Reserve Goods at Crossroads: How to bridge the gap between compliances under Drugs law and GST?

It is commonplace for specific laws to govern specific aspects of a particular category of goods. Typically, there are multiple laws to govern different aspects of same category of goods. In India, an example of this in respect of drugs is that while the Drugs and Cosmetics (“DC”) Act, 1940 and Food Safety and Standards Act, 2006 regulates the food and drugs manufacturing in India by prescribing standards and procedures to regulate business practices, GST law is applied to tax such drugs. As is evident from the coverage of these laws, the same operates in different and distinct spheres. However, at times, there is an interplay between the two laws, particularly GST laws and the DC Act, which leads to a conflict.

In the above backdrop, there is a mandate under the DC Rules, 1945 [Rule 74A(h) of DC Rules] which requires that pharmaceutical companies must maintain reference samples known as reserve samples from each batch of drugs manufactured for a specified period, which could range from three months to three years, depending on the nature of the drug. These samples are retained for quality control and testing purposes to ensure the safety and efficacy of the drugs, particularly in case of potential recalls or investigations into adverse effects. This reserve batch cannot be sold in the open market, as its sole purpose is regulatory compliance and not commercial distribution. Pharmaceutical companies are required to keep these reserve batches intact, subjecting them to a storage period that could extend up to three years. However, this regulatory obligation introduces a unique challenge when viewed in conjunction with the provisions of the GST Act.

The general rule is that input tax credit (credit) of goods and services is available under GST and the same is linked to use of such goods in the course or furtherance to business. This is subject to specific barred categories of credit. One such category is goods which are disposed of on a free of charge basis [Section 17(5) of the CGST Act].

Given the peculiar nature of the goods in question, namely, drugs, it is typical for such reserve batch ultimately to lose their market value, often reaching expiry before any commercial transaction can occur. The only option available to the pharmaceutical companies is to not avail input tax credit, which otherwise is a quintessential feature of the GST regime. The inability to claim tax credit on these non-saleable goods results in a financial loss, effectively penalizing companies for complying with essential safety regulations.

It is interesting to note that the conflict does not end with the credit treatment of reserve batches. There is another pressing issue which arises when pharmaceutical companies outsource the manufacturing of drugs to job workers, as is a common practice in the industry. In order to appreciate this other problem, it is pertinent to understand a specific provision of GST law [Section 143(1) of the CGST Act], which requires that if a registered person sends his inputs for manufacturing to a job worker, then in such case such finished goods or raw material should be brought back by the registered person within one year of sending such goods for manufacture to job worker. Thus, the pharmaceutical company acting as a principal and engaging a job worker to manufacture goods is required to bring back such manufactured goods/ raw materials within a period of one year. Furthermore, in case the principal fails to bring back the manufactured goods/ raw material, it would be deemed as a supply of goods and accordingly, GST is required to be paid [Section 143(3) of the CGST Act].

Here, it is worth noting that the DC Act requires the reserve batch goods to be maintained for three years on the premises of the manufacturing facility. This brings in a stark gap between the two laws as the pharmaceutical company would be required to mandatorily store the reserve goods at the premises of the job worker even post the expiry of the time period prescribed for bringing back goods from the job worker premises. After the mandatory period of maintaining the reserve goods, which is more than the one-year limit in GST law, when such goods are brought back from the job worker premises, the same qualifies as supply. In effect, due to the requirement under the DC Act to store reserve goods in the premises of manufacture (job worker premises in this case), there is an additional burden to pay GST, treating it as supply.

In order to ensure ease of doing business, the industry can consider filing a representation asking for an exception to be carved out for such reserve goods to not be required to be subject to the upper time limit of returning within one year.

In the absence of such exception being brought in by way of amendment, owing to the above anomaly, it is relevant for businesses to evaluate certain alternative models so that the compliances under both the DC Act and GST law are met. One such possible option can be obtaining registration at the job worker premises. However, the practical feasibility of such an alternative model is required to be weighed against the compliance under GST law. Another alternative can be the brand owner/ principal (pharmaceutical company) selling the reserve goods prior to the expiry of the limit of one year and then the job worker selling it back to the pharmaceutical company.