Ramblings on GST’s Anti-profiteering Provision

I have been a keen follower of various issues related to GST for quite some time now. Today, on 1st July, 2019, we are commemorating the second anniversary of GST implementation in India. While many things have been done well, much more needs to be done, but to start with, a few things still need to be cognised of by Companies. The two areas I have been talking about for long are:

• Anti-profiteering is the most deadly provision in GST, it is not going to go away in a hurry, and companies need to take it more seriously than they have been doing so far
• GST is not merely a tax- but a business-related inflection point, and will have a deep, profound, and abiding impact on all types of transactions. This will have an impact on M&A transactions, old contracts would need to be redrafted, and new contracts would need to be drafted in keeping with these implications.

Both these issues have largely been relative blind spots for industry. This article is related to the anti-profiteering provision, how it is currently playing out, and the likely scenarios to be played out in the future.

I remember, in my earlier avatar as a GST consultant, almost beseeching clients to not take Section 171 of the CGST Act lightly, not to take a self-destructive stance that this was an unnecessary provision (it wasn’t / isn’t), not to pretend that it is a temporary provision (and therefore one can bide time and tide it over), and most importantly, not to go into a denial mode by positing that the provision is ambiguous (and hence impossible to comply with). I will admit that many “GST consultants” have also added fuel to the fire, by unfortunately further strengthening these misconceptions.

In as much as even I would have preferred if the Govt had not taken a “nanny state” approach towards pricing, and left it to market forces to ensure that the benefits of GST are passed on to consumers, past history as well as CAG reports have shown that this does not happen. When the Govt realized that in the earlier regime, they did not have any legal provision for ensuring this (as also pointed out by CAG), it was obvious that this would be part of GST. Let us just accept this as a fait accompli.

The assumption that this would be a temporary provision has been belied by the recent decision of extending the tenure of NAPA, which will keep on happening in future also. The entire infrastructure and enabling provisions governing anti-profiteering have been further strengthened. Firstly, section 171 is a permanent section in law, not a rule, and hence will remain in the statute books till removed (highly unlikely). Secondly, the journey towards rate convergence (e.g. merging the two standard rates into one), and including other items in GST (e.g. electricity, fuels) is still not over. Each time a change in this is made, the anti-profiteering provision will kick-in to ensure that the benefits are passed on, and compliance paperwork will be required.

I have for long said that B-2-C manufacturing companies are at a greater risk of being scrutinized, as compared to others, but that does not mean that B-2-B companies don’t need to comply. There are major issues with Services cos, where pricing is not linked to costing methodologies, and hence present a severe problem, but that’s for a separate article. Companies have for too long pretended that the methodology has not been delineated, compliance norms are opaque, and hence they cannot comply with this provision. Asking na?ve questions like should benefits be calculated at a company, division, product category, product or SKU level, is unnecessary. If pricing is done at the SKU-level, and the section talks about passing benefits accrued in the form of price reduction, then obviously the calculation has to also be done at the SKU level. Recent judgements by NAPA and other state-level advance ruling authorities have only confirmed this.

Complying with the provision requires three things – and in order – Bonafides, Transparency and Documentation. Many companies have failed at the first step itself. There were unverified stories of companies calculating GST benefit at the division-level, and passing it on in the pricing of “fast-moving” products only, or renaming earlier business discounts as “GST benefits passed on as price reductions”, etc. The assumption was that the Dept would not be able to differentiate between the two, or challenge it. In many recent cases, this has not been found to be valid. Incidentally, rumour has it that the Dept has been trained on costing methodologies also.

My advice to companies is given that the Govt seems to be very serious about ensuring compliance, and is putting severe penalties in place, it makes sense to not only comply, but be seen to have complied, and also to be able to pass scrutiny on compliance. Some basic do’s and don’ts are as follows:

• Calculate the benefit accrued due to GST, through both rate reduction and additional input tax credit, at the SKU level, and pass it on.
• Keep the pre- and post-GST costing and pricing methodologies unchanged, and yes documented. E.g. have an identified committee that takes pricing decisions and keep detailed minutes, including assumptions made, and calculations relied upon. If material cost variations were earlier passed on say once a year, then club it with the GST benefit and net it off. If not, then don’t mix the two.
• Don’t club regular business practices like seasonal / volume discounts, or dynamic pricing, with GST benefits that need to be passed on.
• Even if the decision taken was to not make any pricing changes, e.g. if costs went up that offset GST benefits, document detailed calculations, and establish precedence that cost increases were passed on as price increases in the pre-GST regime also.
• Document any delays in making price changes, calculate the impact, and pass it on as a one-time benefit in the price.
• Conduct mock audits, as sooner or later, you will get questioned on anti-profiteering, and your team needs to be able to answer questions and demonstrate compliance.

There are a few other mind-set issues that need to be addressed, as follows:

• Most companies have done a relatively good job of calculating the benefits through rate reductions, but not on benefits gained through additional input tax credit. This is a lacuna that will cost them heavy, if they get taken up for audits.
• Just because you are in a B-2-B business, it does not mean that you are exempt from this provision. The Dept will work its way up the value chain, and failure to comply will make you liable for prices from July-2017! Many B-2-B cos have not complied with the provision as yet, and are risking severe penalties, as and when they get taken up for audit.
• You cannot contract your way out of compliance with the provision, which means that even if you have say a fixed-price contract, this cannot be a defence against non-compliance. Law overrides the contract each and every time. Although there are no departmental clarifications on this as yet, I am convinced that this is a ticking time-bomb for many companies.
• There are issues with services, as they are usually not priced on a “cost-plus” basis. Having said that, I am convinced that Services cos also need to take cognisance of this provision, and make attempts to comply, as the law does not exempt anyone. Inadequate compliance is always a better defence, in case things get contentious, than no compliance at all.
• There is an admitted ambiguity on whether the GST benefits received from vendors, need to be treated as pass-throughs, to be in turn passed on to customers, or retained as your benefit due to GST. In my personal view, the section clearly reads “any benefit to the recipient”, and not any benefit accrued in the supplies made by the recipient. An unbiased reading of this would suggest that intent of the provision is that you should not retain any benefit accrued through GST, either directly (i.e. in your own supplies), or indirectly (i.e. benefits passed on by your vendors in your purchases). My suggestion is that cos should maintain a separate record of benefits accrued to them from their vendors due to GST, and cognize of it clearly in the costing calculations, and pass it on. I would hate to see a judicial pronouncement on this later coming back to bite you.

There are many experts postulating that the volume of litigation is going to dramatically increase under GST. I think that they are right. My submission is that along with the litigation which would flow from simple disagreements on compliances and tax amounts, which assessees are in a sense used to, there will be a lot of litigation in newer and unexpected areas. I would put anti-profiteering as a very high probability on this list, and next to that I will add treatment of transactions and contracts. A lot of things mentioned in contracts (e.g. commitments made which could be seen as a supply without consideration to a related party, and hence being treated as a taxable transaction). Not to sound pessimistic, but I think that we have barely scratched the surface on how this huge indirect tax reform will play out. My biggest criticism is that for too long GST has been seen as a “tax problem”, for the Head of Tax and tax consultants to solve. It will have to be equally seen as a legal issue, for the General Counsels and lawyers to get equally involved, and review transactions and contracts from a GST lens also.

PS Views expressed above are personal. Please do no view the above as tax or legal advice offered.