Unlock 1.0 may bring forth new GST challenges

Surbhi Premi | Updated on June 26, 2020

Businesses will need guidelines to deal with possible GST levy on failure to fulfil contracts, and cancellation or return of piled-up inventory

With Unlock 1.0, the nationwide Covid-19 lockdown is being relaxed in many States. The focus is on returning to normalcy for economic activities. Every business will face tremendous challenges as the nation begins the path to recovery, while still facing the public health threat of the virus. The challenges would be multifold — liquidity, labour shortage, unfulfilled contractual obligations, and tax and legal considerations.

In order to provide relief to businesses amidst the pandemic, the Ministry of Finance had introduced several relaxations and extensions in deadlines etc, with regard to compliances mandated under the GST law. Most of these extensions such as filing of appeals, replies, various returns/reports and deadlines for making GST payments — including TDS and TCS payments — will expire towards the end of June 2020. In the recent 40th GST Council meeting held on June 12, 2020, the Council has recommended relief by waiving late fees and interest only for small taxpayers (aggregate turnover upto ₹5 crore).

Contractual obligations

While being mindful of statutory compliances, businesses seek to understand their options and determine how to proceed in terms of contractual obligations. What happens if you or your suppliers cannot deliver goods and/or services on time, or there is a short lifting of goods as against the minimum committed quantity? What happens if the contract is cancelled? What happens if the supplier imposes interest/penalty on delayed payment, or if the advance is forfeited due to non-fulfillment of contractual terms?

Understanding your contractual obligations and others’ obligations to you is of utmost importance amid Unlock 1.0. This situation has led to several discussions around whether this pandemic will be treated as a force majeure event, to excuse a party of non-performance/delayed performance of contract or of having frustrated the contract such that it is rendered it impossible or impractical to perform. The applicability of force majeure is a question of interpretation, and is fact-specific. In cases where the plea of force majeure is untenable, contractual breaches such as non-performance or delayed performance of agreed obligations could result in a surge in claims for contractual penalties and damages.

Applicability of the GST on penalties and damages has always been a bone of contention, given that an entry in Schedule II of the CGST Act which deems “agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act” as a service. The challenge, therefore, is to determine whether the damages can constitute consideration for supply of service, namely agreeing to the obligation to tolerate an act.

There is a plethora of AARs which have upheld the levy of GST on contractual damages. This entry faced a series of challenges as a declared service under the erstwhile service tax regime as well. There are certain favourable Tribunal decisions holding non-applicability of service tax on damages. But the recent trend of AARs shows a clear departure from the earlier position taken by the Tribunal, and therefore, setting the field for future litigations. The true colour of the payment, whether named as penalty or damages, would depend on the facts and circumstances of each case.

Supply-chain disruptions

Yet another problem to be dealt with during Unlock 1.0 is piled-up inventory in the retail supply chain, either due to lower demand or due to cancellation of contracts and returns. Let’s take a simple example of return of goods, there would be two options. First, supplier can treat it as return of goods and issue a credit note to the recipient if the return is within the specified time prescribed under the CGST Act. The recipient would reverse ITC availed earlier and the supplier would adjust the excess tax paid due to return of goods.

Alternatively, the supplier can treat it as a fresh supply received from the buyer against a fresh invoice. The recipient would pay tax on the fresh supply, which should be available as ITC to the supplier. But the same would pose issues if the returned goods are expired. Here, the requirement of reversal of “attributable” ITC may arise in the hands of the supplier upon scrapping of the goods.

Let us take another example from service industry, say real estate, where the market is currently sluggish and there’s very clearly an overhang of inventory with the increasing load of contract cancellations. These are long-term contracts, and it is very much possible that at the time of their cancellation during the pandemic, the period for issuance of credit note as well as for filing of the refund claims both have already passed. It is vital that the government comes with a suitable amendment to clear the air.

In the recent GST Council meeting, no rate changes have been proposed. However, going by the global trend of slashing down the GST rates, it is still likely that a specified percentage GST rate reduction may be recommended by the GST Council specifically for the severely impacted sectors in its next meeting for the revival of industries. In a recent circular, department has taken a view that where the input and output are the same, though attracting different tax rates at different points in time, they shall not get benefit of refund due to inverted duty structure under Section 54 of the CGST Act. The government should immediately withdraw such a clarification. In fact, in such a scenario, where the rate reduction entails accumulation of credits, the Government should ensure a full refund of the credits so accumulated.

In this backdrop, not only would businesses have to reinvigorate their strategies to face the challenges posed by the global pandemic, but the government would also need to extend further assistance by way of effective measures to tide over the coronavirus crisis.

The writer is Joint Director, Lakshmikumaran & Sridharan Attorneys

Published on June 26, 2020

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