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UNDERSTANDING COMPOSITE SUPPLIES UNDER GST

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UNDERSTANDING COMPOSITE SUPPLIES UNDER GST
By: Srikantha RaoT
November 2, 2018
  • Contents

Composite contracts have traditionally posed problems in terms of taxation under service tax and VAT over the years. Very often the matter had to be referred to Courts for resolution of issues. The complications were due to the fact that the two levies referred to above were falling under different tax jurisdictions i.e. one with Union and the other with the States respectively. Resolving this issue was therefore one of the priorities while seeking to introduce GST (Goods & Services Tax). In GST an effort has been made to define composite supply where there is a mix of goods or services or both and to introduce a deeming fiction on classification thereof based on   perceived dominant component of the same for taxing the mix.

Catering contracts, erection, commissioning and installation contracts and annual maintenance contracts and some supply and installation contracts to name a few, have all come into focus in this regard. The question of splitting up a contract into one of supply of goods and one for service has come up quite often in recent past in all these cases. One of the trends noticed has been the high number of cases that have been referred to Advance Ruling authorities across States by assessees owing to the fear of possible substantial litigation costs at a later date in the event of wrong classification of contracts and objection by Revenue Authorities thereon. It would be interesting to look at these Rulings to understand principles followed even though the Rulings in themselves are not binding on assessees other than the Applicant.

Before we proceed further it would be pertinent to understand the legal provisions under GST with regard to composite supplies. Section 2(30) of Central Goods & Services Tax Act 2017 defines the term “composite supply” to mean a supply made by a taxable person to a recipient consisting of two or more taxable supplies of goods or services or both, or any combination thereof, which are naturally bundled and supplied in conjunction with each other in the ordinary course of business, one of which is a principal supply. An illustration has also been provided to explain the concept and this goes as follows - “Where goods are packed and transported with insurance, the supply of goods, packing materials, transport and insurance is a composite supply and supply of goods is a principal supply.”

One of the reasons why a proper determination of the nature of the contract is so critical is the fact that u/s 8(a) of Central Goods & Services Tax Act 2017 the tax liability in respect of a composite supply comprising of two or more supplies, one of which is a principal supply, is based on the principal supply. This is because the composite supply is treated as a supply of such principal supply. This would mean classification and rates of tax being based on such principal supply. One more reason is to avoid classification of the contract as a mixed supply which if found to hold true, would involve taxing of the supply under the contract at the highest applicable tax rate of all tax rates found to apply to various components of the mixed supply going by Section 8(b) of the Act.

The term “mixed supply” has been defined under the Act u/s 2(74) to mean two or more individual supplies of goods or services, or any combination thereof, made in conjunction with each other by a taxable person for a single price where such supply does not constitute a composite supply. An illustration has been provided as follows – “A supply of a package consisting of canned foods, sweets, chocolates, cakes, dry fruits, aerated drinks and fruit juices when supplied for a single price is a mixed supply. Each of these items can be supplied separately and is not dependent on any other. It shall not be a mixed supply if these items are supplied separately.”

While the illustrations given in definitions seem to deal with simplistic scenarios, in reality the scenarios could be far more complex and there could be genuine difficulties in identifying the true nature of certain supplies. This is also compounded by the fact that the concept of “natural bundling” referred in the definition above has not been elaborated further. One would have to look at circumstances of each case in order to see whether or not various elements of a supply can be seen to be bundled so as to satisfy definition of composite supply. If one were to refer P. Ramanatha Aiyar’s Advanced Law Lexicon (Page 3193 4th edition Volume 3 Published by LexisNexis Butterworths Wadhwa) the term “naturally” signifies according to the nature of things, and applies therefore to the connection which subsists between events according to the original constitution or inherent properties of things.

The term “bundling” on Page 630 of Volume 1 of the said Advanced Law Lexicon has been defined to be practice of providing more than one product or service at once at an inclusive price (such as software with a computer or life assurance with a loan). Looking at both these terms together one can possibly conclude that where goods or services are to be clubbed or provided together considering their nature as well as inherent properties apart from usual trade practice followed, there can arise a composite supply. Schedule II to Central Goods & Services Tax Act 2017 read with Section 7(1A) of the Act provides list of some supplies which are deemed to be services even if there is some element of transfer of property in goods involved in their execution. These are –

  • Treatment or process which is applied to another person’s goods i.e. job work
  • Works contracts
  • Development, design, programming, customisation, adaptation, upgradation, enhancement, implementation of information technology software
  • Supply, by way of or as part of any service or in any other manner whatsoever, of goods, being food or any other article for human consumption or any drink (other than alcoholic liquor for human consumption), where such supply or service is for cash, deferred payment or other valuable consideration.

While the schedule specifically talks about the second and fourth entries above as composite supplies, in reality there could be other cases of such supplies where combination of goods or of services or both are involved. What is also relevant is the fact that the concept of works contract u/s 2(119) of CGST Act 2017 has undergone a change in GST as compared to the old law/s as it is now restricted to immovable properties alone. So, while classifying a contract resulting in immovable property would not be much of a problem, scenario could be different where goods are involved and resulting property (if any) is movable. In such cases, one guideline would be the test laid down by the Supreme Court in Bharat Sanchar Nigam Limited Vs UOI (2006 (3) TMI 1 - Supreme Court) where the need to determine substance of the contract or adopting the dominant nature test was highlighted. This would continue to hold good even today.

We have had couple of circulars post 1st July 2017 seeking to clarify the concept of composite supply in certain specific instances. In Circular 11/11/2017 GST dated 20th October 2017, in the context of printing contracts with respect to books, pamphlets, brochures, letter cards etc. the following has been clarified –

“In the case of printing of books, pamphlets, brochures, annual reports, and the like, where only content is supplied by the publisher or the person who owns the usage rights to the intangible inputs while the physical inputs including paper used for printing belong to the printer, supply of printing [of the content supplied by the recipient of supply] is the principal supply and therefore such supplies would constitute supply of service falling under heading 9989 of the scheme of classification of services.”

“In case of supply of printed envelopes, letter cards, printed boxes, tissues, napkins, wall paper etc. falling under under Chapter 48 or 49, printed with design, logo etc. supplied by the recipient of goods but made using physical inputs including paper belonging to the printer, predominant supply is that of goods and the supply of printing of the content [supplied by the recipient of supply] is ancillary to the principal supply of goods and therefore such supplies would constitute supply of goods falling under respective headings of under Chapter 48 or 49 of the Customs Tariff.”

This nevertheless would require readers to analyse each case to determine the predominant supply element in order to correctly classify the contract. In Circular 34/8/2018 GST dated 1st March 2018, supply of retreaded tyres where the old tyres belong to the supplier has been held to be supply of goods. One of the yardstick which could be considered to determine essential nature has been held to be that of value involved which though need not be the sole indicator.

In Circular 32/06/2018 GST dated 12th February 2018, in the context of food supplied to in-patients while providing healthcare services by a clinical establishment, the following has been clarified - “Food supplied to the in-patients as advised by the doctor/nutritionists is a part of composite supply of healthcare and not separately taxable. Other supplies of food by a hospital to patients (not admitted) or their attendants or visitors are taxable.” 

It would now be worthwhile to look at some of the decisions in the context of composite supply which could be used to understand the concept.

Free supply of medical instruments without consideration linked to supply of reagents having consideration

In Abbott Healthcare (P) Ltd., (2018 (10) TMI 598 Authority For Advance Rulings Kerala), the placement of specified medical instruments to unrelated customers like hospitals, labs etc. for their use without any consideration, against an agreement containing minimum purchase obligation of products like reagents, calibrators, disposals etc for a specific period constitute composite supply. Here, if the customer failed to meet its exclusive purchase obligation or its minimum purchase obligation, the applicant had the right to recover the deficit amount from the customer. This was a Ruling based on analysis of the real intention of the supplier on review of contractual terms.

After sales services provided in India to end customers

In Toshniwal Brothers (SR) Private Limited, (2018 (10) TMI 597 Authority For Advance Rulings Karnataka), the Authority held that pre-sales marketing and promotion services for client located outside India and post sales support and installation services could not be naturally bundled as post sale service is dependent on there being a supply from client located outside India to the end consumer in India. This was therefore held not to be composite contract with the pre-sales promotion and related service being regarded as intermediary services owing to service provider in India acting as agent of foreign principal and engaging in price negotiations on his behalf.  

Blasting work carried on at customer site

In M/s Khedut Hat (2018 (10) TMI 302 Authority for Advance Ruling (Gujarat)), use of explosives for carrying out the service of blasting activity was held to result in composite supply owing to deemed transfer of consumables/explosives used in the service. This was despite explosives never being handed over to client. This however will have to withstand judicial scrutiny if one were to consider dominant nature test.  

Body building on vehicle chassis

This has been subject matter of some confusion of late. There are two Circulars from Tax Research Unit of Department of Revenue, Ministry of Finance which seem to contradict each other in some ways. Circular 34/8/2018 GST dated 01st March 2018 clarifies that in the case of bus body building there is supply of goods and services. Thus, classification of this composite supply, as goods or service would depend on which supply is the principal supply which may be determined on the basis of facts and circumstances of each case. However Circular 52/26/2018 GST dated 9th August 2018 seeks to take a definitive stance on the bus body building activity undertaken by fabricator for principal who sends the chassis, by classifying it as a service and taxing it as such.

Similarly, we have two advance rulings which contradict each other. In Re: M/s Paras Motor Industries (2018 (7) TMI 1422 Authority For Advance Rulings Haryana), the Authority held bus body building activity to be supply of bus body and activity of fitting/mounting of bus body on chassis being ancillary activity to the principal activity of supply of bus-body. Hence, in terms of the clarification issued by the CBEC vide circular No.34/8/2018-GST dt. 01.03.2018, the activity was held to be a composite supply, with principal supply being supply of bus-body. In Re: Arpijay Fabricators Pvt. Ltd (2018 (8) TMI 284 Authority For Advance Rulings Madhya Pradesh), the Authority disagreed with the contention of the Applicant that body building activity is a service.

The Authority was of the view that the statute nowhere provided for ‘predominant intention’. The classification in case of a composite supply had to be arrived at on the basis of ‘predominant element’ of a composite supply, which in turn would be the ‘Principal Supply. It held that the predominant component of the composite supply involved in the activity of Body Building would determine the rate of tax applicable on such composite supply. In case the ‘Goods’ part was predominant, then the Composite Supply in that case would be governed by Chapter 87 depending upon the nature of body being built by the Applicant on the chassis supplied by the principal. In case, the ‘Service’ part was predominant in the composite supply, then the rate of tax would be applicable as per Heading No.9988 i.e. as a service.

In a recent Ruling in M/s Automobile Corporation of Goa Ltd (2018 (10) TMI 1044 Authority For Advance Ruling Goa), the Authority followed the view that body building on chassis supplied by principal under FOC challan would be service and taxed at 18% while body building on own chassis would tantamount to supply of bus and taxed at 28%

Supply of battery with UPS

Where an Uninterrupted Power Supply is supplied along with battery there could be a case for regarding the same as a composite supply as UPS cannot function without a battery. However, In Re: M/s Switching Avo Electro Power Limited (2018 (8) TMI 1071 Appellate Authority For Advance Rulings West Bengal) the Appellate Authority has held that when the battery is supplied separately with UPS, the same cannot be considered as composite supply or naturally bundled supply. The Appellate Authority was of the view that when a UPS is supplied with built-in batteries so that supply of the battery is inseparable from supply of the UPS, it should be treated as a composite supply and as a composite machine.

Whether or not a composite machine can be equated with a composite supply is in itself a question which will have to be taken up before the Judiciary as we are not dealing with classification of one item as such but a combination of items each of which may be separately classifiable individually but presented together as a bundled supply. This point would assume significance if we were to look at accessories to certain goods which are presented along with the principal item/goods. For example, cell phone and battery charger where the latter was regarded as accessory in Nokia India Pvt. Ltd vs State of Punjab (2014 (12) TMI 836 Supreme Court) and not part of composite goods i.e. cell phone for classification. This pertained to a scenario where battery charger was claimed to be part of cell phone.

The issue on hand now is one of composite supply and if one were to go by the Arthaikatva axiom under Mimansa Rules of Interpretation ((Pages 80-81) of KL Sarkar’s Mimansa Rules of Interpretation (Tagore Law Lectures 1905) Fourth Edition Edited by Justice Markandey Katju Published by Thomson Reuters), double meaning cannot be attached to a word or sentence occurring at one and same place to bear both literal and metaphorical senses at the same time. This could mean composite supply not being capable of being equated with composite goods.  

Supply in the course of works contract execution

While the test for determining whether or not a contract could be construed as works contract has been laid down by the Supreme Court in M/s Kone Elevator India Pvt. Ltd Vs State of Tamil Nadu & Others (2014 (5) TMI 265 Supreme Court) and in M/s Larsen & Toubro Limited & Another Vs State of Karnataka & Another (2013 (9) TMI 853 Supreme Court) and this could be followed by readers, there have been few Advance Rulings under GST in the context of classification of supplies under turnkey contracts.

In Re: Vihaan Enterprises (Swati Dubey) (2018 (9) TMI 546 Authority For Advance Ruling Madhya Pradesh), agreement for constructing a Pooling Sub-station on turnkey basis was held to be works contract and all supplies thereunder held to be one of composite supply of works contract which was classifiable as a service. In re: Dinesh Kumar Agrawal (2018 (6) TMI 466 Authority For Advance Rulings Andhra Pradesh), supply of solar power plant under turnkey EPC contract involving civil works, procurement of goods and erection and commissioning was held not to amount to supply of solar power generating system for any possible exemption. Where supply of components was by one contractor and erection, commissioning and installation undertaken by another contractor, one could have a case of supply by the former where transfer of title over goods was involved.

In Fermi Solar Farms Private Limited (2018 (9) TMI 1339 Appellate Authority For Advance Ruling Maharashtra), contract for setting up and operating a solar power plant was held to be a composite supply in the nature of works contract which could not be split artificially into one for supply and one for service as the implementation schedule also included erection, testing and commissioning of plant. The fact that resulting property was immovable in nature and until date of final acceptance all risk of loss was with supplier and not customer, was also relied upon to arrive at the conclusion.

In re: M/s R.B Construction Company (2018 (6) TMI 559 Authority For Advance Rulings Gujarat) contract for supply, laying and testing and commissioning of pipeline was held to be works contract as after laying the pipeline underground, these could not be removed without damaging them.

In Re: EMC Ltd (2018 (5) TMI 964 Authority For Advance Ruling West Bengal), the importance of cross fall breach clause in determining nature of contract was established. This clause specifies that breach of one contract will be deemed to be a breach of the other contract, and thereby turn them into a single source responsibility contract. This would mean even if a contract is split into two so as to have one for supply of goods and the other one for erection, installation and commissioning, the two could be treated as one composite supply in the nature of works contract if cross fall breach clause is found to exist. In this case, while the first contract was for supply of materials (ex-works) required for commissioning of transmission lines, the second contract was for completion of all other activities for complete execution of the tower package including transporting materials to site for execution. The first contract was held to be incapable of performance independent of the second one as one could not have supply without place of supply which in this case, was the site.

A similar view was taken in Re: IAC Electricals (P) Ltd (2018 (5) TMI 1701 Authority For Advance Ruling West Bengal) where service of transportation and in-transit insurance was held to be part of composite supply where delivery had to be made to contractee’s site.

In Re: Skilltech Engineers & Contractors Pvt. Ltd (2018 (6) TMI 111 Authority For Advance Ruling Karnataka), three agreements covering Supply of Materials, Erection & Civil Works respectively awarded to the applicant in response to a single tender notification with the general terms and conditions being commonly applicable to all the three agreements was held to be indivisible and works contract as the applicant was supplying the material and providing the erection of towers service and also civil works service.

Consultancy services and reimbursements

In re: EGIS India Consulting Engineers (P) Ltd (2018 (8) TMI 283 Authority For Advance Ruling Madhya Pradesh), reimbursements of costs on goods procured on behalf of recipient (viz., laptop, desktop, refrigerator, furniture etc.) for providing project management consultancy services under PMAY scheme to State/Urban Local Bodies from the recipient based on actual cost, was held not to disentitle Applicant to benefit of exemption on the concerned service as such reimbursements at actuals did not make the contract a composite supply contract.

Exam support services and training services

In Re: M/s BC Examinations & English Services India Pvt. Ltd (2018 (7) TMI 1495 Authority For Advance Ruling Haryana) services of conducting exams covering sourcing and managing test centres, supplying test materials, collecting papers post-test and managing security, managing logistics, office support for financial controls and accounting processes, printing results, recruiting, training and monitoring invigilators, trainers and evaluators, etc. were held to be composite supply of services as these did not have independent existence.

In Re: IL & FS Education & Technology Services Ltd (2018 (7) TMI 755 Authority For Advance Ruling Odisha), contract for supply, installation, maintenance and commissioning of projection system, interactive white board, computer hardware, connected accessories, installation of software and other allied accessories, site preparation, maintenance of equipment and provision of computer education services for 5 years in Govt, and Govt. aided high schools of Odisha in the state of Odisha was held to be composite supply of goods and services not naturally but artificially bundled and not contract for training programme for any possible exemption.

Renting of immovable property and additional services

In the European Union where the lease agreement for letting out immovable property also provided for services of water, heating, security, cleaning of premises, repair of structure and machinery at additional charges with a stipulation that non payment of such charges by tenant/lessee would result in landlord getting the right to terminate the lease, the arrangement was seen to constitute a single supply (Field Fisher Waterhouse LLP Vs Commissioners For Her Majesty’s Revenue & Customs (In Case C-392/11) (Judgement of The Court (Sixth Chamber)) ECLI:EU:C:2012:597). The court further held that scenario would not change even where the services are supplied by a third party directly to the tenant as long as the provision of services is part of agreement the tenant has with the landlord.

Leasing of items with insurance coverage thereon

In B.G.Z Leasing Sp Z.o.o Vs Dyrektor Izby Skarbowej w Warszawie (Judgement of The Court (Sixth Chamber) (In Case C-224/11) ECLI:EU:C:2013:15) the Court held that even if insurance coverage was needed by lessor and resulted in less risk for lessee, by nature it was linked to the item it covers but at the same time, such insurance service had to be taken in principle as being distinct from leasing service of item involved as insurance services were an end in itself to the lessee and constituted independent service.

Looking at the aforesaid views one can only hope the subject matter receives some more clarity. A detailed clarification from Department of Revenue Ministry of Finance would certainly be welcome especially on the concept of natural bundling.

The author could be reached at srikantharaot@gmail.com or on 9845273812 in case of any doubts on this article.

 

By: Srikantha RaoT - November 2, 2018

 

 

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