Demand of GST on “Services of holding equity of subsidiary companies”

[Shripada Hegde]

Revenue Officers have started issuing notices (at least in Karnataka they have started issuing notices) demanding tax on ‘share capital held in subsidiary company’ or ‘share capital of a company held by a foreign holding company’. While on the first category tax is being demanded from the Indian Holding company under forward charge basis, in the second category tax is being demanded from Indian Subsidiary company under Reverse Charge Mechanism. Demand is made because the ‘Scheme of Classification of Service’ contains entry “Services of holding equity of subsidiary companies” against Service Code 997171. 18% tax rate is being adopted based on residual entry - Entry 15(v) of Notification No. 11/2017-Central Tax (Rate). To arrive at the taxable value some officers are adopting Earnings Per Share as taxable value for each share and some formations are adopting 1% of the share capital held as taxable value by applying Rule 32(2)(b)(i) equating the transaction to ‘Service of purchase and sale of Foreign Currency including money changing’. Gravity of the situation is such that an Indian Holding Company having subsidiaries (whether in India or abroad) will end up paying GST at 18% on its share of profits of all the subsidiaries and an Indian Subsidiary of a Foreign Company will end up paying GST at 18% on all of its profit allocable to equity shareholders (whether or not that profit is earned in India and whether or not one had paid GST on transactions through which such profit was earned). Worst part is, if such arguments are to hold good, entities will end up paying tax on their share of profit of subsidiary or their own profit, as the case may be, each year. In this article an effort is made to analyze the validity/correctness of such demands.

The biggest flaw in the notices being issued is the lack of explanation on how ‘what it claims to be a service’ fits into the definition of ‘service’ contained in Section 2(102) of CGST Act, 2017 or qualify as ‘supply’ in line with Section 7 of said Act. All that notices refer is the scheme of classification of service. Said scheme of classification was notified as an Annexure to Notification No. 11/2017-Central Tax (Rate). Said notification reads “In exercise of the powers conferred by sub-section (1), sub-section (3) and sub-section (4) of section 9, sub-section (1) of section 11, sub-section (5) of section 15, sub-section (1) of section 16 and section 148 of the Central Goods and Services Tax Act, 2017 (12 of 2017)”. Powers provided under these Sections are listed hereunder

• Section 9(1) – Gives power to notify rate of tax
• Section 9(3) – Gives power to notify categories of supply subject to RCM
• Section 9(4) – Gives power to notify class of persons subject to RCM on URD purchases
• Section 11(1) – Gives power to notify exemption from tax
• Section 15(5) – Gives power to notify manner of determining value in certain cases
• Section 16(1) – Gives power to notify conditions for availing ITC
• Section 148 – Gives power to notify certain classes of registered persons, and the special procedures to be followed by such persons including those with regard to registration, furnishing of return, payment of tax and administration of such persons (used in exceptional scenarios – like Notification No. 73/2020-CT to prescribe special procedure for issuance of e-Invoice till 31.10.2020)

From the above it is clear that none of provision from which power is drawn to issue the notification provide power to ‘deem a transaction as service’. Hence, a conclusion cannot be reached that anything and everything contained in Scheme of Classification qualifies as ‘Service’. It is a settled position of law that ‘burden of proof’ towards taxability of a transaction is always on revenue and revenue must explain and prove that a particular transaction on which tax is being demanded is taxable in the manner claimed by them. Section 9 of CGST Act levies tax on ‘supply of goods or services or both’. Hence, before demanding tax on any transaction one is bound to explain how a particular transaction fits into the scope of ‘supply’ and how ‘what is being alleged as supplied’ qualifies as ‘goods’ or ‘services’ or ‘both’. In the absence of any provision deeming a particular transaction to be a ‘service’ or power to notify such legal fiction, mere an entry in scheme of classification cannot be a ground to treat something as service. When notices don’t explain how a transaction fits into the definition of ‘Service’ and do not show how a transaction is covered within the meaning of ‘supply’, demands fail on the count of ‘burden of proof’.

The scheme of classification also contains entry for “Funeral, cremation and undertaking services” against Service Code 99973. However, “Services of funeral, burial, crematorium or mortuary including transportation of the deceased” have been prescribed neither as service nor as goods under Schedule III. When the very enactment, under which rate notification has been issued, prescribed that the “Services of funeral, burial, crematorium or mortuary including transportation of the deceased” shall not be supply of service, there is no reason why a classification is required to be prescribed via a notification (which is a subordinate legislation). With this, the argument – mere mention in scheme of supply doesn’t lead to a conclusion or assertion that there is a supply of service – gets furthered. Hence, mere reference to an entry in scheme of classification doesn’t discharge the revenue from its burden of proof towards taxability.

Nature of transaction is that holding company has bought the shares of the subsidiary. As per Section 44 of Companies Act, 2013 shares are ‘movable property’ (goods in other sense). Once the same is bought it is an asset of the buyer and he holds it as an owner of the asset. If the act of holding his own asset is interpreted as a service to someone else, such interpretation can only be called absurd.

Definition of both ‘goods’ and ‘service’ contained in GST Laws exclude ‘securities’ from the ambit of the scope of those terms. Hence, when the share is allotted – which is a transfer in property of a good – the transaction doesn’t qualify as supply of goods or supply of service. After the allotment any perks which are enjoyed by the owner of the shares is part and parcel of the transaction of sale/allotment of shares. When right to enjoy the perks arises as a result of transaction of sale/allotment of shares, mere enjoyment of the perks in itself cannot be a reason to imply/infer that ‘a service is being rendered’.

It is also to be noted that the entry in scheme of classification covers only the cases where shares are held by majority corporate shareholders. If the activity of ‘holding/owning shares of a company’ is a service, it should be a service irrespective of who is holding it or how much is being held. If that be the case, it would have been one of the big revenue generating service as PAT of all companies in India and relevant profit portion of all foreign companies would be subject to GST. Hence, if the legislative intent was to levy GST on PAT of all the companies there would have been clear provision in that respect. It would not have been the case that such big revenue generating activity is taxed in a hidden manner by including an entry in scheme of classification. Moreover, there was no reason to differentiate between majority stakeholders and minority stakeholders or corporate stakeholders and non-corporate stake holders. Equal treatment under law is a constitutional guarantee/right under Article 14. Differentiation can only be made on the basis of what is known as “reasonable classification”. If there are no sufficient reasons to apply separate treatments to transactions/persons of equal footing, the legislation would fail Article 14. It is not the case that GST is levied only on supplies made by corporates. Reduction of compliance burden to marginal/small shareholders is taken care by the 20/40 Lakhs exemption limit. Thus, if the ground that ‘holding shares is a service’ is to be assumed as correct for the sake of argument, there appears to be no basis for prescribing a classification and tax rate only with respect to transactions of corporate majority shareholders. No such basis was placed in public platform in any manner whatsoever. Thus, either the interpretation being adopted is contrary to legislative intent or the legislative intent may have to be tested for arbitrariness in the light of Article 14.

In GST the term ‘service’ has been given the widest meaning possible. The definition reads

“(102) "services" means anything other than goods, money and securities but includes activities relating to the use of money or its conversion by cash or by any other mode, from one form, currency or denomination, to another form, currency or denomination for which a separate consideration is charged;

Explanation – For the removal of doubts, it is hereby clarified that the expression "services" includes facilitating or arranging transactions in securities”

But the phrase “anything other than goods” cannot be interpreted to mean anything and everything under sun. Although usage of term “anything” gives a widest meaning to the scope of provision, it has to be understood and interpreted in the light of the context in which it has been used. In the case of GOVERNMENT OF NCT OF DELHI VERSUS UNION OF INDIA & ANOTHER [2018 (7) TMI 1426 - SUPREME COURT] had held – “words of  wide  import  must  be  construed by placing reliance upon the intention with which the said words have   been   used”; “the word 'any’ can have different meanings depending on the context in which it has been used and the Courts must not mechanically interpret it to mean 'everything'”. While highlighting the importance of context in understanding the words of wide import, Honorable Apex Court refers to J. L Austin’s observations - “When I see the word "any" in a statute, I immediately know it's unlikely to mean "anything" in the universe. “Any" will have a limitation on it, depending   on   the context. When my wife says, "there isn't any butter." I understand that she's talking about what   is in our refrigerator, not worldwide. We look at context over and over, in life and in law”. The Supreme Court of India also refers to the judgement of Supreme Court of United States in the case of Small vs United States wherein it was held "The question before us is whether the statutory reference   "convicted in any court" includes a conviction entered in a foreign court. The word "any" considered alone cannot answer this question. In ordinary life, a speaker who says, "I'll see any film," may or may not mean to include films shown in another city. In law a legislature that uses the statutory phrase "'any person'" may or may not mean to include "'persons'" outside the jurisdiction of the state.". After a detailed discussion the Apex Court has held that word ‘any’ cannot be read mechanically to mean ‘every’ and the context in which it has been used has to be given due weightage so as to deduce the real intention and purpose in which the word has been used.

GST was enacted to replace the erstwhile indirect tax laws and to bring the laws on taxing sale of goods and services under one umbrella. PAT of companies or share of profit of foreign companies were never transactions on which indirect taxes were levied. If the legislature had any intent of bringing a new category of transaction into the indirect tax bracket, such intention would have been brought on public platform in one form or the other and a detailed consideration would have been given to it. Even the enacted law would have made sure that such intent is reflected in the provisions of the Act. Moreover, profits of companies are already subject to levy of Income Tax. So are the share of profit received from foreign companies. In such circumstances, ‘anything other than goods’ cannot be so drastically interpreted to include even the investment in shares of a company and resultant passive enjoyment of perks of holding the shares. The provision of service should be established with positive evidences and not just inference. It is more so when ‘securities’ have been specifically kept out of the ambit of both ‘goods’ and ‘services’.

It is also to be noted that Explanation to Section 2(102) was inserted vide Central Goods and Services Tax (Amendment) Act, 2018 to explicitly clarify that “facilitating or arranging transactions in securities” is covered within the meaning of ‘service’. Even in general sense the act of ‘facilitating or arranging transactions in securities’ is considered as service and it in itself a business (intermediaries, brokers, depositories, etc.). But the legislature is conscious and careful enough to come out and explicitly put forth that such transactions (which are even otherwise considered as service by general public) are included in term ‘Service’. When circumstances are such, it could not have been the case that a transaction which in general is not considered as service in relation to securities is taxed in an indirect (or not so explicit/apparent) manner. Any such construction would not be harmonious with the rest of the law and is required to be avoided.

The valuation being adopted is also flimsy. Rule 32(2)(b)(i) is being adopted which is applicable only to ‘Service of purchase and sale of Foreign Currency including money changing’. This shows the sad state of affairs wherein tax administrators are not even able to differentiate between transaction of converting currencies and a transaction of investment. This also shows that administrators issuing notice themselves are not clear about the taxability of the transaction. If they are unable to differentiate these two wide apart transactions, one is left to wonder the effectiveness of consideration which will be given to the critical arguments the assessee may raise.

There is an urgent need for the Government to consider this issue and give a clarity so that assessee can choose the response in timely manner. If timely action is not taken, each company which is a subsidiary of a foreign company or has subsidiary will get dragged into the litigation. Headache of not having certainty is an additional side effect to the main effect of ‘cost of interest, penalty and loss of ITC’.

Any critical comments or additional points are most welcome.

Discussions to this article

[Arihant Sipani]

Nicely written

[Shyam Naik]

Government want all those business, who cannot afford hefty cost of litigation or approaching High Court for relief against senseless SCNs should be out of business.