GST on Salaries?

The uncertain principle that will lead to all sorts of

paradoxes

Introduction –

Ever since the GST regime was brought into force, it has provided some much-needed respite
and clarification on various issues. However, in the recent case of Cummins India 1, there
arose a paradoxical conundrum due to the adjudicating authority’s ruling. Cummins India had
approached the Maharashtra Authority for Advance Rulings (“AAR”) with the question of
whether availment of ITC on common input supplies on behalf of other unit/units registered
as distinct person attracts GST and if yes, whether Cummins India is compulsorily required to
be registered as an Input Service Distributor (“ISD”) considering Cummins India has no
intention of distributing the ITC between the branch units? The AAR answered both the
questions in yes leading to an appeal by Cummins before the Maharashtra Appellate
Authority for Advance Rulings(“AAAR”). AAAR, however, affirmed the ruling by AAR and
further stated that recovery of the salary cost of Head Office's employees from the branch
offices would be covered under Section 7 of the Central Goods & Services Tax Act (“CGST
Act”) and will be subject to GST. The article aims to examine the flawed reasoning given by
the adjudicating authority and how it can lead to starting of issuance of notices by the
Department.

Understanding the concept of Input Service Distributor (“ISD”) –

Before we begin, let us understand the concept of ISD. Section 2(61) of the CGST Act
defines ISD as, “an office of the supplier of goods or services or both which receives tax
invoices issued under section 31 towards the receipt of input services and issues a prescribed
document for the purposes of distributing the credit of central tax, State tax, integrated tax or
Union territory tax paid on the said services to a supplier of taxable goods or services or
both having the same Permanent Account Number as that of the said office.” One of the main
requirements to qualify as an ISD is to receive the invoices in the prescribed format given
under Section 31 of the CGST Act. Further, as per Section 24(viii) of the CGST Act, any
office of a company can register itself as a ISD for distributing the credit on common input
supplies between distinct units having same Permanent Account Number (“PAN”). It is
pertinent to note that under the ISD mechanism, credit on common invoices pertaining to

1
Cummins India Limited (2022-VIL-03-AAAR)
only input services is distributed and not goods. The ISD mechanism has been created
especially for companies who wants to distribute the credit on common input supplies
between different distinct units in a seamless manner.

In the present case, Cummins India had no intention of issuing the invoice in the prescribed
format considering the Head Office want to avail the ITC on common input services received
on behalf of the branch units and utilise the same for setting of the liability as a normal
supplier.

However, the adjudicating authorities gave a narrow meaning to the definition of ISD and
held that Cummins India’s Head Office receives tax invoices towards the receipt of common
input services on behalf of its units and therefore qualifies as an ISD.

Now, that we’ve understood the concept of ISD, let’s understand the nuances of an employer-
employee relationship under GST.

Employer-Employee relationship under GST –

The AAR had ruled that supply made between distinct persons of the company qualifies as
supply even though there is an absence of any consideration and therefore levy of GST is
applicable. By way of this, the adjudicating authority has defined an employer and employee
as two distinct persons and hence GST needs to be paid on every function performed by an
employee from one unit for another unit. However, since it is established law that an
employment relationship is between an employee and the Company as a whole encompassing
all its establishments, GST need not be paid on every function performed by an employee
from one unit for another unit as the employees are performing functions for the same legal
entity and this establishes an employer-employee relationship.

An employment relationship is multifaceted and GST law to the best of its ability has tried to
explain the scope of an employer-employee relationship. Schedule III of the CGST Act
specifies the transactions and activities which are not to be treated as a supply of goods or
services. Thus, services by an employee to the employer in the course of employment would
be treated neither as a supply of goods nor a supply of services.

The above provision of law clears the air thus indicating that the functions performed by the
employee from one distinct unit for another distinct unit of the Company fall within the
definition of an employer-employee relationship and Schedule III to the CGST Act explicitly
excludes levy of GST on services by an employee to the employer in the course of
employment.

After having our basics cleared, it is now going to be easier to understand how the findings
by adjudicating authorities (AAR and AAAR) are flawed. 

Loopholes in the findings of AAR and AAAR:

As per the authors, there are 3 major loopholes which are as follows:

The AAR and AAAR were both of the opinion that the availment of ITC on common input
services by the Head Office on behalf of other units would qualify as a supply thus attracting
GST. Additionally, Cummins India is required to be registered as an ISD. As per the authors,
there are 3 major loopholes which are as follows:

Firstly, both AAR and AAAR have confirmed that Cummins India is required to be
registered as an ISD even when Cummins India has no intention of issuing the invoice in the
prescribed format which is one of the primary requirements of ISD.

Secondly, Cummins India Head Office cannot utilise the credit on behalf of the branch units
even when the Head Office and branch offices are units of the same legal entity. The sole
reason given by both AAR and AAAR is that common input services received by Head
Office which is being used by the branch units is in the furtherance of branch unit business
and not in furtherance of Head Office business.

Thirdly, the recovery of the salary cost of Head Office's employees from the branch offices
would attract GST. Cummins India is recovering the costs of the salary of Head Office's
employees from the branch offices in the capacity of an employer-employee relationship. As
per Schedule III of the CGST Act, an employer-employee relationship does not fall within
the purview of GST law thus, GST will not be applicable. Moreover, the Central Board of
Indirect Taxes and Customs (“CBIC”) in a press release dated 15th November 2019 had
clarified that no GST can be demanded on salaries paid to chief executive officers or
employees. Thus, the Appellate authority’s ruling is against the established law.

Conclusion
Since, employer-employee relationship is outside the purview of GST law, the topic of salary
too isn’t within the ambit of law as per Schedule III of CGST Act. However, the ruling by
appellate authority is bound to cause unnecessary confusion for companies as it is
contradictory to the provisions of the law. This ruling basically allows the department to
issues notices to companies which will further lead to litigation. It’s a free pass for
department to act as per their whims and fancies thus harassing conglomerates. Hence, it is
necessary for the government to issue a clarification and settle the issue at the earliest.