Reverse Charge Mechanism under GST

Table of Contents

1. Concept of Reverse Charge Mechanism
2. Rationale Behind Reverse Charge Mechanism

Check out Taxmann's GST Practical Guides | Reverse Charge Mechanism under GST Act which analyses various aspects such as the levy and collection of tax under reverse charge, compulsory registration, the timing of supply, e-commerce operations, etc. It also delves into the impact of notifications 13/2017 and 04/2017 on reverse charge applicability, the nuances of revenue neutrality, and insights into the tax collection process. It is amended by the Finance Act 2023 and is developed by the Goods & Services Tax Practitioners' Association of Maharashtra.

1. Concept of Reverse Charge Mechanism Under GST

Generally, the supplier of goods or services is liable to pay GST. However, in specified cases like the notified supplies, the liability may be cast on the recipient under the reverse charge mechanism. Reverse charge means the liability to pay tax is on the recipient of supply of goods or services instead of the supplier of such goods or services in respect of notified categories of supply.

The Concept of Reverse Charge Mechanism was prevalent since the time of Service Tax under Finance Act, 1994 and MVAT Act, 2002.

The Service Tax was imposed on few categories of services in 1994. The Service Tax on services provided by the goods transport agency was imposed in 1997. Notification No. 42/97-ST, dated 5-11-1997 was issued which inserted Rule 2(1)(d)(xvii) of the Service Tax Rules, 1944 whereby the customer receiving the services and paying for the goods transport operator was made responsible for paying the service tax. In other words, the liability to pay the service tax was shifted to the customer, i.e. the person who hires and pays for the service of transporter.  At the relevant time, section 68(2) of the Chapter V of the Finance Act, 1994 did not provide for recovery of tax from the recipient of service. Therefore, the recovery of tax from recipient of service was challenged before the Honourable Supreme Court in the case of Laghu Udhyog Bharti v. Union of India [1999] 105 Taxman 630 (SC).

The levy of service tax on goods transport operator’s services was set at zilch by the Hon’ble Supreme Court who held that levy of tax from the receiver was illicit as the same is ultra vires the Finance Act, 1994. In this case, it was held that the levy of service tax on the recipient of the service instead of person providing the service was clearly illegal and unsustainable in law.

To Counter the Honourable Supreme Court Judgment in the case of Laghu Udhyog Bharti (supra). Section 68 was amended by incorporating sub-section (2) which empowered the Government to specify the services and person liable to pay tax by notification. After the issuance of notification, tax was payable by the person specified in the notification . The Government has issued notification from time to time for recovery of tax from the recipient of services.

Even under the erstwhile MVAT Act, 2002, there was a concept of Purchase Tax under section 6A and section 6B of the MVAT Act, 2002 wherein the purchase tax was payable on purchase of certain goods from specified suppliers.

Section 6A envisaged the liability of purchase tax on the purchaser of cotton, if the dealer purchased cotton directly or through a commission agent, from a person who is not a dealer or a dealer who is not a registered dealer if the cotton  so purchased are dispatched outside the State, to any place within India, not by reason of sale, to his own place of business or of his agent; or the cotton so purchased are used in the manufacture of tax free goods; or taxable goods and the goods so manufactured are dispatched outside the State, to any place within India, not by reason of sale, to his own place of business or of his agent. Similar provisions were enacted under section 6B of the MVAT Act, 2002 wherein the liability was cast on the purchaser of oil-seeds.

Hence, the concept of Reverse Charge Mechanism is not new under GST. The same concept of reverse charge has been brought into GST from service tax and VAT laws.

2. Rationale Behind Reverse Charge Mechanism Under GST

The following are the factors which formed the basis for providing of payment of tax under reverse charge :

Large number of assessees with small payment of tax from each assessee

Sometimes the number of Assessees (who is supplier of Goods or Services or both) are very large and the recipient of goods or services or both are few. The Government feels that each of the large number of assessees will pay small amount of tax and recovery of tax from the service recipient will be much simpler and will save public at large from burden of complying with law.

For example, Insurance Agents. There may be over one crore insurance agents employed by 25 to 30 Companies engaged in providing life insurance services. The Commission received by each of the agent may not exceed Rs. 20 Lakhs. Therefore the Government may not get substantial revenue if the service provider is made liable to pay tax. The Government can collect the same amount of tax or more amount of tax for the services rendered by the Insurance Agents from its 25 to 30 Insurance Companies. Thus the administrative problems in collecting tax is heavily reduced.

Jurisdiction of collecting the tax

In case of import of service, the service provider is located outside India. The taxable territory for levy of GST is India. The Government has no jurisdiction to demand tax from the person located outside India. Accordingly, the recipient of service is made liable to pay the tax as he is located in India. The Government can recover tax from recipient.

Difficulty in Collection of Tax

In many cases, the Government finds it very difficult to recover tax from small class of assessees like individuals, partnerships, HUF etc. In some trades like providing security service, renting of motor vehicle, the recovery of tax is a big headache of Government. Therefore it provides for payment of tax from the recipient of services who are body corporates.

To indirectly tax the commodities or services provided by the persons who are exempt from taking registrations

From the inception of taxation system in India, the Government never intended to tax Agriculturist. Hence, the Agriculturist is exempted from taking registration in India. However, in case of certain commodities like Bidi leaves, tobacco products which are in use on regular basis, the Government in order to earn more revenue from these products brought the same under reverse charge on the persons who purchases such products from the agriculturists.

Definition of Reverse Charge

Section 2(98) of the CGST Act, 2017 defines reverse charge which is reproduced hereunder :

“(98)  “reverse charge” means the liability to pay tax by the recipient of supply of goods or services or both instead of the supplier of such goods or services or both under sub-section (3) or sub-section (4) of section 9, or under sub-section (3) or sub-section (4) of section 5 of the Integrated Goods and Services Tax Act”.

Hence, by defining reverse charge under CGST Act, 2017, Government has made its intention very clear to collect the taxes in case of notified goods or services from the persons who are not actually the supplier of the goods or services.