of not being at arm’s length and therefore tax provisions prescribe that such transactions should be undertaken at market value and be based on usual commercial terms, as if done with a third party. Transactions with related parties are always subject to scrutiny and are required to demonstrate that the transactions are driven by commercial understanding.


The Goods and Services Tax (GST) regime also prescribes for definition of related persons and applicability of valuation rules, as prescribed in case of transactions with related persons. This article intends to highlight some of the issues that the GST switchover will bring about in case of guarantee provided by related parties.


Guarantees, as we understand, will always be provided by related persons. To determine a reasonable interpretation here seems a risky proposition in itself! This will lead to varying or disregarding arrangements and value of supply determined by the contracting parties and will open up tax assessments, which may be an unwarranted exercise.


Under the service tax regime as well, there are valuation rules that could be triggered to disregard the value of the service computed by the assesse. However, in case the consideration for a service was zero, then the valuation rules were not triggered to assess a deemed value and therefore no service tax was charged on zero consideration. Under the GST regime, however, there is no question of treating the value of the service as zero and drawing upon valuation rules, therefore it increases the cost of providing guarantee, dissuading companies from giving guarantees.

In case of non-banking finance companies (NBFCs), where there is a service tax levied on the guarantee provided, the loss of input credit is an additional cost to the transaction.

Therefore providing of guarantee as services to related persons seems like stepping on a land mine!


Also if there are transactions in different states, the interpretation could be subject to vagaries of different tax officers.


Section 15 of the Central GST Act states that the value of supply of goods or services shall be considered to be the actual price paid or payable for the purpose of taxation, where the transactions is not between related persons and price is the sole consideration for supply. In case the supply of goods or services is between related persons then the value of such supplies shall be determined by the valuation rules prescribed in this regard.

Who are related persons?
Explanation to Section 15 of the Central GST Act explains that


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 25% 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 be related.


Therefore holding and subsidiary, associates, fellow subsidiaries shall be taken to be related persons.
 

Identifying issues in guarantee transactions
Rule 2 of the Determination of Value of Supply Rules, provides for determining the value of supply of goods and/ or services between distinct or related persons, other than through agent. The rule prescribes that the value of the supply between related persons shall be:

a. the open market value of such supply;
b. where open market value of such supply is not available, it shall be the value of supply of like kind and quality;
c. and where the value cannot be determined by the mechanisms stated in (a) and (b) above, it shall be determined by application of Rule 4 or Rule 5 of the aforesaid rules.

Guarantees provided by holding to a subsidiary or transactions alike between related persons will be considered to be a supply of service for the purpose of GST and usually, there is no guarantee commission charged.  
So in case of guarantees provided by related person, the valuation rules shall apply. Also there is no market for guarantee commissions or service of like nature.

Proviso to Rule 2 states that –

Provided that where 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 goods or services:


The provisos creates a carve out, a) where there is regular supply of such goods or b) where the recipient is eligible for full input tax credit, the value of the supply shall be based on the invoice value for the purpose of taxability.
In case of guarantee, the relevant proviso is where the recipient is a full input tax credit eligible entity. In case it is not, then one will have to look at Rule 4 and Rule 5 to conclude on the value of supply.

Rule 4 and Rule 5
Rule 4 states that –

Where the value of a supply of goods or services or both is not determinable by any of the preceding rules, the value shall be 110% of the cost of production or manufacture or cost of acquisition of such goods or cost of provision of such services.

In case of guarantees, there cannot be a computation of costs. Therefore, the rule is not relevant.

Rule 5 is the residual method of valuation and states that –

Where the value of supply of goods or services or both cannot be determined under rules 1 to 4, the same shall be determined using reasonable means consistent with the principles and general provisions of section 15 and these rules:


Rule 5 exposes the determination of value of supply to the discretion of the tax officer. The officer can apply any methodology to arrive at the value of guarantee for the purpose of tax.


The definition of related persons and the rationale for valuation is in lines with the World Trade Organisation Customs Valuation Agreement.


The transition into GST is a mega reform in the Indian tax regime and for the corporates to deep dive into the ocean to find the pearls or may be just pennies.

(Nidhi Bothra is executive vice president at Vinod Kothari Consultants Pvt Ltd)

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Nifty, Sensex headed lower – Tuesday closing report

We had mentioned in Monday’s closing report that if Nifty were to close below 9,600, the index might give up more gains. The major indices of the Indian stock markets were range-bound on Tuesday and closed with miniscule gains over Monday’s close. The trends of the major indices in the course of Tuesday’s trading are given in the table below:

Shrugging off the previous day's losses, the Indian equity markets on Tuesday traded in the green on the back of firm global cues, broadly positive domestic macro-economic data and healthy buying in capital goods, banking and consumer durables stocks. According to the data released by the Central Statistics Office (CSO) after-market hours on Monday, India's annual retail inflation (Consumer Price Index) eased to a record low of 2.18% in May 2017, and the factory output growth (Index of Industrial Production) marginally slowed to 3.1% in April 2017. This, according to market analysts, provided a boost to the key equity indices. On the NSE, there were 698 advances, 700 declines and 47 unchanged.
 
The equity benchmarks, which opened on a flat note, gained on the back of positive Asian markets. Retail inflation data came lower than expected and is positive for the market. Mid-cap and small-cap -- both the indices traded up, observed market analysts.
 
Drug major Sun Pharmaceutical Industries on Tuesday announced that one of its wholly owned subsidiaries has received final approval from the US Food and Drug Administration (USFDA) for its generic version of ezetimibe tablets. According to Sun Pharma, the generic ezetimibe tablets -- used to reduce higher levels of cholesterol -- are therapeutic equivalents of Merck's Zetia tablets. "As per IMS, ezetimibe tablets had annual sales of approximately $2.7 billion in the US for the 12 months (which) ended April 2017," the drug major said in a regulatory filing to the BSE. The company’s shares closed at Rs536.45, up 0.62% on the BSE.
 
Lending major State Bank of India (SBI) on Monday said that its paid-up capital has increased to Rs863.20 crore after its recent share placement through QIP. "Pursuant to the allotment of equity shares in the issue, the paid-up equity share capital of the bank stands increased from Rs810,98,57,182 to Rs863,20,50,393 comprising 863,20,50,363 equity shares of face value of Re1 each," the company informed the BSE in a regulatory filing. Last week, the lending major had allotted more than 52 crore shares of face value of Re1 each at a price of Rs287.25 per equity share aggregating to Rs14,999 crore to 61 "successful eligible investors". SBI shares closed at Rs283.80, down 0.44% on the BSE.
 
With the uncertainty across industries and cities, the job market continues to be volatile, according to the Naukri Job Speak index released on Monday. The index for May at 1904 was 4% down from year-ago month, indicating a fall in the overall new job creation scenario. The IT-software industry was hit the most during the last month with a 17% decline in hiring as compared to corresponding month last year. Key industries like telecom and BPO/ITES saw a 7% and 10% fall respectively, while banking saw an 8% increase in hiring during May 2017. "The job market continues to be volatile and there is an air of caution and uncertainty across industries and cities. The Jobspeak index for May has shown negative growth of 4% year-on-year. This trend may continue for few more months before the job market starts moving north again," said Naukri.com's Chief Sales Officer V. Suresh. According to data, 12 out of the 13 key cities tracked saw a decrease in hiring activity in May. The S & P BSE Information Technology Index closed at 10,040.68, down 1.00% on the BSE.
 
The top gainers and top losers of the major indices are given in the table below:
 
 
The closing values of the major Asian indices are given in the table below:
 

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How 15,080 profitable firms paid no tax in 2015-16
Tax incentives allowed 15,080 profit-making companies to have effective tax rates of zero, and in some cases less than zero, in 2015-16, according to an IndiaSpend analysis of the latest available national tax data or, more specifically, a government analysis called the Revenue Impact of Tax Incentives under the Central Tax System.
 
The central government introduced minimum alternate tax (MAT) in the late 1980s to tackle this anomaly, but even MAT has exemptions that appear to have negated its original intent partially: 52,911 companies made profits in 2014-15 and paid no tax.
 
Larger corporates paid lower tax rates than smaller ones for 2015-16.
 
Effective tax rate is the tax rate actually paid by companies on profits, calculated as tax actually paid divided by profits before tax. While effective tax rates rose between 2012-13 and 2015-16, many exemptions remain, especially for larger companies.
 
For instance, corporates have a statutory tax rate of 34.47 per cent, which they must pay on profits. The effective tax rate in 2015-16 was 28.24 per cent, higher than it was in 2014-15 (24.67 per cent).
 
The effective tax rate for a company making a profit up to Rs 1 crore was 30.26 per cent in 2015-16 while the corporate tax rate was 25.90 per cent for those with profits greater than Rs 500 crore.
 
This means companies making smaller profits are competing in an unequal environment against bigger companies with substantial taxation benefits even though the gap in effective tax rates has been narrowing over the years.
 
The effective tax rates of the lowest paying industries (cement, sugar, financial leasing companies), which were in single digits in 2014-15, have increased substantially and all are touching nearly 20 per cent.
 
These sectors, however, continue to be taxed at lower rates than other industries are.
 
There are interesting contrasts on tax rates of different industries in the same sector:
 
1. Banking companies paid tax at 40.3 per cent while share brokers/sub-brokers paid tax at 25.1 per cent (both financial services).
2. Courier agencies paid tax at 41.7 per cent compared to transporters who paid tax at 26.4 per cent (both services).
3. Forest contractors paid tax at 37.6 per cent while mining contractors paid tax at 28.2 per cent (both contractors).
4. Drugs and pharmaceuticals paid tax at 24.2 per cent, while electronics paid tax at 35.5 per cent (both manufacturing).
 
"The plan for phasing out of exemptions will kick in from April 1, 2017," Finance Minister Arun Jaitley said in his 2017-18 budget speech.
 
The government provided the corporate sector Rs 76,857.7 crore in tax breaks or exemptions in 2015-16.
 
The biggest tax exemption is the deduction on expenditure for scientific research (including for seeds and other biotech purposes), which allows for exemption which is twice the expenditure incurred and export profits of units in special economic zones (SEZs).
 
The government also provided customs duty exemption of Rs 69,259 crore and Rs 79,183 crore for excise duty in 2015-16.
 
As many as 43 per cent of companies made losses, three per cent companies made no profit and 47.7 per cent of companies made profits up to Rs 1 crore in 2015-16.
 
About six per cent of companies recorded profits in excess of Rs 1 crore, according to the tax data.
 
Contribution by corporates to political parties shows variance compared to reporting by political parties to the
Election Commission for 2015-16.
 
The deductions granted on account of contribution by corporates to political parties has declined from Rs 112 crore in 2014-15 to Rs 14 crore in 2015-16, according to tax data.
 
This is in contrast to the data submitted by parties to the Election Commission.
 
Donations received by political parties in excess of Rs 20,000 was Rs 576 crore in 2014-15 and Rs 77.3 crore in 2015-16, according to data from Association for Democratic Reforms, an advocacy.
 
One possible explanation for the variance could be under-reporting by corporates.
 
Disclaimer: Information, facts or opinions expressed in this news article are presented as sourced from IANS and do not reflect views of Moneylife and hence Moneylife is not responsible or liable for the same. As a source and news provider, IANS is responsible for accuracy, completeness, suitability and validity of any information in this article.

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