The recently launched goods and services tax (GST) is having teething trouble and has opened a Pandora’s box of legal issues to be addressed, by taxpayers and the revenue department, as well as tax practitioners.
The event which triggers tax liability under GST is supply, but the nature and scope of “supply” as used in the definition of GST under article 366(12A) of the Constitution (One Hundred and First Amendment) Act, 2016, is yet to be interpreted and laid down by the judiciary.
There are divergent views on whether “supply” as used in the constitution can encompass transactions such as penalties imposed on a supplier for the late supply of material, amounts payable by a contractor for delay in the completion of work, amounts received or retained on the cancellation of a service contract, charges paid by a customer for not purchasing a specified minimum quantity, payments for failure to give sufficient notice as agreed in an employment contract, and many more such transactions where no “positive activity” is done by the “supplier”.
To arrive at the meaning of “supply”, we should first examine the concept of supply in general terms and then apply a test to determine whether the context of its use in the constitution demands a different meaning. It also must be remembered that when interpreting legislation, tax entries should receive the broadest possible interpretation.
For common usage, we may refer to dictionaries. For instance, “supply” as a verb is defined in the Oxford Advanced Learner’s Dictionary as “to make available for use or to provide something to someone” and in the Cambridge Dictionary as “to provide something that is wanted or needed”.
Looking at clarificatory rulings in other countries where a similar legal provision exists, the South African case of Shell’s Annandale Farm examined whether land expropriation fell outside the definition of a supply. The court held that some act on the part of the vendor is required before a supply of goods or services can be said to have been made. As the applicant had done nothing which contributed to the transfer of the land which was expropriated or in relation to the divesting of ownership, there was no supply. Shortly after the ruling, the tax law was amended to specifically include expropriation in the definition of supply.
Similarly, in New Zealand the term “supply” has been interpreted to mean “to give something”. New Zealand courts have held that despite wide interpretation, “supply” should not include a transaction where an amount is received but where something has not been provided to the counterparty by the recipient of the amount.
Based on the conventional meaning of supply, as well as interpretations of “supply” in foreign jurisprudence, something must be provided, made available or delivered for a transaction to constitute a supply.
If this line of reasoning is followed, grounds exist to advance an argument that there is no positive action by a supplier where penalties, damages, compensation, or cancellation charges are incurred. Nothing is supplied when a customer receives a penalty payment from a supplier for late supply of material, compensation from a contractor for delay in completion of work, etc., and hence these should remain outside the scope of “supply”.
Even the scope of the entry – in schedule II of the central and state GST acts – covering “agreeing to the obligation to tolerate an act or a situation” should be interpreted in a restricted sense and should not be extended beyond the meaning of “supply” as used in the constitution. To fall under the above entry, there should be a wilful desire of the party to tolerate an act. Any amount receivable by a party due to breach of the terms of a contract by the other party would be merely in the nature of compensation/damages.
Conversely, it is possible to argue that the penalty, damages, or compensation received on breach of contract is for giving up the right to sue due to the breach, and hence the activity of giving up such a right itself is a positive action by the “supplier”.
As one can see, there seems to be no clarity on how expansive the scope of the term “supply” can be, and how widely this should be interpreted.
The latest FAQs and tweets released by the government give a very wide interpretation to the term “supply”. It seems that government intends to include the examples given above within the ambit of GST. It is now up to the judiciary to test and lay down the exact scope and ambit of “supply”.
L Badri Narayanan is a partner and Tushar Aggarwal is a joint partner at Lakshmikumaran & Sridharan.
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