GST UPDATE No 195 ON SC DECISION ON LEVY OF GST ON OCEAN FREIGHT UNDER RCM

The levy of tax on ocean freight under reverse charge mechanism is not free from disputes as the litigation has its roots in the erstwhile indirect tax regime. The confusion as regards levy of GST on the ocean freight paid by the foreign seller to a foreign shipping line under reverse charge mechanism by the importer was presented before the hon’ble Gujarat High Court in the case of MOHIT MINERALS PVT. LTD. wherein it was held that notification no. 8/2017-Integrated Tax (Rate) and Notification no. 10/2017-Integrated Tax (Rate) levying GST on ocean freight under RCM to be paid by importer was declared as unconstitutional and ultra vires the IGST Act, 2017. The issue further travelled before Apex Court and the final verdict was recently pronounced which is the subject matter of discussion of our present update. The respondent contended that the Section 13(9) of the IGST Act contemplates that the place of supply of services, in the case of transportation of goods shall be the destination of the goods. The respondent alleges that the impugned notifications create an element of double taxation, as ocean freight is included in the value of goods for the purpose of customs duty which the importer is liable to pay. The respondent does not dispute the liability of integrated tax on supply of service of transportation when it imports goods on an FOB basis. The Union of India urged before the High Court that although tax is being paid twice on the value of ocean freight, it is not unconstitutional as the tax is on two different aspects of the transaction, namely the supply of service and import of goods. The rationale for the impugned notifications, according to the Union Government, is to remove the disparity between Indian and foreign shipping lines, as the former are unable to claim input tax credit that forms a part of their transportation costs, since supply of goods was hitherto exempt from service tax. The levy of the integrated tax does not, according to the Union of India, impose an additional cost on importers as the cost paid on inward transportation of goods and import CA. PRADEEP JAIN ??www.capradeepjain.com??pradeep@capradeepjain.com??5 freight services is available to them as ITC. The Union Government has contended that the recommendations of the GST Council are binding on the legislature and the executive. It was submitted that since the recommendations are binding, the rule making power of the Government under the provisions of the IGST Act and CGST Act, exercisable on the ‘recommendations’ of the GST Council, are also very wide. The Supreme Court analysed the legislative history of the Constitution and held that before the introduction of Articles 246A and 279A by the Constitution Amendment Act 2016, the legislative powers of the Union and the States on taxation were exclusive. The Union and the State could not impose tax under the same head since the concurrent list did not include an entry for taxes. Reliance was also placed on the decision given in the case of HOECST PHARMACEUTICALS LTD. VERSUS STATE OF BIHAR which recognised the exclusive powers held by the Union and the State on taxation. In the pre-GST regime, Union had the exclusive power to impose indirect taxes on inter-state sale of goods while States had the exclusive power to impose tax on intra-state sale of goods. With introduction of GST, Article 246A was introduced which vests the Parliament and the State Legislatures with concurrent power to make laws with respect to GST. Article 246A has a non-obstante provision which overrides Article 254. Article 246A does not provide a repugnancy clause. Unlike Article 254 which stipulates that the law made by Parliament on a subject in the Concurrent list shall prevail over conflicting laws made by the State legislature, the constitutional design of Article 246A does not stipulate the manner in which such inconsistency between the laws made by Parliament and the State legislature on GST can be resolved. The constitutional role and functions of the GST Council must be understood in the context of the simultaneous legislative power conferred on Parliament and the State legislatures. It is from that perspective that the role of the GST Council becomes relevant. It was noted that the GST Council will be a joint forum for the Union and the States to discuss issues on GST and the recommendations of the GST Council will be a benchmark and guiding force CA. PRADEEP JAIN ??www.capradeepjain.com??pradeep@capradeepjain.com??6 for the Union and State Governments. In the same vein, it was observed that the legislature will be free to exercise its power on all issues recommended by the Council. The Standing Committee reiterated in its conclusion that GST Council will only play a ‘constructive and enabling role’ vis a vis the legislature would not override the role of the legislature. The Apex Court held that though the legislative history is not readily used in interpreting the law as per the traditional view of interpretation of statues, modern trend of thinking has enabled the Courts to look at the history of legislation to understand the purpose of words used. In this context, reliance is placed on decision given in the case of K P VARGHESE VS ITO and KALPANA MEHTA VERSUS UNION OF INDIA. The Supreme Court also discussed the nature of the recommendations of the GST Council. Article 246A vests Parliament and the State Legislatures with a unique, simultaneous law-making power on GST. It is in this context that the role of the GST Council gains significance. The recommendations of the GST Council are not based on a unanimous decision but on a three-fourth majority of the members present and voting, where the Union’s vote counts as one-third, while the States’ votes have a weightage of two-thirds of the total votes cast. First, the GST Council has an unequal voting structure, where the States collectively have a two-third voting share and the Union has a one-third voting share; and second, since India has a multi-party system, it is possible that the party in power at the Centre may or may not be in power in various States. Therefore, the GST Council is not only an avenue for the exercise of cooperative federalism but also for political contestation across party lines. Thus, the discussions in the GST Council impact both federalism and democracy and cannot be binding. Furthermore, the meaning of “recommendations” was analysed and it was held that the Article 279A states that recommendations of the Council shall be made to the “Union and States” and so notion that recommendations of the GST Council will transform into legislation automatically is farfetched. As Article 279A does not begin with non-obstante clause, the recommendations of Council do not transform into legislation. Hence, GST Council is CA. PRADEEP JAIN ??www.capradeepjain.com??pradeep@capradeepjain.com??7 recommendatory body aiding the government in enacting legislation on GST. Reliance was placed on decision given in the case of MANOHAR VERSUS STATE OF MAHARASHTRA wherein it was held that ‘recommendation’ must be interpreted in contradistinction to ‘direction’ or ‘mandate’. Similarly, reliance was placed in the case of NARAINDAS INDURKHYA V. STATE OF MADHYA PRADESH wherein a Constitution Bench observed that a ‘recommendation’ has persuasive value. It was further stated that certain provisions of the IGST Act, CGST Act and SGST Acts expressly provide that the rule-making power delegated to the Government shall be exercised on the recommendations of the GST Council. Merely because a few of the recommendations of the GST Council are binding on the Government under the provisions of the CGST Act and IGST Act, it cannot be argued that all of the GST Council’s recommendations are binding. The Apex Court framed the question that whether Central Government, in consultation with the GST Council, has the powers to designate the importer as a recipient of service under section 5(4) of the IGST Act, when goods are imported on CIF basis. The critical fact in this case is that the service of shipping in these CIF contracts is availed by the non-taxable exporter who engages and pays a foreign shipping line of their choice, without the involvement of the importer. In contrast, in FOB contracts, the Indian importer pays for the services of shipping and directly deals with the shipping line. It was further pointed that the payment of IGST under RCM is provided in section 5(3) and 5(4) of the IGST Act, 2017. As per section 5(3), IGST may be paid on reverse charge basis on specified categories of supply of goods or services or both. The Central Government is empowered to specify the categories on the recommendations of the GST Council. The power is to only specify categories of goods or services and not to specify recipient of the supply of goods or services. Hence, the moot question is whether entry 10 of notification no. 10/2017 deeming importer of goods as recipient of service of transportation of goods is ultra vires the IGST Act. Similarly, whether entry 9(ii) of notification 8/2017 levying IGST of 5% CA. PRADEEP JAIN ??www.capradeepjain.com??pradeep@capradeepjain.com??8 on transportation of goods in a vessel from a place outside India upto the customs station of clearance in India is ultra vires the IGST Act. The Apex Court held that the legislature is required to perform its essential legislative functions. Once the skeletal structure of the policy is framed by the legislature, the details can emerge through delegated legislations. It is a settled position that the legislature cannot delegate its ‘essential legislative functions’. The essential legislative functions with respect to the GST law are the levy of tax, subject matter of tax, taxable person, rate of taxation and value for the purpose of taxation. The respondents have alleged that the importer cannot be validly termed as a taxable person. However, this argument has to fail on a close reading of the impugned notifications alongside Sections 2(107) and 24 of the CGST Act. Section 24(iii) of the CGST Act mandates persons required to pay tax under reverse charge to be compulsorily registered under the CGST Act. Section 2(107) of the CGST Act defines a “taxable person” to mean a person who is registered or liable to be registered under Section 24 of the CGST Act. Neither Section 2(107) nor Section 24 of the CGST Act qualify the imposition of reverse charge on a “recipient of service” and broadly impose it on “the persons who are required to pay tax under reverse charge”. Since the impugned notification 10/2017 identifies the importer as the recipient liable to pay tax on a reverse charge basis under Section 5(3) of the IGST Act, the argument of the failure to identify a specific person who is liable to pay tax does not stand. The Supreme Court concluded the issue in favour of the taxpayer by referring to the provisions of composite supply and issues of double taxation. It was pleaded that the transaction between the foreign exporter and respondents is already subject to IGST as ‘supply of goods’. An additional levy of IGST on imported goods, that is on the supply of transportation service by designating the importer as the recipient would amount to double taxation. The transaction at hand involves three parties- the foreign exporter, the Indian importer and the shipping line. The first leg of the transaction involves a CIF contract, wherein the foreign exporter CA. PRADEEP JAIN ??www.capradeepjain.com??pradeep@capradeepjain.com??9 sells the goods to the Indian importer and the cost of insurance and freight are the responsibility of the foreign exporter. In other words, the foreign exporter is liable to ensure that the goods reach their place of destination and the Indian importer pays the transaction value to the exporter. The second leg of the transaction involves an agreement between the foreign exporter and the shipping line (whether foreign or Indian) for providing services for transport of goods to the destination, i.e., in the territory of India. On the first leg of the transaction, between the foreign exporter and the Indian importer, the latter is liable to pay IGST on the transaction value of goods under Section 5(1) of the IGST Act read with Section 3(7) and 3(8) of the Customs Tariff Act. Although this transaction involves the provision of services such as insurance and freight it falls under the ambit of ‘composite supply’. Furthermore, as per provision contained in section 2(30) of the CGST Act, 2017, a transaction may have two or more taxable supplies, where one of them is a principal supply so in case of CIF contracts for supply of goods, principal supply is that of supply of goods. As per section 8 of the CGST Act, 2017, tax liability on composite supply which comprises of two or more supplies will be levied on principal supply. Thus, it was pleaded that IGST is payable only once on the entire transaction of CIF contract of supply of goods. It was urged by the respondents that levy of IGST on service aspect of the transaction separately will violate the concept of ‘composite supply’. On the contrary, Union Government has submitted that the impugned levy is on the second leg of the transaction, which is a standalone contract between the foreign exporter and the foreign shipping line and has also placed reliance on the decision given in the case of McDowell. The Union Government has urged that the levy is on different aspects of the transaction which was not agreed to by the Supreme Court. The Apex Court held that the submission of the respondent that importer cannot be considered as recipient as importer is not party to contract between foreign exporter and foreign shipping line plus importer does not pays consideration to the foreign shipping line. This submission has been rejected by the Supreme Court on the grounds that the notifications prescribing importer as recipient are valid as law is beyond contract CA. PRADEEP JAIN ??www.capradeepjain.com??pradeep@capradeepjain.com??10 executed for transaction. However, the Union Government is now contradicting the main plank of its submission by contending that the two legs of transaction are separate standalone agreements. That would imply, that while on the one hand the Union Government seeks to levy tax on the Indian importer by going beyond the text of the contract between the foreign shipping line and foreign exporter (for the purpose of identifying the Indian importer as the recipient of services), on the other hand, as far as the submissions on composite supply are concerned, the Union Government urges that the contracts must be viewed as separate transactions, which is unjustifiable. The Union of India cannot be heard to urge arguments of convenience – treating the two legs of the transaction as connected when it seeks to identify the Indian importer as a recipient of services while on the other hand, treating the two legs of the transaction as independent when it seeks to tide over the statutory provisions governing composite supply. The Apex Court concluded that levy of IGST on the supply of service component of the transaction would contradict the principle of composite supply as enshrined in section 8 and will be in violation of the scheme of the legislation. It was held that while the impugned notifications are validly issued under Sections 5(3) and 5(4) of the IGST Act, it would be in violation of Section 8 of the CGST Act and the overall scheme of the GST legislation to levy IGST separately on ocean freight in CIF contract. Moreover, it was stated that as per section 7(3) of the CGST Act, 2017, the Central Government has the power to notify an import of goods as import of services and vice-versa whereas there is no such power to interpret composite supply of goods and services as two segregable supply of goods and supply of services. Hence, the Supreme Court agreed with the view of the Gujarat High Court that a tax on supply of a service which has already been included by the legislation as a tax on the composite supply of goods cannot be allowed. The above decision is landmark decision as it seeks to quash the levy of IGST on ocean freight in CIF contracts which was menace to the taxpayer. Although, the input tax credit of the IGST paid on ocean freight was admissible but there were taxpayers who were already having excess input tax credit and wanted to avoid payment of IGST on ocean freight under reverse charge mechanism. This CA. PRADEEP JAIN ??www.capradeepjain.com??pradeep@capradeepjain.com??11 decision is highly appreciated as it seeks to remove redundant provision as even if IGST was paid under RCM, taxpayers were eligible for availing input tax credit thereby leading to revenue neutral situation.

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GST UPDATE No 195 ON SC DECISION ON LEVY OF GST ON OCEAN FREIGHT UNDER RCM

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