India’s Goods and Services Tax (GST) has multiple rates — seven to be precise. The four main rates are 5, 12, 18, and 28 percent; plus three extreme rates: viz. 28+cess (tobacco, cars, aerated drinks, etc.), 3 (for gold and precious metals), and nil (food grains, etc.).
The classification of an item determines what rate it receives. However, classifying items is often open to interpretation.
Does a car speaker fall under the category of a loudspeaker, i.e., heading 8518 at 18 percent GST? Or would it fall under automobile parts, i.e., heading 8708 at 28 percent? In a B2B supply, it would not matter much, as the buyer would get credit for all taxes paid to the supplier. However, when you and I go to an auto accessories shop to replace a faulty speaker in our car, the rate difference would matter to us.
Therefore, vendors should use care when determining the appropriate classification and corresponding tax rate of the items they sell.
Combined supplies pose a problem
Quite often goods are packed and sold together, creating challenges. For example:
- A pack of festival sweets may have candies as well as chocolates, which would attract different GST rates.
- A manufacturer may sell a car to a dealer and arrange its transport. Should the car and the transport be taxed separately?
- I may buy groceries and other items at a mall attracting different rates from nil (food grains) to 28 (perfumes); however, these items may all be included in a single bill.
In all the above cases, it is not easy to decide what rate to charge. The authors of the GST law wanted to simplify the problem for us and therefore introduced two concepts: mixed supply and composite supply.
Mixed supply means two or more individual supplies of goods or services made in conjunction with each other for a single price. Since they are priced as one, they are taxed as one — at the rate of the item that draws the highest tax. So while the festival pack of confectionery may contain sugar confectionery taxed at 18 percent and chocolates taxed at 28 percent, together the combination pack would be taxed at 28 percent, the higher rate.
Composite supply, on the other hand, is a supply consisting of two or more taxable supplies of goods or services, or both, that are naturally bundled and supplied in conjunction with each other in the ordinary course of business, one of which is a principal supply.
In such cases, GST law requires vendors to charge the tax rate applicable to the principal supply. In the case of the car sold and transported by the manufacturer to the dealer, ordinarily the principal supply would be that of the car; transport service is purely incidental to that supply, and the combined value of the whole supply would, therefore, attract 43 percent GST.
Matters are simple and clear until here, but they can become complex in many cases.
When you dig deep, there are many questions: Would the answer differ if the transportation was arranged by the manufacturer on the dealer’s request, who pays it separately to the manufacturer? Would the answer change if the transportation charges are paid directly by the dealer to the transporter, though the transport is organized by the manufacturer? There are many grey areas.
In the case of purchases at a mall, even if there is only one invoice, there would be a distinct supply of different commodities that would attract different rates. It is neither a case of mixed supply nor a composite supply. Let us call it a “segregated supply.”
Single transaction but varying interpretations
Take a case of car repair services. I take my car to the repair station due to some strange noise it is making. The mechanic opens the bonnet, replaces a part, and bills me for the part and his labor. Is this a case of composite or mixed supply, or is it a segregated supply of goods and services? One can substantiate all of these answers.
- It is a service — a composite supply
I went to the mechanic to stop the strange noise my car was making. What I wanted was a vehicle that did not make that noise. I didn’t care if he replaced a major part or simply struck the bonnet with his hammer to stop the noise. Therefore, what I wanted was the service, which was the principal supply in the whole transaction.
- It is goods — a composite supply
The bill contained two elements, one of which was the replaced part accounting for about 70 percent of the bill. One could argue that the principal supply in terms of value was definitely goods and that the supply of this good should be taxed at the rate that the part attracts.
- It is a mixed supply
If there was a single amount on the bill, one could also argue that both the supply of the service and the supply of the goods are equally important — offered together without a principal supply. Therefore, the vendor should apply the highest rate of the constituent supply.
- It is a segregated supply
We can also argue that both the goods and services are equally important and that there is no principal supply. Moreover, the value of goods and services should be accounted for separately on the invoice. It is also possible that I, the car owner, bought the part from a car accessory shop and gave it to the mechanic to replace, and therefore the supply of the part and of the labor are two distinct supplies. The vendor could combine the two supplies into a single invoice and apply different GST tax rates for each constituent.
How to break the deadlock
Value of the constituent
Often people want to decide on the basis of the value of each constituent. This, however, could be treading on a slippery surface. Should a vendor say that just because a constituent item has a value of 51 percent, it should be considered a principal supply? Moreover, it is often difficult to find out the value of constituent supplies and may be much more difficult to substantiate to a tax officer.
Intention of the supplier and recipient
This could be a better test as it would reveal what the supplier intended to supply, and what the buyer intended to buy. This would also explain the economic rationale behind the supply. A supply should not be artificially split or combined if the economic rationale does not warrant that.
Description on the invoice
The invoice may throw some light on the nature of the transaction. A mixed supply will always have a single value, while a composite supply may or may not. Segregated supply will always have a separate value for each constituent.
One may also look at different practices followed in the industry to reach a conclusion: One airline may include the cost of food in the price of the ticket (composite supply with air transport as a principal supply). The other may charge separately for the food (segregated supply of air transport and food).
Break open a transaction
It may also make sense to imagine splitting the transaction into separate parts to see if it offers any clues. Let’s take an example of an artisan making jewelry out of gold provided by the jeweler on job-work-charges basis. This is simply a service. However, in the course of making the jewelry, the artisan required some additional gold that he selected from his own inventory. While the principal supply appears to be that of service, the value of gold would always be substantially higher than the value of service. Would this make gold the principal supply? To find an answer, we can split the transaction into two parts: 1. The artisan first sells the additional gold to the jeweler. 2. The artisan then takes that gold back and works on the same so that it then looks like a segregated supply of goods and of service.
There could be many approaches, and the search for the answer could be really long.
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