Understanding the differences in taxation of free services and sale of goods between the pre-GST and GST regimes
There may be free lunches, but it is quite clear that such lunches will not be free from tax. Recently, the tax department withdrew its demand notice to banks on free service. The Goods and Services Tax (GST) Council also issued an FAQ to clarify that certain free servicesprovided by banks will not be subject to GST. But the free supply of goods and services is not altogether outside the purview of GST. An extra portion of garlic bread may not be liable to GST, but if you have the opportunity to hear a live performance, be prepared to pay GST.
The pre-GST regime
Taxation of free services and sale of goods were generally not an issue in the pre-GST regime. This was because the basis for levying a tax (taxable event) — sale of goods or provision of services — generally contemplated consideration for such goods or services. A more precise definition with respect to the nature of the taxable event also reduced ambiguity — ‘sale’ or ‘services provided’ as against ‘supply’ in GST law. Manufacture of goods made the goods liable to excise duty, and inter-State sale of goods was exclusively subject to Central Sales Tax (CST). Only the Central government could levy both. Under CST, sale contemplated consideration, as did many of the State Value Added Tax (VAT) laws. Service tax law contemplated ‘value of services’ to be the ‘gross amount charged’ or value as determined. Barring the demand on free services in banking transactions, there was far greater clarity and certainty under the service tax regime and there have been limited instances of the tax department valuing free services. In respect of excise duty, testing samples and free samples were not exempted from excise duty, unless exempted by a specific circular. To encourage exports or for other administrative reasons, transactions of such a class were exempted from tax.
Another transaction of a similar nature was one between an employer and employee. The Authority for Advance Rulings (AAR) ruled that provision of canteen services by an employer for which recoveries were made from employees would be liable to GST. This was specifically exempted under a Service Tax Notification. Another issue that has arisen is applicability of GST between two branches of the same company — again an issue which didn’t arise under service tax laws, since taxable entities were considered to be different ‘persons’. In the context of goods, inter-State branch transfers were exempted under CST law, and VAT laws could not tax inter-State transfers. Similarly, sales made in customs area, previously exempt as a sale made in the course of export, has been held to be liable to GST by the AAR.
The legal question
GST has now done away with many of the exemptions and exceptions that formed an integral part of the pre-GST tax regime. There is nothing illegal or unconstitutional about this — the legislature in exercise of taxation powers has taxed legitimate transactions. Even if the tax authorities aren’t aggressively interpreting GST laws, a plain reading would show that the approach of the tax department may not be unreasonable. While we may debate the economic wisdom of taxing such transactions, we cannot question the legality. Sound economic canons require minimal exemptions and low rates for ease of administration and greater compliances.
But taxation of free services isn’t the dark line threatening the silver cloud of GST. Even the ominous anti-profiteering rules, with limited rulings and enforcement, haven’t been a poor measure in GST. Delayed refunds, taxation of exports and possibly taxation of digital economy seem to be more worrisome issues. The biggest concern, however, may relate to taxation powers itself. Powers of taxation between the Centre and States were meant to be mutually exclusive. However, the 101st Constitutional Amendment Act, 2016, may have left wiggle room for States by giving them power to tax ‘entertainments and amusements’. Concurrent exercise of taxation powers was impermissible prior to the constitutional amendment. This anomalous situation will enable a State to tax the same transaction that has already been subject to GST. The full effect of State autonomy has also not unfolded yet.
Despite the Supreme Court’s observations on cooperative federalism, differences between States and the Centre on tax allocation and finances are subject to political relations between the Centre and the State. One hopes that a pragmatic approach is taken as it would have adverse effects on businesses across the country.