GST treatment of returning expired drugs Fails Logic-Tests

Laws are interpreted literally. Interpretation of laws become illogical in certain situations.

During a meeting with our clients in healthcare industry, it was observed that the Input tax credit is denied to the manufacturer, even though, he has paid full tax on the supply of drugs manufactured by him. 

In this post, we will discuss how GST treatment (of return of expired drugs) is illogical and can lead to tax avoidance practices in the industry?

GST treatment of return of expired drugs

The recent circular has clarified the procedure to be adopted for return of expired drugs and has given two options to the manufacturer of drugs: 

1.   Return of expired goods to be treated as fresh supply:

• The registered recipient may return the said drugs by treating it is as a fresh supply and thereby issuing an invoice;
• The value of the said goods may be taken from the invoice on the basis of which the goods were supplied earlier, as the value of such return supply; and
• The manufacturer who is the recipient of such return supply shall be eligible to avail Input Tax Credit of the tax levied on the said invoice.

Destruction of medicine by the Manufacturer

• The manufacturer is required to reverse the ITC availed on the return supply in terms of the section 17(5)(h) of the CGST Act, as the Manufacturer destroys the goods. ITC required to be reversed is ITC availed on the return supply and not the ITC that is attributable to the manufacture of such time expired goods.

2. Return of time expired goods by issuing Credit Note:

• The manufacturer may issue a credit note in relation to expired drugs returned by the buyer as per Section 34(i) of the CGST Act. The buyer shall issue a delivery challan for return of such expired drugs.
• In case credit notes is issued prior to the month of September following the end of the financial year in which original invoice is issued, the manufacturer may reduce its tax liability, provided the buyer has reversed the credit. 
• If such time limit has lapsed, a credit note may still be issued by the manufacturer for such return of drugs but the tax liability cannot be adjusted by him in his hands. Further, if credit note is issued beyond the time period, there is no requirement to declare such credit note in the GST returns as tax liability cannot be adjusted in this case.
• In the instant case, the buyer shall not be required to reverse input taxes credit availed at the time of original receipt of drugs;

Destruction of medicine by the Manufacturer

• The manufacturer shall reverse ITC availed on the return supply in terms of the section 17(5)(h) of the CGST Act. ITC to be reversed shall be ITC attributable to the manufacture of such goods.

Test of Logic - Goods returned under a credit note without GST adjustment

Logic:

GST is levied on value added. Taxes payable on sale of goods are adjusted for the tax paid on purchase of such goods.

Test: 

In case drugs are returned under a credit note without GST adjustment, the following merit consideration:  

(i) The manufacturer is to pay taxes at the time of original supply of goods and he is not able to avail the credit (as the credit availed is reversed at the time of destroying the expired drugs). Payment of tax on full value without availing credits is against the principles of value added tax.

(ii) The buyer of goods has never sold the goods and has never been required to pay tax, but it could avail the credit on purchase of goods (such credit was not reversed). Availing the credit without the output liability is against the principles of value added taxes.

In nutshell, buyer of goods could avail the excess credit at the cost of manufacturer (as credit is denied to the manufacturer).  

Tax Avoidance: 

Example: The manufacturer has accumulated excess credit say of Rs 10 Cr (which he not able to utilize) and the buyer pays GST in cash. 

The aforesaid transaction is entered wherein buyer of goods has returned the drugs under a credit note from manufacturer without GST adjustment of Rs 1 Cr. The buyer will avail credit of Rs 1 Cr (on original supply of goods) and manufacturer will pay Rs 1 Cr out of its earlier accumulated credit. The manufacturer shall reverse the credit taken, resulting net nil credit to the manufacturer.    

As a result, the buyer shall have a credit of Rs 1 Cr and no GST liability in respect of this transaction. He shall be able to use such credit to pay off GST liability in respect of other transactions. The same GST liability would have been paid by him in cash in case he would not have returned the aforesaid drugs.

The manufacturer could utilize its excess credit by 1 Cr.

The whole transaction shall result a net cash loss of Rs 1 Cr to the exchequer.

The above anomaly shall be corrected in order to plug this opportunity of the tax avoidance. The credit note should only be issued by the manufacturer with GST adjustment or drugs should be returned under fresh invoice only. 

We hope that this post shall give you some food for thoughts. Eventually, we all will be able to concurr the lawmakers to make only logical tax laws.

For your action:

In case you find this post to be useful, give you comments. In case you think that more information needs to be added, please feel free to share them in the comments box. In case you need a specific advice on GST, please feel free to request for a free consulting session.  

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Meet you in the next post on logic test on applicability of GST on export houses. 

Happy Learning!!!

(The authors Balwan Bansal and Vivek Mittal are co-founder and Manager respectively at Acupro Consulting Private Limited , which specialises in providing regulatory, taxation and accounting services to MNC companies and to tech start-ups)