Beyond Boilerplate: GST Indemnities In Commercial Contracts And Allocation Of Tax Risk

A company has signed a supply contract with a vendor at a fixed price. The vendor raises a tax invoice on which GST is charged. The company pays the entire amount, including GST, and accounts for it in its books. After a few months, on a tax audit or departmental inspection of its records, the company is informed that the vendor has either not remitted the GST collected, has not reported the invoice correctly to the department, or has had issues in its compliance related to the invoice. The claim for input tax credit is thus denied to the company, entailing liability for interest and penalty. Meanwhile, the vendor may have become untraceable, insolvent, or commercially unwilling to cooperate. While the initial battle will be with the tax department, the more significant fight is typically between the buyer and the seller under the supply contract - who should ultimately bear this loss? The buyer who had paid in good faith? The vendor who made a default? Or, perhaps, the party that got carried away with a “price inclusive of all taxes” clause? This is the point at which a routine tax clause becomes a serious risk-allocation clause.Those clauses may sound all fine to you at the time of signing. But under the GST regime, tax exposure is not over on payment of the invoice; it spans across return filing, invoice reporting, ITC matching, RCM, audit, investigation, reassessment, and even demands after termination of the contract from past periods. That is why the GST indemnities are not boilerplate wording anymore but are critical components of commercial risk allocation. Contractual Nature of GST RiskThough GST is an indirect tax, its economic incidence normally comes to rest through a contractual arrangement. The economic impact of levy, collection, and compliance falls upon private parties, as defined by law, but this economic burden on individual parties is allocated through contract.This distinction is important. For example, the GST legislation may impose the obligation to collect and pay the tax upon the supplier. However, a supplier can make good on this obligation by contracting to charge the tax to the buyer and recover the payment. Conversely, though the GST legislation might not allow a recipient to claim the input tax credit if not all statutory requirements are met, the recipient might contract for indemnity from the supplier in case the denial is on account of fault on the part of the supplier. The GST risk therefore exists at two levels: the statutory risk, being between the taxable person and the Revenue authorities, and the risk that operates between parties to the transaction, through a contract. These must be taken care of in any well-drafted commercial contract.However, the problem is that quite a number of commercial contracts address only the first layer, generally stipulating that taxes will be charged as may be applicable under the law. It, however, fails to address tough questions such as: what if the classification adopted by either party is later questioned by the department? What if the tax rate is changed after entering into a contract? What if the supplier uploads the invoices at a later date? What if the input tax credit is not allowed due to the supplier's delay in filing returns? What if a penalty and interest are levied for default and notice is received after the transaction is completed or the contract is terminated? These are not farcical situations; they occur regularly under GST.ITC Denial and Supplier Default: The Buyer's Hardest ProblemIt is the most common, and therefore, most important, trigger for careful GST indemnity drafting that the buyer stands to lose input tax credits. Input tax credit lies at the heart of GST. Businesses transact under the assumption that the GST paid on inward supplies is available to them as credit (subject to compliance with legal requirements), which is factored into their pricing, cash flow, margin calculation and commercial negotiations. Should the credit turn out to be inadmissible post-completion of the transaction, the commercial bargain may be disturbed. This situation becomes exacerbated when the disallowed ITC is a result of a supplier's non-compliance. A buyer may have already received goods or services, paid the invoice consideration, remitted the GST amount to the supplier, and preserved requisite documents, and yet, if the supplier defaults in discharging their own GST duties, the buyer may face issues relating to claiming credit. From a business perspective, this represents a material equity deficit, as a buyer may have no control over the manner in which the supplier files their tax returns, pays their GST obligations, declares sales in invoices or manages their internal compliance processes, but the buyer will bear the financial impact if credit is blocked due to the supplier's non-adherence. It is important not to oversimplify and state a generic clause such as “supplier will comply with tax laws”. The contract must clearly...

Beyond Boilerplate: GST Indemnities In Commercial Contracts And Allocation Of Tax Risk

Ayush Unnikrishnan

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Ayush Unnikrishnan

Beyond Boilerplate: GST Indemnities In Commercial Contracts And Allocation Of Tax Risk

Ayush Unnikrishnan

This is a premium content Available exclusively to Our subscribers

INR 1099+GST

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Ayush Unnikrishnan

This is a premium content
Available exclusively to
Our subscribers