CCH Direct Tax, CCH India, Direct Tax, Income Tax , Case Laws , Act , Commentary

GST – Implications on Mergers and Acquisitions

Shrenik Shah and Khushbu Vora,

GST is looked as a panacea to several issues faced by the taxpayers under the existing indirect tax regime. A flawless implementation of GST is expected to rationalize taxes, liberalize credit norms and increase the level of transparency for the taxpayers. Because of these reasons, GST has a potential to play an instrumental role in changing the way business is done in India and unleash greater investment opportunities. With the Government’s push to Make-In-India initiative and implementation of a tax policy as revolutionary as GST, the transactions of mergers and acquisitions (M&A) are expected to increase manifold. With the revised draft of model GST laws in place, it is worthwhile to understand and assess the GST implications on M&A transactions. GST on sale / transfer of securities One of the means of acquiring any company is by purchasing its shares. Under the current indirect tax regime, State VAT laws exclude securities from the definition of ‘goods’ and hence, securities are not liable to VAT. Contrary to this, service tax law has specifically included ‘securities’ under the definition of ‘goods’. By considering them as goods, securities are kept outside the ambit of service tax. Accordingly, transfer of security is not liable to either service tax or VAT. Under the first draft of the model GST laws, the definition of ‘goods’ specifically included ‘securities’ under its ambit, signifying that sale and transfer of securities will be considered to be supply of goods and hence, liable to GST. However, the better sense prevailed and securities were specifically excluded from the definition of goods in the revised draft of model GST laws. The revised position is in line with global practice. Most countries have specifically exempted supply of securities. Had securities not been specifically excluded, it would have led to a situation where securities sold to overseas investors would be considered as export of goods (hence zero rated) by virtue of residual rule of place of supply of service provisions while the same securities sold to domestic investor would have been liable to GST. GST on transfer of business Indirect tax implications of a transaction of transfer of business vary depending upon the manner in which the transaction is undertaken, as substantiated by the documentary evidences, intention and conduct of the parties to the transaction and facts & circumstances of each case. Even though most of the State VAT laws are silent on applicability of VAT on transfer of business, the Courts have consistently held that transfer of a business as a whole on a going concern basis is not liable to sales tax or VAT. Besides, the activity of transfer of business on a going concern basis has been specifically exempted under Entry 37 of Service Tax Notification No. 25/2012. This position remains unchanged under the revised draft of the model GST law. According to Schedule II of the revised draft of Model GST law, only itemized sale involving individual assets would be subject to GST. Sale of business on going concern basis is not considered to be supply in the course of business, keeping it outside the ambit of GST. Treatment of historical tax liabilities and obligations Investing into new company always has the element of risks attached to it. ‘Caveat Emptor’ - latin for ‘let the buyer beware’, if applied to an M&A transaction, emphasizes the need for an acquirer to satisfy himself of potential risks in undertaking an acquisition before signing the dotted line. In case of indirect taxes, the concept of ‘Caveat Emptor’ holds significant importance. This is because the historical tax obligations and liabilities pertaining to the business proposed to be transferred remain and travel with the transferred business by virtue of the specific provision of VAT laws in various States, Section 11 of Central Excise Act, 1944, Section 142 of Customs Act, 1962 and Section 87 of Finance Act, 1994. These provisions make the acquirer, a party to liability or obligation of the transferor, by virtue of principle of joint and several liabilities. In light of Section 127 of the revised draft of model GST law, the treatment of historical liabilities under GST regime would remain unchanged. In the revised draft of the model GST law, the provisions have been aligned to the existing VAT laws i.e. joint and several responsibility of the transferor and transferee in case of historical liability of the business transferred. This indicates that statutorily, the buyer will be equally liable as the seller would be, and hence, it will be extremely essential for the buyer to be aware about the quantum of exposure being inherited along with the business. Transfer of unutilized tax credit Unutilized tax credit means the amount of tax credit (pertaining to the transferred business) claimed but remaining unutilized in the hands of transferor at the time of business transfer. Most of the State VAT laws have specific provisions that allow transfer of VAT credit to the buyer of the business. In States where the VAT laws are silent with respect to transfer of credit, a position is usually adopted by the trade and industry that since VAT laws cast liability in the hands of transferee for any historical tax liabilities and obligations of the transferor, the transferee should also be entitled to claim unutilized tax credit balance identified as pertaining to the transferred business. Similarly, the CENVAT Credit Rules, 2004 permit transfer of unutilized CENVAT credit to the transferee in case of transfer of business. For transferring of CENVAT credit, it is however mandatory to transfer the liabilities of the business and also the inputs and capital goods on which such credit is taken. Section 18(6) of the revised model law also permits transfer of unutilized GST credit to the transferor in the case of transfer of a business. However, this is subject to the condition that the liability of the business are also transferred along with the assets but at the same time, the condition of transfer of inputs and capital goods to which the credit pertains, has been removed. Additionally, the condition of accounting the credit and the goods in the financial statements of the transferee to the satisfaction of the tax authorities has also been done away with. Hence, the position under GST will remain similar to the existing position under the CENVAT Credit Rules, with the relaxations indicated above. Relaxation of the conditions and specific provision provides clarity on the treatment of credit which is currently lacking in many State VAT laws. Taxability of inter-company transactions during intervening period Intervening period refers to the period between the appointed date (i.e. date from which business of the transferor vests with the transferee) and the effective date (i.e. when the Court order is submitted to the Registrar of Companies, in cases involving transfer of business through a Court scheme). Technically, in case of an amalgamation or merger with retrospective effect, two companies should be considered as a single entity from the appointed date and thus any transaction of goods and services between the appointed date and effective date should be considered as transaction with oneself. As excise duty is payable on removal, reorganization in the form of merger or amalgamation does not alter the excise duty liability. There is no specific provision in the service tax law that deals with a situation of levy of service tax on the services transaction between the transferor and transferee during the intervening period. However, in light of Chennai Tribunal’s decision in the case of IOCL (23 STR 625) and Delhi Tribunal’s decision in the case of ITC Hotels (27 STR 145), a position has been adopted by many taxpayers that during the intervening period, the transactions between the transferor and transferee should be considered to be between the same entity and hence, service tax paid on such services during the intervening period should be allowed to be claimed as refund. However, this position has often been challenged by the tax authorities. Conversely, the VAT implication on a sale transaction between the transferor and transferee in the intervening period varies from State to State. VAT laws of many States have a specific provision wherein the transferor and transferee are treated as separate entities till the effective date and hence, are liable to VAT. The inconsistency between VAT laws and service tax law in this matter has been put to rest under GST. According to Section 129 of the revised draft of model GST law, two or more companies are to be treated as distinct companies upto the date of the court order, implying that the transactions between them during intervening period will be liable to GST. Conclusion GST law has tried to address most of the concerns in relation to M&A transaction by providing specific provisions for the same. The position for most the aspect remains unchanged or has been clarified providing a lesser room for ambiguity. 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GST impact on Financial Services

M. S. Mani, Senior Director, Deepak Agarwal, Director and Sagar Shah, Deputy Manager,

Introduction of Goods and Services Tax (‘GST’) in India is the most discussed topic today in every business meeting; not only in India, but globally as well. GST, an undisputed game changer for the Indian economy has been delayed over a decade now. However, the reaffirmation of the progress of GST by the Union Finance Minister in the Union Budget 2017 on 1 February 2017, signifies that GST may be implemented w.e.f. 1 July 2017. GST would subsume most of the indirect taxes in India and remove thetrade barriers caused by the State boundaries from an indirect tax perspective. Further, it would create a level playing field for the businesses across the country. It would also minimize thecomplexities existing in the present indirect taxlaws in terms of classification, valuation, rate of tax applicable, etc. It would also supplementthe ‘ease of doing business’ initiative of the Government. While GST will have an impact on the manufacturing sector, the impact of GST on the services sector would also be significant. Presently, while the service sector contributes more than half of the Indian GDP; Financial Services sectorcould be considered to be the backbone of the Indian economy. GSTmay not only enhance business opportunities but also lead to savings in the tax cost for the financial services sector. The following paragraphs discuss the impact of GST on the financial services sector at a broad level. Registration: The financial services sector have been complying with the obligations under the Finance Act, 1994 (i.e. service tax) by obtaining a centralized registration and local VAT laws with State specific registrations. The accounting, invoicing and maintenance of records have historically been carried out at a principal place of business on a PAN India basis (except for real estate). Centralized accounting led to ease in compliance and better process control from an indirect tax perspective. Absence of the concept of ‘centralized registration’ under GST may call for decentralization of registrations, processes, accounting and attached compliances forthe financial services sector (except real estate). This would not only call for revamp of the business and compliance processes, but also lead to substantial increase in compliance cost.Representations have been made to the Government for dispensing the need for obtaining State specific registrations and verdict on the same is awaited. Taxability: The definition of goods and services, as provided in the Revised Model GST law is unambiguous, thereby easing the categorization of a transaction into supply of goods or services. Further, Schedule II appended to the Revised Model CGST Act categorizes certainhitherto disputed transactions as deemed supply of goods or services. For instance, works contracts have been deemed as supply of services, whereas hire purchase transactions have been deemed to be supply of goods. It could thusbe reasonable to conclude that the goods vs. services war could come to end vis-à-vis transactions specified in Schedule II. While the earlier version of Model law covered securities under the definition of goods, the same has been excluded not only from the definition of goods, but also services. Consequently, trading in securities may not attract GST. However the same could lead toreduction in the credit pool. Further, the disputes regarding taxability of sale of repossessed assets by the banks and financial institutions has also been put to rest by broadening the definition of the term ‘business’ and shall attract GST. Moving on to the real estate sector, it could be agreed that the taxation of real estate sector in India has been the most litigated area in India. The dispute not only exists in the Service Tax domain, but also from a VAT perspective. Time and again the Constitutional validity of the tax sought to be levied on the real estate transactions has been tested at different levels of the judicial system. It may be wrong to say that GST would put an end to these disputes, however the disputes relating to classification (into goods and services) and valuation could be ruled out. This is in light of the fact that construction contracts would be considered as supply of service. It is also important to note that actionable claims have been considered as ‘goods’. Consequently, transactions in transferable development rights (‘TDRs’) could be regarded as supply of goods. However further clarity is expected on this aspect from the GST Council. Valuation / Rates: The financial services sector presently enjoys an alternate valuation mechanism for various products and service. For instance, a bank / authorized dealer engaged in money changing is entitled to pay Service Taxat a composite rate. Further, real estate developersare required to assess the value on which VAT shall be payable in accordance with state specific divergent laws. An insurance company engaged in life insurance business has an option to discharge Service Tax at a composite rate. The Model GST law is presently silent on any composite rates / alternate rates of GST. However, the same could be expected to be addressed in the final legislation. The composite rate or an abated value benefit that the real estate and the insurance sector presently enjoys could cease to exist under the GST regime. The GST Council is expected to discuss the rates of tax for supplies of services in its next meeting scheduled on 18 February 2017. Further, presently, there are special provisions for valuation of construction contracts for charging VAT as well as Service Tax. However, since the construction contracts are in the nature of works contract, the aggregate taxation base exceeds 100% of the contract price, thus leading to double taxation. With GST treating construction contracts as supply of service, double taxation issue could be ruled out. Place of Supply: The place of supply provisions have been prescribed in the revised Model GST law. There are separate provisions for place of supply for banking sector, insurance sector as well as the real estate sector. In order to determine whether it is an inter-State supply liable to Integrated GST (‘IGST’) or an intra-state supply liable to Central GST (‘CGST’) /State GST(‘SGST’),the place of supply rules become relevant. As per the Model GST law, the place of supply for banking and other financial services where either the banks and financial institutions or the account holder is located outside India, is the location of the supplier of services. In all other cases, the place of supply is the location of the recipient of services on record of the banks / financial institutions.Determining place of supply for non-account linked services or account linked services (where supplier as well as recipient is in India) could lead to an anomaly since banks / financial institutions capture both, the correspondence address as well as the permanent address of the customer. Clarity would be required in this regards. The place of supply of insurance services provided to a registered person shall be the location of such person and to a person other than a registered person, shall be the location of the recipient of services on record of the supplier of services. However the aspect relating to location of the service provider i.e. sourcing branch, servicing branch or underwriting office, is a subject matter of interpretation. Further there would be issues where the service recipient changes his address in the middle of the year. The place of supply for the real estate sector has been provided to be the location of the immovable property. It has also been provided that services directly in relation to immovable property such as architects, interior decorators, engineers, etc. shall be the location at which the property is located. It is also provided that place of supply for service ancillary to the above main services would be the location of such property. Thus the provisions relating to determining place of supply for real estate sector are unambiguous as compared to the existing provisions. Input Tax credit: The introduction of GST is aimed at seamless availability of credit and avoiding cascading effect of taxes. GST couldachieve its purpose if there are minimum credit restrictions and minimum exemptions. Having said that, there are few supplies, on which GST is not leviable, such as trading in securities or transaction in money (except money-changing). Since the transactions of advancing loans and deposits, are in the nature of transaction in money and do not attract GST under the revised model GST Law, there would be corresponding restrictions on the input credits of the persons engaged in such financial transactions. Presently, the banks and other players in the financial services sector incur costs in terms of the VAT paid on the infrastructure and capital goods. Further, presently the banks have an option to reverse CENVAT Credit of upto 50% of the eligible CENVAT Credit availed. Though the provisions for input tax credit reversals weren’t a part of the earlier version of Model GST law, the revised Model law grants an option to the banks and financial institutions to avail only 50% of the eligible input tax credit. The said option shall be in lieu of the provisions requiring the registered taxable persons to restrict the input tax credit only attributable to its taxable supplies. The benefit that the banks and financial institutions could derive from this aspect would depend on whether they are allowed centralized registration under GST. In addition to this, the banks would also benefit as they would now be able to avail input tax credits of VAT paid. There are no specific input tax credit provisions for insurance companies and hence the same provisions as applicable to other taxable persons would be application to such entities. Further, presently CENVAT Credit in respect of Service Tax paid for construction is available to the persons engaged in construction activities. In this regard, it is relevant to note that the input tax credit for civil construction is permissible as per the Model GST law. Transitional Provisions: For successful implementation of a new law, the appropriate transitional provisions are of utmost importance to ensure smooth roll-over. With the transitional provisions being incorporated in the Model GST law itself, the smooth roll out of GST could be well expected. The Model GST law has envisagedall major transitional issues that could be faced by trade and commerce. To illustrate, the transitional provisions for long term construction contracts, as provided in the Model GST law clarifies that all goods and services supplied in pursuance of long term construction contracts after the date of implementation of GST would be chargeable to GST and not under the erstwhile laws. Further, the carry forward of the credits under respective Central and State laws into the GST regime with minimal conditions, is a welcome provision under GST. Thefinancial services sector shall be allowed to carry forward CENVAT Credit of Excise Duty on inputs and capital goods, Service Tax on input services and as well as VAT on goods. The credit would be allowed to carry forward into the GST regime only if the same was eligible under the respective erstwhile legislation as well as under the GST regime. The only anomaly that remains unaddressed is distribution of the brought forward credit in the GST regime into the CGST,SGST or IGST. Concluding thoughts: While few intricaciesdo exist in the Model GST law, it could very well be expected that substantial ones would be addressed while laying the blue-print of the draft GST law. The phrase ‘well-begun’ is half done would be apt for the introduction of GST as it would not only revolutionize the indirect taxation system in India, but pave a way for plethora of opportunities across the businesses in India. ******* Disclaimer: Above expressed are the personal views of the author, and the publisher or the author disclaim all, and any liability and responsibility, to any person on any action taken on reliance of it.