APEX COURT ON TAXABILITY OF FREE SUPPLIES

[Dr. Sanjiv Agarwal]

Any indirect tax has to be levied on the basis of valuation of goods or services. In case of Goods and Services Tax (GST), it is on the value of supplies where as in erstwhile Service Tax regime, it was on value of taxable services provided or to be provided.

The value of taxable service means, the gross amount received by the service provider for the taxable service provided or to be provided by him. Taxable value had to be determined as per the provisions of the Section 67 of the Finance Act, 1994 read with Service Tax (Determination of Value) Rules, 2006. Section 67 and valuation rules enabled charging of service tax in cases where the consideration received is not in money terms. Where the service tax was charged on the basis of similar services provided by the same person, the same ought to be based on a normal transaction between two independent persons at an arm’s length price.

Free Services / Goods

In many cases, free supply of goods and /or services are involved which pose challenge to valuation thereof and whether same would be included in valuation for taxation purposes or not.

Service Tax (Determination of Value) Rules, 2006 in rule 3 addresses the issue of determining the value of taxable service. It addresses two situations - one where consideration is not wholly or partly in money and two, where consideration is not ascertainable. In both the cases, there must be some consideration, whether in money form or in non-ascertainable form. The valuation rules apply only when some consideration is received or given. There was no deeming provision in section 67 or the rules framed thereunder.

If there is no consideration, there is no value of taxable service or its value is nil and therefore, there cannot be any levy of service tax thereon [Also see Chandravadan Desai v. CCE, Calcutta-I 1997 (9) TMI 1 - CEGAT (CALCUTTA) ].

Receipt of free supply of items by a manufacturer is similar to receipt of materials free of cost by a service provider, as both the manufacturer and the service provider will have to otherwise incur cost of these items to produce excisable goods or to render taxable service. In both the cases, receipt of free supply of materials does not yield any additional return to the assessee. However, it is well recognized that for the purpose of section 4 of the Central Excise Act, free supply of items constitutes additional consideration received by a manufacturer. Therefore, inclusion of money value of free supply on items in the taxable value of the service rendered is consistent with the intention of the Legislature as reflected in the language of the Act as well as the Service Tax (Determination of Value) Rules, 2006. In a case where the service recipient does not provide such items to the service provider, the assessee will include the value of the materials used in rendering the taxable service and charge the same from the client. The assessee cannot exclude the value of these material in computing the taxable value. The Commissioner rightly relied on the judgment of Supreme Court in Burn Standard Co. Ltd v. Union of India 1991 (7) TMI 102 - SUPREME COURT OF INDIA wherein it was held that value of free supply of items was includible in the assessable value under section 4 of Central Excise Act. (Refer VPR Mining Infrastructure Pvt. Ltd v. CCE, Hyderabad ( 2011 (3) TMI 183 - CESTAT, BANGALORE )

In view of conflicting decisions, Larger Bench of Tribunal analyzed the issue of taxability of free supply of goods or materials in cases of construction of services in a bunch of 23 appeals in Bhayana Builders Pvt. Ltd. v. CST, Delhi  2013 (9) TMI 294 - CESTAT NEW DELHI (LB) and its inclusion in value for the purpose of exemptions. There are certain exemption in Service Tax which are allowed subject to non-availment of Cenvat Credit or no benefit been taken under any other notification or exemption subject to full value including free supply being considered.

It observed that section 67 of the Act deals with valuation of taxable services and intends to define what constitutes the value received by the service provider as “consideration” from the service recipient for the service provided. Implicit in this legislative architecture is the concept that any consideration whether monetary or otherwise should have flown or should flow from the service recipient to the service provider and should accrue to the benefit of the later. “Free supplies”, incorporated into construction (cement or steel for instance), even on an extravagant inference, would not constitute a non-monetary consideration remitted by the service recipient to the service provider for providing a service, particularly since no part of the goods and materials so supplied accrues to or is retained by the service provider. Wherever a monetary consideration is charged for providing the taxable service and no non-monetary consideration forms part of the agreement between the parties, the value of the taxable service would in such case be the gross amount charged by the service provider and paid by the service recipient.

Thus, section 67 did not require inclusion of free supplies in the gross value charged for computation of the value of taxable services. Based on a reasoned interpretation, the bench concluded that -

“goods and materials, supplied/provided/used by the service provider for incorporation in the construction, which belong to the provider and for which the service recipient is charged towards the value of such supply/provision/use and the corresponding value whereof was received by the service provider, to accrue to his benefit, whether independently specified as attributable to the specific material/goods incorporated or otherwise, would alone constitute the gross amount charged. This is not to say that an exemption Notification cannot enjoin a condition that the value of free supplies must also go into the gross amount charged for valuation of the taxable service. If such intention is to be effectuated the phraseology must be specific and denuded of ambiguity.”

The final conclusion was thus as follows :

“(a) The value of goods and materials supplied free of cost by a service recipient to the provider of the taxable construction service, being neither monetary or non-monetary consideration paid by or flowing from the service recipient, accruing to the benefit of service provider, would be outside the taxable value or the gross amount charged, within the meaning of the later expression in Section 67 of the Finance Act, 1994; and

(b) Value of free supplies by service recipient do not comprise the gross amount charged under Notification No. 15/2004-ST, including the Explanation thereto as introduced by Notification No. 4/2005-ST.”

Supreme court has recently settled this issue by its order dated 19.02.2018 in CST v. Bhayana Builders Pvt. Ltd. [(2018) 2 TMI 1325(SC)] deciding in favour of assessee and against the revenue. It observed that explanation 3 to sub-section (1) of Section 67 removes any doubt by clarifying that the gross amount charged for the taxable service shall include the amount received towards the taxable service before, during or after provision of such service, implying thereby that where no amount is charged that has not to be included in respect of such materials/goods which are supplied by the service recipient, naturally, no amount is received by the service provider/assessee. Though, sub-section (4) of Section 67 states that the value shall be determined in such manner as may be prescribed, however, it is subject to the provisions of sub-sections (1), (2) and (3). Moreover, no such manner is prescribed which includes the value of free goods/material supplied by the service recipient for determination of the gross value.

A plain meaning of the expression ‘the gross amount charged by the service provider for such service provided or to be provided by him’ would lead to the obvious conclusion that the value of goods/material that is provided by the service recipient free of charge is not to be included while arriving at the ‘gross amount’ simply, because of the reason that no price is charged by the assessee/service provider from the service recipient in respect of such goods/materials. This further gets strengthened from the words ‘for such service provided or to be provided’ by the service provider/assessee. Again, obviously, in respect of the goods/materials supplied by the service recipient, no service is provided by the assessee/service provider.

Service tax is to be calculated on a value which is 33% of the gross amount that is charged from the service recipient. Obviously, no amount is charged (and it could not be) by the service provider in respect of goods or materials which are supplied by the service recipient. It also makes it clear that valuation of gross amount has a causal connection with the amount that is charged by the service provider as that becomes the element of ‘taxable service’.

Likewise, the words, ‘any amount credited or debited, as the case may be’, to any account whether called ‘suspense account or by any other name, in the books of accounts of a person liable to pay service tax’ would not include the value of the goods supplied free as no amount was credited or debited in any account. In fact, this last portion is related to the debit or credit of the account of an associated enterprise and, therefore, takes care of those amounts which are received by the associated enterprise for the services rendered by the service provider. The service tax is to be levied in respect of ‘taxable services’ and for the purpose of arriving at 33% of the gross amount charged, unless the value of some goods/materials is specifically included by the Legislature, that cannot be added.

The sole question before the Court was that whether, the value of goods/material supplied or provided free of cost by a service recipient and used for providing the taxable service of construction or industrial complex, is to be included in computation of gross amount (charged by the service provider), for valuation of the taxable service, under Section 67 of the Act and for availing the benefits under Notification No. 15/2004-ST dated September 10, 2004.

In a ruling in favor of the assessee, it has been held that service tax cannot be levied on the value of goods/material supplied free of cost by a service recipient during construction. The assessees in the instant case were covered by Section 65(25b) of the Finance Act, 1994 as they are rendering ‘construction or industrial construction service’, which is a taxable service as per the provisions of Section 65(105)(zzq) of the Finance Act.

This order of Supreme Court settles the issue of taxability of free supplies in of goods and services favour of taxpayers and against the revenue. However, in GST regime, such supplies shall be taxable in view of the statutory provisions.