Library / Goods and Services Tax: The Professional's Master Guide

5. Meaning and Scope of Supply (Section 7 and Schedules I, II and III)

The taxable event under GST is supply. If there is no supply, there is no tax, whatever the amount received. Section 7 of the CGST Act defines supply in an inclusive way, and three Schedules extend it, classify it and cut it down. The right order of analysis is: is it a supply under section 7(1); is it excluded by Schedule III; if not, is it goods or services under Schedule II; and then which rate and exemption apply.

5.1 Supply for consideration in the course of business (section 7(1)(a))

Supply includes all forms of supply of goods or services, such as sale, transfer, barter, exchange, licence, rental, lease or disposal, made or agreed to be made for a consideration by a person in the course or furtherance of business. Four elements are needed: a supply of goods or services, a supplier and a recipient (two persons), consideration, and a link with business. An agreement to supply is enough; the event need not be complete.

"In the course or furtherance of business" covers far more than the main line of trade. Sale of old assets, scrap, canteen coupons or surplus stock is part of business under section 2(17)(b). A transaction by an individual in a personal capacity, such as sale of a private car by a salaried person, is not in the course of business and is not a supply.

Illustration 21: Sale of old laptops by a business

Kavya Infotech bought 20 laptops three years ago for Rs. 12,00,000 plus GST Rs. 2,16,000 and took ITC. It now sells them for Rs. 3,00,000.

Step 1: The sale is in the course of business and is a supply. GST on transaction value at 18% = Rs. 54,000.

Step 2: Under section 18(6), where capital goods on which ITC was taken are sold, the tax payable is the higher of (a) the tax on transaction value and (b) the ITC taken, reduced by 5 percentage points for every quarter or part of a quarter since the invoice date.

Step 3: 12 quarters have passed. Reduction = 60 percentage points. Amount under (b) = 40% of Rs. 2,16,000 = Rs. 86,400.

Result: Kavya Infotech pays Rs. 86,400, the higher of Rs. 54,000 and Rs. 86,400.

5.2 Clubs and associations (section 7(1)(aa))

Under the pre-GST law, supplies by a members' club to its own members were not taxed because of the principle of mutuality: a person cannot trade with himself. Section 7(1)(aa), inserted by the Finance Act, 2021, treats activities or transactions by a person other than an individual to its members or constituents (or the reverse), for consideration, as supply. An Explanation deems the person and its members to be separate persons, notwithstanding any judgment. The provision was made retrospective from 1 July 2017 and was notified with effect from 1 January 2022.

Judicial view: Mutuality and section 7(1)(aa)

State of West Bengal v. Calcutta Club Ltd. (Supreme Court, 2019): The Court held that the doctrine of mutuality continued to apply to members' clubs, including incorporated clubs. Supply of food and beverages by a club to its members was not a sale, and service tax could not be levied on services provided by a club to its members under the law then in force. Section 7(1)(aa) was inserted to overcome this.

Indian Medical Association v. Union of India (Kerala High Court, 2025, Division Bench): The Court declared section 2(17)(e), section 7(1)(aa) and its Explanation unconstitutional for lack of legislative competence, holding that supply under the Constitution needs two distinct persons. The Union has appealed; the Supreme Court issued notice in July 2025 and directed that no recovery steps be taken against the Association meanwhile.

Practical relevance: The question is pending in the Supreme Court. Outside Kerala the provision remains on the statute book and officers apply it. Clubs and associations should consider paying under protest or keeping full records of the amounts involved, and should not treat the Kerala ruling as settling the issue nationally.

Illustration 22: Resident welfare association charges

Shanti Heights Co-operative Housing Society in Ahmedabad has 200 flats. It charges each member Rs. 9,000 per month for maintenance, security and common electricity. Its annual collections are 200 x Rs. 9,000 x 12 = Rs. 2,16,00,000, so it is required to register.

Step 1: The exemption for such associations covers contributions up to Rs. 7,500 per member per month for sourcing goods or services from third parties for common use. The charge of Rs. 9,000 is above the limit, and CBIC has clarified that the whole amount then becomes taxable, not only the excess.

Step 2: GST at 18% per member per month = Rs. 1,620. For 200 members = Rs. 3,24,000 per month.

Result: Keeping the monthly charge at or below Rs. 7,500 (for example by billing a sinking fund contribution separately where genuine) avoids tax. The society should also watch the pending Supreme Court appeal on section 7(1)(aa).

5.3 Import of services (section 7(1)(b))

Import of services for consideration is a supply whether or not it is in the course or furtherance of business. This is an exception to the business test. However, an exemption notification under the IGST Act exempts services received from abroad by an individual for purposes other than business (except online information and database access or retrieval services), and by certain Governments and charitable entities.

Illustration 23: Import of services by an individual and by a firm

Kavya, a doctor in Vadodara, pays a US architect USD 3,000 (Rs. 2,55,000 at Rs. 85 per USD) for designing her own house.

Step 1: This is import of services for consideration, a supply under section 7(1)(b), even though it is not for business.

Step 2: It is exempt because an individual receives it for a non-business purpose. No IGST is payable.

Step 3: If Kavya's clinic (a registered proprietorship) had imported a marketing service for the same amount, IGST at 18% = Rs. 45,900 would be payable under reverse charge. Health care services being exempt, the clinic could not take ITC of it.

5.4 Supplies without consideration (Schedule I)

Section 7(1)(c) brings in the four activities in Schedule I, which are supplies even when made without consideration. They exist to protect the credit chain: where ITC has been taken, the goods or services must bear output tax when they leave the business, and supplies between related parties must not escape tax through nil pricing.

Para	Activity treated as supply without consideration
1	Permanent transfer or disposal of business assets where ITC has been availed on them
2	Supply of goods or services between related persons, or between distinct persons under section 25, in the course or furtherance of business. Gifts by an employer to an employee not exceeding Rs. 50,000 in value in a financial year are not a supply
3	Supply of goods by a principal to his agent where the agent undertakes to supply them on behalf of the principal, or by an agent to his principal where the agent receives them on behalf of the principal
4	Import of services by a person from a related person or from his own establishment outside India, in the course or furtherance of business

Illustration 24: Business asset given away

Patel Pumps donates a used office computer, bought two years ago with ITC taken, to a local school. Its open market value today is Rs. 50,000.

Step 1: The computer is a business asset on which ITC was availed. Its permanent disposal without consideration is a supply under para 1.

Step 2: Value is determined under the valuation rules, here taken at the open market value of Rs. 50,000. GST at 18% = Rs. 9,000 (CGST Rs. 4,500 + SGST Rs. 4,500).

Result: Had no ITC been taken on the computer, the gift would not be a supply at all.

Illustration 25: Gifts to employees

Sharma Textiles gives its manager a Diwali gift worth Rs. 30,000 in October 2025 and a watch worth Rs. 25,000 in March 2026.

Step 1: Employer and employee are related persons. Gifts up to Rs. 50,000 in a financial year are not a supply.

Step 2: Total gifts in 2025-26 = Rs. 55,000, which exceeds Rs. 50,000. The prevailing view is that the entire value, not only the excess, is then a supply.

Step 3: GST on open market value of Rs. 55,000 at 18% = Rs. 9,900.

Result: ITC on goods given as gifts is blocked under section 17(5)(h) in any case. Keeping gifts per employee within Rs. 50,000 a year avoids output tax as well.

Cross charges between branches

Head office functions (accounts, HR, IT, management) serve branches in other States. Each branch is a distinct person, so the head office is treated as supplying services to it. CBIC Circular 199/11/2023 clarified that where the recipient branch is eligible for full ITC, the value declared in the invoice is deemed to be open market value, and where no invoice is issued, the value may be treated as nil. Salary cost of head office employees need not be included in such cases. Where the branch makes exempt supplies, a proper valuation under rule 28 is needed, or the common input services should be distributed through an ISD registration.

Illustration 26: Cross charge by head office

Mehta and Co. has its head office in Ahmedabad and a branch in Mumbai. Head office costs attributable to the Mumbai branch are Rs. 30,00,000. The Mumbai branch makes only taxable supplies.

Step 1: Head office raises an invoice for Rs. 30,00,000 plus IGST at 18% = Rs. 5,40,000.

Step 2: The Mumbai branch takes ITC of Rs. 5,40,000. The net tax effect for the company is nil.

Result: Because the branch is eligible for full ITC, the invoice value is accepted. Had the branch made exempt supplies, the value would have to be supported by a proper cost allocation.

Principal and agent

Illustration 27: Goods sent to an agent

Joshi Fabrics sends cloth to Kumar Agencies, which sells it to retailers in its own name and issues its own invoices. Kumar Agencies sells the cloth for Rs. 4,00,000.

Step 1: The agent issues invoices in its own name, so para 3 of Schedule I applies (Circular 57/31/2018). Joshi Fabrics makes a supply when it sends the goods to Kumar Agencies.

Step 2: Under rule 29, Joshi Fabrics may value the supply at 90% of the price charged by the agent to unrelated customers: 90% of Rs. 4,00,000 = Rs. 3,60,000. GST at 5% (fabric) = Rs. 18,000.

Step 3: Kumar Agencies charges GST on its sales: 5% of Rs. 4,00,000 = Rs. 20,000, and takes ITC of Rs. 18,000.

Contrast: If Joshi Fabrics invoiced the retailers directly and Kumar Agencies only earned a commission of 5% (Rs. 20,000), no para 3 supply arises. Kumar Agencies pays GST of Rs. 3,600 (18%) on its commission only.

Judicial view: Secondment of staff by a foreign group company

Commissioner of Customs, Central Excise and Service Tax v. Northern Operating Systems (P) Ltd. (Supreme Court, 2022): Employees of an overseas group company worked in India for the Indian entity under secondment. The Indian entity paid their salaries locally and reimbursed other costs. The Court looked at the substance of the arrangement and held that the overseas company supplied manpower service to the Indian entity, liable to service tax under reverse charge.

Practical relevance under GST: Similar arrangements are import of services, and from a related person they are a supply even without consideration (Schedule I para 4). CBIC Circular 210/4/2024 clarified that where the Indian recipient is eligible for full ITC, the value declared in the invoice (including nil where no invoice is issued) may be taken as open market value.

5.5 Goods or services (Schedule II)

Schedule II does not decide whether something is a supply; it decides whether a supply is of goods or of services. The main entries are shown below.

Activity	Treated as
Transfer of title in goods	Supply of goods
Transfer of right in goods without transfer of title (for example, lease or hire)	Supply of services
Transfer of title under an agreement where property passes on full payment (hire purchase)	Supply of goods
Lease, tenancy, easement or licence to occupy land; letting out a building for business	Supply of services
Job work: treatment or process applied to another person's goods	Supply of services
Business goods put to private use or used for non-business purposes	Supply of services
Goods transferred or disposed of so as no longer to form business assets	Supply of goods
Renting of immovable property; construction of a complex before completion certificate; IPR licence; software development; agreeing to refrain from or tolerate an act	Supply of services
Works contract; supply of food or drink (not alcohol) as part of a service, such as a restaurant	Composite supply of services

Paragraph 5(e), "agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act", is the entry the department often relies on to tax compensation, damages and penalties. As explained below, CBIC has itself narrowed its reach.

5.6 Neither goods nor services (Schedule III)

Schedule III lists activities that are neither a supply of goods nor a supply of services. They are outside GST altogether.

Para	Activity
1	Services by an employee to the employer in the course of or in relation to employment
2	Services by any court or tribunal
3	Functions of MPs, MLAs, members of Panchayats, Municipalities and local authorities; duties of constitutional post holders; duties of chairpersons, members or directors of Government bodies not deemed employees
4	Funeral, burial, crematorium or mortuary services, including transport of the deceased
5	Sale of land and, subject to Schedule II para 5(b), sale of a building (a completed building sold after completion certificate or first occupation)
6	Actionable claims, other than specified actionable claims
7	Supply of goods from one place outside India to another place outside India without the goods entering India (merchanting trade)
8(a)	Supply of warehoused goods to any person before clearance for home consumption; from 1 July 2017 (by the Finance Act, 2025) this includes goods in an SEZ or FTWZ sold before clearance for export or to the DTA
8(b)	Supply of goods by the consignee by endorsement of documents of title after dispatch from the port of origin abroad but before clearance for home consumption (high-sea sales)

Paras 7 and 8 were effective from 1 February 2019 but made retrospective from 1 July 2017 by the Finance Act, 2023, without refund of tax already paid. For high-sea sales and warehoused goods, IGST is collected once by customs from the buyer who clears the goods, on a value that includes the sale price. For ITC purposes, Schedule III activities are generally not counted as exempt supplies, except sale of land and completed buildings (para 5), which must be included in exempt turnover under rules 42 and 43, and sales of warehoused goods to the extent prescribed.

Illustration 28: Flat sold before and after completion

Shree Developers sells two identical flats (not affordable housing) for Rs. 1,00,00,000 each, including land.

Flat A: Agreement and payments before the completion certificate. This is construction service under Schedule II para 5(b). GST at the effective rate of 5% (after the deduction of one-third for land, without ITC) = Rs. 5,00,000.

Flat B: Sold after the completion certificate, with the entire consideration received after that date. This is sale of a building under Schedule III para 5. No GST.

Result: The builder must reverse ITC attributable to Flat B, since it counts as an exempt supply for ITC.

Illustration 29: Merchanting trade

Global Trade Links, Mumbai, buys machine parts from a supplier in China for Rs. 50,00,000 and sells them to a buyer in the UAE for Rs. 55,00,000. The goods are shipped directly from China to the UAE.

Step 1: The goods move from one place outside India to another without entering India. Schedule III para 7 applies.

Result: No IGST on the purchase or the sale. Customs duty does not apply either, as nothing is imported. Service charges paid in India for arranging the deal remain taxable in the normal way.

5.7 Tricky receipts: CBIC clarifications

Vouchers

CBIC Circular 243/37/2024 clarified that vouchers (gift cards, prepaid instruments) are neither goods nor services; they are like money or an actionable claim. Sale or distribution of vouchers on a principal-to-principal basis is not a supply; tax arises only on the underlying goods or services when the voucher is redeemed. Where a distributor acts as an agent for a commission, the commission is taxable. Unredeemed vouchers (breakage) are not consideration for any supply. The Finance Act, 2025 then omitted the voucher provisions in sections 12(4) and 13(4).

Illustration 30: Gift voucher redeemed for a shirt

Kavya buys a Rs. 1,000 gift voucher from a clothing chain. Her friend later uses it to buy a shirt priced at Rs. 1,050 (inclusive of GST) and pays Rs. 50 in cash.

Step 1: Sale of the voucher is not a supply. No GST at that stage.

Step 2: On redemption, the shirt is supplied. Apparel up to Rs. 2,500 per piece is taxed at 5%. Tax = Rs. 1,050 x 5 / 105 = Rs. 50; taxable value Rs. 1,000.

Result: If the voucher had never been redeemed, the chain would have no GST liability on the Rs. 1,000 it kept.

Liquidated damages, compensation and penalties

CBIC Circular 178/10/2022 examined Schedule II para 5(e) and said that a payment is consideration for "tolerating an act" only where there is a separate agreement to tolerate it and the payment flows from that agreement. Money paid as compensation for a breach, or as a deterrent, is not consideration for a supply. The circular's conclusions are:

Liquidated damages for delay or breach, forfeiture of earnest money, compensation for breach of contract: not taxable.
Fines for dishonour of cheques and penalties imposed by law: not taxable.
Amounts recovered from employees under an employment bond or for short notice on leaving: not taxable, as they are penalties to dissuade premature exit.
Cancellation charges (hotel, airline, rail): taxable as part of the principal supply, at the rate of that supply.
Late payment surcharge or fee: taxable, at the rate of the principal supply.
Fixed capacity charges in power supply: part of the supply of electricity, not a separate service of tolerating non-consumption.

Judicial view: Notice pay is not consideration

GE T and D India Ltd. v. Deputy Commissioner of Central Excise (Madras High Court, 2019): Notice pay recovered from employees who left without serving the notice period was held not liable to service tax. The employer does not provide any service of tolerating the employee's early exit; the amount is a recovery under the employment contract.

Practical relevance under GST: The ruling is consistent with Circular 178/10/2022. Employers should not charge GST on notice pay or bond recoveries, and demands raised on this ground can be contested.

Employee recoveries and perquisites

Services by an employee to the employer are outside GST (Schedule III para 1). CBIC Circular 172/04/2022 clarified that perquisites provided by an employer to employees under the contract of employment are not a supply. Canteen recoveries are more fact-specific. Where the employer merely collects the employees' share and passes it to the canteen contractor without any margin, several Authorities for Advance Ruling have held that the employer makes no supply; others have taken a different view where the employer itself runs the canteen. The contract structure decides the answer.

Tips, service charge, donations, sponsorship and grants

Service charge added to a restaurant bill is part of the value of the restaurant service and is taxable. A tip paid voluntarily by a customer directly to staff is not consideration for the restaurant's supply.
Security deposits are not consideration unless applied (Chapter 4). Advances forfeited on cancellation are taxable if they are in substance cancellation charges, but not if they are compensation for breach under Circular 178/10/2022. Read the contract.
Donations to a charity are not consideration where the donor gets nothing in return other than a plain acknowledgement. Where the donor's name or brand is advertised or promoted, the payment is sponsorship, a taxable service (under reverse charge where the recipient of the sponsorship service is a body corporate or partnership firm).
Grants by Government or others without any obligation to supply goods or services to the grantor are not consideration. A grant tied to specific deliverables for the grantor may be.

Illustration 31: Which recoveries attract GST

Bhavani Foods Ltd. has the following receipts in a month.

(a) Notice pay recovered from a departing employee: Rs. 1,20,000. Not a supply. No GST.

(b) Charges for a dishonoured cheque from a distributor: Rs. 500. Not a supply. No GST.

(c) Interest for late payment charged to a distributor on an invoice for goods taxed at 18%: Rs. 3,000. Taxable as part of the principal supply. GST at 18% = Rs. 540.

(d) Liquidated damages deducted from a contractor's bill for delay: Rs. 2,00,000. Not a supply by Bhavani Foods. No GST.

Result: GST payable on these receipts = Rs. 540 only.

Practice note

Where the department proposes tax on damages or penalties, check the contract. The circular protects payments that are compensation for loss or deterrence. It does not protect a payment that is really the price of agreeing to something, such as a non-compete fee or a fee for allowing early exit from a lease on agreed terms.

Chapter summary

• Supply under section 7(1)(a) needs a supply, two persons, consideration and a link with business; one-off asset sales are covered.

• Section 7(1)(aa) taxes clubs and associations on supplies to members; the Kerala High Court struck it down and the Supreme Court appeal is pending.

• Import of services for consideration is a supply even outside business, but exempt for individuals for personal use.

• Schedule I taxes supplies without consideration: business assets with ITC, related and distinct persons (gifts to employees up to Rs. 50,000 excluded), principal and agent, related-party import of services.

• Schedule II classifies supplies as goods or services; Schedule III removes employee services, sale of land and completed buildings, actionable claims, merchanting, warehoused and high-sea sales from GST.

• Vouchers are not taxed until redemption; liquidated damages, notice pay, cheque dishonour fines and penalties under law are not supplies; cancellation and late payment charges are.