GST and Inverted Duty Structure: SC Upheld Constitutional Validity of RULE 89(5): No Refund For Accumulated ITC on Input Services
In Union of India & Ors Vs. VKC Footsteps India Pvt Ltd dated; 13th September, 2021, the Hon’ble apex court has upheld that Rule 89(5) which denies refund of unutilised ITC in respect of input services on account of inverted duty structure is constitutionally valid.
POINTS DECIDED
√ Section 54 (3) of the CGST Act, 2017 provides for claiming refund of “any unutilised input tax”. Per contra, Rule 89(5) of the CGST Rules restricts the claim of refund only to “input goods”, excluding “input services” from the purview of ITC. This is constitutionally valid.
√ There is no constitutional guarantee for right to Refund, but is purely statutory.
√ The latitude to make classification in matters of taxation by Parliament is wider than in other forms of legislation. Classification between input supplies & input services is valid & non-arbitrary.
√ Provisos in a statute have multi-faceted personalities. Where provision of a statute lacks clarity, proviso explains true meaning of the same and guide between possible constructions and give proper view of the statute.
√ Rule making powers are wide and shall include the power to make rules with retrospective effect, but not earlier than the date on which the provisions of the Act came into force. Mere absence of the words “as may be prescribed” in section 54(3) does not deprive the rule making authority to make rules.
√ Formula given under rule 89(5) is neither untoward nor ultra vires. An anomaly in a formula per se cannot invalidate a fiscal rule. inequities in a formula to be ironed out by the government in the due course and no judicial review is required.
√ Given the anomalies pointed out by the assessees herein, it is strongly urged to the GST Council to reconsider the formula, in the light of the anomalies therein, and take a policy decision regarding the same
FACTS OF THE CASE
The Civil Appeal filed by VKC Footsteps (No. 4810 of 2021) is the lead case in a batch of cases disposed by the Hon’ble apex Court through a common judgment. The common question sought to be answered in the writ petitions filed before the High Court of Gujarat and before the High Court of Madras is whether the petitioners are entitled to a refund of the entire unutilised input tax credit that each of them has accumulated on account of inverted duty structure. As a result, the registered person is unable to adjust the available input tax credit fully against the tax payable on output supplies; consequently, there is an accumulation of unutilised input tax credit. The case of the petitioners is that they are entitled to a refund of the entire unutilised input tax credit, irrespective of whether such credit accumulated on account of procurement of input goods and/or input services by paying tax at a higher rate than that paid on output supplies. On the contrary, the case of the Union of India and the Tax Department, both at the Central and State level, is that refund of unutilised input tax credit is permissible only in respect of the quantum of credit that has accumulated due to the procurement of input goods at a higher rate than that paid on output supplies, and that credit accumulation on account of procuring input services at a rate of tax higher than that paid on output supplies is impermissible. By its judgment in VKC Footsteps India Pvt. Ltd. v. Union of India dated: 24.07.2020, the Division Bench of the Gujarat High Court, held that “Explanation (a) to Rule 89(5) which denies the refund of “unutilised input tax” paid on “input services” as part of “input tax credit” accumulated on account of inverted duty structure is ultra vires the provision of Section 54(3) of the CGST Act, 2017.” Per contra, the Division Bench of the Madras High Court in Tvl. Transtonnelstory Afcons Joint Venture Vs. Union of India & Ors and in connected cases on 21.09.2020 s held that “Section 54(3)(ii) does not infringe Article 14 and refund is a statutory right and the extension of the benefit of refund only to the unutilised credit that accumulates on account of the rate of tax on input goods being higher than the rate of tax on output supplies by excluding unutilised input tax credit that accumulated on account of input services is a valid classification and a valid exercise of legislative power”. The divergent views taken by the two high courts forms the subject matter of this batch of civil appeals. One of the core issues in these appeals is interpretation of the expression “inputs” in Section 54(3)(ii) of CGST Act and the definition of “Net ITC” in the amended Rule 89(5). On civil appeals being filed by the Union of India & others.
HELD BY THE COURT
- As per Section 2 (52) the expression ‘goods’ is defined to mean every kind of movable property other than money and securities. It also includes certain other items incorporated in the inclusive part (“but includes”) of the definition. The expression ‘goods’ is broadly defined. As per Section 2(102) “services” means anything other than goods, money and securities but includes activities relating to the use of money or its conversion by cash or by any other mode, from one form, currency or denomination, to another form, currency or denomination for which a separate consideration is charged. The expression ‘services’ is thus distinguished from goods since the expression means “anything other than goods”
- the submission which has been urged on behalf of the assessees is that registered persons constitute a class within the meaning of sub-Section (3) of Section 54 and each of them is entitled to claim a refund of unutilized ITC whether its origin lies in input goods or input services. In other words, it has been urged that Section 54(3) constitutes one homogenous class of registered persons who have unutilized ITC. The fallacy of the argument is in the hypothesis that unutilized ITC cannot be unbundled for the purpose of fiscal legislation. Accumulated ITC may result due to a variety of circumstances, some of which may while others may not lie within the volition of a registered person. The class, comprising of registered persons with unutilized ITC, covers a bundle of species as opposed to one unique or homogenous specie. Once this is recognized, it is necessary to allow the legislature the latitude to distinguish between credits arising out of the input goods stream and input service stream. As on date, there is an absence of uniformity in GST rates and it is the multiplicity of rates which has given rise to an inverted duty structure. Registered persons with unutilized ITC may conceivably form one class but it is not possible to ignore that this class consists of species of different hues. Given these intrinsic complexities, the legislature has to draw the balance when it decides upon granting a refund of accumulated ITC which has remained unutilized. In doing so, Parliament while enacting sub-Section (3) of Section 54 has stipulated that no refund of unutilized ITC shall be allowed other than in the two specific situations envisaged in clauses (i) and (ii) of the first proviso. Whereas clause (i) has dealt with zero rated supplies made without the payment of tax, clause (ii), which governs domestic supplies, has envisaged a more restricted ambit where the credit has accumulated on account of the rate of tax on inputs being higher than the rate of tax on output supplies. While the CGST Act defines the expression ‘input’ in Section 2(59) by bracketing it with goods other than capital goods, it is true that the plural expression ‘inputs’ has not been specifically defined. But there is no reason why the ordinary principle of construing the plural in the same plane as the singular should not be applied. To construe ‘inputs’ so as to include both input goods and input services would do violence to the provisions of Section 54(3) and would run contrary to the terms of Explanation-I. Consequently, it is not open to the Court to accept the argument of the assessee that in the process of construing Section 54(3) contextually the court should broaden the expression ‘inputs’ to cover both goods and services.
- Provisos in a statute have multi-faceted personalities. As interpretational principles governing statutes have evolved, certain basic ideas have been recognized, while heeding to the text and context. Where the substantive provision of a statute lacks clarity, a proviso may shed light on its true meaning. If the enacting portion of a section is not clear, a proviso appended to it may give an indication as its true meaning. As stated by LORD HERSCHELL: “ Of course a proviso may be used to guide you in the selection of one or other of two possible constructions of the words to be found in the enactment, and show when there is doubt about its scope, when it may reasonably admit of doubt as to having this scope or that, which is the proper view to take of it.” Clause (ii) of the proviso to section 54(3) of the CGST Act, when it refers to “on account of” clearly intends the meaning which can ordinarily be said to imply ‘because of or due to’. When proviso (ii) refers to “rate of tax”, it indicates a clear intent that a refund would be allowed where and only if the inverted duty structure has arisen due to the rate of tax on input being higher than the rate of tax on output supplies. Reading the expression ‘input’ to cover input goods and input services would lead to recognising an entitlement to refund, beyond what was contemplated by Parliament.
- The court must be cognizant of the fact that no constitutional right is being asserted to claim a refund, as there cannot be. Refund is a matter of a statutory prescription. Parliament was within its legislative authority in determining whether refunds should be allowed of unutilised ITC tracing its origin both to input goods and input services or, as it has legislated, input goods alone. By its clear stipulation that a refund would be admissible only where the unutilised ITC has accumulated on account of the rate of tax on inputs being higher than the rate of tax on output supplies, Parliament has confined the refund in the manner which it is described above. While recognising an entitlement to refund, it is open to the legislature to define the circumstances in which a refund can be claimed. The proviso to Section 54(3) is not a condition of eligibility but a restriction which must govern the grant of refund under Section 54(3).
- The submission which has been urged on behalf of the assessees is that if Section 54(3) is construed to confine a refund of unutilised ITC only to the extent that the accumulation arises on account of the rate of tax on inputs (meaning input goods) exceeding the rate of tax on outward supplies, the principles underlying Article 14 of the Constitution would be attracted and the statutory provision would suffer from the vice of arbitrariness. The submission is that this has become an incident of a class legislation: the class consists of registered persons having unutilised ITC. The class comprises of the following species (i) domestic suppliers; and (ii) exporters. The sub-species are (i) input goods; and (ii) input services. Opposing this submission, the appellant’s submission is that this is a valid classification, denying one of the species namely input services the benefit of refund. As a matter of first principle, it is not possible to accept the premise that the guiding principles which impart a measure of flexibility to the legislature in designing appropriate classifications for the purpose of a fiscal regime should be confined only to the revenue harvesting measures of a statute. The precedents of this Court provide abundant justification for the fundamental principle that a discriminatory provision under tax legislation is not per se invalid. A cause of invalidity arises where equals are treated as unequally and unequals are treated as equals. Both under the Constitution and the CGST Act, goods and services and input goods and input services are not treated as one and the same and they are distinct species. Parliament engrafted a provision for refund, Section 54(3). In enacting such a provision, Parliament is entitled to make policy choices and adopt appropriate classifications, given the latitude which the constitutional jurisprudence allows it in matters involving tax legislation and to provide for exemptions, concessions and benefits on terms, as it considers appropriate. Parliament while enacting the provisions of Section 54(3), legislated within the fold of the GST regime to prescribe a refund. While doing so, it has confined the grant of refund in terms of the first proviso to Section 54(3) to the two categories which are governed by clauses (i) and (ii). A claim to refund is governed by statute. There is no constitutional entitlement to seek a refund. Parliament has in clause (i) of the first proviso allowed a refund of the unutilized ITC in the case of zero-rated supplies made without payment of tax. Under clause (ii) of the first proviso, Parliament has envisaged a refund of unutilized ITC, where the credit has accumulated on account of the rate of tax on inputs being higher than the rate of tax on output supplies. When there is neither a constitutional guarantee nor a statutory entitlement to refund, the submission that goods and services must necessarily be treated at par on a matter of a refund of unutilized ITC cannot be accepted. Such an interpretation, if carried to its logical conclusion would involve unforeseen consequences, circumscribing the legislative discretion of Parliament to fashion the rate of tax, concessions and exemptions. If the judiciary were to do so, it would run the risk of encroaching upon legislative choices, and on policy decisions which are the prerogative of the executive. The court is therefore unable to accept the challenge to the constitutional validity of Section 54(3).
- Rule 89(5) of the CGST Rules provides for the computation of the refund of ITC on account of an inverted duty structure. The rule, as it was originally enacted, provided for a refund of ITC paid both on input goods and input services. Rules 89(5) was amended on 18 April 2018 with prospective effect. On 13 June 2018, Rule 89(5) as amended was substituted with retrospective effect from 1 July 2017. The effect of this amendment is that refund of unutilized ITC can only be availed on input goods. Section 164 of the CGST Act empowers the Central Government to make rules for carrying out the provisions of the Act on the recommendations of the GST Council. Sub-Section (3) of Section 164 stipulates that power to make rules shall include the power to make rules with retrospective effect not earlier than the date on which the provisions of the Act came into force.
- It may be true that in certain specific statutory provisions, the Act recognizes, by using the expression ‘prescribes’, that rules may be framed for that purpose. But the converse cannot be assumed inferentially, by presuming that in other areas, recourse to the rule making power cannot be taken. By its very nature, a statutory provision may not visualize every eventuality which may arise in implementing the provisions of the Act. Hence it is open to the rule making authority to frame rules, so long as they are consistent with the provisions of the parent enactment. The rules may interstitially fill-up gaps which are unattended in the main legislation or introduce provisions for implementing the legislation. So long as the authority which frames the rules has not transgressed a provision of the statute, it cannot be deprived of its authority to exercise the rule making power. The wide powers given under Section 164 of the CGST Act are only limited by the provisions of the Act itself, in furtherance of which a rule may be framed. It is for this reason that the powers under Section 164 are not restricted to only those sections which grant specific authority to frame rules. Thus, it is found that the absence of the words “as may be prescribed” in Section 54(3) does not deprive the rule making authority to make rules for carrying out the provisions of the Act.
- Rule 89(5) in defining Net ITC to mean “input tax credit availed on inputs” does not transgress the statutory restriction which is contained in proviso (ii) of Section 54(3). The challenge to Rule 89(5) as a piece of delegated legislation on the ground that it is ultra vires Clause (ii) of the first proviso to Section 54(3) is therefore lacking in substance. As reasoned in the earlier part of this judgment, Clause (ii) of the first proviso is not merely a condition of eligibility for availing of a refund but a substantive restriction under which a refund of unutilized ITC can be availed of only when the accumulation is relatable to an inverted duty structure, namely the tax on input goods being higher than the rate of tax on output supplies. There is therefore no disharmony between Rule 89(5) on the one hand and Section 54(3) particularly Clause (ii) of its first proviso on the other hand (Para 92)
- With regard to the formula under Rule 89(5), it would be material to advert to the provisions of Rule 42. Rule 42(1) provides that the ITC in respect of input goods or input services which attract the provisions of sub-Section (1) or sub-Section (2) of Section 17. Rule 42 provides for the manner in which the attributions of ITC in respect of the input or input services under sub-Sections (1) or (2) of Section 17 shall be carried out. Rule 43 similarly provides the manner in which ITC in respect of capital goods attracting the provisions of sub-Section (1) of Section 17. Both Rules 42 and 43 provide for a formula for attribution. Rule 86 provides for the maintenance of an electronic credit ledger. Rule 89(5) provides for a refund. In both sets of rule clusters, Rules 42 and 43 on the one hand and Rule 89(5) on the other hand, a formula is used for the purpose of attribution in a post assimilated scenario. The use of such formulae is a familiar terrain in fiscal legislation including delegated legislation under parent norms and is neither untoward nor ultra vires.
- Regarding the anomalies of the formula, an anomaly per se cannot result in the invalidation of a fiscal rule which has been framed in exercise of the power of delegated legislation. Ruling in RK Garg v. UOI (1981) 4 SCC 675, underscored the importance of the rationale for viewing laws relating to economic activities with greater latitude than laws touching civil rights. The dictum in RK Garg (supra) squarely applies to the present case in which the Government has exercised its powers of delegated legislation to frame a formula, which has certain inequities. However, these inequities are to be ironed out by the Government in the course of the application of the formula. It is affirmatively viewed that this Court should not in the exercise of the power of judicial review allow itself to become a one-time arbiter of any and every anomaly of a fiscal regime despite its meeting the jurisdictional framework for the validity of the legislation, including delegated legislation
- The judicial precedents indicate that in the field of taxation, this Court has only intervened to read down or interpret a formula if the formula leads to absurd results or is unworkable. In the present case however, the formula is not ambiguous in nature or unworkable, nor is it opposed to the intent of the legislature in granting limited refund on accumulation of unutilised ITC. It is merely the case that the practical effect of the formula might result in certain inequities. The reading down of the formula would take this Court down the path of recrafting the formula and walk into the shoes of the executive or the legislature, which is impermissible. Accordingly, the court shall refrain from replacing the wisdom of the legislature or its delegate with the court’s in such a case. However, given the anomalies pointed out by the assessees, it is strongly urged to the GST Council to reconsider the formula and take a policy decision regarding the same.
- The judgment of the Madras High Court needs to be affirmed by dismissing the appeals challenging that verdict while the appeals against the judgment of the Gujarat High Court by the Union of India should be allowed. The Division Bench of the Gujarat High Court having examined the provisions of Section 54(3) and Rule 89(5) held that the latter was ultra vires. In its decision in VKC Footsteps India Pvt. Ltd. the Gujarat High Court held that by prescribing a formula in sub-Rule (5) of Rule 89 of the CGST Rules to execute refund of unutilized ITC accumulated on account of input services, the delegate of the legislature had acted contrary to the provisions of sub-Section (3) of Section 54 of the CGST Act which provides for a claim of refund of any unutilized ITC. The Gujarat High Court noted the definition of ITC in Section 2(62) and held that Rule 89(5) by restricting the refund only to input goods had acted ultra vires Section 54(3). The Division Bench of the Madras High Court on the other hand while delivering its judgment in Transtonnelstory Afcons Joint Venture declined to follow the view of the Gujarat High Court noting that the proviso to Section 54(3) and, more significantly, its implications do not appear to have been taken into consideration in VKC Footsteps India Pvt. Ltd except for a brief reference. Having considered this batch of appeals, and for the reasons which have been adduced in this judgment, the view of the Madras High Court is affirmed and the view of the Gujarat High Court is disapproved.
RESULT
Decision of Madras High Court in Tvl. Transtonnelstroy Afcons Joint Venture v. UOI – Affirmed.
Decision of Gujarat High Court in VKC Footsteps India Pvt. Ltd. v. UOI – Set aside.
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