GST impact on Export of services to related parties
Any Indirect tax such as VAT or GST follows either the origin principle or the destination principle. It will be of use to understand these two concepts.
| Origin Principle | Destination Principle |
| Tax is levied at point of origin of the goods or services or both | Tax is levied at point of consumption of the goods or services or both |
| Tax is levied on all value added domestically, i.e., tax is levied on all goods and services produced (or traded) within the country [Produced domestically] | Tax is levied on all value added domestically, i.e., tax is levied on all goods and services produced (or traded) within the country [Consumed domestically] |
| Exports are taxed because the goods or services produced domestically are exported | Exports are NOT taxed because the goods or services consumed outside the country |
| Imports are not taxed because these do not form a part of domestic production of goods and services | Imports are taxed because the imported goods or services are consumed within the country |
| In a nutshell, all domestic production or services are taxed, whether exported or not as these are produced within the country and imports are not taxed as these are not produced in the country. | In a nutshell, all domestic production and services including imports are taxed as these are consumed in the country. Exports are not taxed as these are not Consumed in the country. |
GST law in India follows the destination principle. Hence, in principle, exports are not taxed. That said, export of services can be exempt exports or zero-rated exports. It is essential to understand the difference between ‘exempt’ and ‘zero rated’.
Zero rated export of services –
Section 16 if The IGST Act, 2017, defines ‘Zero rated Supply’. Accordingly, service will be considered to be exported (hence, zero rated) when the following conditions are fulfilled:
(i) the supplier of service is located in India;
(ii) the recipient of service is located outside India;
(iii) the place of supply of service is outside India;
(iv) the payment for such service has been received by the supplier of service in convertible foreign exchange or in Indian rupees wherever permitted by the Reserve Bank of India; and
(v) the supplier of service and the recipient of service are not merely establishments of a distinct person in accordance with Explanation 1 in section 8;
As you will note, condition (v) requires that the supplier and recipient of services are not merely establishments of a ‘distinct person’.
In this context we refer to the meaning of distinct person as per Section 8 and also the departmental clarification provided in this respect. We quote from Frequently Asked Questions (FAQs) on Goods and Services Tax, 3rd Edition dated 15th December, 2018
“Q 32. How is condition 5 viz the supplier of service and the recipient of service are not merely establishments of a distinct person in accordance with Explanation 1 in section 8 of the IGST Act, 2017 impacts the taxability?
Ans. Explanation I in section 8(2) of the IGST Act, 2017 states that where a person has an establishment in India and any other establishment outside India then such establishments shall be treated as establishment of distinct persons. Where the Indian arm is set up as a liaison office or a branch they would be treated as establishments of the same entity and hence the supply inter se shall not qualify as export of services.
However, if the Indian arm is set up as a wholly owned subsidiary company incorporated under the Indian laws, the foreign company and the Indian subsidiary would not be governed by the provisions of distinct person or related person as both are separate legal entities.”
Based on the above and subject to conditions (i) to (iv) being fulfilled by the supplier, one may conclude the following transactions to be zero rated or otherwise –
| 1 | Supplies by Indian supplier to unrelated foreign supplier | Zero Rated |
| 2 | Supplies by Indian supplier to foreign holding company | Zero rated as both are separate legal entities |
| 3 | Supplies by Indian supplier to foreign subsidiary company | Zero rated as both are separate legal entities |
| 4 | Supplies by Indian supplier to its branch outside India | Not Zero rated because condition (v) is not satisfied. |
Exempted export of services –
The supply of services by an Indian supplier to its branch outside India, item 4, above, does not qualify as ‘Zero Rated’ export of services. However, such services do not become taxable for the simple reason that India follows the destination principle or consumption-based GST. In order to avoid export of taxes, the government has issued notification no.15/2018-Integrated Tax (Rate) dated 26/07/2018, thereby exempting the supplies made by an Indian supplier to foreign branch office. Consequently, Entry 10F of Notification No.9/2017- Integrated Tax (Rate) was introduced. The same is reproduced hereunder for immediate reference –
| Sl. No. | Chapter, Section, Heading, Group or Service Code (Tariff) | Description of Services | Rate (per cent.) | Condition |
| 10F | Chapter 99 | Services supplied by an establishment of a person in India to any establishment of that person outside India, which are treated as establishments of distinct persons in accordance with Explanation 1 in section 8 of the Integrated Goods and Services Tax Act, 2017. | Nil | Provided the place of supply of the service is outside India in accordance with section 13 of Integrated Goods and Services Tax Act, 2017. |
Impact of Exempted exports on Input Tax Credit (ITC):
In terms of Section 17 of the CGST Act, 2017, a supplier of taxable as well as exempt output supplies has to restrict the ITC to the extent attributable to taxable output supplies. This means that the Indian supplier who makes exempt supplies to its branch outside India will have to reverse ITC in the following manner –
- ITC directly attributable to the outward supplies made to the foreign branch, and,
- Pro-rata reversal of ITC on common inputs and input services.
Needless to state, the ITC reversal faced by the Indian suppliers will result in cascading effect by increasing the final supply price to the foreign branch. The company as a whole will face higher cost while at the same time making India a less attractive destination for back office operations and business process outsourcing services.
We trust the above article is of some help to the readers for planning their transactions with foreign branches. Questions or comments of readers on this article are welcome.
Dipen Lathi,
Chartered Accountant
www.Lathico.com
DISCLAIMER : No assurance is given that the revenue authorities/ appellate authorities/ courts would concur with the views expressed herein. Our views are based on the existing provisions of law and our interpretation thereof. We do not assume responsibility to update the views consequent upon such changes, if any. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.
All rights reserved. No part of this material may be reproduced, without the prior written permission of the author. Fair use of the content is permitted provided credit is given to the author.
© Dipen Lathi
MMXX