Certain features of the GST treatment of physician samples, which are not exempted but have zero value, are discussed in this piece.

History of tax on interstate consignment of goods

Earlier, the states taxed sale of goods, and neighbouring states often had different rates of sales tax. There was a tendency to avoid higher rates of tax by consignment of goods to one's own depot in another state and sell them from there. To plug the leakage in revenue, the 46th amendment to the Constitution amended Article 269 and thereby extended the tax on sales to include interstate consignment of goods. The reasons for doing this were clearly explained in the Statement of Objects and Reasons to the amendment. These reasons are otiose now, as all states have identical rates of GST.

Further we may note that the power to tax interstate consignment of goods is derived from Article 269 and the revenues so collected are assigned to the states. This provision remains in force. GST is levied under authority derived from Article 269A, which does not does not empower Parliament to levy tax on consignment of goods to the consignor himself. Nevertheless, Parliament has enacted the CGST Act with Schedule I which levies tax on consignment of goods to the consignor himself if the destination is in another state.

Exempted vs free goods

Exempted goods remain exempted from GST through the supply chain by virtue of the exemption notification. But free-supply items like samples are not exempted goods. Not being sold for a consideration, they are not taxed in GST because the transaction thereby falls short of being a "supply" as defined. However, under an exception made in Schedule I of the CGST Act, samples get taxed under as deemed supply if moved to another premises of the same taxpayer ("distinct person") in a different state.

Burden of irrecoverable GST

Pharmaceutical companies are allowed to give upto 2 per cent of their production as free

samples. The turnover of the pharma industry in 2023-24 was over 4,17,345 crores of rupees (Source).

Two per cent of this turnover is a sizable quantity of products moving around for free. When these free samples are transferred to the company's own depots in other states ("distinct persons"), this gets covered under Schedule I to the CGST Act as a deemed supply, and the relevant rules are brought into play to determine taxable value.

This anomalous situation was confirmed by the CBIC under its Circular No. 92/11/2019-GST

dated 7 March 2019, which says that - "Accordingly1 it is clarified that samples which are supplied free of cost1 without any consideration, do not qualify as "supply" under GST, except where the activity falls within the ambit of Schedule I of the said Act.1"

Despite payment of GST, no input tax credit is possible as the product is given out free of charge. Section 17(5)(h) of the CGST Act blocks input tax credit in this situation. The GST paid on the samples remains an irrecoverable cost.

Anomaly In tax on free supply

The anomaly in the situation is clear from the comparison below:

• Samples supplied to company's depot within the state: zero GST.

• Samples supplied to hospitals / doctors within the state: zero GST.

• Samples supplied to hospitals / doctors in another state: zero GST.

• Samples supplied to company's depot in another state: GST payable because the depot in another state is a "distinct person" in GST, and movement of goods to a distinct person

It is immediately apparent that the word "supply" has been used in its legal meaning in the caption, but in its normal meaning in entry 2. Entry 2 carves out a subset of "supply" (as normally understood), being the supply made between related persons/ distinct persons in the course or furtherance of business, as "supply" in the legal sense.

These shifting meanings will be kept in mind while reading the valuation provisions that are

discussed further below.

Central excise duty vs GST on pharma samples

The pharma companies are resigned to the situation because the battle on free samples was fought and lost in central excise. The courts held that central excise was on 'manufacture' and was attracted as soon as the samples were fully manufactured; and that free delivery was not germane. The courts also observed that physician samples were part of the commerce in pharmaceuticals though not sold: on this ground, the argument of "not marketable, therefore not goods and not exigible to excise duty" was rejected.

The situation is, however, quite different in GST. The levy of GST is on "supply". Manufacture, per se, does not attract GST. For this reason, the judicial precedents in central excise do not justify taxing physician samples in GST.

Granting that consignment of physician samples to the company's own depot in another state is a deemed supply under Schedule I of the CGST Act, the determination of value still needs careful scrutiny. We will see below that application of the rules for valuation in GST will lead to a conclusion of zero tax.

Determining value in GST

Where there is no transaction value, the taxable value is determined under the rules for valuation as contained in rules 28 to 31 of the CGST Rules 2017. Of these, rule 28 is applicable for valuing transactions with a distinct person or related person (other than through an agent).

RULE 28. Value of supply of goods or services or both between distinct or related persons,

other than through an agent. - The value of the supply of goods or services or both between

distinct persons as specified in sub-section (4) and (5) of section 25 or where the supplier and

recipient are related, other than where the supply is made through an agent, shall -

(a) be the open market value of such supply;

(b) if the open market value is not available, be the value of supply of goods or services of like kind and quality;

(c) if the value is not determinable under clause (a) or (b), be the value as determined by the application of rule 30 or rule 31, in that order:

Provided 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:

Provided further 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. It is seen that the rule has a hierarchy of options for valuing goods supplied to distinct persons other than through an agent.

Rule 28(a): "open market value of such supply"

The first clause of rule 28 provides that the value of supply of goods to distinct persons will be taxed by taking the open market value of "such supply" to be the taxable value. Only if this is not available can we go to the next option. (However, this can be overridden by the option under the first proviso to the rule, as discussed later here.)

In central excise the value of "such goods" was taken as the assessable value when no price was available. This meant the price of the same drug as sold in the market. However, the CGST Rule 28(a) refers us to the open market value of "such supply" and not of "such goods".

This is because GST is a transaction tax, while excise duty was a tax on manufacture.

Accordingly, "such supply" in rule 28(a) refers to the transaction and not to the goods transacted. The transaction in doctor samples is one of free supply for advertisement purposes, as noted by the Supreme Court in the case of Medley Pharmaceuticals (para 29) [Civil Appeal No. 3626 of 2005 with C.A. Nos. 1354-1355 of 2010, decided on 14-1-2011].

The Drugs and Cosmetic Rules prohibit sale of physician samples. Thus, the open market value of transactions in doctor samples is kept at nil though the supplier may gain several benefits in making this supply at zero price. The taxable value of these samples in interstate movement would also, therefore, be nil.

Rule 28(b): supply of goods of like kind and quality

Clause (b) of rule 28(b) does posit the value of supply of goods of like kind and quality as a basis for valuation of supply to "distinct persons" / related persons. However, this rule comes into play only if the open market value of the supply is not available. As seen above, the open market value of transactions in physician samples is easily ascertained as being nil. This rules out clause (b) of rule 28.

Shifting meaning of the word "supply"

An objection may come to mind that rule 28(a) refers to open market value of such "supply", and that therefore it may not be correct to take a free supply as "supply". However, we have seen that the CGST Act itself uses the word in different senses; hence, we need to use common sense, historical context, as well as a sense of perspective on the objects of the law, while arriving at the best interpretation.

Rule 28 proviso gives an option to pay GST on 90% of the sale price of identical goods.

The first proviso to Rule 28 gives the supplier the option to fix the price of the goods at 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 non-related customer. If applicable, this would present us with a taxable value that is 90 per cent of the price at which identical drugs are sold from the depot. This proviso gives an option of overriding clauses (a) and (b) of rule 28. It is a less controversial option than clause (a) in the Rule in that it remains with the value of identical goods ("such goods") as per the central excise precedents rather than bring in a new concept like the value of "such supply". It gives a small benefit of ten per cent reduction in taxable value for those who would prefer to play safe and avoid litigation.

Conclusion

In sum, (i) it is perfectly within the letter and spirit of the law to take the value of interstate supply of physician samples as zero and thereby not pay GST on them; (ii) for the less adventurous, some outgo may be saved by paying GST on a value that is ninety per cent of the price at which identical drugs are sold from the depot.