Input Service Distributor is defined under section 2(61) of the CGST Act. It refers to an office of the supplier of goods or services or both which receives tax invoices issued under section 31 towards the receipt of input services and issues a prescribed document to distribute the credit of central tax, state tax, integrated tax or union territory tax paid on the said services to a supplier of taxable goods or services or both having the same Permanent Account Number as that of the said office.
It must be an office of the supplier of goods or services. The ISD receives invoices for input services only and not for input goods or capital goods. It issues the prescribed document for distributing Input Tax Credit, which is the ISD invoice as mentioned under Rule 54(1). The Input Tax Credit is distributed only to units having the same PAN.
Legal Provisions for Cross Charge
Cross Charge is not expressly defined in the GST law. However, it is recognized through various provisions that trigger the concept of cross-charge. Section 29 provides for the levy of GST on the value of supply made by a taxable person for a consideration and in the course or furtherance of business. Section 7(1)(c) includes activities listed in Schedule I to the CGST Act as supply even if made without consideration. Entry 2 of Schedule I relates to the supply of goods or services made between distinct persons.
Section 25(4) and Section 25(5) define distinct persons as two or more units of the same legal entity registered separately, whether in the same State or Union Territory or different ones.
Legal Provisions for Levy, Collection, and Valuation
Section 9 deals with the levy and collection of GST. It states that subject to the provisions of subsection (2), there shall be levied a tax called the central goods and services tax on all intra-state supplies of goods or services or both except on the supply of alcoholic liquor for human consumption, on the value determined under section 15 and at such rates as notified by the government on the recommendations of the council.
Section 7 outlines the scope of supply. The expression supply includes the activities specified in Schedule I, made or agreed to be made without consideration. Schedule I treats the supply of goods or services or both between related persons or between distinct persons as supply when made in the course or furtherance of business.
Section 25(4) provides that a person who has obtained or is required to obtain more than one registration, whether in one state or more, shall, in respect of each such registration, be treated as a distinct person for this Act. Section 25(5) provides that where a person who has obtained or is required to obtain registration in a state or union territory in respect of an establishment has an establishment in another state or union territory, then such establishments shall be treated as establishments of distinct persons.
Provisions Governing Valuation Mechanism for Cross Charge
Section 15(1) of the CGST Act states that the value of supply of goods or services or both shall be the transaction value, which is the price paid or payable for the said supply, where the supplier and recipient are not related,, and the price is the sole consideration.
Section 15(4) states that where the value cannot be determined under sub-section (1), it shall be determined in such manner as may be prescribed. Rule 28 governs the value of supply between distinct or related persons other than through an agent. It provides that the value shall be the open market value of such supply. If the open market value is not available, it shall be the value of the supply of goods or services of like kind and quality. If this is not determinable, the value shall be determined by application of Rule 30 or Rule 31 in that order.
The first proviso to Rule 28 states that where the goods are intended for further supply as such by the recipient, the value shall, at the option of the supplier, be an amount equivalent to ninety percent of the price charged for the supply of goods of like kind and quality by the recipient to his customer not being a related person.
The second proviso states that where the recipient is eligible for full input tax credit, the value declared in the invoice shall be deemed to be the open market value of the goods or services.
Rule 30 states that where the value of supply cannot be determined under the previous rules, it shall be one hundred and ten percent of the cost of production or manufacture, or the cost of acquisition or provision.
Rule 31 provides a residual method for the determination of value using reasonable means consistent with the principles and provisions of section 15 and the rules of this chapter. In case of supply of services, the supplier may opt for this rule, ignoring Rule 30.
Comparative Summary of ISD and Cross Charge
The Input Service Distributor mechanism and the Cross Charge mechanism serve different purposes under the GST law, though both relate to transactions among distinct persons of the same legal entity. Understanding their key differences is crucial for determining the correct application.
ISD requires a mandatory separate registration. An office functioning as an ISD must be distinctly registered to receive input services and distribute the corresponding Input Tax Credit to other branches of the same entity having the same PAN. On the other hand, Cross Charge does not require separate registration. Any branch or head office that is already registered under GST may issue an invoice to another distinct person within the same legal entity, thus transferring taxable services.
Under the ISD mechanism, only input services can be distributed. There is no provision for distributing input goods or capital goods through ISD. In contrast, the Cross Charge mechanism allows for the supply of common inputs, input services, and capital goods among different registrations within the same legal entity.
The ISD mechanism mandates a prescribed formula for distribution as provided under Section 20,, read with Rule 39 of the CGST Rules. This formula ensures the correct proportionate allocation of Input Tax Credit. In the case of Cross Charge, the valuation mechanism is governed by Section 15 read with Rules 28, 30, and 31. This framework prescribes the valuation based on open market value or cost-based valuation methods, depending on the situation.
ISD involves separate return filing obligations. The ISD is required to file GSTR-6 and GSTR-6A to report the distribution of Input Tax Credit. In contrast, Cross Charge does not require any separate returns. The tax paid through cross charge is reported in the regular GSTR-1 and GSTR-3B of the respective registration.
Analysis of Specific Advance Rulings
In the case of Columbia Asia Hospitals Private Limited, the Authority for Advance Rulings in Karnataka held that services provided by employees at the head office, such as IT services, payroll services, and HR services to other branches of the same legal entity that are registered separately, qualify as supply and are liable to GST. The Appellate Authority for Advance Rulings emphasized a fundamental difference between the ISD and Cross Charge mechanisms. In the ISD framework, only the Input Tax Credit on input services attributable to other distinct persons is distributable. In contrast, in a Cross Charge, all expenses incurred by one distinct person that benefit other distinct persons must be cross-charged. In this case, the cross charge is viewed as a service provided by one registration to another, whereas in ISD, there is no service being rendered—only ITC distribution.
In Cummins India Limited, the Maharashtra Appellate Authority for Advance Rulings held that when the head office avails ITC for common input services on behalf of branch offices, it constitutes a supply that attracts GST. The authority also ruled that the head office cannot retain the ITC and must distribute it. It was held that the head office must register as an ISD and distribute the credit accordingly to the branch offices.
In B G Shirke Construction Technology Private Limited, the Authority for Advance Rulings in Maharashtra held that managerial and leadership services provided by the corporate office to its group companies or project sites qualify as supply under Entry 2 to Schedule I. GST would apply to such services. The applicant was allowed to continue invoicing a lump sum amount as done previously. The authority relied on the second proviso to Rule 28, noting that most of the recipients were eligible for full Input Tax Credit. Any recipients not eligible were required to comply with the applicable provisions of Section 17 of the CGST Act at their end.
Clarifications by CBIC on Inter-Office Transactions
The Central Board of Indirect Taxes and Customs issued Circular No. 199/11/2023-GST dated seventeenth July two thousand twenty-three, which provides detailed clarifications on the taxability of services provided by one office of an organization to another office located in a different state or union territory. These transactions are treated as supply between distinct persons and are therefore liable to GST, unless exempted. The clarifications address key practical concerns and provide optionality and flexibility in adopting either the ISD or Cross Charge mechanism.
Distribution of ITC via ISD or Cross Charge
The circular confirms that the taxpayer may choose between ISD and Cross Charge for distributing the credit of common input services received from third-party vendors. This choice offers flexibility and operational convenience, depending on the structure and compliance strategy of the business. However, once a method is chosen, consistency must be maintained to avoid audit issues and misinterpretation.
Valuation of Services in Case of Cross Charge
In cases where internally generated services are cross-charged from one registration to another, valuation becomes important. The circular confirms that valuation should be by the second proviso to Rule 28 of the CGST Rules. It reinforces that where the recipient is eligible for full Input Tax Credit, the value adopted in the invoice will be deemed as open market value. This holds even if certain components, such as the salary cost of employees, are not included in the valuation.
Recipient Eligible for Full ITC
Where the recipient of services under a cross-charge arrangement is eligible for full Input Tax Credit, the valuation of such internally generated services is flexible. The value declared on the invoice is deemed to be the open market value. The circular clarifies that even in scenarios where no invoice is raised, the value may be considered as nil and still be accepted as the open market value. This clarification provides relief and simplifies compliance for entities that perform internal allocations across multiple registrations where full ITC is claimable.
Recipient Not Eligible for Full ITC
For cases where the recipient is not eligible for full Input Tax Credit, the circular provides significant relaxation. It clarifies that the inclusion of the salary cost of employees in the taxable value of such internally generated services is not mandatory. This marks a shift from earlier rulings, particularly the decisions in Columbia Asia and Cummins India, where the salary component was required to be included in the valuation. This change provides flexibility to businesses and avoids unnecessary litigation over employee cost components, especially where they are not directly connected to a specific supply.
Implications of the Clarifications
These clarifications override previous interpretations that mandated strict inclusion of costs such as salaries in the valuation of cross-charge transactions. The taxpayer now has the flexibility to determine the valuation method depending on the eligibility of the ITC by the recipient. This eases compliance and removes ambiguity, particularly in complex group structures where inter-office services are frequent and hard to evaluate precisely. The circular also ensures that taxpayers do not face penal consequences for genuine differences in valuation approaches if proper disclosure and consistency are maintained.
Valuation Mechanism for Cross Charge When Recipient is Not Eligible for Full ITC
One of the unresolved concerns under the cross-charge mechanism is how to determine the appropriate valuation when the recipient is not eligible for the full input tax credit. The rules and circulars do not provide specific guidance on whether the valuation must include costs such as employee salaries, administrative overheads, or indirect expenses. While recent clarifications indicate that inclusion of salary is not mandatory, the lack of a precise method leads to interpretational challenges, especially for organizations with complex cost structures.
Inclusion of Non-GST or Exempt Supplies in Cost of Provision for Cross Charge
There is ambiguity on whether the value of non-GST or exempt supplies should be included in the overall cost base when computing the taxable value for cross-charge. For example, services provided to an SEZ unit or other exempt activities may distort the valuation. Whether or not these should be factored into cost allocation affects the tax liability and creates a risk of over- or under-reporting.
Interpretation of Eligibility for Full ITC: Qua Supply or Qua Recipient
There is no clarity on whether the eligibility for full input tax credit should be determined based on the nature of the supply or based on the recipient’s general ITC eligibility. This distinction becomes important when the same supply is made to different units with varied ITC entitlement. If the supply itself is eligible, but the recipient has mixed or exempt outward supplies, the question arises whether the second proviso to Rule 28 can still be applied.
Option to Use Different Valuation Mechanisms for Different Recipients
There is uncertainty over whether a taxpayer may apply different valuation methods for recipients based on their ITC eligibility. For instance, using the second proviso to Rule 28 for a unit eligible for full ITC and using Rule 30 or Rule 31 for a unit with partial ITC eligibility. No clear guidance exists on whether a mix of methods can be adopted in the same tax period or across periods, which could create practical and audit-related challenges.
Consequences of Not Choosing ISD or Cross Charge
Taxpayers who neither distribute credit through ISD nor raise cross-charge invoices may face challenges during an audit. If ITC is retained entirely by one registration and not allocated appropriately to other units that benefit from the services, it may be treated as ineligible credit, resulting in reversal and penalty. Such inaction may be viewed as a procedural lapse with financial consequences.
Flexibility to Alternate Between ISD and Cross Charge in Different Tax Periods
Another open question is whether the flexibility to choose between ISD and cross-charge applies to the same common service across different periods. For instance, if the taxpayer uses the cross-charge route in one quarter and ISD in the next, it is unclear whether such a shift is permitted. While the law does not prohibit it explicitly, a lack of consistency may invite scrutiny from tax authorities.
Interpretation of Internally Generated Services and Exclusion of Salary Costs
The phrase internally generated services has not been defined, yet it plays a critical role in determining the taxability of transactions under cross-charge. Whether the provision of support functions like accounting, HR, legal, or IT within an organization amounts to an internally generated service is subject to interpretation. Similarly, whether the salaries of employees performing these tasks need to be included in valuation remains debatable, although recent clarifications provide relief by excluding the mandatory inclusion of such costs.
Challenges if ISD is Made Mandatory
Recommendations from the 50th GST Council Meeting
In the fiftieth GST Council meeting held in New Delhi on eleventh July two thousand twenty-three, a proposal was made to amend the GST law to make the ISD mechanism mandatory prospectively for distributing ITC of common input services procured from third parties. This recommendation, if implemented, will significantly change the current compliance structure for businesses with multi-state operations.
Identification of Common Input Services from Third Parties
One of the key challenges if ISD becomes mandatory is the identification and classification of common input services. Many services used by the head office or shared services center may benefit multiple units, and accurate classification is crucial for proper ITC distribution. Lack of clarity may lead to misallocation and disputes during assessments.
Vendor Communication and Invoice Management
To comply with mandatory ISD requirements, vendors will need to be informed to raise invoices correctly. For forward charge supplies, invoices should be addressed to the ISD GSTIN. For reverse charge supplies, invoices must be issued on the regular GSTIN. Ensuring this distinction is consistently followed will be operationally demanding and will require robust communication and controls.
Timely Distribution of ISD Credit
To avoid compliance issues and ensure timely credit availability, ISD credit must be distributed in the same tax month in which it is received. Any delay may result in a mismatch between the input credit availed and the credit passed on to the respective branches, affecting the monthly returns and credit reconciliation.
ITC Accumulation in SEZ Units
In cases where common input services are distributed to SEZ units via ISD, the credit may accumulate since supplies made by SEZ units are generally zero-rated. This could result in cash flow inefficiencies, unless a refund mechanism is allowed. Proper documentation and reporting will be required to ensure such accumulation is justified and claimed appropriately under the refund provisions.
Conclusion
Understanding the distinction between Input Service Distributor (ISD) and Cross Charge under the GST regime is critical for multi-location businesses striving for tax compliance and operational efficiency. Both mechanisms serve the purpose of distributing input tax credit (ITC) among different units of an organization, but their applicability and implementation vary significantly based on the nature of services, business structure, and accounting practices.
The ISD mechanism is ideal for centralizing the distribution of common input services like audit fees, advertisement expenses, or management consultancy services when there is no supply of services between the branches. It offers a simple and clear route to distribute eligible ITC without creating a taxable supply.
Cross Charge, on the other hand, is used when there is an actual provision of services or use of resources between branches or units registered as distinct persons under GST. It entails issuing tax invoices and accounting for tax liability, thereby ensuring a correct flow of ITC and compliance with tax provisions regarding internal transactions.