Supreme Court Judgment on Ocean Freight

The much awaited decision in the case of Ocena freight is pronounced by the Supreme Court much to the relief of the tax payers. Let us first understand how common sense has won the day in the matter and then the way forward for all concerned.

Ocean freight is the cost of transportation of goods by sea. When an importer in India intends to import goods, there are two prominent ways in which the transaction can be proposed – CIF & FOB.

The taxation of ocean freight as illustrated by revenue is given hereunder for ready reference:

In order to provide a level playing field, the GST council has proposed Reverse charge levy on CIF contracts as in all other cases, the input credit is available. Here the overseas supplier engages and pays for the ocean freight. The importer in India is expected to know the charges and pay the RCM on such charges at his end. In the absence of such information, a deemed value of 10% of CIF value is to be adopted for paying GST under RCM. 

Mohit Minerals has filed a writ in Gujarat High Court challenging Notification 8/2017 and Notification 10/201713. The Division Bench of the Gujarat High Court held that the impugned notifications are unconstitutional for exceeding the powers conferred by the IGST Act and the CGST Act.

The revenue has filed a Special Leave Petition against the above judgment in the Supreme Court. Supreme court has made the following observations:

1.       The constitutional role and functions of the GST Council must be understood in the context of the simultaneous legislative power conferred on Parliament and the State legislatures. It is from that perspective that the role of the GST Council becomes relevant.

2.       Section 24(iii) of CGST Act, 2017 provides for compulsory registration of persons who are required to pay tax under reverse charge and it includes such other person or class of persons as may be notified by the Government on the recommendations of the Council.

3.       Section 2(93) of CGST Act defines recipient to include any reference to a person to whom a supply is made shall be construed as a reference to the recipient of the supply and shall include an agent acting as such on behalf of the recipient in relation to the goods or services or both supplied;

4.       Section 7(4) of IGST Act Supply of services imported into the territory of India shall be treated to be a supply of services in the course of inter-State trade or commerce.

5.       Section 7(1)  of CGST Act (b) import of services for a consideration whether or not in the course or furtherance of business; [and] (c) the activities specified in Schedule I, made or agreed to be made without a consideration

6.       Section 13 of IGST Act

(2) The place of supply of services except the services specified in sub-sections (3) to (13) shall be the location of the recipient of services;

(9) The place of supply of services of transportation of goods, other than by way of mail or courier, shall be the place of destination of such goods.

7.       IGST and CGST Act clearly define reverse charge, recipient and taxable persons.

8.       An Indian importer could also be considered as an importer of the service of shipping which is liable to IGST on inter-state supply, if the activity falls within the definition of “import of service” for the IGST Act and CGST Act. The supplier, the foreign shipping line, in this case would be a non-taxable person. However, its services in a CIF contract for transport of goods would enter Indian taxable territory as the destination of such goods. The place of supply of shipping service by a foreign shipping line would thus be India.

9.       The importer of goods cannot be said to be an importer of shipping service since the latter is not an import of service for a consideration under Section 7(1)(b) of the CGST Act. Section 13(9) of the IGST Act creates a deeming fiction of place of supply of transportation services to be in India when the destination of goods is in India. In this case, it is clear the supplier of service- the foreign shipping line - is located outside India; and the place of supply is India. Accordingly, Section 13 of the CGST Act would be applicable to determine the time of such supply.

10.   In the case of goods imported on a CIF basis, the fact that consideration is paid by the foreign exporter to the foreign shipping line would not stand in the way of it being considered as a “supply of service” under Section 7(4) of the IGST Act which is made for a consideration, thereby constituting “supply of service” in the course of inter-state trade or commerce that can be subject to IGST under Section 5(1) of the IGST Act.

11.   The impugned levy on the supply of transportation service by the shipping line to the foreign exporter to import goods into India has a two-fold connection: first, the destination of the goods is India and thus, a clear territorial nexus is established with the event occurring outside the territory; and second, the services are rendered for the benefit of the Indian importer. Thus, the transaction does have a nexus with the territory of India

12.   Since the destination of goods is India, the statute itself is broad enough to cover a taxable event that has extra-territorial aspects, which bears a nexus to India.

13.   Where the statute refers to a person to whom a supply is made, it has to be construed as a reference to the recipient of service.

14.   The power of the Central Government to designate persons and categories of supply for reverse charge derives from Sections 5(3) and 5(4) of the IGST Act and not Section 24(iii) of the CGST Act which mandates the compulsorily registration as a logical corollary to ensure tax collection.

15.   Section 2(98) of the CGST Act, which defines “reverse charge” reiterates that it means the “liability to pay tax by the recipient of supply of goods or services or both instead of the supplier…”. It cannot be construed to imply that any taxable person identified for payment of reverse charge would automatically become the recipient of such goods or service. The deeming fiction of treating the importer as a recipient must be found in the IGST Act. As it currently stands, Section 5(3) of the IGST Act enables the delegated legislation to create a deeming fiction on categories of supply of goods/services alone. Parliament’s intention were to designate certain persons for reverse charge, irrespective of them being the recipient of such goods and services, it must make a suitable amendment to confer such power for exercise of delegated legislation

16.   When the place of supply of services is deemed to be the destination of goods under Section 13(9) of the IGST Act, the supply of services would necessarily be “made” to the Indian importer, who would then be considered as a “recipient” under the definition of Section 2(93)(c) of the CGST Act. The supply can thus be construed as being “made” to the Indian importer who becomes the recipient under Section 2(93)(c) of the CGST Act. This conclusion comports with the philosophy of the GST to be a consumption and destinated based tax. The services of shipping are imported into India for the purpose of consumption that is routed through the import of goods. Although the consideration for shipping is payable by the foreign supplier to the foreign shipping line in CIF contracts, the price is consequently factored into the price of the shipment. The ultimate benefactor of the shipping service is also the importer in India who will finally receive the goods at a destination which is within the taxable territory of India. Thus, the meaning of the term “recipient” in the IGST Act will have to be understood within the context laid down in the taxing statute (IGST and CGST Act) and not by a strict application of commercial principles.

17.   Section 5(3) of the IGST does not confer the powers on the Central Government to create a deeming fiction vis-à-vis who constitutes the recipient. Section 5(3) merely enables the Central Government to identify certain categories of goods and services, where the recipient of such services is subject to a reverse charge, as opposed to the usual mode of taxation where the supplier of the service is charged on a forward charge basis. However, Section 13(9) of the IGST Act read with Section 2(93)(c) of the CGST Act inherently create a deeming fiction of the importer of goods to be the recipient of shipping service.

18.   The transaction between the foreign exporter and the respondents is already subject to IGST under Sections 5 of the IGST Act read with Sections 3(7) and 3(8) of the Customs Tariff Act as “supply of goods”. An additional levy of IGST on imported goods, that is on the supply of transportation service, by designating the importer as the recipient would amount to double taxation. The Supreme Court has agreed to the contention of revenue that the supply of goods on import is a composite supply, where principal supply is the supply of goods. Accordingly the customs duties are levied on such composite supply, which includes IGST as part of it. But artificially vivisecting the same transaction as a standalone service of receipt of ocean freight services in order to attract RCM in the hands of importer in India for a CIF transaction did not find favour from the court. It held that there is no doubt that different aspects of a transaction can be taxed through separate provisions. However, this Court in BSNL (supra) observed that the aspect theory does not allow the value of goods to be included in services and vice versa. The ASG has advanced an interpretation of Sections 5(3) and 5(4) of the IGST Act, read with Section 2(93) of the CGST Act to contend that the importer can be classified as the ‘recipient’ of the services. On this interpretation, the Supreme Court upheld the validity of the impugned notifications under Sections 5(3) and 5(4) of the IGST Act.

19.   The Court has observed that the Union Government is contradicting the main plank of its submission by contending that the two legs of the transaction are separate standalone agreements. That would imply, that while on the one hand the Union Government seeks to levy tax on the Indian importer by going beyond the text of the contract between the foreign shipping line and foreign exporter (for the purpose of identifying the Indian importer as the recipient of services), on the other hand, as far as the submissions on composite supply are concerned, the Union Government urges that the contracts must be viewed as separate transactions, operating in silos. The court is unable to subscribe to this view. The Union of India cannot be heard to urge arguments of convenience – treating the two legs of the transaction as connected when it seeks to identify the Indian importer as a recipient of services while on the other hand, treating the two legs of the transaction as independent when it seeks to tide over the statutory provisions governing composite supply.

20.   To levy the IGST on the supply of the service component of the transaction would contradict the principle enshrined in Section 8 and be in violation of the scheme of the GST legislation. Based on this reason, the court is of the opinion that while the impugned notifications are validly issued under Sections 5(3) and 5(4) of the IGST Act, it would be in violation of Section 8 of the CGST Act and the overall scheme of the GST legislation. As noted earlier, under Section 7(3) of the CGST Act, the Central Government has the power to notify an import of goods as an import of services and vice-versa. No such power can be noticed with respect to interpreting a composite supply of goods and services as two segregable supply of goods and supply of services.

1.       In case of all those who have paid the RCM on CIF imports on ocean freight, since they might have already availed the ITC thereon, it would be revenue neutral and hence there is no action to be taken at their end. However going forward, they need not pay the RCM as the same has been struck down by this judgment.

2.       In case of all those assesses, who have unutilized ITC of such RCM paid they can go for refund consequent to this judgment under other categories wherein they can place the arguments on the grounds that what is paid as RCM is not tax, but a mere deposit and hence no timelines are applicable to seek the refund of such deposit.

3.       In all those cases, where the ITC availed has been partially put to use or distributed under ISD, there would be challenge to file refund claim as there are no provisions for the same under the existing law. Hence GST council has to come out to their rescue in case the judgment is accepted by them and they do not resort to go in for a review or appeal against it before a larger bench.