Whether Section 17(5)(h) covers inputs or outputs/Finished goods Case of loss of Inputs during manufacturing process in Madras High Court
Ruling – Loss of input when consumed during manufacturing process – such loss is not covered by situations u/s 17(5)(h) – ITC reversal not required: HC
Case facts – There is a loss of a small portion of the inputs, inherent to the manufacturing process during manufacturing process. State tax officers seek to reverse a portion of the ITC, proportionate to input loss during manufacturing, referring to the provisions of Section 17(5)(h) of the GST Act.
Considerations in Judgement
a. In Tamil nadu VAT Act, section 19(9(iii) is as “No input tax credit shall be available to a registered dealer for tax paid Omitted[or Payable] at the time of purchase of goods, if such-(iii) inputs damaged in transit or destroyed at some intermediary stage of manufacture.”
b. However as per GST act, restrictions on ITC conditions is as:
Section 17. Apportionment of credit and blocked credits.
(5) Notwithstanding anything contained in sub-section (1) of section 16 and subsection (1) of section 18, input tax credit shall not be available in respect of the following, namely:-
(h) goods lost, stolen, destroyed, written off or disposed of by way of gift or free samples;
Judgement – The situations as set out above in clause (h) indicate loss of inputs that are quantifiable, and involve external factors or compulsions. A loss that is occasioned by consumption in the process of manufacture is one which is inherent to the process of manufacture itself.
reversal of ITC involving Section 17(5)(h) by the revenue, in cases of loss by consumption of input which is inherent to manufacturing loss is misconceived, as such loss is not contemplated or covered by the situations adumbrated under Section 17(5)(h).
Interesting observations – Some interesting principles evolved from this judgment are as:
There are 3 guiding principles pronounced through Judgment. Are these principles as per GST act.
1. Principle 1st – It has been held that “The situations as set out above in clause (h) indicate loss of inputs”. So does goods means inputs under section 17(5)(h). Is it conclusive? Going by the section 16 introductory paragraph as well as section 17, it leaves no doubt that goods means inputs. Sections 16 & 17 are written for procurement of goods by recipient through supplier. As court was dealing issue regarding loss of input only, they have covered inputs under judgement. Thus, capital goods procured will also be covered under section 17(5)(h) and Finished goods will be outside ambit.
In one advance ruling of “General Manager Ordnance Factory Bhandara”, Maharashtra AAR ruled very specifically that “the question of reversal will arise only if the inputs or capital goods are themselves lost, stolen or destroyed. If the finished goods are destroyed, lost or stolen: then reversal should not be required”
Significance of Principle 1 – Department in cases compel registered person to reverse ITC proportionate to inputs consumed in cases of Finished goods destroy, FG given on sample, FG stolen, FG written off etc. Also, it is observed during GST audits, that auditors ask to reverse input corresponding to FG Samples, FG destroyed. So itc is not required to be reverse in FG cases as per GST act and clarity by this decision of Madras High court.
2. Principle 2nd – High court held that “The situations as set out above in clause (h) indicate loss of inputs that are quantifiable, and involve external factors or compulsions”. This seems to be very good remark by High court as inputs along with capital goods are only covered under all situations under section 17(5)(h) is a clear cut guideline and Finished goods are out of ambit.
3. Principle 3rd – It has been held that “The situations as set out above in clause (h) indicate loss of inputs that are quantifiable, and involve external factors or compulsions.
So another principle is that reversal of ITC on inputs (and capital goods as well as discussed above) lost, destroyed etc. will be in those situations which are
a. quantifiable and involve external factors or
b. quantifiable and involve compulsions
So can we take this another principle of quantification with external factors or compulsions as guiding principle.?
For this let’s have a look at Tamil Nadu VAT provisions since issue was regarding rejection of ITC during assessment by State tax officers who are more accustomed to VAT provisions. As per Section 19 of Tamil Nadu VAT, ITC restriction conditions on are as (only ITC restriction clauses quoted):
{Section 19. Input tax credit
(8) No input tax credit shall be allowed to any registered dealer in respect of any goods purchased by him for sale but given away by him by way of free sample or gift or goods consumed for personal use.
(9) No input tax credit shall be available to a registered dealer for tax paid Omitted[or Payable] at the time of purchase of goods, if such- (i) goods are not sold because of any theft, loss or destruction, for any reason, including natural calamity. If a dealer has already availed input tax credit against purchase of such goods, there shall be reversal of tax credit; or (ii) inputs destroyed in fire accident or lost while in storage even before use in the manufacture of final products; or (iii) inputs damaged in transit or destroyed at some intermediary stage of manufacture}
So first, under section 19(8),(9) of TNVAT act, conditions are specifically defined but these conditions do not seem like some external conditions or compulsions in totality. like section 9(iii) states input destroyed at some intermediary stage of manufacture but does not specify any external conditions or compulsions of destruction at intermediary stage. In same way, Section 9(i) states goods lost for any reason…
The point is under VAT there were some conditions specified but under GST no conditions are specified.
Secondly, Quantifiable has been used to emphasize the case on hand and what ought to be. For example, there is input of 100 units in consumption but output/Finished goods can be 91, 92, 93 units within a range. in this case if company wants to obtain 100 units of FG, it is not sure how much input will be consumed since there can be variance in every lot of consumption. Thus loss cannot be quantified at hand since inherent in manufacturing process.
While in cases in which reversal of ITC is required like stolen, destroyed, sample it can be ascertained from records how much inputs quantity is stolen, destroyed or disposed by way of gift without any ambiguity.
Thus principle of “quantifiable, and involve external factors or compulsions” is certainly a clarity. This will be tested in future as GST law just provides the situations without defining same. Still this verdict provides much needed clarity.
Thus, this ruling in one shot solves many issues and indeed a welcome ruling.
Disclaimer – The views expressed are strictly personal.
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