When GST Law Conflicts with Drug Regulations: A Pharma Industry Puzzle
India’s pharmaceutical industry operates at the intersection of two powerful legal regimes: the Goods and Services Tax (GST) law and the Drugs and Cosmetics Act, 1940. While both serve distinct purposes—taxation and public health, respectively—their intersection often leads to confusion, especially concerning reserve goods retained by drug manufacturers.
At the heart of the issue is a regulatory paradox. Companies are mandated to store reserve drug batches for safety purposes under Rule 74A(h) of the Drugs and Cosmetics Rules, 1945, but GST law treats unsold or unreturned goods as supply, triggering tax liability.
Let’s explore this GST law conflict that continues to perplex tax planners and compliance heads across the pharma sector.
🧪 What Are Reserve Drug Batches?
Under the Drugs and Cosmetics (DC) Rules, pharma companies must retain a portion of every drug batch—called reserve samples—for quality control and post-market surveillance. These batches are:
- Non-commercial: They are not meant for sale.
- Time-bound: Must be retained from 3 months to 3 years, depending on the drug type.
- Regulatory: Mandated for safety, recalls, or adverse event investigations.
However, GST law doesn’t carve out specific exceptions for such goods, triggering two main issues:
⚖️ Issue #1: Input Tax Credit Denied on Reserve Goods
Under Section 16 of the CGST Act, input tax credit (ITC) is available for goods used in the course of business. But Section 17(5) disallows ITC on goods disposed of without consideration (i.e., free samples).
🔍 The Problem:
- Reserve goods cannot be sold.
- They expire without use.
- This disallows ITC—even though they are integral to product lifecycle compliance.
🏭 Issue #2: Deemed Supply When Reserve Goods Are at Job Worker Premises
Outsourcing manufacturing is routine in pharma. Under Section 143(1) of CGST Act:
- Inputs sent to job workers must be returned within one year.
- Failure to return them triggers deemed supply under Section 143(3) → GST payable.
🤯 The Clash:
The Drugs Act requires reserve batches to be stored at the site of manufacture (often the job worker’s premises) for up to 3 years.
⚠️ Consequence:
- If the principal doesn’t bring back goods in one year → Deemed supply.
- When finally returned, the goods are taxed again, even though no real supply occurred.
🔄 What Can Industry Do?
This legal gap creates a compliance nightmare. Here are 3 possible solutions:
1. Seek Government Clarification
File representations with the GST Council or Ministry of Finance requesting:
- An exception for reserve drugs under Section 143 time limits.
- Recognition of regulatory necessity in rulemaking.
2. Job Worker GST Registration
If feasible, companies may:
- Obtain GST registration at the job worker’s premises.
- Treat that location as an additional place of business.
⚠️ But this involves compliance complexity and regulatory consent under the DC Act.
3. Two-Step Sale Structure
- Brand owner sells reserve goods to job worker before 1-year deadline.
- Job worker sells them back later as required.
📝 This creates fictitious commercial movement, potentially inviting scrutiny.
📚 Legal & Regulatory References
- Rule 74A(h), Drugs and Cosmetics Rules, 1945
- Section 143, CGST Act, 2017
- Section 17(5), CGST Act, 2017
- Wockhardt Ltd. v. CCE (2022-TIOL-XX) – ITC allowed in absence of actual disposal
- Circular No. 38/2018-GST – Clarifies job work treatment but silent on regulatory overlaps
📊 Why This Matters: Key Stats
- India exported $25 billion worth of pharma products in FY2024-25.
- Over 70% of manufacturing is outsourced to job workers.
- 10-15% of each batch may be earmarked as reserve, adding up to crores in blocked credit.