GST impact on pharma and FMCG firms: Is taxing freebies legally tenable?

Freebies/extras cannot qualify as 'gifts' because the consideration for them is in-built in the price, Sudipta Bhattacharjee says.

Investigations against freebies/extras being provided by various pharma and FMCG companies have been in news, of late. Recently, even banks faced investigation/notices against alleged ‘free of cost’ services. There was an immense criticism of this move and finally, a favourable clarification was issued by the government for banks. However, ‘free’ supplies it seems will continue to remain a ‘red flag’ for tax authorities. After banks, it appears that the pharma and FMCG companies are now on the radar.

Two broad types of schemes can be discussed in this context:

(i) Buy-one-get-one-free schemes; and

(ii) 20 per cent extra: This is generally the increase of quantity in the same price by 20 per cent (or any other percentage which may be decided by the company)

The paragraphs below encapsulate an overview of the line-of-attack/enquiry by tax authorities and legal arguments available against the same.
 

THE EXPECTED LINE OF ENQUIRY BY GST AUTHORITIES
 

The following two-prong approach is expected from the tax authorities:

1. Demanding output GST from companies giving away such  freebies/extras, based on:

A. Entry 1, Schedule I to the CGST Act:

“Activities to be treated as supply even if made without consideration: 1. Permanent transfer or disposal of business assets where input tax credit has been availed on such assets….”

Tax authorities may argue that since input tax credit has been availed by companies on acquisition/manufacture of such freebies/extras, giving away the same ‘for free’ to customers is nothing but ‘permanent disposal of the business assets’

Rebuttal: From reading entry (1) along with the heading of Schedule I, it is clear that for an activity to fall under this head, it will have to be ‘without consideration’. Neither ‘Buy-one-get-one-free schemes’ nor ‘20 per cent extra’ schemes provide anything ‘free’. Reference herein can be made to the recent British decision in the case of Marks & Spencer PLC, wherein under an offer, M&S was providing “free wine for dine” in 10 pounds. The Tribunal held that when a 'commercial common sense approach’ is adopted, the term ‘free’ was being used in a marketing sense, but the economic and commercial reality of the offer was that M&S was offering a package of four items for 10 pounds, so the price must be allocated across all four items for VAT purposes.
 

B.Taxmen may argue that free­bies/extras are being provided for obtaining the brand loyalty of the customers which is an additional underlying consideration and thus ought to be additionally leviable to GST.
 

Rebuttal: First, there is no additional consideration flowing from customers here — adopting the aforementioned ‘commercial common sense approach’ the entire consideration has to be bifurcated between the bundle of products. In any case, brand loyalty cannot be said to be an additional consideration, as any other brand offering ‘buy one get two free’ would have attracted a better response. Also, customers loyal to a brand do not necessarily wait for such offers or their choice is not dependent on such offers.

Second, freebies/extra are given in lieu of discount, and the said discount satisfies the conditions under Section 15(3) of the CGST Act. To that extent, the taxable base for levy of GST cannot include the value of such freebies/extra.

2. Demanding reversal of input credit vis-a-vis such freebies/extras based on:

A. Provision of freebies/extras is not “in the course of furtherance of the business”.
 

Rebuttal: This argument is evidently unsustainable. Such supplies are being made to remain competitive in the market and sell more products. They are obviously ‘in the course of furtherance of business’.

B. Specific input credit restriction under Section 17(5)(h) for “goods lost, stolen, destroyed, written off or disposed of by way of gift or free samples”

Rebuttal: ‘Gifts’ are a voluntary transfer of property by one to another, without any consideration or compensation therefor. A ‘gift’ is a gratuity and an act of generosity and envisages an activity without a contractual/legal obligation. The freebies/extras cannot qualify as ‘gifts’ because:
 

• The consideration for the freebie/extra is in-built in the price and thus such freebie/extra cannot be said to be devoid of consideration

• The ‘get one’/extra product is unavailable unless the ‘buy one’/basic quantity is purchased. There exists a contractual obligation to ‘buy one’ to ‘get one’/extra free.

Companies will do well to keep in mind the above legal arguments in dealing with investigations vis-a-vis GST treatment for freebies/extras and rebutting any tax demands from authorities.

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The writer is partner – tax controversy management & contract documentation, Advaita Legal