GST in a direct selling business model

A recent tax case allowed an appeal against the IRAS’ decision to charge GST based on the open market value of goods sold via a direct selling business model.

Herbalife International Singapore Pte. Ltd. (Herbalife) is a Goods and Services Tax (GST)-registered company in Singapore that operates a direct selling business model where it only sells products to members that are registered with the company (Members).

Members may purchase the products at varying discounted prices either for their own personal consumption, or for resale to end consumers and retain the price difference between what they paid to Herbalife and the price they are contractually bound to sell as their profits. 

In this case, for the sale of products by Herbalife to its Members, the Inland Revenue Authority of Singapore (IRAS) wanted to levy GST based on the open market value instead of the discounted price charged by Herbalife. The GST Board of Review (BOR) ruled in favour of the IRAS but the High Court allowed the appeal by Herbalife.

GST issue in dispute

The issue concerns the value of supply and the GST liability of the transactions between Herbalife and its Members. Herbalife sells products to its Members at varying discounted prices. All Members enjoy a standard discount of 25%, and further tiered discounts depending on the volume of products purchased, as well as the purchases of new members recruited by the Members.

It is not disputed that the products supplied by Herbalife to its Members are liable to GST. However, the issue arises from the value of such supplies on which GST is levied – whether the value of the products sold by Herbalife to its Members is the discounted price charged by Herbalife, or should GST be charged on the open market value?

As the Members are generally not registered for GST, the sale by the Members to the end consumers are not subject to GST. Hence, the difference between the discounted price charged by Herbalife to its Members and the final retail price the end consumers pay is not brought to tax, which according to the Comptroller, results in revenue leakage. To address this revenue leakage, the Comptroller had sought to value the supplies from Herbalife to its Members at open market value, based on section 17(3) of the GST Act, instead of the discounted price.

Section 17(3) of the GST Act states: “If the supply … is not for a consideration or is for a consideration not consisting or not wholly consisting of money, the value of the supply is taken to be its open market value.” According to the Comptroller, the non-monetary consideration would be either the undertaking of obligations by the Members or the provision of marketing services to Herbalife in exchange for the products. Hence, in view of the non-monetary consideration, the Comptroller had concluded that the value of supply is the open market value, which is the retail price of the products less the standard discount of 25%.

Herbalife had argued that:

• The tiered discounts are solely based on the volume of products purchased by the Members, and not on the provision of non-monetary consideration such as promotion and sale of products to other consumers. The tiered discounts are given based on the volume points accumulated by the Members, irrespective of whether the Members had purchased the products for their personal consumption or for resale to end consumers.
• There was no supply of service from the Members to Herbalife. The tiered discounts were given solely based on the volume of purchase by the Members. It should not constitute a supply of service by the Members to Herbalife, which amounted to separate, non-monetary consideration.
• The Members are already separately remunerated in the form of commissions, royalty overrides and bonuses for their services to improve the distribution channels for Herbalife.
• Unlike the UK Value-Added Tax (VAT) legislation, which had a special valuation provision to tax goods sold via direct selling business model, this special valuation provision is absent in the GST Act. Hence, there is a lacuna in our GST Act that has to be filled by Parliament. 
• Section 17(3) is not applicable as the consideration from the Members consists wholly of money and hence section 17(2) of the GST Act should apply. Section 17(2) of the GST Act states as follows: “If the supply is for a consideration in money, its value is taken to be such amount as, with the addition of the tax chargeable, is equal to the consideration.

In this article, we discuss the findings and key takeaways from this recent High Court case.

GST Board of Review’s decision in June 2022

Based on the Comptroller’s value of supply of the products at their open market value with a base discount of 25% that was given to all Members, the Comptroller had raised assessments for the accounting periods from 1 January 2012 to 31 March 2017. 

As Herbalife was not satisfied with the Comptroller’s decision, it filed an appeal to the GST BOR on 27 December 2018 on the grounds that the value of supply should be the discounted price charged by Herbalife. The amount of GST in dispute is S$2,187,089.99, inclusive of a 5% late payment penalty.

The GST BOR agreed with the Comptroller’s position that the supply of the nutritional products had been partially made for non-monetary consideration, which attracted the application of section 17(3) of the GST Act, and that the Comptroller’s assessment of GST based on the open market value should therefore stand. The GST BOR’s decision was based on the following:

• The host of terms and conditions that are found in the membership agreement constituted obligations by the Members that presented a clear, practical and commercial benefit to Herbalife, which was separate from the benefit Herbalife had obtained from the sale of the products to the Members. 
• There is a direct and contractual link between the purchase of the products at discounted price by the Members and the various obligations undertaken to Herbalife in the terms of the membership. If the Members did not comply with these undertakings, there could be no sale of the products at the discounted price. The right to purchase the products at discounted price is clearly conditional on all the terms of membership.

Herbalife appealed to the High Court on the GST BOR’s decision.

High Court’s decision in March 2023

It was necessary for the High Court to determine, based on the facts, whether the supply in question was made in exchange for some form of non-monetary consideration.

The High Court had allowed Herbalife’s appeal, based on the following key considerations:

• The presence of a special valuation provision in the UK VAT legislation and the absence of a similar provision in the GST Act to tax goods sold via direct selling business model is a strong indicator that direct selling cases ordinarily do not involve supplies made for non-monetary consideration, which causes it to fall within section 17(3) of the GST Act.
• It had examined the two requirements laid down by the GST BOR on whether the undertaking of obligations can constitute non-monetary consideration: (i) whether the undertakings were independent of, and not ancillary to the supply of the nutritional products, and (ii) whether the undertakings provided a benefit that goes beyond the monetary transaction in question.
• The terms of trade would not constitute non-monetary consideration except where they contractually demand the provision of something non-monetary in exchange for the supply. Terms of trade provide the contractual structure to regulate the functioning of a business model. The fact that a contractual term requires a recipient of a supply to act in a particular way does not necessarily mean that the act of the recipient is consideration within the meaning of section 17(3) of the GST Act. Hence, on the first requirement, the judge concluded that the obligations only govern how the Member should act as a member of Herbalife as opposed to being the consideration furnished in exchange for obtaining the products.
• The judge also did not agree with the GST BOR’s reasoning that the fact that the suite of contractual obligations enabled the business model to function constituted a “benefit” that the Members provided to Herbalife in exchange for the goods. Hence, on the second requirement, the judge was of the view that these “benefits” received by Herbalife were just the compliance of its members with the contractual terms of trade as opposed to valuable consideration within the meaning of section 17 of the GST Act. The obligations were not furnished in exchange for the products but rather, they were undertaken as conditions to purchase the products for consideration in money.
• The Comptroller has not pointed to a tangible thing, whether in the form of a good, service or something else furnished by the Members to Herbalife, which has objective parity of value with the discount that the Members receive, thereby bringing it within section 17(3) of the GST Act.
• The solution to the revenue leakage raised by the Comptroller lies not in expanding the scope of non-monetary consideration but in the adoption of a special valuation provision similar to the UK VAT legislation. It is however beyond the power of the courts and must be implemented legislatively.

With the above, the High Court allowed the appeal by Herbalife.

Key takeaways

If the perceived gap in the GST Act in relation to direct marketing valuation is to be closed, then this should be addressed through legislation. Neither the IRAS nor the courts may close that perceived anomaly.

It would come as no surprise to see the inclusion of a special valuation provision that seeks to address the issue of revenue leakage in a direct selling business model. If a special valuation provision is included in the GST Act, GST-registered businesses operating direct selling business models would have to account for GST on the open market value of the goods sold to their members.

Application of GST rules

This case exhibits that the application of the GST rules in certain aspects is still subject to interpretation of the law. It also serves as a timely reminder for businesses to review their business transactions periodically for any potential GST issues. In circumstances where the GST treatment is uncertain, to avoid lengthy and costly audit disputes with the Comptroller, it is recommended that businesses should obtain GST rulings from the Comptroller. 

The co-authors of the article are Yeo Kai Eng, a former EY partner and Gwynne Chan, Associate Director, Indirect Tax – Goods and Services Tax from EY Corporate Advisors Pte. Ltd.