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Fixing AAR

The advance ruling mechanism under GST is fraught with many gaps, which is compounding the problems of taxpayers
twitter-logoDipak Mondal | Print Edition: September 6, 2020
Fixing AAR
Illustration by Raj Verma

In June, the Karnataka Authority for Advance Rulings (AAR) for Goods and Services Tax (GST) ruled that Malabar Parota is not the same as ready-to-eat chappati/roti as it has be processed further for consumption, and hence should be taxed at 18 per cent and not 5 per cent (tax rate for chappati). There was outrage and, soon, memes around the ruling started doing rounds of social media.

Blame it on flaws in the way AARs are constituted or complexity of India's tax laws, the Karnataka AAR is not the only one that has been in news of late for wrong reasons.

Take the issue of tax on compensation paid to directors of an incorporated entity. Two state AARs - Karnataka and Rajasthan - came up with different interpretations and rulings on the issue earlier this year. The Rajasthan AAR said directors are not employees and so their fee should attract GST under the reverse charge mechanism (the company will pay the tax on behalf of directors). The Karnataka AAR, however, noted that an 'executive' director sells services as an employee, and therefore, his or her remuneration will not attract GST. However, it also said that remuneration to a non-executive director will attract GST. What is more perplexing is that the Karnataka AAR had, last year, given an opposite ruling on this issue. All this is adding to confusion of taxpayers.

AARs have been set up to help taxpayers seek clarity, in advance, on tax to be paid on certain transactions, and in doing so avoid long-drawn tax litigation that is so common in India.

However, the fact that every state/Union territory has one AAR, manned by 'junior' tax officials, means that the rulings at times lack maturity, consistency and are often pro-revenue, say tax experts.

Design Flaw

Every AAR has two members, one state and one central tax officer. They are mostly additional and joint commissioner level, too junior to handle complex matters that can potentially affect businesses across the country, say experts. Also, both are technical members (there is no judicial member). The composition of AARs is such that they are not fully independent or immune to government revenue pressures. "AARs should be such that they can resist the government's revenue pressures. Here, you have put two additional commissioner-level officers who know that after two-three years they have to go back to the department and work under the same commissioner against which they might be passing orders today," says Kamal Agarwal, Founding Partner & Governing Council Member, SARC & Associates, a chartered accountancy firm.

Experts say the rulings suffer from lack of maturity or consistency primarily because of absence of judicial members, who can be either retired Supreme Court or High Court judges, people from the Indian Legal Service, or senior lawyers. "If we look at the period prior to GST, we had a Central regime where there was a single AAR for customs, excise and service tax. It had both judicial and technical members. As the central AAR in the pre-GST era had judicial members too, its rulings were more reasoned and judicious," says Saloni Roy, Senior Director, Deloitte India.

However, she admits that having AARs in every state has ensured timely disposal of advance ruling applications. "The new system has improved the time taken for the rulings as there are so many benches. But the composition of the benches is such that most of the rulings are in favour of the revenue department," says Saloni Roy.

Take the case of Sanofi India where the Maharashtra AAR held that input tax credit would not be available on expenses on goods procured for sales promotion. Tax experts say the ruling clearly shows the pro-revenue attitude of the authority.

Again, in case of remuneration to directors, there are two rulings - one by the Karnataka AAR and another by the Rajasthan AAR - that directors are not employees and that services rendered by them to a company for which consideration is paid under any head will attract GST under the reverse charge mechanism. "Fueled by these contrived advance rulings, businesses are being served notices for payment of GST on all forms of remuneration to directors. Companies must note that an advance ruling is binding only on the person who has sought it and so does not have any binding efficacy, especially when it has been delivered in another state," says Ranjeet Mahtani, Partner, Dhruva Advisors LLP. As per the GST law, an advance ruling by an AAR is binding only on the applicant and the tax officer concerned. This means it is not applicable to other people in the state as well. Saloni Roy of Deloitte says a pan-India company with different GST registrations in different states may have to approach multiple authorities for clarity on the same issue.

"Because there was a central authority earlier, one decision was applicable across the country. But now, since each state has its own bench, the decision of one bench may not be binding in another state, though its ruling can be used as a precedent to convince the other bench," she says.

When Business Today talked to a member of a state AAR, he said on condition of anonymity (as he is not authorised to talk to the media) that AARs are quasi-judicial bodies whose decisions are not final. If a taxpayer or the tax department does not like the ruling, they can move appellate tribunals.

Each state/Union territory also has an Appellate Authority For Advance Ruling. These also have two members -- one central tax officer at the level of chief commissioner and one state commissioner-level officer. There is a question mark over their independence too as both are from the tax department. There is no judicial member.

The Way Forward

There have been talks of setting up a central AAR for over two years as the Central Board of Indirect Taxes and Customs has had to intervene several times to clarify issues arising out of rulings by state AARs.

For example, after the Goa AAR ruled that alcohol-based sanitisers should be taxed at 18 per cent, all hell broke loose. People took to social media to criticise the move as sanitisers have become essential goods due to Covid-19. The government had to issue an explanation as to why a lower GST rate on sanitisers may prove to be counterproductive. A central AAR might save the government such blushes. However, despite the talks, there has been not much progress in this regard as yet. "Taxability of solar power plants, intermediary services, liquidated damages, etc, are a few examples where contrary advance rulings by different state authorities have added to the quandary of industry. Formation of a centralised AAR could perhaps provide some respite from the dilemma," says Harpreet Singh, Partner, KPMG.

However, a central authority alone may not make things better unless the government addresses the 'design' flaw of AARs.

"Unless the structure changes, this problem will persist. Amend the GST Act because this structure is in the GST law. It should not be under the Ministry of Finance. It should be under the Ministry of Law," says Kamal Agarwal of SARC & Associates. He further says that the state AARs should have at least one judicial member and two technical members. The appellate authority should be a national body headed by at least a high court judge.

Some experts believe that one should become a member of such a tribunal only after resigning from existing posts to maintain the independence of the body.

Saloni Roy of Deloitte says state authorities also need to have a slightly senior officer on the benches, at least a commissioner level officer.

Taxpayers and other stakeholders have been pointing out these shortcomings but no steps have been taken so far to address their issues. It is now up to the government and the GST authorities to bite the bullet and bring the needful reforms to make the advance ruling system work more effectively.

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