Eligibility of ITC on CSR Expenses Under GST

Eligibility of Input Tax Credit (ITC) on Corporate Social Responsibility (CSR) Expenses Under GST

1. Introduction: –

Goods & Services Tax (GST) is regarded as the most ambitious and remarkable indirect tax reform in India’s post-independence history. The GST regime is based on uninterrupted and seamless flow of Input Tax Credit (ITC) in order to mitigate the cascading effect of taxes. This is the essence of GST. However, whether the goal of seamless flow of ITC has been achieved is a question worth Million Dollars. Ever since introduction of the GST, ITC has been the most debated topic. It has gone through numerous changes over the years and is keeping on getting complex day by day. Many activities under GST are such, availability of ITC on which is not free from confusions in the absence of any clarification from Department’s end. One of such topic is Corporate Social Responsibility (CSR).

2. What is CSR? : –

Section 135(5) of The Companies Act, 2013 requires every eligible company (as per section 135(1)) to spend at least 2% of the average of net profits of immediately preceding 3 financial years towards Corporate Social Responsibilities (‘CSR’) activities.

As per rule 2(d) of The Companies (Corporate Social Responsibility Policy) Rules, 2014, as amended time to time, ‘Corporate Social Responsibility’ means the activities undertaken by a company in pursuance of its statutory obligation laid down in section 135 of the Companies Act 2013, in accordance with the provisions contained in CSR Rules 2014, but shall not inter alia include activities undertaken in pursuance of normal course of business of the company with an exception provided for companies engaged in research and development activity of new vaccine, drugs and medical devices.

Further, Schedule VII to the Companies Act 2013 specifies the activities which may be included by companies in their CSR policies which includes activities such as eradicating hunger, poverty and malnutrition, promoting health care, promoting education, promoting gender equality, training to promote rural sports, nationally recognised sports, contribution to the Prime Minister’s National Relief Fund, Contributions to public funded Universities etc.

MCA vide Circular No. 14 /2021-CSR-MCA dated 25th August 2021, has clarified that CSR expenditure can be incurred in multiple modes viz.

• ‘Activities route’, which is a direct mode wherein a company undertakes the CSR projects or programmes as per Schedule VII of the Act, either by itself or by engaging implementing agencies and
• ‘Contribution to funds route’, which allows the contributions to various funds as specified in Schedule VII of the Act.

3. CSR activities and GST: –

Companies may incur expenditure on CSR either in form of contributions or taking up ‘public welfare projects’ like construction of road, hospitals, schools or promoting education, rural sports etc. as discussed above. Unlike contribution to specified institutions, if a company follows activity route and undertakes CSR projects it would be requiring various inward supplies of goods or services in order to complete the same. These inward supplies might have levy of GST. Now an important question which could arise in this context is “whether GST paid on such CSR expenses are eligible for Input tax credit under GST?”

Before discussing eligibility of GST on CSR expenditures; let’s first try to address why does this question of availability of ITC arise at all?

ITC is available only on those expenses which are incurred in the course or furtherance of business. Let us suppose a company which is in the business of FMCG products, say HUL has built a school or hospital as a part of CSR. Now the question arises whether expenditures incurred on building a school/hospital or promoting education can be said to have been incurred in the course or furtherance of his business as no direct linkage can be established between its business and expenses incurred by it.

Further, deduction for CSR expenditure is not allowed under Income Tax Act, 1961. As per explanation 2 to sec 37(1) of the Income Tax Act 1961, “any expenditure incurred by an assessee on the activities relating to corporate social responsibility referred to section 135 of the Companies Act, 2013 shall not be deemed to be an expenditure incurred by the assessee for the purpose of business or profession”. However, “the CSR expenditure which is of the nature described in Sections 30 to 36 of the Income Tax Act, 1961 shall be allowed as deduction”.

The memorandum explaining finance (No. 2) Bill 2014 clearly provides that – “CSR expenditure, being an application of income is not incurred wholly and exclusively for the purpose of carrying on business— if such expenses are allowed as tax deduction, this would result in subsidizing of around one third of such expenses by Government by way of tax expenditure.”

On a perusal of the above, by way of deeming fiction, deduction of CSR expenses is not allowed under Income Tax Act deeming it not to be for business or profession. The Department might use the aforesaid to deny ITC on such expenses under GST Act as not being in course of or furtherance of business. Therefore it is worthwhile to delve into the same under GST regime.

For the reason mentioned supra, question relating to availability of ITC under GST arises.

Now, in order to discuss ‘eligibility of ITC on CSR Activities/expenses’ let’s recap the legal provisions relating to ITC.

4. Eligibility of ITC on CSR Expenses: –

Section 16(1) of the Central Goods and Service Tax (‘CGST Act, 2017’) prescribes the eligibility criteria for taking Input Tax Credit. It states that “Every registered person shall, subject to such conditions and restrictions as may be prescribed and in the manner specified in section 49, be entitled to take credit of input tax charged on any supply of goods or services or both to him which are used or intended to be used in the course or furtherance of his business and the said amount shall be credited to the electronic credit ledger of such person.” While the term business is defined under CGST Act, 2017 as (a) any trade, commerce, manufacture, profession, vocation, adventure, wager or any other similar activity, whether or not it is for a pecuniary benefit;(b) any activity or transaction in connection with or incidental or ancillary to sub-clause (a); the phrase “in course or furtherance of business” has not been defined in the law.

Dictionary meaning of the term “furtherance” implies advancement, promotion of scheme, etc. Therefore, furtherance of business would imply advancement or promotion of business. Any activity carried on with a purpose to achieve business objectives, business continuity and stability would per se amount to an activity in course or furtherance of business.

CSR expenses are mandated by Section 135 of the Companies Act as stated above. Failure to incur these expenses could result in punitive actions and leads to disclosure of non-compliance in board report which could be a public document leading to tarnish the image of a company and lower the brand value. Thus, CSR expenses are well needed to run business smoothly in compliance with applicable law. Therefore, CSR has a nexus with business and may be considered as business expense.

Apart from requirement of sec 16(1) of the CGST Act 2017, eligibility of ITC is further subject to satisfaction of other prescribed conditions and restrictions given u/s 17(5). The relevant provisions of sec 17(5) have been produced hereunder.

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;-

(c) works contract services when supplied for construction of an immovable property (other than plant and machinery) except where it is an input service for further supply of works contract service;

(d) goods or services or both received by a taxable person for construction of an immovable property.

Explanation – the expression “construction” includes re-construction, renovation, additions or alterations or repairs, to the extent of capitalisation, to the said immovable property

(h) goods lost, stolen, destroyed, written off or disposed of by way of gift or free samples.

In the light of above provisions, it can be understood that ITC on CSR expenses would be available only if the expenses incurred on CSR do not specifically fall under Blocked Credit as provided in Sec 17(5) of the CGST Act 2017.

Hence, in order to claim ITC of GST paid on inward supplies relating to CSR, two aspects need to be checked:

1. Whether the expenses incurred are ‘in the course or furtherance of business’?

2. Whether it is blocked u/s 17(5) of the CGST Act 2017?

(It may be noted that requirement of Sec 16(2) is procedural only and the same must be satisfied in order to claim ITC. Hence, the same has not been taken into consideration in our discussion.)

However, if we analyse memorandum explaining finance (No. 2) Bill 2014, Govt. is of the view that providing deduction for CSR under Income Tax, would result in subsidizing of around one third of such expenses. One may argue that the same view is possible in the case of GST as allowing ITC on expenses would result into subsidizing of substantial amount of such expenses. For e.g. if a company has spent Rs. 11.8 Lakh (including GST) in form of CSR and it has claimed ITC of GST paid (say 18% i.e. Rs. 1.8 Lakh) by it, effectively such expenses reduces to Rs. 10 Lakh for the company as ITC of Rs. 1.8 Lakh is an asset which can be used to set off the output tax liability. Hence, what amount should be treated as incurred on CSR in terms of sec 135(5) of The Company’s Act, i.e. Rs. 11.8 Lakh or Rs. 10 Lakh (excluding GST)? In our view, amount of Rs. 10 Lakh should be considered as incurred on CSR and GST payment of Rs. 1.8 Lakh would be available as ITC provided the same is not falling under u/s 17(5) of the CGST Act, 2017.

5. Case Laws: –

The Hon’ble CESTAT Mumbai, in the case of Essel Propack Limited vs Commissioner of CGST states that “CSR is not only a holistic approach but it has integrated the core business strategy since it addresses the wellbeing of all stake holders and not just companies’ shareholders. It enhances the reputation of company, its goodwill by creating a positive image and branding benefits that continue to exist for companies who operate CSR programmes.”

The essence of the above discussion would indicate that CSR is not a charity any

more since it has got a direct bearing on the manufacturing activity of the company.

Therefore sustainability is dependent on CSR without which companies cannot operate smoothly for a long period as they are dependent on various stake holders to conduct business in an economically, socially and environmentally sustainable manner i.e. transparent and ethical.”

The Tribunal made a finding that “If by undertaking CSR activities, a company’s image before corporate world is enhanced, the same would be covered under business activities. Since CSR was a mandatory requirement for the public sector undertakings, it has been made obligatory for the private sector as well, unless the same is to be treated as input service in respect of activities relating to business, the production and sustainability of the company itself would be at stake”. Hence, cenvat credit was allowed.

In addition, there are several case laws that help fulfil the two fold test required for corporations to avail ITC. In Commr. Of CEX, Bangalore v. Millipore India Pvt. Ltd, the Karnataka HC has held that the CSR expenses being a statutory obligation are connected with the business since its cost form part of the finished goods being manufactured by a business. The relevant text of the judgement is reproduced as under:

“… now the concept of corporate social responsibility is also relevant. It is to discharge a statutory obligation, when the employer spends money to maintain their factory premises in an eco-friendly manner, certainly, the tax paid on such services would form part of the costs of the final products. In those circumstances, the Tribunal was right in holding that the service tax paid in all these cases would fall within the input services and the assesse is entitled to the benefit thereof.”

Our Comment: As per above decisions given by the Hon’ble CESTAT Mumbai and Karnataka HC, CSR expenses may be treated as activities in the course or furtherance of business.

In order to have a complete understanding of the scenario in the current GST regime let’s refer to various Advance Rulings wherein different views have been taken.

A. ‘M/s Dwarikesh Sugar Industries Limited (UP AAR)’

In the instant case, the applicant undertakes following activities:

a) Construction of school building, additional rooms, laboratories etc.;

b) Free supply of furniture / fittings such as tables, chairs etc., to be used in the school;

c) Free supply of electrical goods for use in the school; and

d) Other expenses such as provision of goods/ services to Registered Charitable Trusts/NGO’s

Important Findings of AAR:-

a) AAR observed that the applicant is compulsorily required to undertake CSR activities in order to run its business and accordingly, it becomes an essential part of his business process as a whole. Therefore the said CSR activities are to be treated as incurred ‘in the course of business’.

b) AAR considered the decision of Hon’ble CESTAT Mumbai in the case of M/s Essel Propack Limited Commissioner of CGST, Bhiwandi E.L.T. and Hon’ble High Court anywhere under the CGST Act. However, while doing so, the GAAR did not take into consideration the context in which each legislation was enacted.

It is well settled by the Supreme Court in the case of Kohinoor Elastics (P) Ltd. v/s Commissioner of Central Excise, Indore that the context in which certain words have been used in a particular legislation might not be relevant for the purpose of interpreting it in a completely different legislation. The context in which the CGST Act was enacted was to move away from the erstwhile multifarious indirect tax regimes to a “one nation, one tax, one market”. In doing so, one of the advantages was that a lot of tax credits are now available under the GST which were not available earlier. However, GAAR completely ignored the above features of GST while pronouncing its Ruling.

C. ‘Polycab Wires Private Limited (Kerala AAR)’

In this case, the company had distributed electrical goods to the flood-affected people in Kerala in the course of its CSR activities. The AAR held that the company had distributed electrical products free of cost and thus ITC would not be available as per Section 17(5) of the KSGST and CGST Act. Thus, the provisions of section 17(5) were invoked to deny ITC on goods distributed under the obligations of the CSR activities

Held;-

It was held by the Hon’ble AAR that such transactions were in nature of gift or free supply hence, not eligible for ITC.

Our Comment: It may be noticed that UP AAR in the case of M/s Dwarikesh Sugar Industries Limited has held that Section 17(5)(h) would not be applicable on free supply of goods as a part of CSR activities. Hence, there is clear cut contradiction in the rulings given by the various AARs.

Section 17(5)(h) restricts the ITC on goods which are disposed of by way of gift. The term gift has not been defined under the GST Act. A reference to other laws as well as dictionary meaning suggests that gift means something which is given voluntarily to the recipient. It is given out of generosity and not mandatory.

Mandatory CSR expenditure is not a gift since it is done under an obligation laid down by the Companies Act. Hence, input tax credit in this case shall be eligible. Whereas voluntary (over and above the mandatory limit) CSR expenses may qualify as gift since it is not done under an obligation. It may be noted that minimum expense limit is mandated under Companies Act; however no limit is prescribed for the maximum amount to be incurred for CSR activities. Hence input tax credit in this case may not be eligible.

6. Author’s Comments:

As discussed above, being a socially responsible organisation can bolster organisation’s image and build its brand. TATA can be a perfect example of Brand value. Tata being a socially responsible organisation cultivate positive brand recognition, increase customer loyalty, and attract top-tier employees. Brand provides a competitive edge over its competitors and ultimately results in bottom line being higher. Hence, in substance CSR should be considered as a promotional expenses incurred in the course or further of business which leads to enhance the image of a company and higher the brand value.

Merely because such expenditure is not allowed under Income Tax Act by way of deeming fiction, does not ipso facto mean that credit will not be available in the GTS regime. GST registration is a self-sufficient legislation and one cannot interpret the provisions of GST based on the treatment of the same under other statute unless otherwise specifically mentioned. In fact, we may add that it required a deeming fiction to take such expenses outside the purview of business under Income tax Act, otherwise which would have been a business expenditure.

In order to find out whether CSR activities falls within the term ‘in the course or furtherance of his business’, reliance can be placed on the judgements provided by Hon’ble Karnataka HC in the case of Millipore India Pvt. Ltd vs. Commr. Of CEX, Bangalore and CESTAT Mumbai in the case of Essel Propack Limited vs Commissioner of CGST wherein it has been held that “CSR being a statutory obligation are connected with the business and it has got a direct bearing on the manufacturing activity of the company.”

Secondly, whether the said expenses fall within Blocked Credit, needs to be analysed on the case to case basis. If CSR is in the nature of such supplies which are covered under Blocked Credit such as Construction of Immovable property (School or Hospital buildings) then ITC would not be available. Otherwise, ITC would be available.

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CA ROHIT SURANA | B COM. (H), FCA, CS, IMAA CHARTER HOLDER | [email protected]