Introduction:
Many tax payers especially in Construction Sector have been receiving GST notices from department, asking them to reverse Input Tax Credit against retention money pertaining to bills received by suppliers/contractors.
This situation has sparked a significant debate, with tax payers fearing potential financial burdens. The reason behind this demand is the trade practice in which certain amount is retained by the tax payer from the bill amount of its supplier.
However, the real question is whether tax payers should be required to reverse ITC for these retention amounts. In this article, we will delve into the legal dimensions surrounding the retention of money of suppliers and will examine the legal arguments, look at relevant cases, and determine if tax payers truly need to reverse ITC for retention money.
Understanding the Purpose of Retention Money:
Retention money, a standard practice commonly followed in construction contracts, serves to safeguard against potential defects and to encourage on-time project completion. It is a preventive measure to ensure project quality and timely delivery.
Understanding the Legal Dispute:
The heart of the issue lies in a specifically in second proviso to Section 16(2) of the CGST Act, 2017 read with Rule 37 of CGST Rules, 2017. This part of the GST law comes into play when a tax payer fails to pay a supplier within 180 days from the date of invoice issued by the supplier.
Second proviso to Section 16(2) of CGST Act, 2017 is reproduced below for kind reference-
Provided further that where a recipient fails to pay to the supplier of goods or services or both, other than the supplies on which tax is payable on reverse charge basis, the amount towards the value of supply along with tax payable thereon within a period of one hundred and eighty days from the date of issue of invoice by the supplier, an amount equal to the input tax credit availed by the recipient shall be added to his output tax liability, along with interest thereon, in such manner as may be prescribed:
While third proviso to Section 16(2) of CGST Act, 2017 as stated below-
Provided also that the recipient shall be entitled to avail of the credit of input tax on payment made by him of the amount towards the value of supply of goods or services or both along with tax payable thereon.
Below is the bare text of Rule 37 of CGST Rules, 2017
Rule 37. Reversal of input tax credit in the case of non-payment of consideration.-
(1) A registered person, who has availed of input tax credit on any inward supply of goods or services or both, other than the supplies on which tax is payable on reverse charge basis, but fails to pay to the supplier thereof, the amount towards the value of such supply whether wholly or partly, along with the tax payable thereon, within the time limit specified in the second proviso to sub-section(2) of section 16, shall pay or reverse an amount equal to the input tax credit availed in respect of such supply , proportionate to the amount not paid to the supplier, along with interest payable thereon under section 50, while furnishing the return in FORM GSTR-3B for the tax period immediately following the period of one hundred and eighty days from the date of the issue of the invoice:
Provided that the value of supplies made without consideration as specified in Schedule I of the said Act shall be deemed to have been paid for the purposes of the second proviso to sub-section (2) of section 16:
Provided further that the value of supplies on account of any amount added in accordance with the provisions of clause (b) of sub-section (2) of section 15 shall be deemed to have been paid for the purposes of the second proviso to sub-section (2) of section 16.
(2) Where the said registered person subsequently makes the payment of the amount towards the value of such supply along with tax payable thereon to the supplier thereof, he shall be entitled to re-avail the input tax credit referred to in sub-rule (1)..
(4) The time limit specified in sub-section (4) of section 16 shall not apply to a claim for re-availing of any credit, in accordance with the provisions of the Act or the provisions of this Chapter, that had been reversed earlier.
Now, considering the above GST provisions, the question is whether the tax payer needs to reverse the ITC against the amount which is retained from the bill of the supplier and is kept on hold as per the terms of the agreement?
Legal Interpretation & View
It is to be appreciated that Second Proviso to Section 16(2) read with Rule 37 is applicable only if a recipient fails to pay to the supplier of goods or services or both, other than the supplies on which tax is payable on reverse charge basis, the amount towards the value of supply along with tax payable thereon within a period of one hundred and eighty days from the date of issue of invoice by the supplier.
On plain reading of Second Proviso to Section 16(2) read with Rule 37, it is to be highlighted that the both said proviso & rule uses the term- “fails to pay” rather than “does not pay”.
It is to state that there is a big difference in two terms as “fails to pay” refers to a situation where the amount was payable / due as per contract but was not paid, whereas “does not pay” is having a wide connotation and would cover non-payment due to any reason.
In this context, the argument put forth is that the provision for the reversal of credit becomes applicable specifically when the recipient fails to pay. This term “fails to pay” is linked to a specific incident where a payment was expected due to a contractual obligation.
The core argument is that retention money, being a common practice in various industries, should not fall under the definition of “fails to pay.” This is because retention money is withheld in accordance with mutually agreed terms within the contract. Therefore, when a tax payer is not under any obligation to make a payment for retention money within the contractually stipulated 180-day period, it cannot be claimed that they failed to make a payment to the supplier.
Furthermore, it is emphasized that the second proviso to Section 16(2) of the CGST Act primarily serves as an anti-evasion measure within the law. The legislative intention behind introducing this provision was to ensure that suppliers, particularly those from the Micro, Small, and Medium Enterprises (MSME) sector, are paid in a prompt and timely manner.
Henceforth, the argument is that the language of the law and its intent do not align with the application of the second proviso to retention money situations where no obligation to pay exists. This argument seeks to clarify that the provision should be reserved for instances where there is a clear obligation to pay, as intended by the legislation, and not for cases involving retention money.
In support of above, following judgements of erstwhile laws can also relied upon which are squarely applicable in GST regime as well.
i. Anantnath Developers Vs. Commissioner of Central Tax 2018 ACR 83 CESTAT Mumbai wherein it is held that- “He also submitted that the retention of amount out of bill amount was for specific performance of contract. They are placing purchase order on their sub-contractors and take corresponding guarantee from the sub-contractors. The purchase order provides for 5% of retention of bill amount. That service tax amount is paid by them in full to the sub-contractors and only retention amount is retained. Further entire service tax was paid by the contractors to the government. Thus when service tax was paid in full, credit cannot be denied.”
ii. In Malaysian Airlines Vs. Union of India (WP 17 of 2004), failure to pay means non-payment, which means failure to pay when due. In the said case, there is a penalty imposed if amount of foreign travel tax collected is not paid to the government, within fifteen days from the date of collection. It was held that failure to pay within this prescribed time frame would mean non-payment or failure to pay. If any persons fails to pay within the statutory period, then such person is well within the sweep of the words “failure to pay’’ Once the statutory period is over and breach in payment of tax is committed, then it is immaterial when the defaulter in future is making the payment.
iii. Commissioner of Central Excise, Pune-I Vs. Thermax Engineering Construction Co. Ltd. 2017 (12) TMI 1191-CESTAT Mumbai in which it held that – As regard appeal filed by the department against dropping of demand on retention money and on Export of Service we find that though the amount against supply of services by the sub-contractors was retained by the assessee but the amount of service tax was paid in full to the supplier/vendor. The amount was retained by the assessee in terms of understanding between the assessee and their vendors and not due to non payment. The same was agreed to by both the parties.
Conclusion:
The practice of retaining money is an industry norm, aimed at ensuring project quality and timely completion. It should not be equated with a failure to pay, as it is carried out in line with contractual terms and trade practices. The debate over reversing ITC for retention money is complex and significant. Tax payers are not just resisting tax demands; they are seeking clarity on how tax rules apply in situations like this. While the debate continues, one thing is clear: as long as retaining money aligns with the contract and industry practices, it should not be viewed as a failure to pay. Legal precedents further strengthen this interpretation, making a compelling case for the non-applicability of the proviso in such scenarios.
I would love to have your thoughts on same…..!!!!!
Author Bio
