Overview of Related Person Under GST

Businesses often operate with related parties wherein multiple transactions take place at different prices. However, it is crucial to follow the market price for the valuation of such supplies and transactions. The rules for transactions by a related person under GST define the methods to derive the value of transactions between related entities.

This aims to ensure fair pricing and regulatory compliance for businesses to streamline the Indian taxation system.

Transactions Between Related Persons 

In the case of transactions between related parties, the pricing methodologies vary. It is often challenging to arrive at the price due to varied methodologies. The prices in transactions between related parties differ from those of transactions between unrelated parties.

To understand the concept of related parties, taxability on supplies in such transactions, and GST application, continue reading below.

Key Characteristics of Related Parties

Here are the important characteristics of related parties:

●  Control

Related parties often have the controlling authority over another entity. They exhibit a common control structure wherein one party can regulate the financial and operating policies of another party. The controlling authority can be developed based on contractual agreements, ownership of voting rights or other mechanisms. 

●  Influence

Even if there is no direct control, related parties might exert an influence on the other party. One party can influence the decisions or actions of the other party based on business partnerships, familial relationships or other connections.

●  Economic Dependence

Related parties might have financial dependence on each other. These parties might require the financial support of the other party to achieve financial objectives. Economic dependence can develop due to shared resources, intercompany transactions or joint ventures. 

Types of Related Party Relationships

Here are the different types of related party relationships:

●   Parent-Subsidiary Relationships

A parent company regulates the business operations and financial policies of its subsidiary companies. This results in a controlling interest of the parent company in the subsidiary.

●  Sibling Relationships

Sibling entities usually have a common parent company. Alternatively, a sibling company might have a common ownership. However, they operate as separate legal entities.

●  Affiliated Companies

Affiliated companies often have common control or ownership. These companies often share their resources in collaborative activities to achieve common business goals.

●  Key Management Personnel

Key management personnel include the board of directors, executives, shareholders, and other members. They fall in the related party category as they can significantly influence the decision-making process of the company they are associated with.

●  Family Relationships

Several companies operate with family members as the key stakeholders. These are typically family-controlled businesses where family members might include spouses, siblings, children, or parents. The family members can directly or indirectly affect the business activity.

Who Is a Related Person Under GST?

The following categories are defined as related persons under Section 2 (84) of the GST Act:

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●   If an officer or director of a business holds the same position in another business.

●   When legally identified as partners in business

●   The relationship between an employer and an employee

●   A person holding at least 25% of shares of another business indirectly or directly

●   A person controlling another directly or indirectly

●   Persons under common management or control

●   Entities together control another entity

●   Members of the same family work as promoters or managerial persons

In addition, the related persons can be individuals, companies, HUF (Hindu Undivided Family), firms, LLP, a body of individuals, a cooperative society, local authority, an artificial juridical person or government. It includes entities not incorporated in India, sole agents, sole distributors, sole concessionaires and other related parties.

What Is the Taxability of Supply Made Between Related Persons?

A supply between related persons with consideration is treated as a 'Supply'. However, supplies between related parties for inadequate or no consideration are treated as 'Supply' only when it is for the furtherance of business. It is defined under Schedule I of the GST Act.

In addition, an import of service for business purposes from related parties or establishments outside the international border of India (without consideration) is treated as a supply for GST purposes. Notably, a gift by an employer to an employee amounting to less than ₹50,000 is not treated as a supply.

Valuation of Transactions Between Related Persons

Here is how to determine the value of supply between related persons (excluding supply made through an agent):

●   Open Market Value of Supply: The supply between two unrelated entities is termed the open market value of supply. Usually, the prices are significantly influenced by the relationship between two related parties and the supplies between them. For instance, If XYZ Ltd sells products to VW Ltd (related entity) at ₹1,000 and to MN Ltd (unrelated party) at ₹1,500, the latter will be considered for valuation.

●   Open Market Value Not Determined:  If there are challenges in determining the open market value, the value of similar goods will be considered. For instance, X Ltd sells goods to Y Ltd entirely. In such a case, the open market value cannot be determined. Now, if P Ltd sells similar goods as X Ltd at ₹1,200, this price will be considered for valuation.

●   In case the methods mentioned above fail to determine the value of supply, the residual method or a value based on cost (total production cost) needs to be considered.

Section 15 (4) of the CGST Act allows the government to provide the rules for valuation in related party transactions. Here are the examples and rules for valuation for related party transactions:

Rule 27: Value of Supply Not Wholly in Money

There is a supply of a laptop for ₹30,000 in exchange for an old laptop. The open market value (OMV) of the new laptop is ₹36,000 without exchange. Thus, the value of supply will be considered as ₹36,000 and not ₹30,000.

Rule 28: Value Between Distinct or Related Persons

If Tata Steel supplies inputs or goods to Tata Motors amounting to ₹2,50,000 for ₹2,00,000 and Tata Motors, a wing of Tata Sons, claims full ITC of ₹36,000, then the invoice value of ₹2,00,000 will be considered as the open market value.

Rule 29: Value of Supply Through an Agent

The value of supply through an agent is either the open market value or 90% of the price of the supply of like goods in the case of an unrelated party. For instance, a principal supplies wallets to its agent who then sells them to customers at ₹2,000 each. The principal's value of supply will be 90% of ₹2,000 = ₹1,800.

Rule 30: Value Based on Cost

If there are hindrances in determining the value considering the methods mentioned above, the value needs to be 110% of the cost of production. For instance, XYZ Limited manufactures and sells chairs at ₹4,000 per chair. If the open market value is unavailable, the value of the chair will be ₹4,000 * 110% = ₹4,400.

Rule 31: Residual Method

If it is difficult to determine the cost of production of goods supplied, the valuation needs to be determined by the number of man-hours needed to complete the job.

Rule 31A: Value in Specific Supplies

A specific valuation method needs to be followed in the case of lottery, gambling, betting and horse racing. For instance, in the case of a lottery, the organising state notifies the value as a percentage of the face value of tickets.

Rule 32: Determination of Value in Certain Supplies

The exchange of foreign currency is regulated by a special valuation method. For instance, in the case of foreign currency exchange, the supply value is determined based on the rate of currency at which it is bought or sold.

Supply of Goods via Agent

Here is the applicability of GST on the supply of goods through agents:

Scenario 1:

A principal assigns an agent who will supply goods on behalf of the principal. For instance, a company in Delhi assigns an agent in Pune (Maharashtra) and sends him goods for supply. GST will apply in such a case.

Scenario 2:

An agent receives goods on behalf of the principal. For instance, company A, operating in the suburbs employs an agent B in Kolkata. Agent B will buy goods from Kolkata and send them to company A to sell in the suburbs. In such a case, GST applies to both the principal and the agent jointly. However, they can claim an input tax credit (ITC) on the GST paid at a later date. Notably, the value of supply will be based on the concept of related parties.

Taxable Person Importing Services From a Related Person

If a taxable person imports services from a related party or from other establishments outside India for furtherance of business, it is considered as supply. For instance, A Ltd in India and B Ltd in India incorporate ABC Inc. in the US. If B Ltd imports services from ABC Inc. without consideration, it will be treated as supply. B Ltd will have to pay GST on a reverse charge basis.

Permanent Transfer of Business Assets Where ITC Has Been Availed on Such Assets

If there is a sale of business assets or permanent transfer of goods on which ITC has been availed, it will be treated as a supply with no consideration. GST applies to the sale of assets for business and permanent transfer.

Notably, goods sent on job work or for testing or certification are not considered as supply as they will be returned to the principal and are not a permanent transfer. If a business donates assets or disposal or scrapping, it will be treated as supply, when ITC has been claimed.

Identifying Related Party Transactions Under GST

You can identify transactions between related persons as covered under Section 2 (84) of the GST Act in the following cases:

●  Transaction between two businesses by an individual, who is an officer or director in a business while holding the same position in other businesses

●  When businesses are officially identified as partners and transact with each other

●  An employer-employee relationship and transactions

●  If an individual owns a minimum of 25% of shares in another business directly or indirectly and transacts in these two businesses

●  When one party can directly or indirectly control the other and sells goods or services between these two parties

●  If two or more parties are governed by the same management or controlling authority and transact goods and services

●  When two or more parties together control another entity and sell services or goods to each other

●  If promoters, legal persons or managerial personnel of a business are from the same family and transact in goods and services

Criteria for Related Party Transactions Under GST

Here are the criteria for related party transactions under GST:

Definition Under GST:

When businesses are connected through family, capital, or management, they are deemed as related party transactions. It further includes transactions between subsidiaries, holding companies, associates, key management personnel, and their relatives under the GST rules.

GST on Related Person Transactions:

The scrutiny of related party transactions under GST ensures that they are conducted at arm's length. It indicates that the value of the transaction needs to reflect a fair market price that applies to unrelated parties.

Section 188 of the Companies Act, 2013 defines an arm’s length price transaction as a transaction taking place between two related persons or entities, but in a manner that they are unrelated. This section ensures that there is no conflict between other parties due to related party transactions.

Further, Section 92F of the Act defines arm’s length price as the applied or proposed price in an unrelated party transaction in uncontrolled conditions. An unrelated person under Section 92A is an individual not associated with the enterprise or with any personnel of an enterprise directly or indirectly. Moreover, uncontrolled conditions indicate that the situations are not influenced or suppressed by a person or entity to achieve predetermined results.

Breakdown of Different Types of Related Party Transactions

Here are the different types of related party transactions:

●   Sales and Purchases of Goods and Services 

The sale or purchase of goods and services between related parties such as a company selling goods or services to its subsidiary is a type of related party transaction. For instance, if a parent company provides consulting services to its subsidiary, it has to be valued as if it is provided to an outsider. Even if the services are provided free of cost, to comply with GST regulations, it needs to be valued at the market value.

●   Loans and Financial Transactions

The GST regulations include financial transactions such as loans or advances between related entities. However, the interest rates followed by the terms and conditions need to be similar to those of unrelated parties.

●   Property Leases and Rentals

Related parties can rent out or lease out their properties. However, the rent or lease amount of the properties needs to be at par with the market rates and values for unrelated parties' GST and business compliance. This ensures that the transaction has taken place in a fair manner.

Challenges in Identifying and Categorising These Transactions

Here are the challenges in identifying and categorising related party transactions:

●   Complex Ownership Structures

Determining if two parties are related to each other is often a challenge with complex ownership structures. For instance, such challenges are often prominent in large conglomerates with more than one associate company or subsidiary company.

●  Transaction Valuation

The GST regulations mandate the supply valuation between related parties at the market price. This market price is applicable for unrelated parties. Deriving a market price that is fair for these transactions is significantly challenging. These valuations need to meet the arm's length standard for compliance with GST norms and laws.

●  Maintaining Documentation

Error-free documentation is required for compliance with GST rules in related person transactions. There needs to be documents like agreements, contracts and correspondence supporting the transaction values, terms and conditions.

Impact of Related Party Transactions on GST

Here is the impact of related person transactions on GST:

Effect on GST Calculations

Related party transactions include complex calculations under GST. The GST imposed on such transactions varies based on the transaction value which needs to align with the arm’s length price. If businesses provide goods and services to related parties at a lower price, it will likely result in underpayment of GST.

Legal and Financial Implications

Businesses might be subject to huge financial liabilities if GST is underpaid due to differences in the price at which goods are sold to related parties and unrelated parties. The price needs to be at arm's length to avoid penalties and audits by tax authorities.

Understanding Exemptions in GST for Related Party Transactions

If a related party transaction is non-commercial in nature or below the threshold limits defined in GST laws, there can be an exemption.

Impact on Business Strategies

A business can seamlessly devise and implement effective strategies for tax savings and financial planning when it knows the exemption criteria. Thus, this can help the business adhere to legal guidelines and tax norms.

Managing Exemptions Effectively

Businesses (related parties) can reap the benefits of these exemptions while complying with GST laws. Maintaining relevant documents and records and remaining up-to-date on amendments in GST regulation can help in GST compliance. Advice and assistance from tax professionals can help these businesses align with the laws.

Challenges and Risks Associated

The following are the challenges and associated risks:

1. Effective Risk Management Strategies

Staff training, clear internal guidelines and periodic audits are crucial for businesses in the case of related party transactions. In addition, consulting tax professionals can help businesses align with the GST laws to mitigate risks with accurate record-keeping in advanced technologies.

2. Maintaining Transparency and Documentation

Maintaining supporting documents for transactions between related parties is essential to prove the arm’s length nature of such transactions. If businesses cannot present transparent documents during audits, they might be subject to legal complications.

3. Understanding and Adapting to Regulatory Changes

The tax authorities often bring forth amendments to the GST rules and regulations. It is crucial for businesses to stay updated with the revised rules and guidelines to avoid adverse legal implications, penalties and other financial implications.

4. Dealing with Cross-border Transactions

Managing cross-border related party transactions is complex. These transactions not only have to comply with the GST laws in India but also the international standards of tax regulations. Reconciling and understanding the different tax regulations of international standards is subject to complexities and challenges.

5. Technology Integration and Data Management

Deploying advanced technology can help automate processes, and analyse and manage data effectively. However, businesses often face challenges in integrating the right technology or software. Moreover, they often lack the skills and knowledge to operate advanced technologies. Training staff to operate these technologies can be cost-intensive. Thus, it is a significant challenge in related party transactions to calculate values accurately and align with the GST laws.

6. Managing Stakeholder Expectations

Businesses often face challenges in managing the expectations of their stakeholders while complying with the GST rules. Their stakeholders might include major shareholders, related entities, tax authorities and others. Adopting a strategic approach can help businesses cater to the expectations of their stakeholders while meeting compliance requirements as per GST norms.

Importance of Identifying Related Parties

Identification of related entities or persons ensures seamless financial reporting. It additionally aids in compliance with the regulatory guidelines and streamlines taxation on supplies for businesses. Businesses need to reveal related party transactions in accounting standards to maintain transparency. It further helps in a fair representation of the company's financial position and performance.

The regulatory authorities might scrutinise these transactions of entities to ensure valuation based on market value, avoid conflict of interest, and ascertain the integrity of the financial statements of businesses. Adhering to the laws of related party transactions can help businesses comply with GST rules.

Notably, the nature of valuation might vary based on the availability of the open market price. However, following the valuation rules can help businesses adhere to GST norms.

Conclusion

A related person under GST is a person exerting control, influence, or economic dependence on an entity. GST laws mandate the valuation of goods and services supplied by related parties at the market value as if they are sold to unrelated parties. This ensures transparency and compliance for the business entities while operating their business with stakeholders belonging to the related party category under GST.

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