The provision of levying tax on inter-branch cross charges is unworkable and increases compliance costs for businesses. It must be repealed
By Rahul Renavikar
Recently, there was hue and cry concerning the application of GST on the allocation of head office costs of an organisation to its branch offices in different states. It was reported in the media that the government intended to recover GST on cross charges on account of allocation of common costs, including salaries of CEO, CFO, IT support, administration support, etc. The government quickly issued a press release and clarified that there was no intention to levy GST on salaries of the ‘C’ suite of an organisation as the services provided by an employee to the employer are neither a supply of goods nor a supply of services, and hence, do not attract any GST. So far, so good. However, in the same press release, the government clarified that, following global practice, GST will apply to cross charges for inter-branch supplies of goods and services, which, of course, include the salaries of employees. This appears to confirm the fear of taxpayers rather than allaying it. Further, it stated that the GST so charged by one branch to another is available as an input credit, and hence, is not a cost to business.
Many companies follow the accounting practice of allocating common costs amongst various locations within the organisation, especially to determine the profitability of different profit centres within the organisation. Under India’s dual GST, supplies in a state attract the central GST and also the state GST. Further, a branch of an organisation located in another state is treated as a “distinct person”; any inter-state activity between the head office and a branch, or between two different branches, is treated as a ‘supply’ and is subject to the GST levy.
Rather than being a common global practice, India is the only country in the world that applies tax on activities between two branches of the same legal entity. In other jurisdictions, flow of goods or services between two arms of the same legal entity is not considered a supply and isn’t subjected to GST. This reflects the logic that one cannot transact with oneself; you need two to tango. The Indian GST, on the other hand, requires a business entity to register separately in each of the states where it operates, and deems any inter-branch flow of goods or services to be a supply, subject to tax. It is through this deeming fiction that an allocation of head office salaries among the branch is considered a charge for a taxable supply by the head office.
It may be argued that the state-wise registration of each legal entity is necessary for the levy of the state GST. But, this need not be so. Canada also levies a dual GST, but there is no requirement of multiple registrations in each of the provinces where companies operate a business. The two taxes are collected by each legal entity, but under a single registration. In China, individual operating units or branches are required to have separate registrations for VAT, but there is no provision deeming inter-branch activities to be a supply of service that is subject to tax. As there is no fiction of a person making a supply of services to oneself, allocation of CEO, CFO, or other salary costs to branches does not attract any VAT or GST.
This feature of the Indian GST is, thus, without any international precedent. More importantly, it is unworkable. There is no clarity on which inter-branch activities constitute a supply, and how they are to be valued for applying the tax. Does the exchange of information on business performance (MIS reports) between a branch and the head office constitute a supply of service, subject to an 18% tax? What about the inputs provided by different operating units to the head office in raising capital, in managing cash flow, or in developing sales/marketing plans? How are these fictional supplies to be identified and valued? Organisations do allocate some of the common costs among various operating units, but there is no consistency in the practices they follow. It is for this reason that few business entities are currently complying with the GST law and remitting tax on inter-branch service activities. The tax authorities have also not provided any guidelines.
These provisions are a significant contributor to the complexity of GST. Multiple registrations increase the compliance load several-fold. They also add to the costs of administration, with not a paisa gained in revenues. Each registration is treated as a separate pocket, and no offsetting or consolidation of positive and negative balances in different accounts is allowed. This increases the working capital requirement of businesses. There are complex provisions for inter-branch distribution of input tax credits, which would not be needed under a single registration system.
The government press release says that the GST imposed on inter-branch supplies is not a cost to business as it is available as an input tax credit for the recipient branch. This is true only in theory; in practice, organisations dealing in a mix of taxable and exempt supplies (e.g., banks, companies dealing in basic food, alcohol, petroleum, electricity, real estate, and hospitals, etc) are allowed only a partial credit. Where the tax is fully creditable, why impose the burden of computing the tax on fictional supplies and then giving it all back?
The government has been very accommodative since the launch of GST in July 2017. Following global practices, it should repeal the provisions applying the tax on fictional supplies in the form of inter-branch cross charges. As they are unworkable and few companies are complying with them fully, their repeal should have no adverse impact on revenue, but would save the country wasteful spending on workaround solutions.
The author is MD, Acuris Advisors Pvt Ltd Views are personal