No ITC available on Promotional Items on FOC basis under GST supplied to distributors/retailers

The applicant was engaged in manufacturing activity and was selling these products through Franchisees (Carrying applicant’s brand only) and distributors/Retailers (Carrying other brands too) . 

For the purpose of brand promotion, the applicant was procuring promotional items such as Carrying bag (with name of Applicant printed on it), calendes, writing pads, display boards, outdoor hoardings, uniform for employees etc. and was supplying such products to its franchisees and distributors without any cost. 

The Applicant approached Hon’ble AAR to determine whether promotional items procured by the applicant are “Inputs” under CGST Act and whether he is entitled to claim ITC on the same.

The Applicant contended that since advertisement expense is an integral part cost of Final Product and therefore, it tantamount to use in business or in course of furtherance of business. 

Therefore, expense on promotional items is an “Input” under CGST Act. Further, these items are not provided on FOC basis to the distributors, rather, it is provided with an obligation to promote the brand of Applicant. Therefore, corresponding ITC is not ineligible under section 17(5)(h) of CGST Act.

Hon’ble AAR divided Promotional items into 2 categories names 

A. Distributive Items, i.e., which are distributed to the customers and employees on FOC basis and are not returned to the applicant and 

B. Non-Distributive items, i.e., where in title is not transferred to the distributors and same are returned to or destroyed at the end of usage period. 

Further, Franchisees are “Related” to the applicant as per Section 15(5)(c) of CGST Act. 

Therefore, AAR held that:

1. Transfer of Distributive Items to Franchisees without any consideration is “Supply” under Schedule I of CGST Act. Therefore, such transfer is liable to GST. Further, The applicant is entitled to claim corresponding ITC.
2. Distributive items transferred to the distributor on FOC basis is ineligible for ITC under section 17(5)(h) of CGST Act as clarified vide Circular No. 92/11/2019-GST dated 7th March, 2019.
3. Non-Distributive Items are “Capital Goods” and not “Inputs”. Therefore, the applicant is entitled to claim ITC. However, corresponding ITC is required to be reversed when such items are written off or destroyed at the end of its usage period in accordance with Rule 43 of CGST Rules.

1. Brief Facts of the Cases

1. M/s Page Industries Limited (“The Applicant”) is engaged in manufacturing, distribution and marketing of Knitted and woven garments, swimwear and swimming equipment.
2. The applicant also gets the manufacturing done from their job workers.
3. Further, an applicant sells their products through their own outlet or through distributors and dealers.
4. The applicant is carrying out their products’ advertisement in following two ways:
   • Availing service of advertisement agencies for ads in Print Media, electronic Media, outdoor advertisement etc.
   • Procuring promotional products for display purpose in their outlets and distributor’s outlets.
5. The advertising agencies charge GST while raising invoices on the applicant. 
6. To promote a brand, the applicant displays their products at point of purchase, i.e., at outlets. The applicant purchases such POP material and the supplier charges GST on the same.
7. The applicant moves such POP material to its outlet and outlet of distributors under cover of Delivery challan without charging any GST, i.e., title in the material is not transferred to the distributor.  In some cases, the applicant asks the supplier to directly deliver such material to the distributor on bill to-ship to basis.
8. To promote the branch, the applicant gets various marketing items manufactured such as a Carry bag with the name of the applicant printed on it, pens, wall calendars, diary etc. The manufacture charges GST while supplying such items to the applicant, 
9. The applicant in turn distributes such items to its distributor and customers to promote his brand. 
10. To promote its products overseas, The applicant is also exporting such items to its Overseas distributor under cover of letter of Undertaking, i.e., without payment of IGST. 
11. In addition to promotional items, the applicant is also supplying following material at Exclusive Branch Operator showrooms and retail showrooms to promote their brand name:
    • Display Items
    • Display Board for Retail Boarding
    • Uniforms
    • Posters
    • Gifts
    • Outdoor Hoarding
    • Carry Bag

2. Question: Whether the promotional products/material can be considered as Inputs

On the basis of its submission, the applicant placed the following question before Hon’ble AAR:

1. Whether the promotional products/material and marketing items used by the applicant in promoting their brand and marketing their products can be considered as “Inputs” under CGST Act, 2017? 
2. Further, whether the applicant is entitled to claim ITC on such procurement under section 16 of CGST Act?

3. Relevant Legal Extracts

1. Section 16(1) of CGST Act, 2017 is reiterated below:

“16 Eligibility and conditions for taking input tax credit.— 

(1) Every registered person shall, subject to such conditions and restrictions as may be prescribed and in the manner specified in section 49, be entitled to take credit of input tax charged on any supply of goods or services or both to him which are used or intended to be used in the course or furtherance of his business and the said amount shall be credited to the electronic credit ledger of such person.

..”

2. Relevant extract of Section 17(5) of CGST Act, 2017 is reiterated below:

“(5) Notwithstanding anything contained in sub-section (1) of section 16 and subsection (1) of section 18, input tax credit shall not be available in respect of the following, namely:—

…

(h) goods lost, stolen, destroyed, written off or disposed of by way of gift or free samples; and”

3. Definition of “Input” and “Capital Goods” are reiterated below:

“(59) “input” means any goods other than capital goods used or intended to be used by a supplier in the course or furtherance of business; “

“(19) “capital goods” means goods, the value of which is capitalised in the books of account of the person claiming the input tax credit and which are used or intended to be used in the course or furtherance of business”

4. Entry No. 3 of Schedule I of CGST Act is reiterated below:

“3. Supply of goods or services or both between related persons or between distinct persons as specified in section 25, when made in the course or furtherance of business: 

Provided that gifts not exceeding fifty thousand rupees in value in a financial year by an employer to an employee shall not be treated as supply of goods or services or both”

4. Contention of the Applicant

The applicant made following submissions:

1. The applicant has considered all POP material and promotional items as “Inputs” as defined under section 2(59) of CGST Act. Therefore, the applicant has claimed Input Tax Credit (“ITC”) on such procurement under section 16 of CGST Act.
2. Major condition of claiming ITC under section 16(1) of CGST Act is that procured goods or services or both should be used in course or furtherance of business.
3. The applicant contended that the term “used in the course or furtherance of business” has a very wide meaning. It does not include only goods or services procured in relation to “Output” but it includes any goods or material used in course or furtherance of business.
4. The applicant placed reliance on precedence of Hon’ble Apex Court in the matter of Mazagon Dock Limited Vs CIT wherein it was held that the term “business” should be construed in broader sense rather than narrow sense. Further, the word business connotes “some real, substantial and systematic or organised course of activity or conducted with a set of purpose”.
5. Further, the applicant also relied on judgement of Hon’ble Bombay HIgh Court in the matter of M/s Coca Cola Private Limited Vs CCE wherein it meaning of word “relating to business” used in “Input Services” was defined. Hon’ble High Court held that:
   • Business is a continuous activity and the same is not limited to mere manufacturing of products.
   • Therefore, activity in relation to business can cover all the activities that are related to the functionality of a business such as manufacturing, entering into Franchise agreement, promotion of brand name etc.
   • Further, advertisement service can be said to be input service as long as manufacturers can demonstrate the connection between advertisement service and manufacturing of final product. In that case, manufacturer can avail the credit of service tax paid on input service.
   • Cost incurred on advertisement is added to the cost of the final product and it establishes a connection between advertisement and final product.

6. Above discussed View of Hon’ble Bombay High Court was upheld in the case of M/s CCE, Nagpur Vs. Ultratech Cement Limited. Hon’ble Bombay High Court held that where input service is integrally connected with manufacturing of final product and cost of Input service forms part of cost of final product then credit with respect to such input service shall be allowed.
7. Relying on above mentioned judgements, the Applicant contended that expense incurred on promotional items is an integral part of business and it tantamount to use of such goods in business or furtherance of business. Therefore, same qualifies as “Input” under CGST Act, 2017 and the applicant is entitled to claim ITC on same under Section 16 of CGST Act.
8. As per Section 17(5)(h) of CGST Act, 2017, no ITC is available with respect to goods distributed by way of gift or free samples.
9. However, The applicant contented that he has not transferred title in such goods to its distributors. Also, goods are not sent on a Free of Cost basis rather the same are sent with an obligation of promoting the brand of the applicant. Distributors are not allowed to use them for personal purposes.
10. In case of gift distribution, there is no further obligation on the part of the recipient of the gift. However, in the given case, distributors have obligations vide agency/dealership agreement.
11. Promotional Items are sent under cover of delivery challan and not tax invoice. Further, expense on promotional items is a kind of advertisement expense. Therefore, same is qualified as “Input” under CGST Act.
12. Also, sending promotional items to the distributors is neither a “supply” nor there is a gift. Therefore, provision of Section 17(5)(h) of CGST Act shall not apply at all.
13. Therefore, expenditure on promotional items is considered as “Input” under CGST Act and ITC shall be available on the same.
14. With respect to other items such as carry bags, pamphlets etc. the applicant has taken the same view that he has not transferred ownership in goods to the distributors and the same is used for promoting the brand. Therefore, same is qualified as “Input” under CGST Act and ITC is available on same.

5. Solution: Analysis by Hon’ble AAR

Hon’ble Authority of Advance ruling discussed following points:

Hon’ble AAR has divided all promotional items in following 2 categories:

1. Non-Distributable Goods: Goods which are delivered to the distributors, franchisees and relatails but they remain in ownership of the applicant and are used at distributor’s location e.g. outdoor hoarding etc.
2. Distributable Goods: Goods which are sent to the distributors, franchisees and retailers on Free of Cost basis and same in turn are given to the employees or customer without charging any cost. E.g. Carry Bag

5.1 ITC on Non-Distributable Goods

With respect to Non-Distributable Goods, Hon’ble AAR discussed following points:

1. These goods remain in ownership of the applicant and physically lies at the place of Distributors. However, these are returnable items. It emerges following 2 scenarios:
   • Goods are returned back to the applicant and same are either destroyed or take in the further use; or
   • Goods are not returned to the applicant and are eventually written off.

2. In case of non-distributable goods, in all the scenarios, the applicant is capitalising such goods in his books of accounts and claiming depreciation on the same till the date of disposal. 
3. Definition of “Input” excludes capital Goods. In the given case, such goods are capitalised in books of accounts. Therefore, they can’t be treated as “Inputs”.
4. Further, as per Section 17(5)(h) of CGST Act, 2017, no ITC is admissible for goods lost, destroyed, written off or disposed off by the way of gift or free sample. The Non-distributable items are used by the applicant for the purpose of business, however, the same is written off or destroyed at the end of usage period. Therefore, the applicant is required to reverse ITC claims with respect to non-distributable items as per Rule 43 of CGST Rules, 2017.

5.2 ITC on Distributable Items

1. Distributable items are used for business Promotion. These items are distributed free of cost and no consideration is received for the same.
2. Since transfer is carried out without any consideration, Schedule I of CGST Act, 2017 should be referred to check whether such transaction is still qualified as “Supply”.
3. Further, treatment on Free samples and gifts is given by CBIC vide Circular No. 92/11/2019-GST Dated 7th March, 2019.
4. As per Entry No. 3 of Schedule III, supply of goods between related party is considered as supply even if the same is made without consideration. In the given case, distributable items are transferred to following two categories:
   • Franchisees (Exclusive Showrooms)
   • Other shops/retailers (all brand stores)
5. As per Section 15(5)(c) of CGST Act, 2017, “persons who are associated in the business of one another in that one is the sole agent or sole distributor or sole concessionaire, howsoever described, of the other, shall be deemed to be related.”
6. In the given case, Franchisees and the applicant are associated in the business of one another. Therefore, franchises and the applicant are related party as per Section 15(5)(c) of CGST Act.
7. Accordingly, any supply of distribution items to Franchisees shall be considered as supply vide Entry No. 3 of Schedule I of CGST Act. Therefore, the applicant is liable to pay GST on distribution items sent to the Franchisees without any consideration and also eligible to claim the corresponding ITC.
8. Goods distributed to the retailers, shall not be considered as supply as transfer is made without any consideration and retailers are not related party. As per Circular No. 92/11/2019-GST dated 7th March, 2019, such transfer shall be considered as “Gift” and the applicant shall not be entitled to claim ITC on the same.

6. Conclusion

Matter decided by Hon’ble AAR is as follows:

Particulars	Scenarios	Precedence
ITC on “Distributable Items”, e.g., carry bag, Uniform for employees, Gift for brand operator etc.	A. Goods are transferred to Franchisees	Franchisees are related parties of the applicant.Sending distributable item without any consideration shall be considered as supply and therefore, will be liable to GSTThe applicant will be entitled to claim corresponding ITC.
	B. Goods are transferred to other retailers/ distributors	Not considered as supply.Transfer of distributable items shall be considered as Gift.Corresponding ITC is not allowed
B. ITC on “Non-Distributable Items”, e.g., Hoardings, Display Boards etc.		Non-distributable items are considered as “Capital Goods” and not “Inputs”.The applicant is entitled to claim ITC on same.However, if same are destroyed or written off then ITC is required to be reversed as per Rule 43 of CGST Rules.