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Related PartiesThe uneven distribution of economic resources across the world and limited local markets are the key drivers for expansion of international trade. Noticeably most international transactions are arranged between related parties.

The concept of ‘related parties’ is defined under the tax statutes to include certain categories of persons (legal entities and individuals) qualified by law as ‘related parties’.

Further, a general clause is inserted in the definition clause to include any person capable of exercising an influence or control over another party in the making of decisions within the definition of ‘related party’. These transactions typically include transaction within the group companies, companies involved in joint venture or between holding company and subsidiaries, etc. The same not only ensures an increase in the volume of global trade but also that the related parties have the ability of ensuring that the income earned is subjected to the most tax-friendly jurisdiction, thereby reducing total global tax outflows of a multinational corporation.

Since the value of the transactions between related parties or associate enterprises may be maneuvered to avoid or reduce tax liabilities, it becomes imperative for the revenue authorities, responsible for collecting both direct and indirect taxes, to have in place the principles for valuation of such transactions.

This article seeks to analyse the concept of related party transactions and their treatment under GST regime in India.

Present situation under the Indirect Tax Regime:

Under the Customs, Excise and Service tax laws in India, transaction value method, that is, actual price paid or payable for such goods is the most common valuation method adopted for the purpose of calculating duties. However, both the Customs and Excise laws recognize that related parties might not use market-based pricing when trading with one another. Therefore, these pieces of legislation specifically provide for a mechanism to compute the appropriate values of the transactions between related parties.

1. Customs Law

The Customs laws provide for a detailed set of rules containing four different methods to arrive at the assessable value of the goods for ascertaining duty liability in case of related party imports. These are to be applied sequentially while computing the assessable value of the goods in the following order:

Transaction value of identical goods: According to this method, transaction value of identical goods imported at or about the same time as the goods shall be considered the value for the purpose of import.

Transaction value of similar goods: According to this method, the transaction value of similar goods imported at or about the same time into India shall be the value of the imported goods.

Deductive value method: This method provides for calculation of value of imported goods on the basis of unit price at which the imported goods or identical or similar imported goods are sold in the greatest aggregate quantity to persons who are not related to the sellers in India, subject to the deductions of usual expenses such as commission, profits and general expenses in connection with sales, costs of transport and insurance and associated costs, customs duties and other taxes payable.

Computed value method: This method provides for computation of value of imported goods by adding cost of production, amount for profit and general expenses and cost/value of all other expenses. An importer has the option to opt for deductive methodology over computed method or vice versa.

2. Excise Law

The Excise laws, provide for a deeming provision, whereby the value of the goods shall be the normal transaction value at which such goods are sold to the unrelated parties. In case such similar goods are not sold to unrelated parties, the excise laws provide that the valuation for such goods shall be the cost of production plus 10 per cent mark-up.

3. Service Tax- Finance Act 1994

The Service Tax (Determination of Value) Rules, 2006 (“Valuation Rules”) is a combination of the aforementioned legislation. In terms of the Valuation Rules, the gross amount charged by a person providing a similar service forms the taxable base provided that the transaction is at arm’s length.

In the alternate, the cost of the provision of the taxable service is deemed to be the consideration which would form the taxable base.

4. VAT

The VAT legislation in India also take cognisance of the fact that price of the goods may be manipulated by related parties in order to reduce or evade the VAT liability.

The VAT legislation in certain States such as Delhi and Arunanchal Pradesh contains a specific provision providing that where a registered dealer who sells or gives goods to a related person and the terms or conditions of the transaction have been influenced by their relationship, the sale price of the goods in such cases shall be deemed to be the ‘fair market value’ of such goods for the purpose of levy of taxes.

However, the applicability of the aforementioned provision is limited only to those cases where the purchasing dealer would not be eligible to claim input credit of the goods purchased from the related parties.

The aforementioned States generally define ‘fair market value’ to mean the value at which goods of like kind and quality are ordinarily sold or would be sold in the same quantities between unrelated parties in the open market at the same time. Further, an interesting point to consider is that no specific rules are provided for cases where goods of the like kind are not sold between unrelated parties.

Most of the other States contain general provision providing that where the VAT authorities are of the view that any goods are sold or purchased by a dealer for a consideration which is less than fair market price of the goods and that consideration for such sale or purchase as agreed to between the parties has not been truly stated in the invoices, the sale price of the goods in such cases shall be deemed to be their fair market value of such goods for the purpose of levy of taxes.

These States define ‘fair market value’ to mean the price that the goods would ordinarily fetch on sale in the open market on the date of sale or dispatch or transfer of such goods. States such as Andhra Pradesh, Kerala, Uttaranchal, etc., also have provision for seizure and acquisition of such goods either on the value declared by the dealer or at 110 per cent of the purchasing value. However again, such States do not provide for specific rules to calculate such ‘fair market value’.

5. Scenario under GST

The importance of the valuation of transactions has not lost sight of in the new GST regime also. The expression “ related persons” was originally defined in section 2(82) of the Model GSt Law brought out in June 2016 as follows:

(82) persons shall be deemed to be “related persons’’ if only –

  1. they are officers or directors of one another businesses;
  2. they are legally recognized partners in business;
  3. they are employer and employee;
  4. any person directly or indirectly owns, controls or holds five per cent or more of the outstanding voting stock or shares of both of them;
  5. one of them directly or indirectly controls the other;
  6. both of them are directly or indirectly controlled by a third person;
  7. together they directly or indirectly control a third person; or
  8. they are members of the same family;

Explanation I. – The term “person” also includes legal persons.

Explanation II. – Persons who are associated in the business of one another in that one is the sole agent or sole distributor or sole concessionaire, howsoever described, of the other, shall be deemed to be related.

However this definition does not fine place in the subsequent Draft GST law brought out in November 2016 and the Final CGST Act 2017 published in the Official Gazette dated 12/04/2017.

Concept of valuation of Supply under CGST / SGST Acts

Section 15 of the CGST Act 2017 provides for valuation of taxable supply of goods or services or both.

As per section 15 (1) of the CGST Act, the value of a supply of goods or services or both shall be the transaction value, which is the price actually paid or payable for the said supply of goods or services or both where the supplier and the recipient of the supply are not related and the price is the sole consideration for the supply and as per section 15 (4) where the value of the supply of goods or services or both cannot be determined under sub-section (1), the same shall be determined in such manner as may be prescribed. Section 15(5) also provides that, notwithstanding anything contained in sub-section (1) or sub-section (4), the value of such supplies as may be notified by the Government on the recommendations of the Council shall be determined in such manner as may be prescribed.

It is very intersting to noe that, though the expression “ related persons” has not been mentioned any where in this section, the meaning of the expression “ related persons” has been provied as Explanation (a) under this section as follows:

Explanation.—For the purposes of this Act,––

(a) persons shall be deemed to be “related persons” if––

  1.  such persons are officers or directors of one another businesses;
  2.  such persons are legally recognised partners in business;
  3.  such persons are employer and employee;
  4.  any person directly or indirectly owns, controls or holds twenty-five per cent. or more of the  outstanding voting stock or shares of both of them;
  5.  one of them directly or indirectly controls the other;
  6.  both of them are directly or indirectly controlled by a third person;
  7.  together they directly or indirectly control a third person; or
  8.  they are members of the same family;

(b) the term “person” also includes legal persons;

(c) persons who are associated in the business of one another in that one is the sole agent or sole distributor or sole concessionaire, howsoever described, of the other, shall be deemed to be related.

It may be noted that this is the same definition which was originally included under section 2 (82) of the GST Model law published in June 2016.

The Government of India has subsequently come out with the Final Determination value of supply Rules 2017 under the GST Act. This rules has been approved by the GST council and pending notification by Government.

Rule 2 of the Determination of value of supply Rules 2017 under the GST prescribes the value to be adopted in respect of supply of goods between distinct persons or between related parties otherwise than through agents.

As per this rule, the transactions a value for supply of goods or services or both in such cases would be:

  1.  the open Marker Value
  2.  if open Market Value is not available. then value of supply of goods or services of like kind and quality
  3.  if value is not determinable under clause (a) or (b), be the value as determined by application of rule 4 or rule 5, in that order:

Rule 4 provides for adoption of 110% of the Cost of Production, or cost of Manufacture or cost of acquisition as transaction value when the same cannot be arrived at based on Rules 1 to 3, while Rule 5 calls for arriving at the transaction value based on the principles of adopted in section 15 of the CGST Act in line with the Generally accepted Principles.

As per the first proviso to Rule 4 where goods are intended for further supply as such by the recipient, the value shall, at the option of the supplier, be an amount equivalent to ninety percent of the price charged for the supply of goods of like kind and quality by the recipient to his customer not being a related person:

This would apply in the case of manufacturer and dealer who are related persons, or between two dealers who are related persons etc.

The second Proviso to Rule 2 of the Determination of Value Rules further simplifies the valuation in such cases by providing that where the recipient is eligible for full input tax credit, the value declared in the invoice be deemed to be the transaction value.

The concept under the proviso 2 appears to be that, this being a revenue neutral transaction there is no need to have more complications in assessment of such cases.

To conclude, as the transaction between related parties, whether for supply of goods or services, attract greater scrutiny from the revenue authorities and may have serious consequences on the taxability of the transaction, it becomes imperative for the companies to ensure that reasonable care of the legislative provisions is taken while planning business operations.

Written By : Geetha Varadarajan

(Founder Ind Tax Consultants Bangalore & Rtd Advisor (Cost) at Ministry of Corporate Affairs and Director Department of Central Excise and Service Tax.)

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3 thoughts on “Related Parties Transactions in GST Regime

  1. Venkataraghavan says:

    A company in India having one or more common directors (with more than 5% shareholding each in Indian Company) serves a US Company as the only customer with on line data related services from a back office in India. Is the Indian Company subject to IGST because it deals with related persons as defined under Sec 15 of CGST Act?

  2. Pratik Desai says:

    Dear Sirs,

    We have scenario as per below. Can anyone advice GST is applicable on the same or not ? Under which Rule ?

    Bill to Party (A) – in India
    Consignee (D) – Outside India
    Order place on (B) – Company in India
    Material supplied from (C) – outside India
    Order Currency – INR

    (A) place order on (B) in INR Currency & advise to supply to (D)
    (B) place order on (C) in Foreign Currency USD
    (C) supply material to (D)
    (C) invoice to (B) in USD & (B) invoice to (A) in INR.

    GST applicable in this transaction ?

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