The arrangement of holding shares in subsidiary company is a regular business phenomenon. It is widely practiced by all foreign companies investing in India, whereby money is invested in shares of a company which is closely held by group overseas companies.

However, tax authorities in multiple states have been relying on Services Accounting Codes (SAC) 997171 which cover “Services of holding equity of subsidiary companies”. As a result, they are demanding tax on "share capital held in subsidiary company" or "share capital held by a foreign holding company". While under the first category, tax is being demanded under forward charge basis, in the second category, tax is being demanded by Indian subsidiaries by classifying the said activity as import of service by invoking residual entry 15 of Notification 11/2017 CGST (Rate).

In relation to valuation, authorities have adopted the valuation as applicable under Rule 28(b) of Central Goods and Service Tax Rules, 2017 (CGST Rules) which provides that in case of related party transactions where open market value is not available, value of supply of services of like kind and quantity should be considered. Accordingly, the risk-free return which is equivalent to the interest rate on fixed deposits in nationalised banks has been considered for arriving at the tax demand.

If such an interpretation is adopted, then all subsidiaries in India will end up paying GST in all cases where there is an equity holding by overseas parent/ affiliate. Further, if a similar interpretation is adopted for domestic shareholding between group companies under Entry 2 of Schedule I of Central Goods and Service Tax Act, 2017 (CGST Act), the outcomes would be disastrous.

Issue

No supply without a positive act

‘Supply’ is the relevant taxable event for GST. For an activity/transaction to be liable to GST, existence of ‘supply’ as defined under S. 7 of CGST Act is a necessity. It is not the service itself which attracts tax, rather the supply of the service is the taxable event. Therefore, unless a positive action is established at the end of the holding company resulting in service being rendered to the subsidiary company by way of holding equity share capital, it is incorrect to conclude that there is a taxable supply.

While holding equity share capital grants the parent company a right to control the operations of the subsidiary, the same is exercised to protect the interest of the parent company and regulate the capital infused by them. Such control is not exercised with an intention to benefit the subsidiary company. Therefore, mere controlling interest does not qualify as a taxable 'supply of service'.

Demand basis the SAC code available in the scheme of classification of services in incorrect

Although tax authorities have been issuing demand/notices invoking the said SAC code as provided in annexure to Notification 11/2017 of CGST (Rate), it has failed to establish the reason as to why the said activity is being considered as “supply” in terms of S. 7(1) of CGST Act.

Further, Entry 4 of Schedule I of CGST Act covers import of service by a taxable person from a related person/firm/any of his other establishments outside India. This entry deems such import of services even if rendered without a consideration as a taxable supply. It is evident that the Entry envisages a contractual arrangement whereby the taxable person seeks to import a service from its related party. A subsidiary does not enter into any such contractual arrangement to seek the investment of its holding company.

Treatment under Income tax

Even Central Board of Direct Taxes (CBDT) itself recognises the fact that shares are nothing but capital receipt and cannot be classified as income.

Valuation being adopted by tax authorities is not valid

The value of said supply is proposed to be fixed at 5% of the amount held as equity throughout the year (5% being the risk free rate on investment in Government bonds).

Recommendation

In this regard, NASSCOM made a submission to GST officials on May 26, 2022 requesting them to issue a Circular clarifying that the activity of holding shares in subsidiary company will not qualify as 'supply of service' under GST. We have also requested them to issue internal instructions to officers stating that all the proceedings initiated, where the stated argument has been agitated, ought to be stopped until the Circular is issued.