A GST allocation is not required to be made for human resources costs since employees have a relationship with the legal entity (as a whole) and not with any one branch.
In this festive season, on the one hand the GST Council is resolving the industry’s GST concerns, besides recommending rate reduction on several products, and, on the other hand, the saga of revenue-favouring advance rulings continues.
Industry’s latest nemesis is the ruling rendered by the Karnataka Appellate Authority for Advance Ruling (KAAAR) that affirms the ruling of the Karnataka Authority for Advance Ruling (KAAR) in the matter of Columbia Asia Hospitals Pvt. Ltd. The assessee-company operates hospitals (branch offices or BOs) in several Indian states and has, as part of the registered unit in Karnataka, an India management office (IMO). The IMO handles certain operations such as accounting, administrative functions, maintenance of IT systems, etc, for which it incurs costs. Chiefly for ascertaining the profitability of each operating unit, such IMO costs are allocated to other units, including BOs in other states (cross charges), and GST is applied.
The IMO also incurred human resources costs that were not allocated to the BOs since the human resources belonged to the legal entity and all its BOs, and did not apply any GST on such amount on the basis of the legal provision that transactions between employer and employee is not a supply of both goods and services.
The KAAR held that the assessee-company is legally obliged to apply GST on the human resources costs allocated to registered units (“distinct persons”) in other states. The KAAAR upheld the ruling on the reasoning that employer-employee relationship should be viewed separately for every registered unit/BO of the legal entity.
The authorities have addressed this issue with an extremely obtuse approach, while brushing aside certain judicial precedents and established legal principles, so as to garner greater tax. Some aspects that require deeper contemplation are described here:
The true nature of the transaction was not understood. It is undeniable that the services of an employee are outside the pale of GST and, so, cannot be taxed. Due to this advance ruling, the IMO is to pay tax on an element (human resources costs) that has been consciously kept outside the ambit of GST, given that the law provides that services by an employee to its employer in the course of or in relation to his employment is not a ‘supply’.
For the external expenses of IMO which were allocated, there was no supply in the economic sense yet, due to applicable legal fiction, GST was liable to be paid on transactions inter se IMO and BO. Such allocation is not required to be made for human resources costs since employees have a relationship with the legal entity (as a whole) and not with any one branch. To require the IMO to apply GST even where ‘supply’ is not made is legally incorrect.
Employment contracts equally permeate all BOs of the company. The Supreme Court, in Agencia Commercial International, declared that BOs are not distinct and separate entities from a head office, (in this case IMO) but rather, they constitute components through which the corporate entity expresses itself. So, a BO does not have a separate legal existence but is cut from the same legal fabric (juristic person), i.e., the company.
In the context of labour laws as well, the Supreme Court, in Transport Corporation of India, recognised that: “…leaves no room for doubt that the branches of the appellant, though spread over different parts of the country, are part and parcel of the main establishment of the company which remains the ‘employer’ and the employees in different branches remain its ‘employees’.” An employee is hired by a legal entity (company), and directed to provide services from any office including those situated in another state. Therefore, an employee’s obligation under the relevant contract is towards the company, irrespective of where they are deputed. To this effect is the unequivocal finding in the Milind Kulkarni case by the CESTAT, that employees of a branch are the employees of a company-organisation.
The advance ruling notes that employee’s services are not to be taxed yet and peculiarly observes that employees are that of a single registered unit in a given state (in this case IMO), and, so, when their (employees’) activities benefit another BO, the transaction is one between ‘distinct persons’ and is exigible to GST, even if no consideration is paid. The advance ruling unduly stretched the deeming fiction in GST law so as to obfuscate the basic position that employee’s services are toward the legal entity (as a whole) and thus not regarded as a supply.
The advance ruling has not accorded due effect to the non-obstante clause in Section 7(2) of the CGST Act, 2017.
An advance ruling does not bind any other person apart from the person who sought it, but it reflects the mindset of the GST authorities. Upon application of this ruling, trade and industry will have a greater cash outgo (by applying GST on such human resource transactions) and in several situations, there will be sticking cost owing to non-availability of input tax credit (ITC), as also burden assesses with additional compliance.
Businesses will have to carefully evaluate its structures and transactions to adopt suitable mitigation.
Given the controversial position, which artificially raises tax costs for businesses, the GST Council should issue a binding clarification, as it has in the recent past, and alleviate the concern at hand.
Co-authored by Nischal Agarwal, senior associate from Dhruva