Destruction Due To Kerala Flood – ITC Implications

1. Flood is a vis majoree. an Act of God. It causes havoc in the lives of the people affected by it. It sometimes takes years to rebuild that which is swept away in minutes. In the present article we shall concern ourselves with the one of the issues related to GST which may come up due to floods.

2. Let us consider a case wherein a supplier had manufactured certain taxable goods and the same were lying in stock. He has availed input tax credit (“ITC”) in respect of various inputs, input services as well as capital goods fulfilling the requirement casted u/s 16(1) of the CGST Act, 2017. Due to incessant rains followed by flood, the finished goods which were is stock were destroyed. Supplier may lodge an insurance claim and receive money as a compensation towards the destroyed goods.

3. Now, the supplier is concerned about the ITC which he has already availed. Is he required to reverse the ITC attributable to the finished goods which have been destroyed ?

4. Sec. 17(5) of the CGST Act, 2017 provides that notwithstanding anything contained u/s 16(1), ITC in respect of certain goods and services shall not be available. In other words, even if a supplier has fulfilled the requirement casted u/s 16(1) (i.e. intention of use for the business), ITC is respect of given goods and services may not be available. Clause (h) of the said provision is relevant and hence reproduced below:

“Sec. 17(5) Notwithstanding anything contained in sub-section (1) of section 16 and sub-section (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;”

5. Above clause thus provides, amongst other things, that ITC shall not be available in respect of goods which are destroyed. Supplier must however consider the following aspects before taking a decision to reverse the ITC:

Lex non cogit ad impossibilia

6. The legal maxim in the title means that law cannot compel a man to do what he cannot possibly do. Herbert Broom calls this a “fundamental legal principle”. Broom describes the application of the principle in more detail as under:

“… that … where the law creates a duty or charge and the party is disabled to perform it, without any default in him, and has no remedy over, the law will in general excuse him….”

7. In Hughey v. JMS Development, Justice Owens of the United States Court of Appeals used these words to describe the principle:

““Lex non cogit ad impossibilia: The law does not compel the doing of impossibilities.”

8. In 2012, Justice Frankel of the British Columbia Court of Appeal described the maxim as follows (in Transportaction Lease Systems Inc. v. Virdi):

“Lex non cogit ad impossibilia, i.e., the law does not compel a person to do that which he or she cannot possibly perform.”

9. Supreme Court of India recognized the said principle in the case of Cochin State Power & Light Corporation Ltd. v. The State of Kerala AIR 1965 SC 1688 wherein it was observed as under:

“The performance of this impossible duty must be excused in accordance with the maxim, lex non cogitate ad impossible (the law does not compel the doing of impossibilities)”

10. Similarly in the case of Raj Kumar Dey v. Tarapada Dey [1987] 4 SCC 398 the said principle was further elaborated by the Apex Court as under:

“The other maxim is “LEX NON COGIT AD lMPOSSIBILIA” (Broom’s Legal Maxims-P. 162)-The law does not compel a man to do that which he cannot possibly perform. The law itself and the administration of it, said Sir W. Scott, with reference to an alleged infraction of the revenue laws, must yield to that to which everything must bend, to necessity; the law, in its most positive and peremptory injunctions, is understood to disclaim, as it does in its general aphorisms, all intention of compelling impossibilities, and the administration of laws must adopt that general exception in the consideration of all particular cases.”

11. Above discussion thus fortifies the conclusion that legislators by law can only impose such condition which can be fulfilled by its subjects. In view of an impossibility, law must make an exception and cannot compel a man to do the impossible. In other words, law must bend to the necessity.

12. Hon. Gujarat High Court in the case of Rolcon Engineering Co. Ltd. v. State of Gujarat (2009) 21 VST 117 (Guj.) has held that from the language of scheme there will be no violation if one could not run the wind farm for reasons beyond his control. In this case appellant was granted benefit on the condition that he must run the wind farm for continuous period of six years. However due to devastating cyclone he could not run the wind farm for continuous period of six years. Government denied the benefit on the ground that the condition of the scheme has been violated. It was however held by the Hon. Court applying the principle of “LEX NON COGIT AD lMPOSSIBILIA” that the benefit must be allowed since wind farm could not be run due to Act of God.

13. In the light of above understanding we must now apply the said principle to the present issue. Word “destroyed” appearing u/s 17(5)(h) cannot be construed so as to also include cases of destruction due to an Act of God. This is because as discussed above, law cannot impose a condition which cannot be possibly performed. Sec. 16(1) permits ITC on an intention of using the goods or services in the course or furtherance of business. Thus supplier in our case has a clear intention of using the same in his business. Destruction of goods due to an Act of God cannot be construed as a change in intention which can permit any restriction of ITC. Hence the word “destroyed” must mean only destruction by a human agency which is wilful in nature. Thus only when supplier wilfully destroys the goods that the restriction envisaged u/s 17(5)(h) can be made applicable.

14. If one closely reads Sec. 17(5)(h), what it requires is that ITC “in respect of goods” destroyed shall not be available. Whether the phrase “in respect of” shall include inputs or input services or capital goods which are used in manufacture of goods which have been destroyed ?

15. Apex court in the case of State of Madras vs M/s. Swastik Tobacco Factory [1966] AIR 1000 (SC) held that in the taxation laws the phrase “in respect of” is synonymous with the expression “on”. Hence it was further held that “excise duty in respect of goods sold” shall only include duty on the finished goods which have been sold and not the inputs which would have gone into the manufacture of such finished goods.

16. Hence even on this ground, ITC cannot be restricted in respect of inputs or input services or capital goods which might have been used in manufacture of goods which have been destroyed.

17. Another interesting facet to consider is whether any method has been prescribed for carrying out the said reversal. This is because Sec. 17(5)(h) provides for restriction of input tax credit and not payment of the tax by assuming that the goods destroyed have been supplied. The term “input tax credit” shall encompass not only credit in respect of inputs but also input services as well as capital goods. GST law does not provided for maintaining one-to-one correlation between ITC claimed vis-à-vis goods or services supplied. In absence of the same, how should one arrive at the amount to be reversed ?

18. Can proportionate formula based on turnover enshrined under Rule 42 (for inputs and input services) & 43 (for capital goods) be applied for carrying out the reversal ? The answer is clear no. This is because the said Rules have been formulated only for the scenarios covered u/s 17(1) & 17(2) as apparent from its plain reading. Said Rules have not been formulated for scenarios covered u/s 17(5). Hence in absence of any Rules, can the provision of Act be applied ?

19. Again the answer seems to be no. This is because Apex Court in the case of Commissioner of Income Tax vs B. C. Srinivasa Setty 1981 AIR 972 (SC) held that in absence of computation provisions, the charging provision shall fail. Hence in absence of any Rule providing for the method of identifying the said ITC which needs to be reversed, in the context that law does not require one to maintain one-to-one correlation of credits with supply, Sec. 17(5)(h) shall fail.

20. Before we part we must also point out that if ITC amount has been recovered from the insurance company, in all fairness the said ITC must be reversed. Said principle was held by Hon. Gujarat High Court in the case of State of Gujarat v. S. A. Himnani Distributors Pvt. Ltd. (2014) (7) TMI 783 (Guj.).

21. Hence to avoid litigation, if the supplier can recover the ITC amount from the insurance company, he must opt for it and reverse the said ITC. In absence of same, he may choose to rely on the above mentioned reasoning to avoid reversal of ITC.

(views are strictly personal)