Treatment of FOC items under GST Laws

 

Brijesh Kothary, Associate Partner & Ananya Raghavendra, Associate, Lakshmikumaran and Sridharan

 

Introduction  

The ambiguity surrounding inclusion of Free of Cost ('FOC') material in the taxable value of supply undertaken by a supplier has been prevalent even prior to the introduction of the Goods and Services Tax ('GST') regime. Such issue primarily arose in various industries wherein as in terms of contractual arrangements between a supplier and its recipient, the recipient provided certain materials (moulds and dies, jigs and fixtures, tools, etc) on FOC basis to be further used by the supplier for making outward supplies to such recipient. The supply of FOC materials was considered as additional consideration requiring addition (actual or notional or amortised) to the value to be determined in terms of Section 4 of the Central Excise Act, 1944 and rules laid down thereunder.

 

Section 15 of the CGST Act 2017 however, does not contemplate inclusion of any notional consideration towards such FOC supplies by the recipient. To address this uncertainty under the GST regime, the CBIC had issued Circular No. 47/21/2018-GST dated 8.6.2018 clarifying that moulds and dies owned by the Original Equipment Manufacturer ('OEM') further provided to a non-distinct/unrelated component manufacturer on FOC basis will not constitute as supply under GST since there is no consideration involved. Therefore, such ambiguity regarding GST implications on FOC supplies seemed to be resolved in favour of the supplier by excluding the same from their transaction value. 

 

However, a dilemma has once again arisen on the inclusion of FOC material in transaction value, in light of divergent interpretation adopted by the AAR in the recent advance ruling of Natani Precast [2023-VIL-79-AAR]. 

 

Summary of the Natani Precast Ruling 

In this case, the applicant was engaged in the manufacture and supply of precast manholes and rises for which it received certain inputs (cement and steel) on FOC basis from the recipient, being provided as per contractual obligations imposed on the recipient. 

 

The AAR ruled that the outward supply of the applicant/supplier being in the nature of 'supply of goods', does not fall within the ambit of 'job work' under GST laws. It was also concluded that the FOC supplies received from the recipient are in the nature of non-monetary consideration and will also be includable in the transaction value of supply undertaken by the applicant/supplier. Lastly, the AAR also ruled that the aforementioned Circular dated 8.6.2018 will be inapplicable in the instant case where FOC materials received would be consumed and therefore lose its identity in the manufacturing of precast manholes, unlike moulds and dies received on FOC basis as covered under the Circular. 

 

Ambiguities/issues arising based on the Ruling 

Based on the observations and analysis in the aforementioned ruling, the issues that arise and may require further examination on a case-to-case basis are three-fold as examined below in detail:  

 

A.    Outward supply being in the nature of 'job work' 

 

The first issue arising in such transactions is whether the provision of outward supply utilising FOC material received would fulfill the requirements of 'job work' as defined under Section 2(62) read with Section 143 of the CGST Act 2017. In the aforementioned ruling, distinction was drawn between the outward supply undertaken by the applicant and 'job work' services to the extent that the applicant was engaged wholly in manufacturing new goods and not merely undertaking treatment or processes on such inputs received and further, on the basis that ownership of the FOC material remains with the applicant. 

 

Therefore, an issue may arise for suppliers in ascertaining whether the receipt of FOC material on non-returnable basis would lead to the transfer in ownership of such FOC material especially if consumed by the supplier entirely, and consequently, whether such outward supply would still amount to 'job work' services by such supplier. 

 

This issue is to be examined based on the facts and circumstances of each case and as per the contractual obligations, which will thereafter lead to implications on the nature of outward supply by the supplier i.e., whether in the form of supply of goods or supply of services (as job work). In the view of the authors, even if there is transformation to obtain a new product, the activity undertaken will satisfy the meaning of job work and the supply will continue to remain as job work subject to GST as 'services'.

 

B.    Implication on valuation vis-a-vis contractual terms and conditions 

 

The issue of inclusion of FOC material in the transaction value had been previously settled by the Supreme Court in favour of the supplier under the erstwhile regime[1]. Under the GST regime, inclusion in the transaction value may either be by way of Section 15(1) of the CGST Act vis-à-vis conclusion based on distinction drawn between 'non-monetary consideration' vs mere 'condition to contract', or under Section 15(2)(b) basis an analysis of the obligations of each party to the contract.

 

It may be noted that the instant ruling in Natani Precast is divergent from previous favorable rulings[2] wherein it was ruled that FOC material provided by the recipient is not includable in the value of outward supply of the applicants / suppliers. While all the favourable rulings have attributed utmost importance to the contractual terms in answering such issue of valuation, the instant ruling of Natani Precast has also done so, but thereafter interpreted similar contractual terms to the detriment of the applicant. Therefore, such divergent interpretation of contractual terms might require revisiting of existing contracts to avoid any ambiguity in its interpretation to the disadvantage of the supplier. 

 

C.    Implication on valuation when FOC items (other than moulds and dies) get 'consumed' for provision of outward supplies: 

 

In the Natani Precast ruling, the authority differentiated between moulds and dies provided on FOC basis as covered under the Circular dated 8.6.2018. and FOC materials provided by the recipient in the instant case to the extent of such FOC materials being 'consumed' in the course of supply undertaken by the applicant/supplier. It is also pertinent to note that all the aforementioned favourable rulings under the GST regime are in respect of situations wherein FOC materials were provided on returnable basis after usage by the supplier. 

 

Therefore, there still remains an ambiguity on FOC material (other than moulds and dies) provided on non-returnable basis which gets consumed for/during the provision of outward supply by the supplier, wherein the same may constitute a part of the transaction value under Section 15(1) as 'non monetary consideration' or under Section 15(2)(b) as being part of the obligations of the supplier.

 

Such issue is especially relevant and widespread in the transportation/logistics industry wherein the recipient of services generally provide HSD Oil/Diesel on FOC basis which gets consumed in the course of supply by the supplier. In this regard, there have been various rulings in favour of the service provider stating that such FOC items are not includable in the transaction value[3]. However, AARs have also provided divergent rulings stating that such FOC items are includable in the transaction value[4]. 

 

Similar issues of inclusion in the transaction value may also arise in the Vehicle Body Building industry wherein for the manufacture and supply of chassis by an OEM, components/raw materials are provided by the OEM's recipient, as well as in the Fast Moving Goods industry wherein the recipient provides all raw materials to job worker in order to manufacture the final product as the contract manufacturer.

 

Parting Remarks 

Although the government has previously attempted to clarify issues on FOC materials vide Circular dated 8.6.2018, in light of the recent divergent ruling and ambiguities arising therein as specified above, further clarification will be required on whether the benefit available under aforementioned Circular can be extended to all FOC items provided by a recipient to its supplier, or whether its applicability is restricted only to 'moulds and dies provided on FOC basis'.  

 

Further, amid multiple interpretations and divergent views as well as the distinctions drawn in the instant ruling of Natani Precast, industries may also be required to revisit their contractual terms and conditions for such transactions, which is essential not only to ascertain transaction value of the supplier, but also to ascertain the impact arising on the reversal of credit by the recipient on such FOC materials provided. 

[Date: 31/05/2023]

 

(The views expressed in this article are strictly personal.)