GST Audit Defence Compendium: Valuation, Discounts, Classification & Rate Disputes

By CA Surekha Ahuja

“In GST, disputes rarely arise from short-paid tax. They arise because the law is read in isolation from commerce.”

THE CONTEXT: WHY THESE DISPUTES KEEP RECURRING

Nearly eight years into GST, audit objections persist around:

• Valuation adjustments

• Post-supply discounts

• Classification and HSN/SAC disputes

• Rate determinations and mixed supply analysis

The reason: Audits are algorithmic; GST law is transactional. Numbers are reconciled mechanically in GSTR-1/3B, but statutory interpretation, commercial reality, and evidence often take a backseat.

The outcome: Sections 73/74 additions that fail under judicial scrutiny, yet consume years of taxpayer bandwidth.

This note provides a resolution-oriented framework for Category 3 disputes, focusing on valuation, discounts, reimbursements, classification, and rate disputes, with audit triggers, statutory anchors, judicial precedents, and evidence-first strategies.

VALUATION UNDER GST: SECTION 15 IS THE STARTING POINT

Section 15 of the CGST Act provides an exhaustive code for transaction value.
Audit misstep: bypassing transaction value and directly adding amounts under Rule 27–31.

Key points:

• Transaction value is primary (Sec 15(1))

• Statutory inclusions (freight, insurance, discount reversal, etc.) apply only if conditions are met

• Related-party or cost-based valuations are exceptions (Rules 28/30)

Practical insight: Any valuation addition without first displacing the transaction value is legally unsustainable.

POST-SUPPLY DISCOUNTS: LAW, COMMERCE, AND JUDICIARY

Audit trigger:

• Credit notes issued after invoicing

• Volume or turnover rebates crystallised post-supply

• GSTR-1 vs ledger mismatches

Statutory position (Pre-Budget 2026):

• Section 15(3)(b) allows post-supply discounts if:

  1. Established in commercial practice

  2. Specifically identifiable and linked to invoice

  3. ITC is proportionately reversed

Judicial support:

• AAAR Gujarat & Maharashtra (Inox Wind Ltd.): Volume/turnover discounts integral to trade; GST cannot tax consideration never received.

Budget 2026 update:

• Removes requirement for prior agreement or invoice linkage

• Only credit note issuance with ITC reversal is required

• Clarifies legislative intent, weakening rigid audit positions

Evidence for resolution:

• Ledgers, buyer confirmations, credit/debit notes, ITC reversal proofs

Practical tip: Ensure all post-supply adjustments are reconciled with ITC reversal to preempt fresh SCNs.

REIMBURSEMENTS & PURE AGENT RECOVERIES

Audit misstep: Treat reimbursements (freight, statutory fees, third-party costs) as additional value.

Legal framework:

• Rule 33: Exclude recoveries if supplier acts as pure agent

• Conditions:

  1. Expense incurred on behalf of recipient

  2. At actuals without markup

  3. Disclosure is separate and transparent

Judicial examples:

• CESTAT Vodafone: Reimbursements not taxable

• AAR Kerala & AAAR UP: Strict proof required but allowed if documentation complete

Key principle: Dispute is evidentiary, not legal.

Evidence checklist:

• Authorization letters, separate invoices, recipient-supplier declarations

RELATED-PARTY TRANSACTIONS & OPEN MARKET VALUE

Audit assumption: Related-party relationship = automatic value adjustment.

Legal position:

• Transaction value remains primary

• OMV only applies when distortion is shown

• Cost-based valuation is a last resort (Rule 30)

Judicial insight:

• Without evidence of suppression or distortion, valuation enhancements fail.

Evidence strategy:

• Valuation declarations, comparables, cost sheets, TP study if variance <10%

FREE SUPPLIES AND EMPLOYEE GIFTS

Audit trigger: Items issued without consideration deemed taxable.

Legal clarification:

• Taxable only if in the course/furtherance of business and falls under Schedule I

• CBIC Circular 92/11/2019-GST:

  • Promotional samples exempt

  • Employee gifts ≤ ₹50,000/year exempt

Resolution: Maintain promotional policies and low-value ledgers; ITC reversal only where applicable.

CLASSIFICATION & RATE DISPUTES

Common missteps:

• Misclassification of composite/mixed supplies

• Arbitrary bifurcation of goods + service

• Improper rate application

Legal principles:

• Principal supply test: Essential character governs classification (Safari Retreats SC 2019)

• Works contracts: Predominant activity test for immovable property (CBIC Circular 105/24/2019-GST)

• Exempt vs taxable mix: ITC reversal must be proportional (Sec 17, Rules 42/43)

Evidence essentials:

• Contract terms, BOQ, site inspection reports, turnover bifurcation, GSTR-9C certifications, SEZ LUTs

Audit cannot arbitrarily tax “split” or “artificial” components — courts consistently quash such demands.

RESOLVABILITY STRATEGY (PRACTITIONER CHECKLIST)

Issue Type	Audit Weakness	Defence Strategy
Post-supply discount	Often presumed undervaluation	Credit notes + ITC reversal; ledger + buyer confirmation
Reimbursements	Misclassified as taxable	Rule 33 affidavit; distinct invoices
Related-party adjustments	Presumed OMV	TP study; cost & comparables
Free supplies	Arbitrarily taxed	Schedule I + Circular 92/11/2019-GST
Classification/rate	Artificial splitting	Principal supply; BOQ & contract analysis
Works contracts	Misclassification	Predominant activity test; site/material report
Exempt ITC	Blanket denial	Sec 17 + Rules 42/43 proportionate reversal

Key insight:

GST audit disputes collapse when law and commerce are read together, and evidence is structured.

CLOSING THOUGHT

Most disputes arise not from evasion, but from valuation misinterpretation and rigid arithmetic assumptions.

A well-prepared SCN reply does not argue figures — it disqualifies the methodology:

• Anchored in statute (Sec 15, Rules 28–33)

• Supported by binding AAAR/SC precedents

• Backed by proper evidence matrix

In GST audits, clarity and documentation resolve more cases than confrontation.