Analysis of GST order served to Biocon Ltd

Biocon Ltd. has been imposed a penalty of around ₹ 3 crores for non-compliance with GST laws. The company has received an order of adjudication imposing a penalty of Rs 3,03,78,465 dated February 22, 2024, from the office of Deputy Commissioner of Commercial Taxes, Divisional GST Office, Bangalore, Biocon Ltd said in a regulatory filing.

The demand is related to input tax credit reporting error in GST monthly returns, denial of input tax credit on sales and promotional expenditures, valuation of Corporate Guarantee & denial of exemption on export of services. 

Play of provisions of GST law: 

1. Denial of ITC on Sales:
•  It is to be noted that the ITC on sales can be denied only upon non-compliance with the conditions prescribed in Section 16(2) of the CGST Act, 2017 & if the sale is in the form of Gift, free samples or personal consumption. 
• Biocon being a bio-pharmaceutical company, supply of sample medicines to the doctors/ physicians is a common practice in industry. The interpretation of the Income Tax Appellate Tribunal on the supply of samples should be considered. It is pronounced that “The free sample of medicine is only to prove the efficacy and to establish the trust of the doctors on the quality of the drugs. This again cannot be reckoned as freebies given to the doctors but for promotion of its products. The pharmaceutical company, which is engaged in manufacturing and marketing of pharmaceutical products, can promote its sale and brand only by arranging seminars, conferences and thereby creating awareness amongst doctors about the new research in the medical field and therapeutic areas, etc.” With the interpretation it is clear that the samples provided by the Pharmaceutical companies is not in the form of gift or free samples but only a promotional expense. Denying ITC on the basis of supply of samples would be unconstitutional. 
2. Denial of ITC on Promotional Expenditures: 
• If the samples are not free then what is the mechanism or value it adds? 
• As provided by ITAT, it promotes the brand of the drug & would be classified under promotion expenses. When the doctor prescribes the drug, the efficacy of the same is tested & decides the life of the drug. 
• There can be two types of promotional expenses. First being target based Sales incentive scheme & second being promotional expenses without the cover of any scheme. 
• For the first category of expenses, AAR Maharashtra Ruling on M/s Sanofi India Ltd is the base for the denial of credit on promotional expenses. Some excerpts from the ruling to help us understand the scenario is provided: 
• The Authority mentions that “The present subject application is in respect of a sales promotion scheme known as “Shubh Labh Loyalty Program 2018” and promotional products which has been floated by them for their customers. In the first case, their distributors/ wholesaler Customers who purchased certain products over and above a certain quantity would be entitled to get reward points. In the second scenario, applicant is giving Brand reminder products like pens, notepad, key-chains to the distributors or Doctors, which serve as an advertisement tool. The brand reminders are distributed to the distributors or doctors with their name embossed on it to promote the brand for sales.
• Taking into account applicant’s contention that the subject free supplies have been made in pursuance of their business, jurisdictional officer submit that the fact remains that the same have been made free of cost and therefore, the same are non-taxable under Section 9 read with Section 2(78) and merits to be treated as exempt supply under Section 2(47). Further, there are no provisions under Section 15 to include the cost of such free supplies in the value of taxable free samples. There cannot be any dispute that the said supplies are exempted, hence credit is not allowable in terms of Section 17(2). Further, gifts has to be disallowed in terms of Section 17(5)(h), notwithstanding the fact that the subject supply has been used in course of furtherance of business in terms of Section 16(1). The provisions of Section 17(5) (h) are applicable notwithstanding the provisions of Section 16(1).
• Whether the different promotional products in the present case can be treated as a gift or not? - HELD THAT: - A contractual arrangement implies especially in view of the magnitude and area of the applicant’s business that it should also be agreed by the customer in writing to such scheme floated by the applicant. We find that they have not submitted any such contract/ agreement and in support of their contention, but they have only submitted a scheme of Shubh labh Loyalty is available on companies web site and interested customers can Login with details to avail the benefit of scheme from 2018 to Jan, 2019 - Hence we find that the promotional products are not given to their customers under any contractual obligation and are voluntarily given on certain conditions achieved by their customers”.
• Analysis of AAR Ruling: 
• The Authority has rejected the claim of ITC for promotional products on the grounds that there was no contractual obligation for the business to provide to its customers. 
• Section 3 Read with Section 10 of the Contract Act, 1872 All agreements are contracts if they are made by the free consent of parties competent to contract, for a lawful consideration and with a lawful object. The communication of a proposal is complete when it comes to the knowledge of the person to whom it is made & the communication of an acceptance is complete, when the proposer accepts & when it is put in a course of transmission to him, so as to be out of the power of the acceptor. 
• In the case of Ruling, the authority clearly mentions that the scheme was put out only on the company’s website & interested customers can sign up for the scheme. The requirements of a valid contract are fulfilled. Even more, the authority themselves state it is at the will of the customer they enroll. Hence no coercion or force to boost the sales. 
• When the customers enroll for the scheme, they become the agents to sell the goods & receive the benefit. Hence Rule 29 of the CGST Rules, 2017 shall be invoked where, the value of supply of goods shall “be the open market value of the goods being supplied, or at the option of the supplier, be ninety per cent. of the price charged for the supply of goods of like kind and quality by the recipient to his customer not being a related person, where the goods are intended for further supply by the said recipient”. 
• Authority has mentioned that there is no provision in Section 15 of the CGST Act, 2017 to include the cost of samples. While it is to be noticed that in order to invoke valuation as per Section 15 (2) of the CGST Act, 2017 two conditions must be satisfied – Price should be the sole consideration & supplier & recipient should be unrelated parties. 
• When the scheme is on, both the conditions of Section 15(1) of the CGST Act, 2017 are not satisfied & hence the contention of the authority requires re-examination on the said grounds. 
• If Rule 29 is considered the cost of samples will also be included in the value of supply & hence it is incidental to the principal supply which makes it eligible for availing the credits. 
• The question of free pens & diaries with the name of the company embossed, the cost of the same is also marked up in the supply if the valuation is based on Rule 29. It should be echoed that the cost of the pens or any other products is NOT marked up in the price, then the question of denial would arise. Does the authority have any evidence to prove that the cost of pens & other products was not included in the price? Business would eventually factor all the costs before providing so. Hence there is no base to deny the credits to the taxpayer. 
• For the second category of promotional expenses, we need to analyse, if there is any contractual agreement. If yes, then the fore-said analyses would apply. If no, then provisions of Section 15 would decide the value of supply. If they are purely gifts for promotion, ITC is denied. It is to bear in mind that ITC on buy one get one offers is fully available. ITC on this category of promotional expenses unless by way of sponsorship would differ case to case. If promotion is by way of sponsor, we need to be mindful of RCM conditions on sponsorship services. 
3. Valuation of Corporate Guarantee: 
• The spark of attention towards the valuation of corporate guarantee stems from Notification No. 52/2023 – Central Tax dated 26th October 2023 where it inserted that “Notwithstanding anything contained in sub-rule (1), the value of supply of services by a supplier to a recipient who is a related person, by way of providing corporate guarantee to any banking company or financial institution on behalf of the said recipient, shall be deemed to be one per cent of the amount of such guarantee offered, or the actual consideration, whichever is higher”. Circular 204/16/2023 clarifies that the above said rule should be adopted irrespective of Claim of ITC. 
• The said rule is prospectively applicable & shall not be retrospective in nature. For the earlier services of corporate guarantee had an option to consider “Provided further that where the recipient is eligible for full input tax credit, the value declared in the invoice shall be deemed to be the open market value of the goods or services”.
• The question now arises is, who is the actual recipient of the guarantee service??? The Bank or the Principal Debtor. Section 126 of the Contract Act, 1872 defines contract of guarantee as “Contract to perform the promise, or discharge the liability, of a third person in case of his default. The person who gives the guarantee is called the "surety", the person in respect of whose default the guarantee is given is called the "principal debtor", and the person to whom the guarantee is given is called the "creditor". A guarantee may be either oral or written”.
• As per the provisions of Section 186 of the Companies Act, 2013 it may seem like the subsidiary company is the benefactor, while if we get to the layers of transactions the ultimate beneficiary is the creditor – the lending bank. The holding company will provide guarantee to the extent it is sure that it can recover the amount in case of default from the principal debtor. Hence in anyway, the principal debtor discharges the loan. It is the bank which enjoys. 
• When the bank is the ultimate recipient of the supply, how rule 28 would come to play? If it is for the consideration, then consideration alone between the companies would be taxable & not the amount of guarantee itself. Also, at the time of signing the contract it cannot be decided to what extent the guarantor would be liable to pay. 
• For eg. The principal debtor has paid 25 installments out of the 30 installments the guarantor would be responsible only for the remaining 5 installments. 
• Hence when the time of supply for the same is not known, how will the valuation rule apply? It requires clarity from the provisions. 
4. Denial on exemption of export of services: 
• There are two types of exports – Exports outside India & Supply to SEZ. The two can be made with / without payment of taxes. Export of services has to fulfill the following conditions in Section 2(6) of the IGST Act, 2017: 
• i. The supplier of service is located in India;
• ii. The recipient of service is located outside India;
• iii. The place of supply of service is outside India;
• iv. The payment for such service has been received by the supplier of service in convertible foreign exchange or in Indian rupees wherever permitted by the Reserve Bank of India; and
• v. 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;
• If the above conditions are fulfilled, export of services is eligible for exemption & cannot be denied. It is an indefeasible right given to the taxpayer. While the situation gets complex for Export of services when supplied to SEZ units. With Effect From 01st October 2023 it has been made mandatory that the supply to SEZ for authorized operations would require an endorsement. The said has come to force from Rule 30(4) of the SEZ Rule, 2006 where, “A copy of the document referred to in sub-rule (1) or copy of Bill of Export, as the case may be, with an endorsement by the authorised officer that goods have been admitted in full into the Special Economic Zone shall be treated as proof of export and a copy with such endorsement shall also be forwarded by the Unit or Developer to the Goods and Services Tax or Central Excise Officer having jurisdiction over the Domestic Tariff Area supplier within forty-five days failing which the Goods and Services Tax or Central Excise Officer, as the case may be, shall raise demand of tax or duty against the Domestic Tariff Area supplier”. 
• It should be noted that the access to get the endorsement from the officer in the SEZ Zone would be possible only for the SEZ Unit, but the domestic supplier is asked to submit the endorsement within 45 days. If the burden is not passed on then how the same can be recovered from the DTA Supplier? GST Department have issued notices even before the same was made effective & provide reasons to recover from DTA. Why will the taxpayer be penalized for the mistake of the SEZ Unit? Many questions remain unclear when effectiveness of provisions in various laws have time lapse. 
• Hence, Biocon order may not be effective of the above perspectives are not considered. 

- K N Akshaya MA LLB