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Treatment of “Free gifts” and FOC items under GST law – GST Station

Treatment of “Free gifts” and FOC items under GST law

Treatment of “Free gifts” and FOC items under GST law

Authors CA. Raginee Goyal (Guwahati) and Advocate Rakesh Chitkara (New Delhi)

The issue of taxability and Input Tax Credit availability on gifts has been a constant matter of discussion and confusion among trade and professionals too. Especially with the festive season following the implementation of GST in India, “Sale”, “gift and “free” are the buzzwords at this time of the year.

The word ‘gift’ has not been defined in the CGST Act. Thus, to determine the meaning of this term, one will have to refer to other laws as well as case laws.
The Gift-Tax Act had defined the word “gift” to mean transfer by one person to another of any existing movable or immovable property voluntarily and without consideration in money or money’s worth.

The Honorable Supreme Court cited the definition of ‘gift’ from Corpus Juris Secundum, Volume 38 in the case of Sonia Bhatia v. State of UP [1981] 2 SCC 585 as follows: A ‘gift’ is commonly defined as a voluntary transfer of property by one to another, without any consideration or compensation therefor.

A ‘gift’ is a gratuity and an act of generosity and does not require a consideration, but there can be none; if there is a consideration for the transaction, it is not a gift. The Australian High Court in the case of Commissioner of Taxation (Cth) v. McPhail [1968] 41 ALJR 346 held that to constitute a ‘gift’ the property should be transferred voluntarily and not as a result of a contractual obligation. In this case a person agreed to give a donation to a school in return of school charging less fees for the education of the child of said person. Hence, the Court held that such donation cannot be termed as ‘gift’ as it was made under a contractual obligation wherein school was required to charge lower fees against the donation made.

Thus, for any item to be held as a gift, there are two basic ingredients that MUST exist:
(i) Absence of any contractual obligation
(ii) Absence of consideration in money or money’s worth either.

Different types of gifts may be given in course or furtherance of business. In the commercial world also, some of them are customary and almost all of them are in course or furtherance of business. Customary gifts are like Diwali gifts or gifts on festive occasions, New year gifts etc. whereas, other gifts given by business houses may be unbranded gifts, FOC items, branded/ customized gifts in the form of publicity material, target based rewards in lieu of discounts/ incentives etc., promotional schemes of various denominations, etc. Some of these are in course of business while others are in furtherance of business.

“In course of business” means usual business practice such as manufacturing, trading etc. It implies those transactions which are directly related to business without which business cannot be run, like purchase of raw material, capital goods etc. On the other hand, furtherance of business means the act of advancement/promotion of business for its sustained growth and profitability. In such a scenario, it can be understood that Diwali gifts and other festive and customary gifts are given to persons related to a business and shall be deemed to be in the furtherance of business. These gifts are generally given to sustain good business relations for the advancement of business activity. Whereas, gifts for sales promotion/ target based or incentive based gifts shall be understood to be given “in course of business” and may not actually be “gifts” but incentives given under contractual obligations.

Now the question that has been raised and argued is the availability of ITC on gifts, which has been dealt at two specific places under the GST law. The first provision is Section 17 (5) of the CGST Act which deals with Blocked credits. Clause (h) of Section 17(5) deals with ITC on gifts. The relevant part of the said provision reads as under:

Sec. 17(5): Notwithstanding anything contained in sub-section (1) of section 16 and sub-section (1) of section 18, input tax credit shall not be available in respect of the following, namely:—

(a) …………………………….

(h) goods lost, stolen, destroyed, written off or disposed of by way of gift or free samples;

The Second provisions is Entry Number 2 to Schedule – I, which reads as under:

  1. Supply of goods or services or both between related persons or between distinct persons as specified in section 25, when made in the course or furtherance of business:

Provided that gifts not exceeding fifty thousand rupees in value in a financial year by an employer to an employee shall not be treated as supply of goods or services or both.

The above two provisions stipulate that any goods disposed off by way of gift are not eligible for ITC and that even if supply is in course or furtherance of business between related or distinct persons, it shall be considered as supply except to the extent of fifty thousand rupees in a financial year, when given by an employer to its employee.

In order to avail ITC, two basic provisions need to be complied with, i.e. Section 16 and Section 17. As per Section 16, a taxpayer is entitled to take credit of input tax charged on any supply of goods or services to him which are used in the course or furtherance of his business.  Thus, Section 16 itself disallows ITC for non-business purposes. This certainly gives an indication of the intent of law that what remains to be subjected to Sub-Section (5) under Section 17 is thus, business gifts only, which has been barred. The issue for the blocking of credit by way of Section 17(5) is not whether it is in course or furtherance of business or not, but rather it is whether it is for consideration or not. If yes, whether the quantification of the consideration and payment of GST on the same is distinctively required or not.

A “gift” is nothing but an inducement, i.e. a means of influencing the recipient. The act of inducement cannot in general be excluded from the scope of being a supply, however, the point that deserves attention here is that the consideration is not wholly in money, the transaction becomes subject to Valuation Rules. In such case the Valuation Rules require the transaction to be valued at Open Market Value of the subject goods (given by way of gift). The “Open Market Value” of ordinarily purchased goods can be easily reckoned as the purchase price of the same goods. In such case, if the giving away by way of gift is considered as a supply to be valued at the cost of purchase, the Input Tax Credit involved shall be equal to the output GST payable on the supply of the said gift, in course or furtherance of business. Thus the output GST and input GST on the goods to be given as gift will be same and the act of not paying GST on the giving of the gift shall be compensated by way of foregoing the Input Tax Credit on the purchase of the said gifts. Availing ITC on purchases of said goods and paying same amount as GST on giving the goods as gift or foregoing both would stand at par. The concept of input removed as such under Central Excise law also was established on similar principles.

Due to Section 17(5), it is so stipulated that no ITC on any goods can be availed, if they are given as gifts, whether or not in course of furtherance of business. Or in other words, if it is so opined that the said gifts have an extra commercial consideration, then they shall be subjected to GST when given away or disposed of and then ITC of the same shall also be available, because as soon as a commercial value is assigned to any transaction, it shall not remain a gift anymore. However, in that case, the value shall require to be assigned in compliance with Section 15 read with the Valuation Rules and not hypothetically.

Clause (h) of Section 17(5) of CGST Act 2017 stipulates that the input tax credit with respect to the “goods” disposed of by way of gift shall not be allowed. The definition of goods as per Section 2 (52) means “every kind of movable property. which are agreed to be served before supply or under a contract of supply”.  That means, for a commodity to be called “goods” under this law, it is necessary that it is used for the purpose of supply and in order to deem a particular transaction as supply, it should have some consideration involved or else, the same should be mentioned under Schedule I of the Act. There is neither any consideration nor is there any reference of gifts under Schedule I except in case of those given to employees. In such circumstances, another view emerges that do these Diwali gifts move out of the ambit of the terms “goods” itself from the perspective of the registered person, purchasing such gifts and hence they are not even goods and hence not hit be Section 17(5). Here it deserves to be noted that a “gift” is a regular supply of goods for the supplier who supplies such gifts to the purchaser who will gift it further. What is vital is that there should be tax charged on supply of “goods” by a supplier to a recipient. It nowhere restricts that such commodities should also qualify as “goods” for the recipient to be held as “goods” for him separately. The inward supply is the event that brings in ITC to the recipient, whether eligible or reversible whatsoever. Therefore, it can be clearly construed that Diwali gifts fulfil the conditions of Section 2(52) and Section 16 as well, and cannot be said to be excluded from being hit by provisions of Section 17(5)(h) by way of this fiction of the definition of “goods”.

Now, when it is clear enough that gifts are in course or furtherance of business and the conditions under Section 2 (52) and Section 16 also are satisfied, why ITC on gifts should not be available.

ITC on goods given away or disposed as “gifts” should not be available when no tax is being paid on their disposal. The logic of satisfying Section 16 (1) is of no avail to earn this credit lawfully, because Section 17(5) itself starts with a non obstante clause, which means even if Section 16 (1) allows, Section 17(5) shall block. Moreover, Section 17 (5) is a specific provision because it is an established principle that specific provisions prevail over general provisions.This doctrine has always been upheld. The cases on the subject will be found collected in the third edition of Maxwell which is ‘generalia specialibus non derogant’ – i.e. ‘general provisions will not abrogate special provisions.

Similar application arises when there are two provisions under the same statute also, one of which is specific and the other general. If there is dispute between Section 16 and Section 17(5), in our view, Section 17(5) should prevail.

Readers would appreciate that Section 16 is a general provision and Section 17(5) is specific. Section 17(5) over rides Section 16(1) in clear words. Furthermore, though 17(5) is non obstante clause unless

section 16 conditions fulfilled ITC is not eligible and once eligible if not hit by 17(5), only then ITC can be availed. In other words, if something qualifies for ITC under section 16 but is blocked from ITC under section 17 then ITC would not be available. Similarly, if there is a contradiction between Schedule I and Section 17(5) (h), in my view, Schedule I should prevail.

The above discussion would remain incomplete without discussing the question whether the sweets and beverages purchased for distribution to employees/workers/customers/ associates on Diwali would be eligible for ITC. It should be noted that section 17(5) (b) (i) specifically restricts the input tax credit with respect to food and beverages and Section 17(5) (h) restricts or bars credit on gifts. Hence any sweets or beverages given to bought for employees/workers/customers/ associates whether construed as “food or beverages” or as “gifts” shall not be eligible for claiming input tax credit (however the monetary limit under Schedule I shall interfere when given to employees). Furthermore, since the ITC availability on food and beverages, also is separately dealt with under Section 17(5), the treatment in case of inward supply of food and beverages except when given away as gifts may vary depending upon facts.

Regarding gifts given as offer packs, like Buy1Get1free, X item free against purchase of 100 pieces Y item etc., the first provision that deserves attention is Section 15 of the CGST Act talks about “Transaction Value”. Every time, something is given free of cost or a promotional scheme, it has an extra commercial consideration which creates the confusion for payment of GST on outward supply or reversal of ITC or both. The above are gifts/ free supplies in course of business. If consideration for these goods is not charged directly, they shall qualify as “gifts” and ITC shall not be eligible. If these goods are said to be given in lieu of discount, and the said discount satisfies the conditions under Section 15(3), i.e. the discount (whether in full or in part) arises and is recorded as a contractual obligation under specific invoice(s), ITC shall be available on such goods. It may be worthwhile to show such goods under the respective invoice/ credit note after establishing on record, the agreement under which it arises. As soon as an obligation is attached, the commodity loses its identity as a “gift” and no denial of ITC can arise under Section 17(5) in such case. However, festive gifts/ customary gifts, in our view can never fetch this status.

It is also very common that publicity material or company branded goods, say an umbrella is bought and branded with the company’s logo and given as gift to a wholesaler by the distributor company. Such giving away is sales promotion expenditure and hence some businesses contend that it is not a gift and can ITC be availed. The intention in such kind of gifting is not to popularize the logo in itself, but to get some sort of business mileage, however, it is worthy to note first, that incurring an expenditure is nothing, but consuming something. When that expenditure is directly related to the supply in course or furtherance of business, it is an input. No customer seeks an obligation of company logo printed publicity material, in course of supply of its goods. It is the supplier’s own will to supply such goods and he gives them as gifts as no customer would wish to pay for it voluntarily, and hence it cannot be said to be a component in course of supply.

The above arguments emphasize towards two vital aspects to be comprised in a transaction for furtherance of business:

  • Regularity : Is the activity conducted in a regular manner based on sound and recognized business principles?
  • Consideration: Is the activity predominantly concerned with the making of taxable supply for consideration/ profit motive?

In the above transaction, both are missing and ITC cannot be availed even by virtue of Section 16 in such case, whether or not these publicity materials are considered as gifts. We all know, nothing in the business world is free, then what is the intent of the harsh Section 17(5)(h). The intent of Section 17(5) (h) can be read by connecting with the erstwhile provisions under Central Excise law or the Cenvat Credit Rules to understand the intent and relate the principles underlying the provision.

The basic intent behind Section 17(5)(h) seems to be that it tries to restrict people from (a) selling goods in cash without payment of tax by showing them as gift (b) give benefits or exchange consideration in kind in lieu of cash/ goods in the garb of gifts to avoid valuation and thus avoid levy of tax (c ) give incentives / benefits to employees as business expenditure, which are not clearly accountable as given to them as reward for their services and which do not become taxable in their hands as remuneration either.

The intent is that, all goods should suffer indirect tax upto the level at which they are consumed, unless specifically exempted. If gifts given to business associates or employees are not taxed when they are disposed, and ITC is also allowed upon them, the tax on such goods shall get avoided in a way.

Even the erstwhile Central Excise law, did not allow Cenvat credit on items purchased and given as gifts, or free samples. The erstwhile Rule 3(5) had prescribed that when inputs or capital goods, on which CENVAT credit has been taken, are removed as such from the factory, or premises of the provider of output service, the manufacturer of the final products or provider of output service, as the case may be, shall pay an amount equal to the credit availed in respect of such inputs or capital goods and such removal shall be made under the cover of an invoice referred to in Rule 9. The Cenvat Credit availed on procurement of such goods could be utilized for payment of –

Duty on such goods when removed as such or after being partially processed and the duty payable on these goods was held to be an amount equal to CENVAT credit taken on inputs. A conjoint harmonious reading of Section 15, 16 and Section 17(5) appears to carry the same intent.

As far as ‘gifts’ to employees is concerned, there are two rival entries; the first in Schedule I and the second in Schedule III. The proviso to Entry 2 of Schedule I gives an implied meaning that gifts exceeding Rs.50000 to an employee by his employer in a financial year is to be construed as “supply”.

Whereas Entry I of Schedule III states that services of an employee in the course of or in relation to his employment is not a ‘supply’. When both these entries are read together, it so appears that anything which has been given in the ordinary course of employment to an employee is reward or compensation for the service which he rendered as an employee and hence beyond scope of supply.

Entry 2 of Schedule I, requires one to pay GST on gifts made to employees exceeding Rs 50,000/- to an employee during a year. Now what is Schedule I, it is those transactions which are without consideration but held as supply. Which means, if anything is given for a consideration, i.e. service as per terms of service in case of employment, it is covered by Schedule III and cannot be covered under Schedule I at all. Only those transactions shall enter Schedule I, which are without consideration, i.e. not covered by the terms of contract in case of employees, but given voluntarily. Since they are not exempt by virtue of Schedule III, limited exemption of Rs 50000/- per year employee is conferred under Schedule I specifically.

There is little space to argue beyond the principle that anything given to an employee, unless mentioned in his offer letter or such defined remuneration / incentive will be “gift”. Thus, if gift to employee is more than Rs. 50,000/- during a year, it will become a fresh supply from employer to employee and because they are related party, value is to be determined as per rules as discussed above. This gives an impression that there is double taxation on all gifts which get covered under Entry 2 of Schedule I. Similarly, for gifts exceeding Rs. 50,000/- whether foregoing of ITC under Section 17(5)(h) will suffice or GST will have to be paid again on the amounts exceeding 50,000/-. If yes, how will such valuation be made?

For once, on a plain reading, it so appears that there is double taxation in this case, but then taxing twice is against the spirit of GST and it is hard to accept that this is the intent of the provisions. As discussed above, the value of outward supply in such cases as per valuation rules is open market value, i.e same as purchase cost. The foregoing of GST is nothing but payment of GST on the said goods disposed without any consideration. This should suffice. This also paves way for availing ITC on gifts to employees upto the value of Rs 50,000 in a year.

Any gift above Rs 50,000 to an employee during an year is deemed supply by virtue of Schedule I, and 17(5) talks about non availment of credit on all gifts. First of all, does the exemption of Rs 50,000/- under Schedule I entitle one to avail ITC on such gifts when procured, because not allowing ITC on such goods will tantamount to levy of GST on such goods, when disposed as gifts by way of deemed fiction of valuation. However, it seems reasonable and convincing to accept that the foregoing or reversal of ITC (as a consumer of such goods / as a B2C transaction as discussed above) is itself at par/ equivalent to the payment of GST on any transaction being considered as deemed outward supply. As per earlier central excise law also, payment of duty was considered at par with reversal of cenvat credit. In GST also, if ITC is foregone, no further payment of GST should lie on transactions without consideration.

Now, it is ironical though, it so appears that under Schedule I, gifts to all other related persons are considered as supply as gifts are invariably, without consideration. In case, gifts are given to those who are not related persons, it will not be a supply, and hence not liable to GST. In both cases, Section 17(5) (h) disallows/ blocks the ITC. This definitely leaves the question unanswered that how are they both different or are they different at all. The ultimate impact appears to remain same in both cases of gifts to employees above the monetary limit of Rs 50,000 or below such limit, as double taxation cannot be held tenable.

The dynamic idea of charging nominal amount for gifts to employees or other related persons does not help to avoid double taxation due to the force of the Valuation Rules when transactions are between related persons and not fully in money’s worth. Gifts to employees which are not part of the terms of service or not contractually obligatory cannot be said to be a mode of payment for his services, unless so recorded. In that case they will even get subjected to TDS obligations of employer for the employee under Income tax law.

The crus of the above few paragraphs is that Entry No 2 of Schedule I vis a vis employees and all other related persons is a gamut of confusion and needs to be immediately reviewed by the law makers with seriousness and addressed with clarity.

All said and done, the reversal or non availment of ITC on gifts shall be a tedious task in return filing, as to which items are given as gifts, and under which bill the same were purchased would need to be identified and reversal shall need to be made. Businesses are confused as to how the invoices should be taken for these gifts and how this hardship can be reduced.

It cannot be denied that since a gift is without consideration, the purchaser of the goods who disposes the said goods as gifts is himself the consumer of the said goods and ITC is available only against B2B supplies. ITC cannot be availed on B2C supplies and it seems reasonable to purchase goods for the purpose of gifts as B2C inward supply to eliminate the pain of reconciliation, matching and reversal on such goods by the person who makes the gift. When purchased as B2C, ITC will not become available and the total cost of purchases including the GST component can be availed as deduction under Income tax law. Especially, because gifts are voluntarily given and do not create any contractual obligation, even if they are in course or furtherance of business, the registered person should adopt a policy that whenever goods are purchased for the purpose of gifts, they are purchased as B2C supplies from a registered person to reduce/ remove hardship of reversal and reconciliation.

The authors duly acknowledge the academic contributions and time given by various GST experts, consultants and academicians based in various cities of India, namely, Sri Akshay Rajendra Shah, Sri Amar Nath Singla, Sri Anket S Dodya, Sri Anuj Kakkar, Sri Ashu Dalmia, Sri Abhay Desai, Sri Chintan Shah, Sri Gaurav Gupta, Sri Gawesh Narula, Sri Jignesh Kansara, Sri Keshav R Garg, Sri Mithun Khatri, Sri Mohit Golchha, Sri Monish S Shah, Sri Prashant Shukla, Sri R K Soni, Sri Sanjiv Pahwa, Sri Saurabh Gupta, Ms. Shaifaly Girdharwal, Sri Sudhir Jhanjee, Sri Tarun Agarwal, Sri MP Vasudevan (IRS), Sri Vikas Modi and Sri Vikas Yadav thorugh an online panel discussion for completing this study and presenting this Article.