WHITE PAPER - ISD AND CROSS CHARGE MECHANISM UNDER GST REGIME www.rsmindia.in
1.0 Introduction GST was introduced on 01 July 2017 replacing multiple Indirect Taxes with a single tax. However, a lot of concepts from the erstwhile law have also been carried forward in GST. Input Service Distributor ISD is one such concept. Further, with a new GST in place, a new concept of cross charge was also introduced. Both the concepts are different but do result in apportionment of input taxes across different registered presences under the GST regime. So much so that industry needs to choose whether to follow ISD mechanism or cross charge mechanism. The below paper is intended to explain both the concepts to enable the industry take an informed decision. This paper shall be useful for all companies which have multiple registered presences under the same Permanent Account Number. 2.0 Input Service Distributor Mechanism ISD as a concept always existed under Service Tax regime and the same has been carried forward under GST. The purpose of ISD was to enable the location which is incurring expenses to avail and distribute the credit. To understand the meaning of Input Service Distributor lets consider below mentioned example. ABC Limited is a manufacturing company; registered in India and the Head Office ( HO ) is situated in Mumbai, Maharashtra. Company has factories located in Gujarat, Delhi and Madhya Pradesh. As a practice, ABC incurs expenses from Head Office centrally and all invoices are addressed also to the head office in Mumbai. Such a practice is common and extensive in the industry and prevalent for exercise of effective control and for management of the alternate locations. Further, in addition to that, Head office also incurs certain expenses centrally such as Audit expenses, Legal & Professional expenses, etc. Such a practice over a period of time results in accumulation of GST credits at the Head Office, which is generally a cost center and does not render outward supplies. Such excess accumulation of credits results in non-utilization of credits. Further, such ITC accumulated at HO is not available to discharge GST liability at alternate locations (Gujarat, Delhi and Madhya Pradesh) which may have huge GST liability. In order to address the potential hindrances that may arise in effective employment of working capital, a mechanism is introduced under GST to distribute the GST credits in relation to input services to respective locations by way of ISD. Under ISD, HO can transfer transfer the input tax credit so accumulated to the concerned locations by issuing an appropriate document. The statutory definition of Input Service Distributor which is provided under section 2(61) of the Central Goods and Services Tax, Act 2017 ( CGST Act ) reads as under: Input Service Distributor means an office of the supplier of goods or services or both which receives tax invoices issued under section 31 towards the receipt of input services and issues a prescribed document for the purposes of distributing the credit of central tax, State tax, integrated tax or Union territory tax paid on the said services to a supplier of taxable goods or services or both having the same Permanent Account Number as that of the said office. From the above definition, following inferences can be drawn- 1. It is an office of supplier and not the actual supplier of goods or services. 2. ISD shall deal with only input services and not with goods including capital goods. 3. ISD shall receive tax invoices for taxable supplies and distribute the tax charged on such invoice to appropriate supplier having the same Permanent Account Number (PAN). 4. ISD must issue an appropriate document to distribute the ITC.
3.0 Manner of distribution of ITC As we understand, ISD can distribute the tax charged in inward supplies received by it, to the appropriate supplier. GST law has prescribed the specific manner for distribution of such taxes which an ISD must adhere to. Section 20 of CGST Act deals with the manner of distribution of such credit by ISD which reads as under- 20. (1) The Input Service Distributor shall distribute the credit of central tax as central tax or integrated tax and integrated tax as integrated tax or central tax, by way of issue of a document containing the amount of input tax credit being distributed in such manner as may be prescribed. Further, the provisions of ISD are made mutatis mutandis applicable to IGST provisions by virtue of section 20 of Integrated Goods and Services Tax, Act 2017 ( IGST Act ). The respective State Goods and Services Tax Acts also contain the provisions of ISD which are akin to provisions of CGST Act. Therefore, we may conclude the following with regard to distribution of credit by ISD- Tax charged on invoices for input services Tax can be distributed as Recipient is within same state IGST IGST or CGST and SGST IGST CGST CGST IGST SGST SGST IGST Recipient is in another state Section 20(2) of CGST Act provide for conditions to be complied with while distributing the credit by ISD which reads as under- 1. The credit can be distributed to recipient with documents having particulars as prescribed under the law. 2. The credit distributed shall not exceed the total credit available for distribution. Note: In case of excess distribution of credit to one or more recipients, such excess amount shall be recovered from such recipients along with interest. 3. Distribution to one recipient Where credit of input services is attributable to one recipient, same shall be distributed to that recipient only. 4. Distribution to one or more recipients Where credit of input services is attributable to more than one recipient then such credit shall be distributed among such recipients on prorata basis taking turnover in a state or turnover in a union territory of such recipient during the last financial year as base. 5. Calculation of ratio: Ratio for distribution of credit shall depend on the preceding year s turnover of locations to whom credit is to be distributed in case some / all recipients do not have turnover during the previous period, turnover of the last quarter for which such turnover is available. It may further be noted that ISD cannot keep any credit in its own books. Thus, in case ISD has availed credit which is ineligible under the GST provisions, ISD shall be required to reverse the credit or may transfer the credit and the recipient shall be required to reverse the ineligible credit.
4.0 Cross Charge Mechanism under the GST regime Now that we have looked at ISD mechanism, let us look at the cross-charge mechanism for distribution of credits to different establishments. As per schedule 1 of CGST Act, any supply between different GST registrations having the same PAN (distinct persons) shall be treated as supply even when made without consideration. The said provision reads as follows: Schedule 1: ACTIVITIES TO BE TREATED AS SUPPLY EVEN IF MADE WITHOUT CONSIDERATION 1 2 Supply of goods or services or both between related persons or between distinct persons as specified in section 25, when made in the course or furtherance of business Further, section 25 of the CGST Act states that A person who has obtained or is required to obtain more than one registration, whether in one State or Union territory or more than one State or Union territory shall, in respect of each such registration, be treated as distinct persons for the purposes of this Act. Further section 25(5) of the Act states that Where a person who has obtained or is required to obtain registration in a State or Union territory in respect of an establishment, has an establishment in another State or Union territory, then such establishments shall be treated as establishments of distinct persons for the purposes of this Act. It is the combined reading of Schedule 1 and the concept of distinct persons that gives rise to the need to cross charge. Thus, based on the provisions as stated above, any supplies between different GST registrations of the same entity shall be termed as a supply and shall attract GST. In line with the said provisions, every supply between distinct persons result in cross charge between such entities. Such supply shall be undertaken by issue of appropriate documents. Further, the receiver of the supply shall be entitled to GST credit subject to conditions. Cross charging can be understood in better manner with help of below mentioned example- XYZ Limited has Head office in Maharashtra, following centralized billing and payment mechanism. XYZ Limited has 2 registrations at Delhi and Karnataka. HO has availed certain audit services on payment of IGST. However, such audit services shall be used at both the locations i.e. Delhi and Karnataka. Thus, when the HO charges for the said audit services to respective locations, it shall be required to supply under an appropriate invoice and cross charge the value of audit services accordingly.
5.0 Value of supply of services between Head office and alternate locations As per the section 15 of CGST Act, value of supply, in case of distinct person, shall be determined as per Rule 28 of CGST Rules which prescribes the methods to determine the value. Rule 28 of CGST Rules reads as under- The value of the supply of goods or services or both between distinct persons as specified in sub-section (4) and (5) of section 25 or where the supplier and recipient are related, other than where the supply is made through an agent, shalla) be the open market value of such supply; b) if the open market value is not available, be the value of supply of goods or services of like kind and quality; c) if the value is not determinable under clause (a) or (b), be the value as determined by the application of rule 30 or rule 31, in that order. Rule 30 provides for value as 110% of the cost of production or manufacture or the cost of acquisition of such goods or the cost of provision of such services. Rule 31 provides value shall be determined using reasonable means consistent with the principles and the general provisions of section 15 and the provisions of this Chapter. Provided that where the recipient is eligible for full input tax credit, the value declared in the invoice shall be deemed to be open market value of the goods or services. Based on the above provision, HO shall be required to discharge GST on the following value, Open market value of such supply Value of supply of like kind or quality 110% of cost of acquisition of such goods or cost of provision of such services or Any other reasonable means 6.0 Cross charge / ISD to SEZ units A situation may arise wherein a location might require to cross charge to a unit located in SEZ. Since supply to a Special Economic Zone is considered as a zero rated supply, cross charge may be required to be considered as export under both the options i.e. on payment of IGST or under LUT without payment of IGST. Further, an ISD may distribute credit attributable to SEZ under an invoice and SEZ shall be eligible to avail the credit on the same. Now that we have looked at the legal provisions governing cross charge, it may be pertinent to look at certain practical examples governing the mechanism for ISD and cross charges. 7.0 Certain Other Important Aspects pertinent to ISD and cross charge 1. A person can obtain registration under GST as normal taxable person and also as Input Service Distributor. 2. An ISD has to distribute the input tax credit to its concerned units in the same month in which such inward supplies have been received.
8.0 Illustrative example to explain the ISD and Cross Charge Mechanism Commerce Limited has Head office in Maharashtra along with two manufacturing unit in Gujarat and Uttar Pradesh (UP). Commerce Limited has following data and wants to determine the cross charge value to be charged to other units. Extract of Profit and Loss Account of ABC Limited for the month of May 2018 Particulars Amount in Lakhs Received at Related to Income: Sales- Maharashtra 400 Maharashtra Maharashtra Sales- Gujarat 500 Gujarat Gujarat Sales- UP 600 UP UP Interest received on loan given 2 Maharashtra Common Dividend received 1 Maharashtra Common Total income 1503 Expenses Purchase of raw materials & Direct cost- Gujarat 250 Gujarat Gujarat Purchase of raw materials & Direct cost- UP 235 UP UP Employee Cost- Gujarat 190 Gujarat Gujarat Employee Cost- UP 175 UP UP Employee cost 110 All locations All locations Advertisement 70 Maharashtra UP Meeting and events/ Brand promotion 40 Maharashtra Common Audit fee 10 Maharashtra Common Legal and Professional fees 22 Maharashtra Common Lodging & Boarding expenses 12 Maharashtra Maharashtra Interest on loan taken 35 Maharashtra Common Rent 8 UP UP Total Expenses 1,157 Net profit 346
Steps for calculation of cross charge 1. Identification of expenses for cross charging First and foremost cross charging from Head office shall be done only for expenses borne by it but they are common expenses or related to other units. Therefore, Head office need to identify such expenses as under- Nature of expenses Amount in Lakhs Received at Related to Cross charge Purchase of raw materials & Direct cost- Gujarat 250 Gujarat Gujarat No 1 Purchase of raw materials & Direct cost- UP 235 UP UP No 2 Employee Cost- Gujarat 190 Gujarat Gujarat No 1 Employee Cost- UP 175 UP UP No 2 Advertisement 70 Maharashtra UP Yes Meeting and events/ Brand promotion 40 Maharashtra Common Yes Audit fee 10 Maharashtra Common Yes Legal and Professional fees 22 Maharashtra Common Yes Lodging & Boarding expenses 12 Maharashtra Maharashtra No 3 Interest on loan taken 35 Maharashtra Common No 4 Rent 8 UP UP No 2 Total Expenses 1,047 Note Notes: 1. These expenses are directly attributable to Gujarat unit and are borne by Gujarat unit only. Thus, question of cross charging by Head office does not arise. 2. These expenses are directly attributable to Uttar Pradesh unit and are borne by Uttar Pradesh unit only. Thus, question of cross charging by Head office does not arise. 3. This expense is related to and borne by Head office, Maharashtra and thus, same should not be charged to other units. 4. Interest on loan is exempted supply under GST regime which means no GST would have been charged by lender on such expenses. In our view, such exempted supply should not be considered for cross charging. If such interest is considered in calculation then there may be GST liability on such exempted supply also as Head office would be making outward supply in the form of Business Support Service which is taxable supply. Based on above, green highlighted expenses should be charged to concerned units.
2. Identification of basis for cross charging The basis for cross charging would be very subjective and depends upon the industry practice. However, a standard approach could be taking taxable turnover made by concerned units which is also akin to the manner of distribution of common credits by ISD under CGST Act. Some other basis of cross charge could be the number of employees, space, plant capacity utilization or other reasonable basis that are used for costing purposes. Based on this following shall be the ratio for distributing the common expenses- Units Taxable turnover in lakhs (Rs.) Ratio (%) Head Office- Maharashtra 400 27.00 Gujarat Unit 500 33.00 Uttar Pradesh Unit 600 40.00 Total 1500 100.00 3. Identification of directly attributable expenses There could some expenses which are directly related to any specific units but the same have been borne by the Head office. In such cases, instead of distributing the ITC on such expenses as per the specific ratio, it shall be directly apportioned to the concerned unit. In the instant case, Advertisement expenses of Rs.70 lakhs is borne by Head office but it directly related to Uttar Pradesh unit and hence such cost shall be directly charged to Uttar Pradesh as whole without any allocation to the other establishments. 4. Distribution of common expenses Such common expenses should be distributed to concerned units in turnover ratio as calculated above. Nature of common expenses 5. Calculation of cross charge value Amount in Lakhs (Rs.) Maharashtra (27.00%) Gujarat (33.00%) Meeting and events/ Brand promotion 40 11 13 16 Audit fee 10 2.5 3 4 Legal and Professional fees 22 1 3 8.8 Total 72 14.5 19 28.8 Uttar Pradesh (40%) Head office shall raise the tax invoice on Gujarat and Uttar Pradesh Units considering below mentioned taxable values- Particulars Gujarat Unit Uttar Pradesh Unit Directly attributable cost - 70.00 Add: Apportionment of common expenses 19.00 28.80 Total Cost 19.00 98.80 Add: 10% mark up 1.90 9.88 Taxable Value (110% of Cost) 20.9 108.68
8.0 Concluding remarks GST law requires state wise registration and treats each registration as distinct person. The common expenses may be either distributed via ISD or may be charged via cross charge. Both the options attract their respective compliances which shall be adhered to with all the provisions of the GST law which at times may be cumbersome also especially with regards to maintenance of accounts and record along with audit provisions under GST regime. However, for supplies made between distinct taxable persons, cross charge is the only option. While ISD mechanism brings in a lot of structure in the manner of distribution of credits, it also increases the compliance burden as monthly returns need to be filed for entities registered as an ISD. Cross charge mechanism offers flexibility and is also, the only mechanism that can be employed for distribution of credits related to goods and capital goods. Both mechanisms have their pros and cons and need to be evaluated carefully before a decision is taken.
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