Section 7(5) of the IGST act– Loophole or a Black Hole?

Ranjeet Mahtani & Stella Joseph 

The nation awaits the outcome of the GST Council’s 15^th meeting. The agenda is loaded with the finalisation of rates for certain commodities, certain rules & regulations and issues raised by trade & industry. 

Yet, as industry and Governments rush to meet the stated (01^st July, 2017) deadline for embracing and implementing GST, various nuances of the GST legislations are slowly coming to the fore. The devil lies in the detail. 

One provision which is likely to have serious implications for businesses is Section 7(5) of the Integrated Goods and Services Tax Act, 2017 (“ÏGST Act”). When the supplier is located in India and the place of supply is outside India (as determined by an application of the relevant Sections of the IGST Act), the transaction would be treated as inter-state supply. Such inter-state supply would be ordinarily be liable to IGST except, when the transaction qualifies as an export (of goods or services as the case may be), in which situation it will be treated as a zero-rated transaction. 

For supply of goods to qualify as an export, there should be physical movement of goods from India to outside India. For supply of services to qualify as an export the conditions are: a) the supplier should be in India b) the receiver should be outside India c) the place of supply should be outside India d) consideration should be received in foreign currency and e) the supplier and the recipient should not merely be establishments of a “distinct person” as per Explanation 1 in Section 8 of IGST Act. 

Practically, there may be transactions which do not qualify as export, where the above-stated conditions are not satisfied but, in these cases, Section 7(5) will trigger and IGST will have to be paid. This may result in various incongruities including the following: 

• The supply of goods which originate from India and move outside India are eligible to be treated as exports and would thus be zero-rated. However, if such goods have been brought into India (for e.g. a ship), and have been sold while outside India, the supply would be liable to GST if the supplier is in India, in view of Section 7(5). The transaction does not qualify as an export as the ship is not taken from India to a place outside India, and so, the conditions of export of goods are not satisfied, resulting in GST liability. 

• Any consideration by a head office (“HO”) located outside India to its branch in India, would always be liable to GST. This is because conditions of export of service can never be fulfilled in case of a supply made between the HO and the Branch since these are establishments of a distinct person as per Explanation 1 in Section 8 of IGST Act (thus the last condition of export of service is not satisfied). MNCs would have to closely monitor such transactions and discharge GST where applicable, as regards transactions between the HO / overseas branches and branches.

The above are some instances of implications of Section 7(5) of the IGST Act, and one will have to wait and watch whether any more transactions fall within its scope and become taxable. On the other hand, the position in these described scenarios is at divergence from the position existing under Service tax and VAT (Value Added Tax), where for both the scenarios a tax consequence did not arise. It can, therefore, be said that the principle of equivalence has not been upheld. 

More serious is the repercussion that the provision results in discriminatory treatment between Indian suppliers and foreign suppliers (whether suppliers of goods or services). For a transaction where the place of supply is outside India, the supply from a foreign supplier would not be taxed, but the same supply from an Indian supplier would be liable to GST. This does not align with “Make In India” / “Serve From India” initiatives of the Indian Government. 

During this advanced stage, companies may be more focused on aspects such as IT/ system changes, GST enrolment/migration etc. however, there is a need to minutely study provisions such as Section 7(5) of the IGST Act and understand its implications/ repercussions on businesses for full compliance with tax obligations.