Taxability of Intermediary service

[Brijesh Thakar]

Introduction

The issue of taxability of “intermediary service” has been a matter of debate and concern for a long period of time. Though the concept has been borrowed from Service tax law, it needs to be looked into afresh under GST Law. The reason for this is GST has been enacted to remove some of the defects in earlier taxation laws and achieve “ One Nation One Tax” and “ Consumption Based taxation”.

To explain the issue on hand, let me start with an example, suppose Mr. A (located in India) is a provider of service and recipient is located outside India and amount is received in a convertible foreign exchange then as per section 2 (6) of the IGST Act, 2017 this supply is covered under Export of service and due to operation of section 16 of the IGST Act it is considered as Zero Rated supply. However, if Mr A is covered under the definition of “intermediary” as given under section 2 (13) of the IGST Act, 2017 then in such case the supply cannot be considered as Export of service and consequently Mr. A has to pay GST on such supply even though other conditions given under section 2(6) are satisfied. Merely by reading this simple example, at the outset I wish to give my opinion( with due respect to the views of Gujarat High Court in case of Material Recycling Association of India Vs Union of India), that such a provision is ultra vires to Article 14 and Article 19 of the Constitution. It clearly discriminates one exporter from another by way of a deeming fiction created by section 13(8)(b) of the IGST Act, 2017. Having said so, now let us examine the applicable legal provisions of law and judicial scrutiny made by honourable High Courts.

Gujarat High Court judgement in case ofMATERIAL RECYCLING ASSOCIATION OF INDIA VERSUS UNION OF INDIA & 2 OTHER (S) 2020 (8) TMI 11 - GUJARAT HIGH COURTon 24^th July 2020 and  recent judgement given by honourable justice Ujjal Bhuyan in case of DHARMENDRA M. JANI VERSUS UNION OF INDIA AND OTHERS - 2021 (6) TMI 383 - BOMBAY HIGH COURT ( Bombay High court- 9^th June, 2021 and opposite judgment DHARMENDRA M. JANI VERSUS THE UNION OF INDIA CENTRAL BOARD OF INDIRECT TAXES AND CUSTOMS (ERSTWHILE CBEC) , GOODS AND SERVICE TAX COUNCIL, PRINCIPAL COMMISSIONER OF GOODS AND SERVICE TAX, MUMBAI, STATE OF MAHARASHTRA - 2021 (6) TMI 563 - BOMBAY HIGH COURT by Justice Abhay Ahuja on 16^th June, 2021) are relevant for our discussion. I have also discussed judgement delivered by justice Abhay Ahuja in the same case which  gives exactly an opposite view on the matter.

Applicable provisions of IGST and CGST Act

As per section 2 (13) of the IGST Act, 2017,  “intermediary” means a broker, an agent or any other person, by whatever name called, who arranges or facilitates the supply of goods or services or both, or securities, between two or more persons, but does not include a person who supplies such goods or services or both or securities on his own account.

Hence as per this definition anyone who arranges or facilitates the supply of goods or services or both between two or more persons are called intermediary. Generally we understand that intermediary receives commission as consideration for supply of such services. Example of intermediary can be marketing agents, brokers, agents etc.

Definition of export of services as per section 2(6) of the IGST Act-

 “export of services” means the supply of any service when,––

1. the supplier of service is located in India;
2.  the recipient of service is located outside India;
3. the place of supply of service is outside India;
4. the  payment  for  such  service  has  been  received  by  the  supplier  of service in convertible foreign exchange; and
5. the  supplier  of  service  and  the  recipient  of  service  are  not  merely establishments  of  a  distinct  person  in  accordance  with    Explanation  1  in section 8;

Here, if all of the above five conditions are fulfilled then we can say that the supply of service is an export of service and consequently a zero rated supply. Three questions  are important in this definition. 1. How to decide location of supplier 2. How to decide location of recipient 3. How to decide the place of supply.

As per section 2(15) of the IGST Act, “location of the supplier of services” means,––(a)  where  a  supply  is  made from  a  place  of  business  for  which  the registration has been obtained, the location of such place of business;(b) where a supply is made from a place other than the place of business for which registration has been obtained (a fixed establishment elsewhere), the location of such fixed establishment;(c) where a supply is made from more than one establishment, whether the place of business or fixed establishment, the location of the establishment most directly concerned with the provision of the supply; and(d) in absence of such places, the location of the usual place of residence of the supplier;

As per section 2(15) of the IGST Act,  “location of the recipient of services” means,––(a)  where  a  supply  is  received  at  a  place  of  business  for  which  the registration has been obtained, the location of such place of business;(b) where a supply is received at a place other than the place of business for which registration has been obtained (a fixed establishment elsewhere), the location of such fixed establishment;(c) where a supply is received at more than one establishment, whether the place of business or fixed establishment, the location of the establishment most directly concerned with the receipt of the supply; and (d) in absence of such places, the location of the usual place of residence of the recipient;

Whether supply is an inter-state supply or intra-state supply that will be determined by section 7 and 8 of the IGST Act-

Section 7 of the IGST Act deals with inter-State supply as under:

Inter-State supply.

1) Subject to the provisions of section 10, supply of goods, where the location of the supplier and the place of supply are in--

(a) two different States;

(b) two different Union territories; or

(c) a State and a Union territory,

shall be treated as a supply of goods in the course of inter-State trade or commerce.

2) Supply of goods imported into the territory of India, till they cross the customs frontiers of India, shall be treated to be a supply of goods in the course of inter-State trade or commerce.

3) Subject to the provisions of section 12, supply of services, where the location of the supplier and the place of supply are in--

(a) two different States; or

(b) two different Union territories; or

(c) a State and a Union territory, shall be treated as a supply of services in the course of inter-State trade or commerce.

4) Supply of services imported into the territory of India shall be treated to be a supply of services in the course of inter-State trade or commerce. 

(5) Supply of goods or services or both,--

(a) when the supplier is located in India and the place of supply is outside India;

(b) to or by a Special Economic Zone developer or a Special Economic Zone unit; or

(c) in the taxable territory, not being an intra-State supply and not covered elsewhere in this section, shall be treated to be a supply of goods or services or both in the course of inter-State trade or commerce.

Section 8 of the IGST Act deals with inter-State supply as under:

Intra-State supply

1) Subject to the provisions of section 10, supply of goods where the location of the supplier and the place of supply of goods are in the same State or same Union territory shall be treated as intra-State supply:

Provided that the following supply of goods shall not be treated as intra-State supply, namely:--

(i) supply of goods to or by a Special Economic Zone developer or a Special Economic Zone unit;

(ii) goods imported into the territory of India till they cross the customs frontiers of India; or

(iii) supplies made to a tourist referred to in section 15.

2) Subject to the provisions of section 12, supply of services where the location of the supplier and the place of supply of services are in the same State or same Union territory shall be treated as intra-State supply:

Provided that the intra-State supply of services shall not include supply of services to or by a Special Economic Zone developer or a Special Economic Zone unit.

Explanation 1.--For the purposes of this Act, where a person has,

(i) an establishment in India and any other establishment outside India; 

(ii) an establishment in a State or Union territory and any other establishment outside that State or Union territory; or

(iii) an establishment in a State or Union territory and any other establishment registered within that State or Union territory,

then such establishments shall be treated as establishments of distinct persons.

Explanation 2.--A person carrying on a business through a branch or an agency or a representational office in any territory shall be treated as having an establishment in that territory.

As far as the place of supply of service is concerned, it is decided by section 12, 13 and 14 of the IGST Act. When location of the supplier or location of the recipient is outside India then the place of supply shall be determined as per section 13 of the IGST Act, 2017. Hence for our discussion section 13 of the IGST Act becomes very important. As per section 13(2), except for services specified in sub-sections 3 to 13, place of supply shall be the location of the recipient. Hence as a normal precedent, location of the recipient is considered as place of supply. However, in case of intermediary services, section 13(8)(b) creates a deeming fiction, and as per this clause, for intermediary services the place of supply shall be the location of supplier and not the location of recipient. Now, assume a case of a supplier of service located in India who provides intermediary service to a recipient located outside India. Here the place of supply will be the place of the supplier even though the service is provided to a person located outside  India.

In such cases the location of the supplier and place of supply will be in same state making it an intra state supply as per section  8(2) of the IGST Act. And the supplier will end up paying CGST and SGST on this supply. From this apparent result, it seems that section 13(8)(b) has been drafted to keep intermediary service outside IGST and cover  it under CGST/SGST. The only question that remains to be answered here is- can this be done in a way in which it has been done? To answer this question we need to discuss some of the article of the constitution.

Discussion on relevant articles of the Constitution

We understand that Indian constitution has a quasi-federal structure. Article 1 of the Indian constitution says India is a union of states. Accordingly Article 246 of the constitution provides for partition of powers between centre  and states ( More correctly, between parliament and legislatures of states). This article is reproduced below-

Article 246

Subject matter of laws made by Parliament and by the Legislatures of States:-

(1) Notwithstanding anything in clauses (2) and (3), Parliament has exclusive power to make laws with respect to any of the matters enumerated in List I in the Seventh Schedule (in this Constitution referred to as the Union List)

(2) Notwithstanding anything in clause (3), Parliament, and, subject to clause (1), the Legislature of any State also, have power to make laws with respect to any of the matters enumerated in List III in the Seventh Schedule (in this Constitution referred to as the Concurrent List) (3) Subject to clauses (1) and (2), the Legislature of any State has exclusive power to make laws for such State or any part thereof with respect to any of the matters enumerated in List II in the Seventh Schedule (in this Constitution referred to as the “State List”).

(4) Parliament has power to make laws with respect to any matter for any part of the territory of India not included (in a State) notwithstanding that such matter is a matter enumerated in the State List”.

It is important to note for readers that primary condition for successful implementation of GST was to make taxation of goods and services parallel. In the provision existing before 101^st Constitutional Amendment,it was very difficult to achieve. Excise, service tax etc were covered under list 1 ( union list) of schedule VII where as right to levy tax on sale of goods was with state legislature under entry 54 of list II ( state list). To achieve “ One Nation One Tax”, this existing structure of partition of powers was the biggest hurdle.

Hence, for proper implementation of GST, it was need of the hour to by-pass Article 246 and give powers to both parliament and state legislature to impose tax called a Goods and Services tax. Accordingly, new article 246A was inserted vide 101^st Constitutional Amendment Act. The Article 246A is reproduced below-

Article 246A

 (1) Notwithstanding anything contained in articles 246 and 254, Parliament, and , subject to clause (2), the Legislature of every State, have power to make laws with respect to goods and services tax imposed by the Union or by such State.

(2) Parliament has exclusive power to make laws with respect to goods and services tax where the supply of goods, or of services, or both takes place in the course of inter-State trade or commerce.

Explanation – The provisions of this article, shall, in respect of goods and services tax referred to in clause (5) of article 279A, take effect from the date recommended by the Goods and Services Tax Council."

Readers can note from clause 2 of the Article 246A that the parliament has exclusive power to make laws with respect to goods and services tax where the supply of goods or services or both have taken place in the course of inter-state trade or commerce. Here question arises as to how can we determine whether the supply is in the course of inter-state trade or commerce or not. This is being decided by section 7 and section 8 of the IGST Act. Hence, a question remains whether this determination can be done through IGST Act or not ? This question can be answered by examination of Article 269A of the constitution which is reproduced below-

Article 269A

 (1) Goods and services tax on supplies in the course of inter-State trade or commerce shall be levied and collected by the Government of India and such tax shall be apportioned between the Union and the States in the manner as may be provided by Parliament by law on the recommendations of the Goods and Services Tax Council.

Explanation. - For the purposes of this clause, supply of goods, or of services, or both in the course of import into the territory of India shall be deemed to be supply of goods, or of services, or both in the course of inter-State trade or commerce.

(2) The amount apportioned to a State under-clause (1) shall not form part of the Consolidated Fund of India.

(3) Where an amount collected as tax levied under clause(1) has been used for payment of the tax levied by a State under Article 246A, such amount shall not form part of the Consolidated Fund of India.

(4) Where an amount collected as tax levied by a State under Article 246A has been used for payment of the tax levied under Clause (1), such amount shall not form part of the Consolidated Fund of the State.

(5) Parliament may, by law, formulate the principal for determining the place of supply, and when a supply of goods, or of services, or both takes place in the course of inter-State trade or commerce.

Readers attention is drawn to explanation 5 to Article 269A which provides that it will be the parliament which can decide by law the principals for determination of place of supply and when a supply of goods or of services or both takes place in the course of inter-state trade or commerce. Hence, it can be concluded that the parliament has power to formulate law for determining whether supply if in the course of inter state trade or commerce or not.

Two more articles i.e. Article 245 and Article 286 are relevant for our discussion.

Article 245. Extent of laws made by Parliament and by the Legislatures of States – 

(1) Subject to the provisions of this Constitution, Parliament may make laws for the whole or any part of the territory of India, and the Legislature of a State may make laws for the whole or any part of the State. (2) No law made by Parliament shall be deemed to be invalid on the ground that it would have extra-territorial operation.”

Article 286. Restrictions as to imposition of tax on the sale or purchase of goods.-

(1) No law of a State shall impose, or authorise the imposition of, a tax on the supply of goods or of services or both, where such supply takes place-

(a) outside the State; or

(b) in the course of the import of the goods or services or both into, or export of the goods or services or both out of, the territory of India.

(2) Parliament may by law formulate principles for determining when a supply of goods or of services or both in any of the ways mentioned in clause (1).”

Here, on analysis of Article 245 and 286 main question arises as to whether the treatment of intermediary services where the location of supplier is in India and recipient is outside India can be treated as intra-state supply by way of a deeming fiction created by section 13(8)(b) of the IGST Act, simply by providing that in case of intermediary services the place of supply shall be the location of the supplier. Apparently, on reading of article 245 and 286 it can be concluded that the parliament has powers to decide what will be the place of supply in particular case and consequently whether the supply will be treated as inter-state or intra-state.

 

Whether provisions of section 13(8)(b) results in to double taxation?

There is no doubt that if we ignore the deeming fiction created by section 13(8)(b) of the IGST Act, the intermediary service shall be considered as export of service as defined under section 2(6) of the IGST Act. By this deeming fiction, there is a clear double taxation if there is a tax on import of such intermediary service in the country of recipient. Let us understand this with the help of an example. Mr.A, who has location in Gujarat provides intermediary service to B Ltd of USA. Due to the deeming fiction of section 13(8)(b) of the IGST Act, this service shall be first taxed in India. Secondly if law of USA considers it as import of service by B Ltd (which is actually the correct position) then B ltd shall pay tax on this import of service. Hence there is a clear case of double taxation. It is also important to take note of report of 139^th Parliamentary standing committee.

The Parliamentary Standing Committee on Commerce submitted report No.139 on Impact of Goods and Services Tax (GST) on Exports. The said report was presented to the Rajya Sabha on 19 December, 2017 and was laid on the table of Lok Sabha on the same day. After referring to the definition of 'export of services' as defined under section 2(6) of the IGST Act, it was noted that service providers providing services to overseas suppliers of goods earn commission in convertible foreign exchange; but IGST @ 18% is leviable on such commission because the government does not recognise their services as export of services. Section 13(8) provides that place of supply of services will be the location of the service supplier and not the location of overseas customers. Even in cases where both the supplier and the buyer are located outside India, commission earned for such transaction also attract IGST @ 18%. In view of the fact that GST is a destination based consumption tax, the Parliamentary Standing Committee made the following recommendations:-

• “Provide that place of supply of Indian intermediaries of goods will be the location of service recipient i.e., customers located abroad (and not the location of such intermediaries as is currently provided), so that intermediary services will be treated as exports; or
• Providing an exemption to Indian intermediaries of goods from levy of IGST, exercising the powers vested under section 6(1) of the IGST Act; or
• Notify such services under section 13(13) of the IGST Act to prevent double taxation (tax in India as well as in the importing country) by treating place of effective use (foreign country) as place of supply.”

Does section 13(8)(b) violates fundamental right under Article 14 of the Constitution?

Article  14 of the Constitution guarantees equality before law. It reads as under

“The State shall not deny to any person equality before the law or the equal protection of the laws within the territory of India.”

From a layman’s point of view, provisions of section 13(8)(b) is clearly in violation of Article 14 of the constitution. Reason for saying so is that it taxes a transaction which is otherwise an export of service and similar other services like management consultants, marketing agents, advisers are enjoying the benefit of provisions of export of service. This benefit  is denied to intermediary services.

However, in case of taxation law, before court can conclude that the statute violates Article 14, it needs to check whether it is case of discrimination or classification of taxpayers? All classifications cannot be considered as discrimination. In case of  RK. GARG VERSUS UNION OF INDIA AND OTHERS - 1981 (11) TMI 57 - SUPREME COURT has laid down that in order to pass the test of reasonable classification, the classification must fulfil two conditions-

 (l) that the classification must be founded on an intelligible differentia which distinguishes those that are grouped together from others and

(2) that differentia must have a rational relation to the object sought to be achieved by the Act.

The differentia which is a basis of the classification and the object of the Act are distinct things and what is necessary is that there must be a nexus between them. This means that Article 14 forbids class discrimination by conferring privileges or imposing liabilities upon persons arbitrarily selected out of a large number of other persons similarly situated in relation to the privileges sought to be conferred or the liabilities proposed to be imposed, it however does not forbid classification provided such classification is not arbitrary. In other words, what is necessary in order to pass the test of permissible classification under Article 14 is that the classification must not be arbitrary, artificial or evasive, but must be based on some real and substantial distinction bearing a just and reasonable relation to the object sought to be achieved by the legislature.

On this premise, Justice Abhay Ahuja in case of DHARMENDRA M. JANI VERSUS UNION OF INDIA AND OTHERS - 2021 (6) TMI 383 - BOMBAY HIGH COURT ( Bombay High court held that the provisions of section 13(8)(b) is a case of classification of taxpayers and not of discrimination.However, there still remains many questions to be answered before we can actually conclude that it is a not a case of discrimination.

Judicial review of section 13(8)(b)

Before we look into what judiciary has said about constitutional validity of section 13(8)(b) of the IGST Act, we need to know that in case of judicial review of a statute, there is always a presumption in favour of constitutionality of a statute. Burden lies on the person who challenges the validity of a statute. It is also settled now that for declaring a statute as unconstitutional, Court has to see two important things

1. whether there is legislative competence to enact the statute or not and
2. whether the impugned provision is violative of any of the fundamental rights given in Part III of the Constitution or not.

 

There are two important judgements reviewing constitutional validity of section 13(8)(b) of the IGST Act.

1. Gujarat High Court judgement in case of MATERIAL RECYCLING ASSOCIATION OF INDIA VERSUS UNION OF INDIA & 2 OTHER (S) 2020 (8) TMI 11 - GUJARAT HIGH COURT and
2. Two different views given by Bombay High court  Justice Ujjal Bhuyan and Justice Abhay Ahuja in case of DHARMENDRA M. JANI VERSUS UNION OF INDIA AND OTHERS - 2021 (6) TMI 383 - BOMBAY HIGH COURT ( Bombay High court- 9^th June, 2021 and opposite judgment DHARMENDRA M. JANI VERSUS THE UNION OF INDIA CENTRAL BOARD OF INDIRECT TAXES AND CUSTOMS (ERSTWHILE CBEC) , GOODS AND SERVICE TAX COUNCIL, PRINCIPAL COMMISSIONER OF GOODS AND SERVICE TAX, MUMBAI, STATE OF MAHARASHTRA - 2021 (6) TMI 563 - BOMBAY HIGH COURT by Justice Abhay Ahuja on 16^th June, 2021).

First in case of MATERIAL RECYCLING ASSOCIATION OF INDIA VERSUS UNION OF INDIA & 2 OTHER (S) 2020 (8) TMI 11 - GUJARAT HIGH COURT, Honourable Gujarat High Court did not find any problem with the provisions of section 13(8)(b). Relevant paragraphs of Gujarat high court judgement is given below-

65. …... The petitioner has tried to submit that the services provided by a broker outside India by way of intermediary service should be considered as “export of services” but the legislature has thought it fit to consider such intermediary services; the place of supply would be the location of the supplier of the services. In that view of the matter, it would be necessary to refer to the definition of “export of services” as contained in section 2(6) of the IGST Act, 2017 which provides that export of service means the place of service of supply outside India. Conjoint reading of section 2(6) and 2(13), which defines export of service and intermediary service respectively, then the person who is intermediary cannot be considered as exporter of services because he is only a broker who arranges and facilitate the supply of goods or services or both. In such circumstances, the respondent No.3 have issued Circular No.20/2019 where exemption is granted in IGST rates from payment of IGST in respect of services provided by intermediary in case the goods are supplied in India.

66. It therefore, appears that the basic logic or inception of section 13(8)(b) of the IGST Act, 2017 considering the place of supply in case of intermediary to be the location of supply of service is in order to levy CGST and SGST and such intermediary service therefore, would be out of the purview of IGST. There is no distinction between the intermediary services provided by a person in India or outside India. Only because, the invoices are raised on the person outside India with regard to the commission and foreign exchange is received in India, it would not qualify to be export of services, more particularly when the legislature has though it fit to consider the place of supply of services as place of person who provides such service in India.

67. Therefore, there is no deeming provision as tried to be canvassed by the petitioner, but there is stipulation by the Act legislated by the parliament to consider the location of the service provider of intermediary to be place of supply. Similar situation was also existing in service tax regime w.e.f. 1st October 2014 and as such same situation is continued in GST regime also. Therefore, this being a consistent stand of the respondents to tax the service provided by intermediary in India, the same cannot be treated as “exporter of services” under the IGST Act, 2017 and therefore, rightly included in Section 13(8)(b) of the IGST Act to consider the location of supplier of service as place of supply so as to attract CGST and SGST.”

As can be derived from the above paragraphs, Gujarat High Court did not find any defect in the provisions of section 13(8)(b). However justice Ujjal Bhuyan in case of DHARMENDRA M. JANI VERSUS UNION OF INDIA AND OTHERS - 2021 (6) TMI 383 - BOMBAY HIGH COURTdid not agree with the proposition laid down by Gujarat High Court. In para 56 of his judgement he writes as under-

“With utmost respect we are unable to accept the views of the Gujarat High Court as extracted above. Having regard to the discussions made in the preceding paragraphs it is evident that section 13(8)(b) of the IGST Act not only falls foul of the overall scheme of the CGST Act and the IGST Act but also offends Articles 245, 246A, 269A and 286(1) (b) of the Constitution. The extra-territorial effect given by way of section 13(8)(b) of the IGST Act has no real connection or nexus with the taxing regime in India introduced by the GST system; rather it runs completely counter to the very fundamental principle on which GST is based i.e., it is a destination based consumption tax as against the principle of origin based taxation.”

In the same case, Justice Abhay Ahuja has different opinion. According to him, provisions of Section 13(8)(b) does not offend Article 245 or 286 and parliament is well within its powers in drafting such a legislation.

As there are two opposite views in the same judgement, the matter has been referred to the Chief Justice of Bombay High Court.

Conclusion and author’s opinion

Though the taxation of Intermediary service is not a new concept and the same law prevailed in service tax also, according to opinion of the author, being a pre existing law, does not make is a good law. Though I agree with the dissenting view in case of Bombay high court judgement in case of DHARMENDRA M. JANI VERSUS UNION OF INDIA AND OTHERS - 2021 (6) TMI 383 - BOMBAY HIGH COURT that the provision does not appear to be offending Article 245 and 286 of the Constitution and it is not ultra vires, I believe that there is a violation of Article 14 of the constitution. It is difficult to accept that this provision is not about discrimination but of classification of taxpayers. Further, it is against the concept of consumption based taxation for sure. It also results into double taxation and is causing injustice to a person who brings convertible foreign exchange in the country like any other exporter. 139^th Parliamentary standing committee report also suggests the same thing. However, parliamentary committee reports are not binding in nature. To conclude, if court cannot hold the provisions ultra-vires, we need to leave it to wisdom of parliament to amend the provision suitably as suggested in 139^th parliamentary committee report.