[Manasvin Andra is a 4th year B.A., LL.B. (Hons.) student at NALSAR University, Hyderabad]
Promotional offers have long been used by companies to draw attention to their products. These strategies have generally proved successful, as they incentivise consumers to buy more of the designated good. However, the tax treatment of these free supplies changed with the emergence of the GST, leading to considerable confusion for companies who sought to reduce their liability while remaining compliant. Though many of the issues were resolved with the issuance of a clarification, uncertainty remains over how questions outside of the scope of the government’s explanations will be answered.
This post aims to break down the existing position on free supply of goods under promotional offers and examine the jurisprudence that has evolved around it. Further, an attempt will be made to highlight some extant issues despite the government’s clarifications, and potential solutions will be proposed to answer the same.
Treatment of free supply under GST
This section will elaborate on the tax treatment of free supplies under GST, first, by outlining the relevant regime and second, by discussing some recent precedents that have emerged in this area.
Under the GST regime, it is the supply of goods and services that is taxed. The expression “supply” has been defined in section 7(1) of the Central Goods and Services Tax Act, 2017 (“CGST Act”) and includes “all forms of supply of goods or services or both such as sale, transfer, barter, exchange, license, rental, lease or disposal made or agreed to be made for a consideration by a person in the course or furtherance of business”. As is clear from the emphasized portion, consideration is a vital aspect for a supply to be taxed under the regime. When consideration is absent, the transaction will not amount to a supply under the Act, and consequently, GST cannot be levied.
However, the issue with respect to promotional products arises due to Schedule I of the CGST Act, which forms the exception to the requirement of consideration. One such exception is “Transfer/Disposal of Asset on which credit has been availed”, wherein an agreement to transfer an asset will amount to supply lacking the element of consideration.
The question then turns to whether companies can reduce their liability by claiming input tax credit (“ITC”), for which the provisions of sections 16 and 17 must be fulfilled. As per section 16, input tax can be availed on any supply of goods or services which are used in the furtherance of business. On the other hand, section 17 enumerates situations where ITC cannot be claimed. Specifically, section 17(5)(h) states that ITC cannot be claimed when goods are “lost, stolen, destroyed, written off or disposed of by way of gift or free samples”. This implies that if a company distributes goods freely (i.e. without receiving consideration or paying output tax), any ITC that is availed during the production of these goods must be reversed. This encapsulates the changes brought by the new regime, as GST now compels companies to bear the burden for free supply.
Amidst this confusion, the Central Board of Indirect Taxes and Customs issued a clarification on 7 March 2019. The Circular dealt with some common types of promotional schemes and discussed their treatment under GST.
According to the Circular, companies distributing free samples – often used by the pharmaceutical industry – cannot avail ITC, as section 17 explicitly bars taxpayers from claiming credit on goods disposed as free supplies. On the other hand, ITC can be availed for “Buy one get one free” schemes, as it is not an individual supply of free goods but a case of “two or more supplies offered for the price of one”. A similar logic prevails with respect to “Buy more save more” schemes, since it is a supply in the course of business for which a reduced consideration is received.
Therefore, the Circular has clarified that ITC can be claimed on certain promotional schemes, since these goods are supplied in the course of business and consideration is received for the same. The next section will illustrate some of the issues with the scope of the government’s clarification.
While the Circular has brought a great deal of clarity in the concerned area, its interpretation has given rise to some noteworthy issues. This can be illustrated by looking through some recent cases, which are spread over a period before and after the issuance of the Circular.
In Biostadt India Ltd., the applicant had launched a sales promotion scheme known as “Kharif Gold Scheme 2018” to incentivise its distributors and retailers to achieve the company’s targets. The scheme was of two types: the first component stated that customers would be entitled to one 10g gold coin if they purchased products above certain quantities, and the second involved rewarding them with one 8g gold coin if they made certain minimum payments after receiving the products from the company. As the applicant had to procure the coins from the jewellers, a question was raised as to whether ITC can be claimed on this account.
Since the hearing took place before the Circular was issued, the AAR minutely analysed the ITC provisions of the Act as well as the meaning of gifts in the context of tax laws. The tribunal first established that the proposed scheme was in fact a voluntary distribution, since no contractual arrangement between the applicant and the distributors could be produced. Subsequently, it was determined that no output tax was being paid by Biostadt on the coins.
As a result, recourse was taken to section 17(5), which discusses the treatment of gifts under GST. Since no tax was being paid, the AAR held that ITC could not be availed for the coins, as they were little more than gifts to the customers. While this ruling was given before the Circular was issued, it is questionable whether the clarification would have helped even if it had been in force during the time. This aspect is explored in greater detail below.
One of the earlier cases where the Circular was relied on was Sanofi India Ltd., which carries some significant observations on the applicability of the Circular.
Here, the applicant was engaged in the sale of pharmaceutical goods and services through group entities, and had commenced a scheme called the “Shubh Labh loyalty programme”. This had two components: the first involved giving customers reward points and allowing them to claim certain products from the applicant; and the second involved provision of products like pens, notepad, key-chains to distributors or doctors, which served as advertisement tools for the company. Since the scheme involved procurement of both the catalogued items as well as the promotional products, the question of whether the applicant could avail ITC was raised.
The tribunal first looked at whether provision of increased sales by the customers in return for availing the catalogued products amounted to “barter” within the meaning of section 7. It was found that no barter was involved in the present case, as the transaction was without consideration and no output tax was paid by the applicant. As a result, the tribunal concluded that this amounted to a gift, and a claim for ITC was barred by the provisions of section 17(5).
Interestingly, the applicant also sought to rely on the Circular and show that the programme in question was designed to act as an incentive to their customers. An attempt was made to demonstrate that the scheme was along the lines of “Buy more, save more” offers mentioned in the Circular, for which ITC can be availed on the basis of the inputs used for the supply. However, the tribunal rejected this submission, since this was not a case where a discount was provided on the supply. Instead, the applicant provided points on the quantity of goods purchased by the customers against which the catalogued products can be availed. As a result, the tribunal noted that there was “no similarity of facts in the scheme explained by the circular and subject matter of the present case, and as such the said circular is of no help to the applicant.”
This finding in Sanofi India is significant, as it illustrates the narrow domain in which promotional schemes operate under the GST regime. Tax breaks – in the form of reducing liability by claiming ITC – are only provided for schemes included in the Circular, with others excluded as falling within the domain of “gifts” as mentioned under section 17(5).
It is submitted that the viability of such a narrow conception of promotional schemes is worth questioning, as such programs have often been key to boosting sales in the past. As it stands, the Circular and the interpretation accorded to it discourages the emergence of unique marketing programs, as there is constant worry regarding whether ITC can be claimed for the supply made through the schemes.
This dilemma is expressed clearly in Sanofi India, where the applicant expected to benefit by incentivising customers and doctors to promote its business. The scheme was run only for a specified period and the procedure for how to obtain the incentives was clear. However, the tribunal’s ruling denied the benefits of the scheme to the applicant, as it was barred from claiming any credit.
Similarly, though the Circular was not in force during the Biostadt India ruling, it is doubtful whether the tribunal would have deemed it helpful to its case. The provision of gold coins as incentives for customers does not fall within any of the recognised schemes in the Circular, and it is unlikely that its presence would have altered the verdict. This is another instance of the GST regime discouraging unique marketing schemes, as a result of its narrow conception of promotional schemes.
Given the benefits of marketing schemes in improving sales, it is submitted that businesses should be allowed to claim ITC for inputs used in promotional schemes. Though section 17(5)(h) bars ITC on gifts and free supplies, it is necessary to view promotional schemes as being in the course and furtherance of business, as they often aid businesses in direct and empirically observable ways. This can be done by expanding the ambit of the government’s Circular and extending it to cover a variety of promotional offers. Whether an input is being used in the course of a business can be assessed on a case by case basis, which will provide the applicant with a chance to demonstrate the benefits of the scheme to their business. This entails a move away from the current position, which places a narrow interpretation on the concept of promotional offers.
Therefore, there is a need to rethink the tax treatment of promotional schemes, as the current regime inhibits companies in carrying out their business. It would be beneficial to allow business to float such schemes especially in a post-COVID environment, taking into consideration the pandemic’s impact on consumer spending. There is a need for business to incentivise consumers to resume consumption, and favourable tax treatment for promotional schemes can prove to be the required stimulating factor.
– Manasvin Andra