GST Clarification – Taxable treatment of costincurred on warranty replacement or repair

There has been ample confusion among the industries related to the taxable treatment of products replaced free of cost under a warranty period, repair service provided, or a composite supply made of both during the said period. Warranty is a common practice for industries for ages. Erstwhile CENVAT credit rules had provisions on the treatment of such transactions, according to which “definition of inputs” used to include products replaced under warranty as eligible CENVAT credit had the price of those products were factored in the original sale price of goods. Under GST, there were no special
restrictions on the input tax credit admissibility of such products to OEMs, but there still had been room for litigation due to a restriction under section 17(5) of the CGST Act for “goods given free of cost”. Recent clarification by CBIC is kind of a welcome move. According to it, the important element is to identify whether the “likely cost of replacement of parts and/or repair services to be incurred during the warranty period” was already included in the price of the original product not. The following circumstances could emerge through the circular:

• OEMs or distributors or any third-acting person do not obtain any consideration from customers: There is no GST levy on outward transactions and OEMs don’t have to reverse the input tax credit.
• Distributors use their own stock and charge it back to OEMs: The distributor shall levy GST on the same and OEM can avail themselves of the input tax credit of same.
• OEMs provide their own stock to a distributor for replacement: OEMs don’t have to reverse the input tax credit.
• The distributor had unsold stock from OEMs which they used in replacement: OEM can raise a credit note to the distributor for adjusting the cost to the distributor, but credit note shall be allowed to OEM subject to provisions of section 34(2) of the CGST Act.
• Extended warranty:

A. If obtained by the buyer at the time of original purchase: It shall be a composite supply having a principal supply of goods. GST shall be payable accordingly.
B. If obtained by the buyer at a later stage of buying goods: Taxable Treatment shall depend on the nature of the extended warranty i.e., is it for the goods replacement or repair service or a composite supply?

SW Point of View:

1. The sentence, “likely cost of replacement of parts and/or repair services to be incurred during the warranty period” is not defined and must be understood liberally. If an entity has strong estimation skills and historical experience, then only it can estimate the likely cost of replacement. It could be difficult for a newly set-up entity to benchmark the cost of a warranty. Therefore, the industry may appreciate if authorities could also clarify what would amount to a “likely cost”.
2. Instead of issuing a credit note to the distributor, entities may explore another opportunity where the distributor issues the return tax invoice to the OEM. This is because a credit note has its own restrictions of issue in GST Law.

Source: CBIC Circular 195/07/2023 dated 17.07.2023

Amandeep Singh Oberoi- Indirect Tax, SW India