Input Service Distribution on common services compulsory in GST Regime?

Business entities having branches in multiple states or having multiple business verticals with different registration in a same are required to deal with concept of Input Service Distributor under GST. This article attempts to analyze if ISD is a compulsion.

Although there is a compulsion to get registered under GST for ISD as per Section 24(viii) of CGST Act, there seems to be no Section which mandates/compels that the credits on commonly used services are to be distributed. Section 20(1) reads as below

“(1) The Input Service Distributor shall distribute the credit of central tax as central tax or integrated tax and integrated tax as integrated tax or central tax, by way of issue of a document containing the amount of input tax credit being distributed in such manner as may be prescribed”

However, the whole Section 20 deals with the manner of distribution of credit. Hence, the compulsion put by the phrase “shall” might have to be read only with respect to manner and not the primary requirement to distribution itself. It might have to be understood as ‘if credit has to be distributed, it shall be distributed in this manner’. Hence, non-distribution might not be an outright contravention of any provision.

However, there might be a requirement/necessity (rather than compulsion) to distribute the credit on common services received. Section 25(4) provides that the different registrations of a single person will be deemed as distinct persons. Further, Section 16(1) authorizes a registered person to avail credit of Input tax charged on supplies used in the course or furtherance of his business. When a common service is received, a part of it is also relevant to the other units which are deemed distinct persons. In such case, the part of the credit related to such deemed distinct persons might not be eligible for ITC as it is not used in the course or furtherance of business of that particular registration.  Hence, if that portion of credit is not to be lost (or the assessee does not want that credit to be litigated by the department), credit has to be distributed.

In the earlier tax regime, this concept of Input Service Distributor came into existence to facilitate the availment and distribution of input tax paid by a unit which was not providing any services or was not clearing any manufactured goods (like administrative office, marketing branches, etc). This was a concept introduced to enable distribution of ITC received by an unproductive unit to productive unit. However, with the introduction of GST, this facilitating concept has turned into a compulsion concept although there is not much necessity to make it compulsive. This has resulted in unnecessary hardship to tax payers. Some examples are as below

• A company consists of one head office and two branches. All the units are providing output service and are having potential to utilize the input tax credit earned on their own (output liability is higher than the ITC). Even in such case, head office will be forced to distribute credit on common services like legal service, consultancy service, auditing service, etc, even though there is no need to do it.
• A company is engaged exclusively in export of service to group companies. It has one head office and two branches. For the services exported, the head office bills the group companies and the branches raise an invoice on head office to discharge tax in line with Schedule I. In this case, the head office will be forced to distribute the credit first and the same credit will flow back to the head office via the invoices raised by the branches. In such cases there seems to be no need to distribute the credit.

As told above, in many cases, this ‘kind of compulsive nature’ of ISD unwarrantedly increases the compliance requirement without any benefit. The things turn worst if the manner in which credit is distributed is somehow found erroneous (say the turnover computed is found not correct as some of the credit notes are subsequently held not deductible from turnover, a transaction treated by the assessee to be not part of turnover subsequently held as part of turnover, change in valuation of supply, etc.), as in such cases taxpayers will end up not only loosing the credit but also paying an interest. Although an argument can be put forth that the manner of distribution is procedural in nature and deviation in the same cannot take away the substantial benefit conferred by law, the argument is less likely to be accepted by most of the adjudicating authorities which results in increased litigation cost.

Only benefit which seems to have been gained by the Government by making ISD a necessity is that it helps in distribution of credit between the Governments which results in better cash collection for the distributing state. However, the benefit comes at a cost of unnecessary hardship to assessees.

Further, although there is no section which expressly compels the taxpayers to distribute the credit on common services, the chances of loosing partial credit or ending up with a litigation cost is high, as a necessity is impliedly imposed in Section 16(1) read with Section 25(4) of CGST Act.

GST, by deeming a part of an entity as distinct person has turned an enabling concept to a necessity even through there is no Section which expressly puts a compulsion on distribution. Hence, the concept of Input Service Distributor is, in my view, more of a necessity than a compulsion.