Impact of GST on Free Supplies & Free Samples:

DISCLAIMER:
The views expressed in this article are of the author(s). The Institute of Chartered
Accountants of India may not necessarily subscribe to the views expressed by the
author(s).
The information cited in this article has been drawn from various sources. While every
effort has been made to keep the information cited in this article error free, the Institute
or any office of the same does not take the responsibility for any typographical or
clerical error which may have crept in while compiling the information provided in
this article.

The Goods and Services Tax (GST) regime has introduced the concept of ‘supply’ as a
taxable event and done away with the erstwhile taxable events of sale, service,
manufacture etc. The taxability and valuation of ‘Free Supplies’ has been a subject
matter of dispute qua taxation, valuation and credit restrictions in the past under
erstwhile indirect tax laws.

While the term ‘free supply’ is not defined under GST law, a ‘free supply’ in general
sense, means a supply of goods or services without consideration. Under GST law, the
incidence of tax is ‘supply’. The term ‘supply’ has been defined in an inclusive manner
under Section 7 of the CGST Act. The term ‘supply’ as defined under Section 7 of CGST
Act, 2017, includes all forms of supply such as sale, transfers, exchanges, barters etc.
made or agreed to be made for a consideration in the course or furtherance of
business.

Free Supplies between related /distinct person

Further, clause (c) of Section 7 (1) provides that the activities specified in Schedule I,
made or agreed to be made without a consideration, is a supply under GST. As per
Para 2 to said schedule, supplies between related persons or distinct persons in the
course or furtherance of business even if not for a consideration shall be termed as
supply. As a result, free supplies between unrelated persons are not ‘supplies’,
therefore, not taxable, whereas free supplies between related persons are ‘supplies’
and therefore, such supplies are eligible to GST. In other words, GST shall be levied
on the supplies made even without consideration between distinct or related persons
on such value as determined in accordance with Section 15 of CGST Act, 2017 read
with Valuation Rules under CGST Rules, 2017.

Scope of Para I to Schedule I to Section 7 of CGST Act, 2017

The said schedule also provides under Para 1 that the permanent transfer or disposal
of business asset where input tax credit (hereinafter referred to as ITC) has been
availed on such asset is treated as supply. The term Business Assets has not been
defined under the Act. According to general rule of interpretations, if the language
used has a natural meaning we cannot depart from that meaning unless, reading the
statute as a whole, the context directs us to do so. According to the plain meaning rule,
absent a contrary definition within the statute, words must be given their plain,
ordinary and literal meaning. In the instant case, the term Business Asset is of very
wide connotation. It includes every asset of the business including capital goods,
finished goods etc. The clause stated above includes free supplies between both
related and unrelated person.
As per our understanding, such clause shall cover following types of situations:
(a) Disposal of Old Machinery to NGO – A company has purchased a machinery and
has availed input tax credit in respect of GST paid on such procurement. Further after
few years, company disposed of such machinery by transferring it to NGO. Such
transfer shall be considered as supply in terms of para stated above. Thus, GST shall
be levied on the transfer of such assets on the value as determined under Section 15
of CGST Act, 2017 read with CGST Rules, 2017.

(b) Disposal of old machinery to related person / distinct person without

consideration can also be covered under the said Para as there is no restriction to the
same and consequently the same shall be considered as supply in terms of Para 1 and
Para 2 of Schedule I to the CGST Act, 2017.

In the opinion of the author, business assets specified in Para 1 shall include only those
capital assets which are being used in the course or furtherance of business. Thus,
input tax credit reversal is not required in the said case. However, transfer and
disposal of such assets shall be considered as supply and GST is leviable on the same.
Department should clarify in this regard to bring clarity and to avoid unnecessary
litigation.

Gifts to incentivise Distributors

These are marketing strategy adopted by various companies. Gifts provided to
Distributors includes:
(a) Goods which are manufactured by company itself or goods in which they are
dealing on their own
(b) Goods purchased from other vendors

On procurement of such goods or manufacturing of such goods, input tax credit in

respect of the same is availed by the companies. Considering the wide definition of
business assets (as discussed above), such goods shall easily be referred to as business
assets. Hence, transfer of such business assets on which input tax credit has already
been availed shall be considered as supply and hence the same shall be exigible to
GST.

However, in term of Section 17(5)(h) of CGST Act, 2017, notwithstanding anything

contained in Section 16(1) and Section 18(1) of CGST Act, 2017, input tax credit in
respect of goods, destroyed, written off or disposed of by way of gift or free samples
shall not be available. The term gift has not been defined in the Act, thus, we would
like to resort to definition provided under Gift Tax Act, 1858.

Section 2 (xii) “Gift” means the transfer by one person to another of any existing movable
or immovable property voluntarily and without consideration in money or moneys worth and
includes transfer or conversion of any property referred in Section 4, deemed to be a gift under
that section.

As per above stated definition, any transfer by one person to another of any existing
movable or immovable property voluntarily and without consideration shall be
considered as Gift. Thus, goods provided free of cost shall fall under definition of gifts
and accordingly input tax credit in respect of them has to be reversed.

A conjoint reading of Section 17(5)(h) of CGST Act, 2017 and Schedule I to CGST Act,
2017 demands harmonious interpretation of law. Such harmonious interpretation
clearly indicates that if the goods are disposed of by way of gift, section 17(5)(h) of
CGST Act, 2017 shall be applicable and accordingly input tax credit in respect of the
same shall not be allowed. Thus, the same shall not be considered as supply. However,
if such goods are disposed of by any way other than gift, then the same shall be
considered as supply in terms of Para stated above and accordingly shall be exigible
to GST and reversal of credit shall not be required.

According to the opinion of the author, goods distributed to distributors free of cost
is a sales promotion expense in the hands of the companies, thus it cannot be
considered as gift. In this regard, we would like to refer to the case of FEDERAL
COMMISSIONER OF TAXATION v. McPHAIL (1968) 117 CLR 111 26 March 1968
wherein Hon’ble High Court has provided that to constitute a “gift”, the property
should be transferred voluntarily and not as a result of a contractual obligation and
no advantage of material character was received by transferor. Relevant text of the
judgement is reproduced as under:

6. But it is, I think, clear that to constitute a "gift", it must appear that the property
transferred was transferred voluntarily and not as the result of a contractual
obligation to transfer it and that no advantage of a material character was received
by the transferor by way of return.

Goods distributed to distributors is benefitting the companies in promoting their

sales. Thus, the same shall not be considered as gift. Hence, input tax credit should be
available in respect of such goods. Here it is essential to highlight here that
Department might litigate on the said issue and disallow the input tax credit in respect
of goods distributed to incentivise the distributors considering them as Gift as there is
no clarity in this regard.

Gifts for Marketing

Companies offer various schemes in the market so as to increase the sale of the
products such as buy 2 get 1 free etc. Here we would like to mention that such gifts
are in the nature of discounts. Such schemes are introduced to give to the buyer an
Incentive to purchase more quantity at a lesser price indirectly by giving something
free & hence it is actually a Discount in real sense ( which we may call by whatever
name Trade Discount/Quantity discount etc…..) One may also refer the decision of
Hon’ble Supreme Court in CCE Vs. Hindustan Lever Ltd (2002) (142) ELT 513 (SC).

In terms of Section 15 of CGST Act, 2017, such value of discount, shall not be included
in the value of supply so as to compute GST liability. According to the opinion of the
author, no reversal is required in respect of such goods provided free of cost.

However, in terms of Section 17(5)(h) of CGST Act, 2017, such goods provided free of
cost can be considered as gift and department may ask for the reversal of the credit in
respect of the same. Thus, it is recommended that in the invoice under such schemes,
companies shall reduce the value of the product provided free of cost, as a trade
discount, from the total value of the products including the product which is to be
provided as gift. In such a case, companies shall be eligible to avail input tax credit of
such goods sold without any fear of litigation.

Further, CBIC’s Sectoral FAQ ( available on CBIC website ) further suggested

following : –

Question – How the Invoicing should be done for free goods given along with sale so that
corresponding input tax credit is not required to be reversed for products under scheme ?
Answer – Invoice Value would include value of all goods including those supplied free. In such
cases, ITC is not required to be reversed.

Disposal by way of Free Samples

Various Companies engaged in Pharmaceuticals, Cosmetics, Food Products etc.
distributes free samples to customers/branches across the country. Such free samples
transferred to customers shall not fall under definition of supply and accordingly no
GST shall be leviable on the same.

For Free Samples there is provision for ITC Reversal u/s 17(5). The same reads as
under:

(5)..Notwithstanding anything contained in sub-section (1) of section 16 and subsection(1) of

section 18, input tax credit shall not be available in respect of the following, namely:—

(a) …….
(b) …….
…….
(h) goods lost, stolen, destroyed, written off or disposed of by way of gift or free samples; and

……..

Further, it also essential to bring to your attention the CBIC’s Sectoral FAQ ( available
on CBIC website where following has been provided:
Question – What are the requirements for clearance of physician samples distributed free of
cost?
Answer – In case of clearance of physician samples distributed free of cost, the ITC availed on
the said samples has to be reversed in view of the provisions under Section 17(5)(h) of the CGST
Act, 2017. No tax is payable on clearance of physician samples distributed free of cost as the
value of supply is zero and no credit has been availed.

Hence according to section 17(5) of the CGST Act, input tax credit will not be available
for goods given as gifts or free samples. Thus, if the taxpayer avails the input tax credit
on account of a purchase of goods, and later gives these goods as free samples, then
he will have to reverse the input tax credit so availed.

Distribution of Samples through Branches

Further, we would like to deal a scenario where a company distributes free samples
through its branches. In such a case, transfer of free samples to the branch, being
related person, shall be exigible to GST and further input tax credit in respect of such
samples shall be allowed. However, branch needs to reverse the input tax credit of
GST paid on such samples to the company. The same can be explained with the help
of an example:
A supplied 2000 sample costing (including all inputs used for manufacturing samples
and are eligible for ITC) Rs 60 each to its Branch located in Haryana. Accordingly, A
charged GST on supply of such samples on value as provided under Section 15 of
CGST Act, 2017 read with Rules thereunder, say Rs 100 (including the value of all
inputs, salary and other expenses). Consequently, tax invoice shall be issued in respect
of the same. In view of the same, A is entitled to avail the credit in respect of the inputs
used for manufacturing such goods, i.e. Rs 60.
Further, when B shall distribute the samples free of cost to the customers, then B is
required to reverse the credit in respect of GST paid on amount charged by A from
branch i.e. on Rs 100. Such reversal would be much more than what is required to be
reversed by A, had the samples were given free of cost by A only. A would have
reversed the credit on Rs 60, however, branch needs to reverse the credit on Rs 100.
Thus, this aspect also has to be taken into consideration while deciding on distributing
free samples via branches.

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Acknowledgements

We thank CA. Krunal J. Davda for drafting this article and CA. Ashok Batra for reviewing the
same. For any queries, you may connect with him at [email protected] .

- Indirect Taxes Committee