The GST enforcement authorities have been issuing multiple notices to several IT companies regarding remittances made by the Indian head offices to their foreign branches for services received from these branches. These transfers are being treated as ‘import of services’ for which authorities are demanding payment of IGST under RCM (Reverse Charge Mechanism). This has led to a wave of avoidable litigation and concerns for IT businesses with international operations regarding cross-border financial transactions within the same company.
Infosys SCN of Rs. 32,000 crores
Last month’s buzzing issue was when DGGI (Directorate General of Goods and Service Tax Intelligence) issued the show cause notice dated 30.07.2024, demanding ₹32,400 crore tax dues for five years, from FY 2017-18 to FY 2021-22, for services that Infosys received from its overseas branches. The notice stated that the adjudication proceedings are being initiated against Infosys due to non-payment of IGST for services that it has received from its overseas branches between July 2017 to FY 2021-22. As the company creates overseas branches to service clients as part of its agreements, those branches and the company are treated as ‘distinct persons’ under the IGST Act. Further it was stated in the notice that in lieu of receipt of supplies from overseas branch offices, the company has paid consideration to the branch offices in the form of overseas branch expenses. Hence, as per DGGI, Infosys was liable to pay GST under the RCM on supplies received from branches located outside India.
Later, after the representations made by Infosys to the department, the tax demand amounting to Rs. 3,898 crores for FY 2017-18 was dropped by the department. It was a clear case of mechanical issuance of show cause notice without application of mind. Ultimately, this back-and-forth by the department led to significant reputational damage to the company. Presently, the demand of Rs. 28,502 crores for FY 2018-19 to FY 2021-22 still looms over the company. The industry was expecting to receive some sort of clarification or relief from the GST Council in its 54th Meeting; however, no such relief was provided by the Council.
Mechanical issuance of notices by the Department
Interestingly, the IT companies have frequently been targeted by the department for issue of non-compliance with the GST provisions. The issuance of show cause notices has become quite prevalent in the IT industry, with the department issuing summon or initiating adjudication proceedings against the companies in even the smaller state jurisdiction offices across the country. For example, prior to the DGGI notice, in April this year only, Infosys faced a penalty amounting to Rs 1.46 lakh for the availment of ineligible input tax credit.
It's not just Infosys that has been targeted. In March, a show cause notice amounting to Rs. 387 crores was issued against LTIMindtree, the country’s sixth largest IT major, by the department for alleged non-payment of IGST on export turnover towards services provided to clients abroad. The company received a similar notice for another GST registration from the same authority. Over the past six to seven weeks, top IT companies, such as Tata Consultancy Services, Infosys, Tech Mahindra and LTIMindtree, have faced numerous penalties and tax orders from the GST departments across the country. These companies and their subsidiaries have got at least 21 penalty notices from GST offices in Punjab, Uttar Pradesh, Delhi, Visakhapatnam, Rajasthan, Bhubaneswar, Chennai, Bengaluru, and Mumbai. While the penalties and tax amount might not be significant – ranging from few thousands to some crores of rupees, which are very small amounts for these cash-rich firms – in almost all these cases, IT firms have declared the intent to contest the notices.
It can be observed that this surge in notices is also a fallout of the expansion of Indian IT services firms into smaller cities. For instance, between July and September so far, TCS has received six notices from five of its locations; Chennai, Goa, Visakhapatnam, Uttar Pradesh, Bengaluru. The highest order is from Visakhapatnam for Rs. 1.17 crore. Similarly, Infosys has also received six notices from Odisha, Chennai, Punjab, Bengaluru. While TechM has got seven notices, LTIMindtree has got two in the same time period.
The domestic entity and foreign affiliate of a same company are treated as separate persons under the GST laws and are thus separate legal entities. Therefore, as per Entry 4 of Schedule 1 of CGST Act, “the import of services by a personfrom a related person or from any of his other establishments outside India, in the course or furtherance of business.” is a supply under GST. The levy comes from the concept of deemed supply between related parties, invoking valuation method under Rule 28(1) of CGST Rules. The department has time and again questioned the invoice values, alleging it to be incorrect open market value, leading to violation of valuation rules and consequential issuance of demand notices.
The IT industry representatives sought clarification from the government on the valuation mechanism issue for this import of services, which led to the 53rd GST Council Meeting recommending clarification regarding the valuation of supply of import of services from the foreign affiliate to its domestic entity (related parties) where recipient is eligible to full input tax credit.
Consequently, the clarificatory Circular No.210/4/2024-GST dated 26.06.2024 (“Circular”) was issued to clarify that in cases where the foreign affiliate is providing certain services to the related domestic entity, for which full input tax credit is available to the said related domestic entity, the value of such supply of services declared in the invoice by the said related domestic entity may be deemed as open market value in terms of second proviso to Rule 28(1) of CGST Rules. Further, in cases where full input tax credit is available to the recipient, if the invoice is not issued by the related domestic entity with respect to any service provided by the foreign affiliate to it, the value of such services may be deemed to be declared as Nil, and may be deemed as open market value in terms of second proviso to Rule 28(1) of CGST Rules.
If we go into the merits of the proposed GST demands, there is a clear violation of the Circular by the department literally within the next week after its issuance. It is a settled position in law that the circulars issued by CBIC are binding on the department, hence the non-compliance of the Circular can also be contested by the companies. It can also be argued by the IT industry that as situation is completely revenue neutral – given that the ITC is fully eligible against the self-invoice issued by the domestic entity and payment of tax under RCM – the mechanical issuance of the demand notices appears to be just an extension of the legal proceedings to harass taxpayers.
GST authorities have deadlines for issuing notices, during which they must scrutinize companies’ returns. As the timelines for adjudication approaches, the department issues demand notices without adequately checking the nature of the services involved. Most notices in the case of IT Companies also originate from State tax offices, which, stemming from the previous VAT regime, have a different - or ‘flawed’—understanding of the GST provisions. All these factors have led to a surge of notices issued before the due date.
The due date for passing orders related to notices issued under Section 73 for FY 2019-20 was 31.08.2024. Consequently, the number of GST orders increased significantly towards the end of the period. This pattern is likely to continue for IT companies, as the deadline for show cause notices under Section 73 of the CGST Act for FY 2020-21 is 30.11.2024. Section 73 provides the adjudication process for the bonafide taxpayer, while Section 74 is invoked in case of fraud, willfull misrepresentation and/or suppression of facts, offering an extended limitation period to the department. The due date for issuance of show cause notices under Section 74 for the FY 2017-18 expired on 05.08.2024. However, for the FY 2018-19 & FY 2019-20, the department has time till 30.06.2025 and 30.09.2025 respectively to issue show cause under Section 74. Therefore, the companies can anticipate receiving further notices from the GST department under Section 73 for FY 2020-21 onwards and under Section 74 for FY 2018-19 onwards. It is also a possibility that the IT companies may be audited in smaller locations (state registration) where fewer large firms are present. The simple logic behind it is that if the number of assessees in a particular state is low, the likelihood of large firms being audited in that state increases.
During the same period, various foreign airlines received notices amounting to Rs. 10,000 crores approx., including British Airways, Emirates, Lufthansa, Singapore Airlines operating in India, for non-payment of GST under RCM on the import of services. However, during the 54th GST Council Meeting, it has been recommended by the GST Council to exempt import of services by an establishment of a foreign airlines company from a related person or any of its establishment outside India, when made without consideration. The notification effecting this exemption is yet to be implemented.
It's interesting how the GST Council has created two classes of services: one for the import of service in the foreign airlines industry, which will be exempt under GST and the second for all the other industries importing services from their foreign entity, which will be under constant scrutiny and dispute by the department even after the issuance of the Circular. Such differentiation classification lacks nexus and reasonable justification and hence, is violative of Article 14 of the Constitution of India.
In such a situation, it may not be a smart move for the companies to subject themselves to the adjudication process as the industry has a strong case on merits. The proposed demands are completely without jurisdiction and authority of law, thus, challenging these demands in Writ Petitions would be a more strategic move. It will be appropriate to invoke the Writ jurisdiction of High Court under Article 226, without any hinderance qua the alternate remedy, as these demands are in violation of the fundamental rights provided under Article 14, 19(1)(g) and Article 265 & 300A of the Constitution of India.
If the companies decide to engage in the long drawn adjudication under Section 73/74 and the subsequent appellate process under Section 107 of the CGST Act, they will have to be cautious that these demands might become contingent liability in their books of accounts. Over that, the mandatory requirement to pay 10% of tax demand as pre-deposit for filing the first appeal, along with additional the pre-deposit payment for the stay in case of second appeal, will also hamper the working capital of the companies. The declared contingent liability may also create a deterrence for foreign investors from investing, leading to difficulty in receiving fundings. This will particularly be challenging in the current economy, where the Indian IT ecosystem is facing a setback. While the established IT giants will be able to handle these finical burdens, but for the Start-ups, these demand notices may heavily impact their pockets if they decided to navigate through the adjudication and appellate processes.
To protect the working capital impact from adverse effects adjudication and appellate process, seeking an interim stay from High Courts would be advisable, more so in light of the recent precedents. Therefore, filing a Writ Petition to contest the legality and validity of the notices is the appropriate course of action for the companies at this time.
Apart from that, companies may also explore the option of making representations before the CBIC and the GST Council, in the hopes that they will consider industry practices and may receive similar relief qua exemptions provided to the airline industry.