Businesses need to be careful while using the route of credit notes or post supply discounts for adjusting taxes, especially in the COVID period.
By Rajat Mohan
The pandemic has arrested business activities across the trade and commerce, and recovery of full payments from the customers on outstanding invoices, is proving to be an uphill task. In order to manage the working capital, businesses are bound to offer some discounts to its customers for realizing timely payments. Further, in worst cases, debts will turn out to be bad, and businesses would not be able to realize any payment. Now the issue is GST is paid to the government, once the invoices are issued and commercially speaking without tax adjustment such discounts/ bad debts would be a double whammy. Let us now analyse the said issues from 360 degrees.
Discounts during COVID-19
GST law per se makes a distinction between pre-sales discount and post-sales discount. Full adjustment of tax is available in case of pre-sales discount, whereas such adjustment is not freely available in case of a post-sales discount. One of the key conditions for reducing tax liability on account of post-sale discount is “such discount shall be established in terms of an agreement entered into at or before the time of such supply and specifically linked to relevant invoices”.
Now the basic issue is that no one has predicted this pandemic and thereby no specific clause exists in the agreement as on the date of supply. In the case of UltraTech Cement Ltd., AAR – Maharashtra held that discount from the value of supply can be allowed only if the discount complies with the provisions of Section 15(3) of the CGST Act, 2017. In this case, there were no criteria mentioned in the agreement based on which the quantum of discount would be calculated. Thereby amount paid to the supplier towards “rate difference” and “special discount”, was considered and allowed as a discount eligible for a tax adjustment.
What emerges from the ruling is that if there are no pre-fixed criteria and basis for arriving at the quantum of discounts which is mentioned in the agreement on the date of supply, then no tax adjustment would be permitted in any case. Businesses are issuing credit notes for any discount during the COVID period without application of mind and careful reading of the legislation, which may prove to be a costly affair once the accounts are being audited by the department.
Deficiency in services
Companies in the service sector are also offering credit notes to lower the value of services, without realizing that such credit notes can be issued only if the supplier agrees that there was a “deficiency in services”. Now the moot question is, would a branded company splurging billions on brand building exercise, ever agree that there was a “deficiency in services” just to have a tax adjustment of 18%.
Besides, there could be other regulatory risks on organizations in the health sector, insurance sector, educational services, hospitality sector, aviation sector, oil, and gas sector, and professionals like chartered accountants, company secretaries, and advocates, if they accept the liability for “deficiency in services”. Offering discounts on tax by service providers may come at a hefty price for businesses as it would increase the tax risk on the businesses.
Bad debts during COVID 19
COVID has pushed quite a few businesses on the brink of bankruptcy. However, Indian legislators have suspended the initiation of fresh insolvency proceedings for six months to shield companies impacted by the outbreak of Covid-19. This will lead to ballooning of the liabilities on the face of balance sheets, eyeing which certain companies may take an aggressive stand to deny payments to there vendors on flimsy grounds.
Once the underlying debt becomes irrecoverable, vendors will rush to take the refund/adjustment of GST paid on the value of supply.
Now the question is whether taxable value can be determined at any point in time instead of a specified time as is mentioned in the law? By combined reading of provisions of the meaning of supply, levy of tax, time of supply, and value supply, it can be construed that the value of supply needs to be computed when the event becomes taxable. The value of supply of goods or services is transaction value, which is the price actually paid or payable for the said supply of goods or services. In the case of bad debts, the amount payable remains the same, however, it is just that it is not realized. These assertions would not change the taxability component in the transaction, thereby no tax benefit can be taken out of bad debt.
The global scenario on tax relief is much more balanced in case of bad debts whereby quite a few tax jurisdictions do not collect taxes on the component of unrealized payments. For example in the United States, States usually provide sales tax relief for tax remitted to the states on the amount that later becomes uncollectible. In Germany, bad debt relief is given if the customer becomes insolvent. However, nothing of this sort exists in India.
Therefore it can be concluded that tax adjustment on a self-assessment basis for discount offerings, the relegation of contract prices and bad debts would higher the quotient of tax risk. Stipulations under GST law are unambiguous and would push the authorities to take a revenue favoring tax position. Businesses need to be careful while using the route of credit notes or post supply discounts for adjusting taxes, especially in the COVID period.
Considering the global best practices, there is a need to change the psyche of Indian bureaucrats whereby an environment of trust is established for businesses to grow and thrive. Indian indirect tax system needs a thorough look into the provisions to identify and uproot any harsh anti-business stipulations.
Rajat Mohan is Senior Partner at AMRG & Associates. Views expressed are the author’s personal.