GST on services provided by related party to each other

This is a common practice in case of group companies where one company provide services to another, most of the time such supply is done free of cost. The main point of question which comes in such type of transaction is valuation of such transactions between related party and their GST treatment. This articles covers the treatment of GST on services provided by related companies to each other.

According to Section 7(1), Supply includes-

1. all forms 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
2. importation of services, for a consideration whether or not in the course or furtherance of business, and
3. the activities specified in Schedule I, made or agreed to be made without a consideration

Further activities without consideration are considered as Deemed Supply:-

1. Permanent transfer or disposal of business assets where input tax credit has been availed on such assets
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.
3. Supply of goods-
4. By a principal to his agent where the agent undertakes to supply such goods on behalf of the principal or
5. By an agent to his principal where the agent undertakes to receive such goods on behalf of the principal

Supply between a related person or distinct person [Para 2 of Schedule I] comes into the picture where any transactions are done betweeen the related companies.

Let us understand the terms ‘related persons’ and ‘distinct persons’

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Related persons:

A person who is under influence of another person is called a related person like members of the same family. Related persons mean as per Section 2(49) of the CGST Act, the spouse and children of the person and the parents, grandparents, brothers, and sisters of the person if they are wholly or mainly dependent on the said person.

Under Section 15, the following person including legal persons are deemed as a related person if:

1. Such persons are officers/directors of one another’s business
2. Such persons are legally recognized partners
3. Such persons are employees & employers
4. A third person controls/ owns/holds (directly/ indirectly) equal to 25% of voting stocks/ shares of both of them
5. One of them controls (directly/ indirectly) the other
6. A third person controls (directly/ indirectly) both of them
7. Such persons together control (directly/ indirectly) a third person
8. Such persons are members of the same family
9. One of them is the sole agent/ sole distributor/ sole concessionaire of the other

For Instance,

• BabaTax holds 30% shares of ABC Ltd and 35% shares of XYZ Ltd. ABC and XYZ Ltd. are related.
• Q Ltd. has a deciding role in corporate policy, operations management, and quality control of R Ltd. It can be said that Q Ltd. controls R Ltd. Thus, Q Ltd. & R Ltd. are related.

Distinct Persons:

 A person who 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 a distinct person according to Section 25(4) of the CGST Act.

Further, where a person who 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 establishment shall be treated as the establishment of a distinct person.

For Instance, Mr. Ram, a Software Engineer, has a registered head office in Mumbai. He has also obtained registration in the state of Delhi in respect of his newly opened branch office. Ram shall be treated as a distinct person in respect of registrations in Mumbai and Delhi.

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Cross Charge:

It is the combined reading of Schedule 1 and the concept of distinct persons that gives rise to the need to cross charge. In other words, when one performs services or supplies goods to others within a company it is termed as cross charge. This mechanism also leads to passing of ITC between the distinct persons and avoids unnecessary blockage of credit and working capital in the head offices or other offices which do not require the same.

For example, when a head office allocates common expenses to its branches then this can also be termed as cross charge, where they are specifying that head office is incurring expenses for branches / units and as a result head office is allocating the cost to the respective units / branches.

Applicability of GST on services provided by related party:

Supply of goods or services or both between ‘related persons’ and between ‘distinct persons’ will qualify as supply and GST will be applicable even if made without consideration provided the supply is made in the course or furtherance of business.

Further, stock transfers or branch transfers qualify as supply. It is a common practice in business that one branch supplies services to another branch of the same entity without consideration. Similarly, goods are transferred among different units of the same entity free of cost, like the distribution of samples or transfer of goods from factory to department or department to factory etc. These transactions are termed self-supplies. Under GST, these transactions are made without consideration and will be qualified as supply provided the goods or services or both are tranferred to:

1. Different locations (with separate GST registrations) of the same legal entity
2. Establishment of distinct persons.

However, transfer between two units of a legal entity under a single registration, within the same state will not be considered as supply.

Further, when an entity makes an import of service from a related person or establishment outside India (without consideration) but for doing business, it shall be considered as a supply.