There will hopefully come a time where the battered and bruised population of the world will one day look back to fathom what really hit them. Reminiscing about the same whenever that occurs will help us understand the true accuracy of several semi speculative articles written by us. This is more so pertinent in the professional lives of lawyers, CAs, and tax consultants who have very known the imaginative interpretative powers of the Department.
Whereas people and communities from different walks of life are affected in many diverse ways. We are here to discuss the issues of Covid 19 lockdown from the point of view of the indirect tax consultants which includes a gamut of activities from accounting, returns,assessments, compliances, appeals, and pending litigation etc.
The crux of the matter is fairly simple. Since mid March 2020, there has been a near cessation of activity barring essential supply and services which can be provided from home without any physical interference. Since the nature of supply under GST is essentially a two party transaction , it is obvious that most affected one transactions will be the ones germinating out of continuous contracts or contracts expiring or covering the duration of lockdown. There will invariably be an adverse impact on the transaction itself alongwith taxability, compliance and limitation challenges.
This article is predominantly attempting to illustratively discuss certain legal issues arising out of contracts viz a viz Force Majeure clauses, rescission, amendments and in some cases novation. I wish to point out that, an extremely detailed and insightful article on force majeure earlier by Mr. Siddharth Ranka, Advocate.
It is fairly accurate presumption that for the first 3 National Lockdowns and even the 4th as far as big cities are concerned, the disruption in Supply and ongoing contracts were immense. Whereas the immediate consequence of such a lockdown would be that, certain contracts may or may not be honoured or the time of delivery may be massively delayed.
Discussion on various aspects related to changes in performance of a Contract and its impact on GST taxability.
Section 62 of the Indian Contract Act 1872 is reproduced herewith
Effect of novation, rescission, and alteration of contract.— If the parties to a contract agree to substitute a new contract for it, or to rescind or alter it, the original contract need not be performed. — 000 If the parties to a contract agree to substitute a new contract for it, or to rescind or alter it, the original contract need not be performed.” Illustrations
(a) A owes money to B under a contract. It is agreed between A, B and C, that B shall thenceforth accept C as his debtor, instead of A. The old debt of A to B is at an end, and a new debt from C to B has been contracted. (a) A owes money to B under a contract. It is agreed between A, B and C, that B shall thenceforth accept C as his debtor, instead of A. The old debt of A to B is at an end, and a new debt from C to B has been contracted.”
(b) A owes B 10,000 rupees. A enters into an agreement with B, and gives B a mortgage of his (A’s), estate for 5,000 rupees in place of the debt of 10,000 rupees. This is a new contract and extinguishes the old. (b) A owes B 10,000 rupees. A enters into an agreement with B, and gives B a mortgage of his (A’s), estate for 5,000 rupees in place of the debt of 10,000 rupees. This is a new contract and extinguishes the old.”
(c) A owes B 1,000 rupees under a contract, B owes C 1,000 rupees, B orders A to credit C with 1,000 rupees in his books, but C does not assent to the agreement. B still owes C 1,000 rupees, and no new contract has been entered into. (c) A owes B 1,000 rupees under a contract, B owes C 1,000 rupees, B orders A to credit C with 1,000 rupees in his books, but C does not assent to the agreement. B still owes C 1,000 rupees, and no new contract has been entered into.”
Although the above section deals primarily with discharge of a contract, it is important to discuss the same owing to the fact, that any transaction under the GST Act which is taxable is a species of the contract.
Novation in essence means that the parties to a contract mutually consent to substitute/novate the original contract with a new one. Resultantly the terms and conditions of supply as per the original contract will cease to exist along with its rights and obligations and the same is replaced with a new contract which is activated with the new terms and conditions as per the contract.
Novation usually requires 3 parties, the third party is the counter party which takes over the obligations and rights. From the GST purview, this would usually happen in case of Supplies which requires a chain of Contract or bigger turn key projects. In several cases, contractors which are now faced with either financial distress or lack of labour; may with the consent of the employer, replace themselves with another contract or change certain approved vendors/sub contractors with the consent of the Employer. During novation, the original agreement would cease and new agreement will come into force. There can be no novation if the earlier contract in any manner survives even after the new agreement comes in force.
As regards GST, as per Section 9 of the CGST Act, tax is payable on supply. Hence for the supplies made under the original agreement shall remain taxable in the hands of the supplier only. It is only for supplies which happen as per the replaced contract, the taxability shall change as per the revised terms and conditions.
As far as novation is concerned, that happens even in the due course of business and hence from the point of view of GST there is no significant change in such cases during the Covid-19 lockdown period.
Alteration/ amendment of Contracts
The difference between Novation and amendment of a contract is that in case of Novation, entire contract is substituted or replaces with a new contract. In cases of alteration/ amendment is that there is no de novo contract as a result of amendment. Certain terms and conditions are changed and rest of the terms and conditions remain the same.
In terms of disruption of business and supply chains due to nation wide lockdown, the mechanisms adopted by most businesses will be amendment of existing contracts.
The reasons for the above are purely commercial and market driven. Due to the lockdown atleast in the initial phases, there was an immediate cessation of all activities and most of it for no fault of either the supplier or the recipient. Only very few supplies and businesses remained unaffected to an extent, they were namely, those involved in the supply of essential commodities, pharmaceuticals, and certain services which were possible to be provided remotely.
Some of the examples of major disruptions are mentioned herein below:
Commercial rent agreements, which the tenant who is specifically forbided by law to work from the premises, may not be able to afford and request for reduction, differing , waiving off the rent during the covid period and beyond.
Perishable goods received by a distributor after an extended period largely due to trucks halted mid way and not allowed inter state travel.
Goods sent for job work and whether approval period of six months to exclude lockdown period
Goods in transit for export goods lying at the port of dispatch.
Although, Price reduction, discounting or waiver are all valid under the GST Act, the scenario like a lockdown is not envisaged under any commercial tax acts and therefore it is important to examine the vagaries from the purview of the Contract Act jointly with the GST implications of it.
Section 7 of the CGST Act clearly states that all kinds of supplies which includes sale, transfer, rental,lease, disposal etc made or agreed to be made for a consideration . Hence it is trite to say that Section 7 by using words made or agreed to be made, puts a notable emphasis on the Agreement between the two parties. Furthermore for any transaction there has to be a consideration which can be taxed. Consideration is something which is determined by both the parties to a contract qua the transactions.
It is also clear, that not all Contracts have clauses which explicitly covers unprecedented scenarios like a covid lockdown and therefore amendments of contract is going to be a norm.
Taking a brief overview of the examples, it is safe to say that. the consideration or rent is usually mentioned in the agreement for a fixed duration. Therefore would it be possible for the land lord to now either waive off the charges or offer reduced rent.
In the considered view of this Author, the reply to the above poser is absolutely affirmative. The agreement merely indicates a consent of the two parties with regards to a certain consideration. Ofcourse the tax event is not solely dependant on the Contract. The taxability , time and place of supply is determined as per the GST law. That being said a contract is important to understand the intention of both the parties and the consideration for such supplies.
A contract can be amended with the consent of both the parties as per Section 62 of the Indian Contract Act. The problem that may arise at the time of assessment, wherein the Department may insist that there has been deliberate under invoicing by the parties to the contract. The only way to avoid doubts would be to have an express written communication by official email, wherein the revised terms including reduction in prices are expressed in clear terms.
Consideration between two parties be it distinct or related, is primarily based on the free market value of a particular supply. Free market value of any product during the lock down and post it will also be affected by supply and storage redundancies and also demand fluctuations. Hence even for related party transaction the consideration which is to be determined as per the open market value Rule 27(a), they will have to take into consideration the peculiar constraints and conditions under which the supplies are effected and it will be difficult to have an omnibus market value for several supplies.
As held by M/S. Ratna Commercial … vs. Vasu Tech Ltd. & Ors. on 26 November, 2009, the Delhi High Court has stated that:
Section 62 is based upon the principle that a contract is the outcome of a mutual agreement and it is equally open to the parties to mutually agree to bring the said contract to an end, enter into a new contract or modify the earlier contract. Contractual obligations can be modified by mutual consent. Parties can vary the terms of the contract and absolve a party from the original obligations. Once Section 62 of the Contract Act applies, parties are bound by the terms and conditions mentioned in the second contract or the amended terms and not by the first contract. Breach of the subsequent contract will not revive the original contract, unless intention of the parties is to the contrary. The question is of intention of the parties, when they enter into second contract or modify earlier terms… emphasis supplied.
The other factor which needs to be considered is in relation to the status of invoices which are already raised for the month of March in April. This was raised as per regular rates. Subsequently, due to loss of business or an impending extension of the lockdown, it might be possible that, either the supplier or recipient may suo moto offer or with mutual negotiations agree to either price reduction or a waiver. In such a case from the GST point of view, a credit note which will have to issued by the supplier as per Section 34. The first condition i.e. credit note can be issued where the value of taxable supply charged in the invoice, exceeds the taxable value, would cover a reduction or redetermination of the taxable value in the present scenario.
Whether such a determination of price or reduction is a discount?
The only real issue herein is whether,such a price reduction can be a post invoice event. It must be noted that, the price reduction or reduction in consideration payable as discussed herein below is not in the colour of discount.
If it is presumed that any revision is a discount in that case, Section 15(3)(b)(i), clearly states that a discount can be offered after raising of invoice as long as there is an agreement entered into before or at the time of the supply. Since such a lockdown scenario may never have been contemplated, in that case the erroneous presumption of the same being called a discount will render most determination of prices invalid even if there is unanimous consent for the same from both parties.
In any case, under normal conditions, 15(3)(b)(i) covers only discounts like trade discounts and other type of discounts which are incorporated in the Contracts. That being said, there is always a clause, that any price revision of a supply can be done after mutual consent of both the parties involved.
In case of the Covid lockdown, most supplies like rent and other such services are not availed or provided for at all due to a Central Act i.e Disaster Management Act and Epidemic Act which forbided any movement to the premises or in case of other services sudden cessation of any activity. Therefore in such a scenario the two parties to a contract are infact re determining the consideration and the reduction infact does not take colour of a discount. A discount can be largely classified as an incentive , whereas in the covid scenario, where a Central act is itself forbidding an activity, the transactions are sought to be priced after re determining the entire consideration and not offered as any incentive. Therefore merely because a contract mentions certain amounts, one cannot say that the amount becomes payable.
The Consideration receivable being an income, in the hands of the supplier, when is the income actually accrued and hence taxable.
In State Bank of Travancore vs. CIT  24 Taxman 337 (SC), the observations of the larger bench of the SC are very important:
“….accrual is a matter of substance and that it is to be decided on commercial principles having regard to the business character of the transactions and the realities and specialities of the situation and cannot be determined by adopting purely theoretical or doctrinaire or legalistic approach. If, therefore, for the purpose of determining whether there has been accrual of real income or not regard is to be had to the business character of the transactions and the realities and specialities of the situation in preference to theoretical, doctrinaire, or legalistic approach I fail to appreciate why interest on sticky loans, which has theoretically accrued but has not factually resulted or materialised at all to an assessee during the accounting year, should not be regarded as hypothetical income and not real income?”.. emphasis supplied
The above mentioned judgment clearly states that commercial realities have to be taken into account before determining whether an income is accrued or not. Therefore merely raising an invoice may in ordinary course of business make a transaction taxable, but when the commercial conditions have changed to such a drastic levels that, either the supply is highly delayed or disallowed due to the Central Disaster Managerment Act, one cannot take a simplistic argument about the consideration mentioned in any invoice becoming taxable merely because the same is raised in the invoice. The amount payable or the consideration can be redetermined in the light of the drastic changes in situations.
In another case while discussing retrospective enhancement of rent , the Hon’ble Supreme Court has made several observations which clearly lays down the principle discussed above, although in this case, there will in most cases always be a post facto reduction of rent or for that matter any other consideration for all kinds of supply. In P. G. & W. Sawoo v. Assistant Commissioner of Income-tax  69 taxmann.com 188 (SC) it was held that :
To controvert the aforesaid contention on behalf of the appellant-assessee the respondent-Revenue contends before us that the enhancement of rent is retrospective i.e. from 01.09.1987 and, therefore, the income must have to be understood to have been received in the said assessment year i.e. 1989-1990.
The issue is capable of resolution within a short compass. A reading of the decision of this Court in E.D. Sassoon & Co. Ltd. (supra) would go to show that the income to be chargeable to tax must accrue or arise at any point of time during the previous year. This Court in E.D. Sassoon & Co. Ltd.’s case (supra) has held in categorical terms that income can be said to have accrued or arisen only when a right to receive the amount in question is vested in the appellant-assessee. The following extract from the judgment in E.D. Sassoon & Co. Ltd.’s case (supra) amply illustrates the above position :
“The word “earned” has not been used in Section 4 of the Income-tax Act. The section talks of “income, profits and gains” from whatever source derived which (a) are received by or on behalf of the assessee, or (b) accrue or arise to the assessee in the taxable territories during the chargeable accounting period. Neither the word “income” nor the words “is received”, “accrues” and “arises” have been defined in the Act. The Privy Council in Commissioner of Income-tax, Bengal v. Shaw Wallace & Co. (1932) I.L.R. 59 Cal. 1343 at 1352 attempted a definition of the term “income” in the words following :-
“Income, their Lordships think, in the Indian Income-tax Act, connotes a periodical monetary return ‘coming in’ with some sort of regularity, or expected regularity from definite sources. The source is not necessarily one which is expected to be continuously productive, but it must be one whose object is the production of a definite return, excluding anything in the nature of a mere windfall.”.. emphasis supplied.
Triggering of Force Majeure from the GST perspective
Wherever force majeure is triggered in such a case, the Doctrine of Frustration(Section 56 of the Indian Contract Act) would be valid grounds to argue, that during the lockdown period the Contract was frustrated wherein unforeseen events which made it illegal or impossible to perform the contract, infact the same can be stated for scenarios where contracts are not performed in a manner which is radically different from what was initially envisaged by both the parties. In that case, there are valid grounds to argue, that the price revision was given effect to save the Contract which otherwise would have been voidable due to impossibility of performance. In such a scenario if the contract is void, the privity would cease thereby no GST will be payable in absence of a ‘transaction’ in the first case.
The Hon’ble Supreme Court while discussing what is impossibility of performance has held in Satyabhrata Ghose vs. Mugneeram Bangur AIR 1954 SC 44 that
“This is much is clear that the word ‘ impossible has bot been used here in the sense of physical or literal impossibility. The Performance of the act may not be literally impossible but it may be impracticable and useless from the point of view of the object and purpose which the parties had in view; and if an untoward event or change in circumstances totally upsets the very foundation upon which the parties rested their bargain, it can very well be said that the promisor finds it impossible to the act which he promises to do”.
Similarly even in the cases of goods sent for job work or goods sent on approval basis. For the period covered under lockdown neither the Supplier of goods, services since the parties were unable to perform their services due to a Central Act forbidding them to do so, the same can be excluded from the time stated under the GST Act under section 142.
Thus to conclude I wish to submit that, when it comes to any revision in price of either goods or services, it is a case of a de novo or fresh determination of the actual consideration now payable. Such a redetermined consideration or as the case may be modified/amended terms of agreement, as long as the same can be directly attributed to the Covid Lockdown, the same shall be valid and allowed as per law.