Issues to be faced while claiming ITC under GST Laws- Part I (INCLUDES Section 17, 18, 19, 20 & 21 of CGST Act, 2017)

1. In part – I we examined various issues related to the provisions concerning input tax credit (ITC) emanating from Sec. 16 of the CGST Act, 2017 as well as Rule 36(4) and Rule 86A of the CGST Rules, 2017. In the current and the last part – II on the topic we shall examine the issues related to the ITC provisions contained u/s 17, 18, 19, 20 and 21 of the CGST Act, 2017. Sec. 17 provides for various restrictions in the form of apportionment of credits and blocked credits. Sec. 18 provides for the availability of credit in certain special circumstances. Sec. 19 deals with ITC in case of job-work transactions. Sec. 20 and 21 deals with the provisions related to input service distribution (“ISD”). We shall deal with the issues chronologically. However, we shall also examine the interplay between various provisions at appropriate places.

Issues to be faced while claiming ITC under GST Laws- Part I

Use for other purposes

2. Sec. 17(1) of the CGST Act, 2017 provides that “where the goods or services or both are used by the registered person partly for the purpose of any business and partly for other purposes, the amount of credit shall be restricted to so much of the input tax as is attributable to the purposes of his business.” Oxford Dictionary defines the word “other” to mean “different than what has been mentioned”. Therefore the term “other purposes” would mean the actual usage of goods or services for a purpose different than for business. It may be noted that Sec. 16(1) permits ITC only if the related goods or services are used or intended to be used for the course or furtherance of business. Hence Sec. 17(1) on plain reading may appear otiose (i.e. redundant). Is that so?

3. In my opinion, Sec. 16(1) permits availment of ITC even for goods or services which are intended to be used for business. What if the given goods/services are not actually used in business? Therefore in such situations, Sec. 17(1) comes into play and restricts the ITC only up to the actual usage for business.

4. It may also be noted that Sec. 17(1) will apply only when the relevant goods or services are actually used for other purposes. The goods or services not capable of been used for business (e.g. on account of destruction, etc.) are not covered by Sec. 17(1). We shall consider the implications of such situations later when we analyse Sec. 17(5).

5. Now consider a situation wherein a body corporate permits the private use of telecom services to its employees but avails the entire ITC on such inward supplies. Can it be termed as a use for other purpose and hence invite ITC restriction u/s 17(1)? Or can it be said that allowing such use to an employee (related party) will be a supply transaction under Sec. 7(1)(c) read with Entry No. 2 of Schedule I and hence be liable for output tax? Recently Hon’ble Bombay High Court in the case of Bai Mamubai Trust Suchitra [TS-736-HC-2019(BOM)-NT] has held that the term “supply” u/s 7 requires a reciprocal enforceable obligation. Therefore if the employment contract itself permits such private use, as part of perquisite, it can be contended that allowing the use shall be a reciprocal enforceable obligation undertaken as part of the ancillary activity (in the course of business) and hence shall be a supply. Once a supply the same shall be taxable under Entry No. 2 of Schedule I even if the same is made without an express consideration. Hence Sec. 17(1) shall then be understood in the context of the non-business use made by the registered person itself which does not amount to supply in the course or furtherance of business. If such use amounts to supply, then ITC shall not be restricted.

6. Rule 42 and 43 of the CGST Rules, 2017 provides for the mechanism to determine the ITC attributable to business in situations covered u/s 17(1). Rule 42 covering ITC related to inputs and input services provides that ITC attributable exclusively to non-business use shall not be permitted. Further, in case of common ITC (e.g. non-contractual personal use of telecom services), the Rule provides that the ITC attributable to non-business use would be deemed to be 5% of such common credits. Interestingly such deeming fiction has not been provided for the common ITC concerning capital goods (e.g. mobile phone) under Rule 43.

7. Now another issue relates to Sec. 7(1)(c) of the CGST Act, 2017 read with Schedule I. Said schedule provides for certain transactions to be covered within the scope of supply even if the same is made without consideration. Entry No. 1 of the said Schedule includes permanent transfer or disposal of business assets where ITC has been availed on such assets. Therefore said entry applies on the permanent transfer or disposal and not on the use of the assets for a non-business purpose.

8. The last issue to consider is the inter-play between Sec. 17(1) and Sec. 17(5)(g) of the CGST Act, 2017. We shall discuss the same when we deal with Sec. 17(5)(g) later.

Exempt supplies

9. Although the ambit of availing ITC under GST laws is much broader than the earlier regime (see the detailed discussion in Part I), still ITC attributable to exempt supplies is not permissible. Provisions in this regard are contained u/s 17(2) & 17(3) of the CGST Act, 2017. Sec. 17(2) provides that “where the goods or services or both are used by the registered person partly for effecting taxable supplies including zero-rated supplies under this Act or under the Integrated Goods and Services Tax Act and partly for effecting exempt supplies under the said Acts, the amount of credit shall be restricted to so much of the input tax as is attributable to the said taxable supplies including zero-rated supplies.” Sec. 17(3) provides that “the value of exempt supply under sub-section (2) shall be such as may be prescribed, and shall include supplies on which the recipient is liable to pay tax on reverse charge basis, transactions in securities, sale of land and, subject to clause (b) of paragraph 5 of Schedule II, sale of building.” An Explanation has also been added to Sec. 17(3) to clarify that the expression “value of exempt supply” shall not include the value of activities or transactions specified in Schedule III, except those specified in paragraph 5 of the said Schedule.

10. Many issues will be faced by the taxpayer when one considers the above provisions in detail. Let us have a look at the same one by one.

11. Sec. 17(2) in a nutshell provides for the restrictions of ITC attributable to exempt supplies. Hence first of all it is important to understand the said term “exempt supply”.

12. The term “exempt supplies” is defined u/s 2(47) to mean “supply of any goods or services or both which attracts nil rate of tax or which may be wholly exempt from tax under section 11, or under section 6 of the Integrated Goods and Services Tax Act, and includes non-taxable supply”. Therefore broadly three kinds of supplies have been included as exempt supplies viz. supplies attracting nil rate (this would be supplies covered at nil rate in the rate notifications stipulating the applicable rates on tax); wholly exempt (this would be supplies covered in the exemption rate notification) and non-taxable supplies (alcoholic liquor for human consumption and petroleum products).

13. Now one may think that only the three kinds of supplies discussed above would be exempt supplies and thus only ITC attributable to such outward supplies will be restricted. However, Sec. 17(3) enlarges the scope by providing that the “value of exempt supplies” u/s 17(2) shall further include: (i) supplies on which the recipient is liable to pay tax on reverse charge basis (ii) transactions in securities (iii) sale of land and (iv) subject to clause (b) of paragraph 5 of Schedule II, sale of building (i.e. sale of completed buildings). Explanation to Chapter V of the CGST Rules, 2017 provides that the value of land and building shall be taken as the same as adopted for paying stamp duty. Further, the value of security shall be taken to be 1% of the sale value of such security.

14. The issue to note is that Sec. 17(3) covers even the supplies on which the recipient is liable to pay tax under reverse charge mechanism (RCM) (e.g. GTA, sponsorship, advocate, etc.). This is very unfortunate for the reason that the supplies under RCM are not exempt. Government receives the tax on such supplies from the concerned recipients. Thus to equate such supplies to exempt supplies and thereby deny the ITC to the concerned suppliers is not in line with the principles of value-added tax. Such provisions create a cascading effect of the tax. Nevertheless, unless the said provision is struck down (remote probability), one may have to live with the given cascading effect. Also an option to pay the tax under forward charge (in case of GTA services) must be explored to avoid the tax cost.

15. Another interesting issue to note is that whether the transactions referred u/s 17(3) will be exempt supplies per se? This is because all the four transactions covered u/s 17(3) (i.e. supplies under RCM, transaction in securities, sale of land and completed buildings) are not exempt supplies in the context of definition u/s 2(47). The transaction in securities, sale of land and completed buildings are as per Schedule III neither supply of goods nor supply of services. The question we asked is relevant because Sec. 17(3) seeks to include the given four transactions only for determining the “value of exempt supplies” and not deem such transactions as “exempt supplies”. Hence there is no deeming fiction u/s 17(3) to actually treat such transactions as exempt supplies. Now one would wonder as to what is the relevance of determining the “value of exempt supplies”? It may be noted that the ITC attributable to exempt supplies is to be determined following Rule 42 & 43 of the CGST Rules, 2017. Perusal of the said rules will show that the attribution of common ITC happens based on the proportion of the value of exempt supplies to total turnover for a given tax period. So it is in the given rules, for apportioning the common ITC, that the “value of exempt supplies” becomes relevant. Thus a question comes as to at what stage shall we apply the rules? Can we say that first we need to consider only Sec. 17(2) and apply the same to the given facts to see whether there are any exempt supplies (as per the normal definition u/s 2(47) which shall not include supplies under RCM, transaction in securities, sale of land and completed buildings? If the answer is in the affirmative only then we proceed to the Rules and then come back to Sec. 17(3) to include the value of transactions (supplies under RCM, transaction in securities, sale of land and completed buildings) for determining the value of exempt supplies. Accordingly, the common ITC is attributed. I would think that the said contention will have a merit in the absence of deeming fiction to categorize the given four transactions as exempt supplies per se.

16. Another issue to consider is whether the value of exempt supplies u/s 17(3) shall also include the value of transactions specified in Schedule III (apart from sale of land and completed buildings specifically included)? The answer will be negative as the provisions u/s 17(3) only seeks inclusion of sale of land and completed buildings and not all other transactions referred in Schedule III. Even an Explanation has been added to Sec. 17(3) to clarify the said aspect. Therefore the transactions like high-sea sales or drop shipment (included in Schedule III w.e.f. 01.02.2019) shall not be included in the value of exempt supplies. Hence full ITC will be allowed even if the same is attributable to high sea sales/drop shipment.

17. Another issue is whether ITC attributable to the zero-rated supplies of exempted goods/services will also be restricted? Sec. 17(1) of the CGST Act, 2017 provides that the ITC is restricted only to the extent of exempt supplies but not to the extent of zero-rated supplies. Also Sec. 16(2) of the IGST Act, 2017 provides that ITC can also be availed for the zero-rated supplies of exempted goods/services. Hence we can conclude that ITC attributable to zero-rated supplies of exempted goods/services shall not be restricted.

18. An issue will also arise concerning interest income. The registered taxpayers may have earned interest income on certain deposits/advances. Said deposits/advances could have been made as part of the business activity. Now Explanation 1 to Rule 43 inserted vide Notf no. 03/2018 – CT dt. 23.01.2018 provides that such interest income will not be considered for determining the value of exempt supplies. Hence the intent seems to be not to restrict any ITC even if the same is attributable to interest income. Further, as the said aspect has been clarified by an explanation without any amendment in the law, it can be considered to be applied retrospectively w.e.f. 01.07.2017. One more issue to consider is that the given Explanation is only limited to non-inclusion of interest come while determining the “value of exempt supplies”. As stated before the “value of exempt supplies” is relevant only for apportioning the common ITC. Therefore whether the benefit of the Explanation shall also extend to even situations where ITC is exclusively attributable to such interest income needs to be considered? It would appear that in case of interest income if the restriction is not sought to be applied to common ITC, the same cannot even be applied to the specific ITC.

19. Another issue to also consider is whether the ITC restriction shall apply to incomes in the form of a dividend? In my opinion, the dividend earned by the taxpayer is out of the activity of distributing the profits and not a consideration against any supply made by the given taxpayer. Same logic will also apply to the distribution of profits by a partnership firm. Therefore such dividend income cannot be considered as a supply and since it is not a supply it cannot be an exempt supply and hence ITC restriction shall not apply for such dividend income.

20. Now since we have examined several issues related to exempt supplies we must also examine some issues relating to the method of attributing the ITC.

21. Sec. 17(6) provides that the Government may prescribe how the credit referred to in sub-sections (1) and (2) may be attributed. Accordingly, the method of attributing the ITC is contained under Rule 42 & 43 of the CGST Rules, 2017. Said method seeks to attribute common ITC based on the proportion of turnover. Hence an issue will arise when the given method leads to an unreasonable attribution. Attribution can be said to be unreasonable when the same is not scientific. As an example attribution of ITC related to production expenses of a brewery will be more scientific if done based on the quantity produced (i.e. alcohol for industrial use (taxable) vs alcohol for human consumption (exempt)) than the value as the value will distort the picture due to higher taxes and higher margins on the alcohol for human consumption as compared to alcohol for industrial use. Similar example can also be taken for other common expenses like rent, etc. Thus in such situations can one adopt the attribution base which is different from the turnover? Courts in the pre GST era has held that the reversal of ITC before its utilization will tantamount to non-availment (see Chandrapur Magnet Wires (P) Ltd. V. CCE 1996 (8) ELT (SC); CCE VS. Bombay Dyeing & Mfg. Co. Ltd. 2007 (215) ELT 3 (SC) and CCE Vs. Ashima Dyecot Ltd. 2008 (232) ELT 580 (Guj)). Hence once the ITC has been reversed on a scientific base, it will tantamount to non-availment and once such ITC is not availed, there should not be a question of applying the formula given under Rule 42 and 43. Even the proviso to Rule 42(m) shall support the said contention. Also the attribution formula based on the area as applicable for the real estate sector w.e.f. 01.04.2019 shall also support the given contention. Therefore in my opinion attribution of ITC for exempt supplies can be done on a scientific base and need not necessarily be limited to value.

22. The last issue to consider is that for capital goods. The formula under Rule 43 assumes the useful life to be 60 months and accordingly permits full availment of ITC initially but provides for reversal throughout useful life based on the proportionate turnover of exempted supplies to total supplies. However, what is interesting is that the said Rule seeks to add the amount of ITC to be reversed to the output tax liability with interest. Hence the issue is whether interest can be imposed on such reversal when the method of availing the ITC in such a situation is given by the law itself?  It is a settled proposition that the levy of interest is a part of substantive law (see J.K. Synthetics Ltd vs Commercial Taxes Officer 1994 AIR 2393 and Indian Carbon Limited and Others v. State of Assam AIR 1997 SC 3054). Therefore I submit that in the absence of any provisions in the Act authorizing the imposition of interest in such situation, a rule seeking the addition of such interest to the liability is going beyond the provisions of the Act. Therefore such rule as far as interest is concerned may not be valid.

Banking Company or a financial institution

23. Sec. 17(4) of the CGST Act, 2017 provides that a banking company or a financial institution including a non-banking financial company, shall have the option to either claim ITC based on the attribution formula given under Rule 42/43 (i.e. in the proportion of taxable supplies to exempt supplies in the form of interest income) or to claim 50% of the eligible ITC on an ad-hoc basis. Therefore as per the second option, 50% of the eligible ITC can be claimed and hence the issue will be as to how to determine the “eligible ITC”?

24. The term “eligible ITC” has not been defined in the Act. However, perusal of Sec. 16 and 17 will reveal that the said term will not cover the entire ITC which is eligible u/s 16. The ineligible ITC u/s 17(5) will have to be excluded from the total ITC to derive the eligible ITC. Also, the second proviso to Sec. 17(4) provides that the restriction of 50% shall not apply to the tax paid on supplies made by one registered person to another registered person having the same Permanent Account Number. Thus the ITC on the stock transfers as well as cross charge can be fully availed. It may also be noted that once one of the two options for claiming ITC has been exercised, the same cannot be withdrawn during the remaining part of the financial year.

Blocked ITC

25. Sec. 17(5) of the CGST Act, 2017 provides the list of supplies in respect of which ITC is not available. Let us examine several issues emanating out of the same.

Motor Vehicles, Vessels & Aircraft

26. Sec. 17(5)(a) of the CGST Act, 2017 contains provisions of ITC restrictions related to motor vehicles , vessels & aircrafts. Pre 01.02.2019 (i.e. from 01.07.2017 to 31.01.2019), ITC for motor vehicles and other conveyances was not eligible unless the same are used in making certain taxable supplies (further supply, passenger transportation and imparting training) or the same are used for transportation of goods. Hence ITC for all kinds of motor vehicles and other conveyances (which will include a vessel, an aircraft and a vehicle) shall be blocked unless the said conveyances fall under the given exceptions.

27. W. e.f. 01.02.2019 the provisions have been amended to the effect that the ITC shall be blocked only for motor vehicles for transportation of persons having approved seating capacity of not more than 13 persons (including the driver) unless the said vehicles are used in making certain taxable supplies (further supply, passenger transportation and imparting training). Also, ITC shall be blocked for vessels and aircraft unless the same is used in making certain supplies as discussed earlier or are used for transportation of goods. Therefore one will have observed that as against a generic blockage of ITC for all types of conveyances, the blockage w.e.f. 01.02.2019 shall extend only to specific types of conveyances subject to exceptions. Therefore it can be concluded that w.e.f. 01.02.2019 ITC shall be available for all motor vehicles for transportation of persons having seating capacity exceeding 13, all kinds of motor vehicles for transportation of goods and anything which is not a motor vehicle but maybe a conveyance.

28. As seen above one of the exception wherein ITC will be permitted is that the given motor vehicle (having a capacity not exceeding 13) is used for making further supply. Hence the issue to consider is that whether such further supply must be by way of transfer of property in goods only (i.e. further sale) or whether the same will even include further supply by way of lease? The exception which permits the ITC provides that there must be further supply. Expressly the said further supply is not restricted to only by way of transfer of property in goods. Hence it can be contended that the ITC will not be restricted even if the further supply is made by way of lease of the motor vehicle. One may also refer to the AAR in the case of NARSINGH TRANSPORT 2019 (23) G.S.T.L. 495 (A.A.R. – GST) wherein the said view has been accepted.

29. This brings us to another interesting issue. Whether the said further supply by way of lease should exist for the entire useful life of the motor vehicle? In other words, what will happen to the ITC availed at the time of purchase if the lease is terminated at a future date and the vehicle is not further leased to any other customer? AAR in the case of NARSINGH TRANSPORT (supra) has held that the ITC will have to be reversed on termination of the lease agreement if the vehicle is not further leased to same or another customer. It may be noted that Sec. 17(5)(a) does not provide for the reversal of ITC in such eventuality. Whether the test for determining eligibility needs to be applied only at the time of availing the ITC or whether the same needs to be applied at all times over the useful life of the vehicle will be a crucial question? In the pre-GST era CESTAT has held that in absence of any provision in law to charge any duty of the removal of cenvatable capital goods, no duty or reversal of cenvat credit can be sought (see PEPSICO INDIA HOLDINGS (P) LTD. v. Commr. 2016 (343) E.L.T. 645 (Tri. – Del.)). It may be noted that it was only from 16.05.2005 that Rule 3(5A) was inserted in the CENVAT Credit Rules, 2004 to seek the payment on the removal of capital goods of an amount equal to CENVAT credit taken earlier after applying percentage deduction. Hence it can be contended that the test for determining the eligibility needs to be applied at the time of claiming the ITC and any subsequent reversal needs to be expressly provided by law. In the absence of a specific provision providing for the reversal of ITC, the same cannot be reversed.

30. Another issue to examine is concerning the demo vehicles used by automotive dealers and sold at a written down value after 2/3 years. Whether such supply after use at much later point in time can be considered as “further supply” (falling in the exceptions permitting ITC) and hence the automotive dealer can claim the ITC for such demo vehicles? AAR in the case of CHOWGULE INDUSTRIES PVT. LTD. 2019 (27) G.S.T.L. 272 (A.A.R. – GST) has held that ITC of demo vehicles shall be admissible. However, I think and as discussed before the test for determining the eligibility needs to be applied at the time of availing the ITC and not at the subsequent point in time. Demo vehicles at the time of purchase are not meant for further supply but are meant for use in the business for marketing. It is only after the said use that the demo vehicles are sold at discounted value. Therefore I will be reluctant to follow the AAR on this issue.

31. The last issue to consider specifically deals with the scenario before 01.02.2019. Before the amendment made u/s 17(5)(a) the ITC was blocked only for the motor vehicle and other conveyances. It is only after the amendment w.e.f. 01.02.2019 that the law specifically provides for the blockage of ITC even for the expenses related to the motor vehicles in the nature of repairs, maintenance, insurance, renting, hiring and leasing if the same are incurred for such motor vehicle whose ITC itself is blocked. In other words, after 01.02.2019 ITC for expenses related to motor vehicle for transportation of persons having a capacity not exceeding 13 persons will be blocked unless the given vehicle falls in the exception which allows ITC. The amendment would thus imply that before 01.02.2019 only ITC on purchase of motor vehicles was blocked and hence ITC for the expenses related to motor vehicles was available. However, it may be noted that ITC for rent-a-cab was expressly restricted before 01.02.2019. Hence before 01.02.2019 except rent-a-cab, ITC for other expenses related to motor vehicles was not blocked.

Food, beverages, outdoor catering etc.

32. Sec. 17(5)(b)(i) of the CGST Act, 2017 provides that ITC shall be restricted for the supply of goods or services in the form of food and beverages, outdoor catering, beauty treatment, health services, cosmetic and plastic surgery, leasing, renting or hiring of motor vehicles, vessels or aircraft referred to in clause (a) or clause (aa) except when used for the purposes specified therein, life insurance and health insurance. However, the proviso provides that ITC shall be permitted even for the given supplies if they used by a registered person for making an outward taxable supply of the same category of goods or services or both or as an element of a taxable composite or mixed supply.

33. Now the issue for consideration is whether the ITC for catering along with the renting of the premises for a single price (e.g. banquet services including food) shall be eligible or not? It may be noted that only ITC for supply of food/beverages/outdoor catering is restricted. Supply of banquet services including food is not expressly covered. Reference is invited to Notification No. 20/2019 – CT (R) dt. 30.09.2019 wherein supply of catering with the renting of premises has been identified as an independent supply attracting 5% tax rate. Thus it can be contended that ITC in such situation will be available.

34. Sec. 17(5)(b)(ii) provides that ITC shall be restricted for services of membership of a club, health and fitness centre. Also, Sec. 17(5)(b)(iii) provides that ITC shall not be eligible for travel benefits extended to employees on vacation such as leave or home travel concession.

35. Now a proviso has been inserted after sub-clause (iii) w.e.f. 01.02.2019 to provide that the ITC in respect of such goods or services or both shall be available, where an employer must provide the same to its employees under any law for the time being in force. Thus the first issue to consider is whether the said proviso is only restricted to sub-clause (iii) since it is placed below it and thus will apply only to travel benefits extended to employees or whether the said proviso will also apply to sub-clauses (i) and (ii) and hence ITC for food or outdoor catering will also be permissible if the same is obligatory for the employer to provide?

36. It is a settled proposition that a proviso carves out an exception to the main provision (Ram Narain Sons Ltd. v. Assistant Commissioner of Sales Tax AIR 1955 SC 765). Now the literal reading of the proviso covers ITC for goods as well as services. Had the intention been to restrict the said proviso only to sub-clause (iii), it should have covered only services as the ITC covered under the said sub-clause is only for the services related to travel benefits. Coverage of goods as well as services shall imply that the proviso shall apply to all the three sub-clauses u/s 17(5)(b). This is also evident from the marginal positioning of the proviso in the bare Act. It can also be observed that permitting ITC in respect of travel benefits under sub-clause (iii) and not for food and catering under sub-clause (i) in situations where providing such benefits is mandatory under laws will not be a reasonable classification and thus can be said to violate Article 14. Thus it can be contended that ITC even in respect of food and catering shall be available if the same has been procured to discharge any obligation under any of the laws.

37. The last issue to consider is whether ITC shall be restricted if some amount is recovered from the employees towards the canteen services provided by the employer as mandated under the law (Factories Act)? The issue is important for the fact that Sec. 7(1)(c) read with Entry No. 2 of Schedule I deems a supply between related persons (employer and employee are considered as related persons) as leviable to tax even if the same is made without a consideration. As discussed earlier Hon’ble Bombay High Court in the case of Bai Mamubai Trust Suchitra [TS-736-HC-2019(BOM)-NT] has held that the term “supply” u/s 7 requires a reciprocal enforceable obligation. Therefore if the employment contract itself provides for granting such services it can be contended that it can tantamount to a reciprocal enforceable obligation undertaken as part of the ancillary activity (in the course of business) and hence shall be a supply. Once a supply it will attract tax on the open market value. Also as it attracts tax @ 5% with the condition that ITC cannot be availed, even the ITC charged by the canteen contractor will become the cost. However, if such recovery is not part of the employment contract but a sharing arrangement, a view can be taken ITC will be restricted only to the extent of the recovery made since the cost of the same has not been borne by the employer. Language of the employment contract will guide the tax implications.

Construction-related ITC

38. Sec. 17(5)(c) provides that ITC for “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” shall not be eligible. Now the term “works contract” has been defined u/s 2(119) of the CGST Act, 2017 to cover many kinds of activities (building, construction, fabrication, completion, erection, installation, etc.) related to immovable property wherein transfer of property in goods is also involved. Therefore ITC related to pure services not involving any transfer of property in goods even if the same relates to immovable property shall not qualify as works contract and hence shall not be covered by Sec. 17(5)(c) (however same may be ineligible u/s 17(5)(d) which is discussed later).

39. Now only ITC concerning works contract services when supplied “for construction” is not eligible. The word “construction” has been defined to include “re-construction, renovation, additions or alterations or repairs, to the extent of capitalisation, to the said immovable property”. The issue to ponder is whether the given restriction about the works contract services applies to all immovable property or not? It may be noted that only ITC related to “construction” is ineligible. The definition of works contract u/s 2(119) includes “construction” as one of the elements. Therefore even though the word “construction” includes addition the same needs to be construed concerning buildings and civil structure. Therefore works contract services like erection, commissioning and installation of plant and machinery shall not be covered by the restriction. This is also clear from the fact that the immovable property in the nature of plant & machinery is excluded from the said restriction. Therefore we can contend that the given restriction shall not apply to movable plant and machinery. Even the same shall not apply to immovable plant and machinery by use of the word “construction” as well as the exclusion of “plant and machinery” from the scope of immovable property.

40. An issue may arise on perusal of the definition of “plant and machinery” as provided in the Explanation to Sec. 17. The term “plant and machinery” means the apparatus, equipment, and machinery fixed to earth by foundation or structural support that are “used for making outward supply of goods or services or both ….”. Hence consider a situation where ITC for the lift installed in the office building is sought to be claimed. The word “apparatus” has been defined in the case of Commissioner of Customs v. C-NET Communication (I) (P) Ltd, (2007) 12 SCC 72 to mean the compound instrument or chain of series of instruments designed to carry out a specific function or for a particular use. The word “equipment” has been defined in the case of K. Balachandran v. State of Kerala, AIR 2005 Ker 187 to mean things used in equipping or furnishing. The word “machinery” has been defined in the case of Commissioner of Income Tax v. Mir Mohammad Ali AIR 1964 SC 1693 to mean some mechanical continuances which, by themselves or in combination with one or more, other mechanical continuances, by the combined movement and inter-dependent operation of their respective parts, generate power, or evoke, modify, apply or direct natural forces with the object in each case of effecting so definite and specific a result. Therefore as far as the lift is concerned it can be contended that the same will be covered within the phrase “apparatus, equipment, and machinery fixed to earth by foundation or structural support”. Issue may, however, arise on the ground that such lift has not been “used for making outward supply of goods or services or both” as it is installed in office premises and hence has no direct nexus with the supply of manufactured goods. It can be contended that the use of the expression “construction” u/s 17(5)(c) implies that ITC concerning works contract services associated with only the building and civil structure is sought to be covered and hence the “plant and machinery” has been excluded from the scope of “immovable property”. Therefore the words “used for making outward supply” needs to be liberally construed and ITC for lifts shall be permitted by applying the test of functionality as well as commercial expediency.

41. A perusal of the definition of “construction” will reveal that ITC concerning works contract services even concerning immovable property in the nature of the building or civil structure shall be eligible if the cost of the same has not been capitalized in the books of accounts. This brings us to an interesting issue as to whether the officer under GST can question the accounting treatment of such expenditure and deny the ITC because the relevant expenditure should have been capitalized and not treated as revenue expense? The contention can be that the definition of the word “construction” does not provide that the aspect of capitalization must be to the satisfaction of the GST officer. If the accounting treatment is in accordance with the relevant standards and finds acceptance with the statutory auditor it can be submitted that the ITC cannot be denied for the expense on the works contract service related to immovable property which has not been capitalized.

42. Another issue to examine is the meaning of the term “plant and machinery”. Same has been defined in the Explanation to Sec. 17(5) to mean “apparatus, equipment, and machinery fixed to earth by foundation or structural support that are used for making outward supply of goods or services or both and includes such foundation and structural supports but excludes — (i) land, building or any other civil structures; (ii) telecommunication towers; and (iii) pipelines laid outside the factory premises.”. Therefore whether ITC concerning the works contract services used for the foundation of the plant and machinery will be eligible or not? As the definition clearly includes even the foundation or structural support for plant and machinery, ITC shall be eligible.

43. It may be noted that “telecommunication towers” and “pipelines laid outside the factory premises” have been excluded from the definition of plant and machinery. Hence the issue can be as to whether ITC related to such supplies will always be ineligible? It may again be noted that the restriction envisaged u/s 17(5)(c) is only concerning the immovable property. The aspect of whether “telecommunication towers” are immovable property or not is pending before the Hon’ble Supreme Court (Special Leave Petitions [2020(32) GSTL JI50(S.C.] & [2015(40) STR J229 (SC)] against a favourable Delhi High Court ruling in the case of Vodafone Mobile Services Ltd v. CST [2019 (27) GSTL 481 (Del)] and an adverse Bombay High Court ruling in the case of Bharti Airtel Ltd. vs. CCE, Pune –III 2014 (35) STR 865 (Bom). Even though the dispute is of the pre-GST era, the final outcome of the decision shall have a bearing also under GST to determine the eligibility of ITC. Also concerning pipelines outside the factory premises, the test of immovability will be relevant to determine whether ITC will be eligible or not.

44. Lastly, even if the ITC relates to works contract services for the construction of immovable property (except plant and machinery), ITC shall still be eligible if it is used for further supply of works contract service.

45. Now Sec. 17(5)(d) provides that ITC for “goods or services or both received by a taxable person for construction of an immovable property (other than plant or machinery) on his own account including when such goods or services or both are used in the course or furtherance of business” shall not be eligible. Therefore one may consider that Sec. 17(5)(c) is with works contract service for construction of immovable property and Sec. 17(5)(d) is concerning goods or services procured separately for the construction of immovable property except for plant and machinery. We have already discussed the issues related to plant and machinery before. Now the restriction u/s 17(5)(c) will not apply if the works contract service is used for further supply of works contract service whereas the restriction u/s 17(5)(d) has no such exclusion. Hence can the words “on his own account” appearing u/s 17(5)(d) be considered to mean that it shall exclude transactions where the goods or services are used for the construction of immovable property for further supply of such immovable property by way of works contract or otherwise? Surely the intent in allowing the ITC u/s 17(5)(c) when it is for further supply of works contract service is to avoid direct cascading effect. Hence we can on that basis contend that the words “on his own account” will not include situations where goods and services are used for the construction of immovable property to make the further supply of works contract services (i.e. supply of under-constructed units). This view will support the argument that the ITC restriction u/s 17(2) read with Sec. 17(3) concerning the sale of completed buildings by including the same in the value of exempt supplies will not become superfluous. The said restriction shall play its role for the reason that the ITC is otherwise not blocked u/s 17(5). Now if we say that the restriction u/s 17(5)(d) shall not apply if the given goods or services are used for making the further supply of works contract because the same will not be considered as “on his own account”, why should the restriction apply just because the further supply is not in the nature of works contract but the same is in the nature of renting of the immovable property. The use which is not “on his own account” cannot be divided into different silos (works contract vs. renting) and permit ITC only in the case of works contract. Also Hon’ble Orissa High Court in the case of Safari Retreats Private Limited v Chief Commissioner of CGST [W.P. (C) 20463 of 2018] read down Sec. 17(5)(d) and held that ITC shall be eligible on goods or services used for the construction of immovable property if the same is intended for giving out on rent on which GST shall also be paid. The Department has filed an SLP before the Supreme Court and the matter is sub-judice (SLP No. 37367 of 2019). Therefore an option to avail the ITC and reverse the same under protest may be considered in such situations.

Composition Tax

46. Sec. 17(5)(e) of the CGST Act, 2017 provides that ITC for the tax paid u/s 10 shall not be eligible. Even the definition of “input tax” u/s 2(62) excludes the tax paid under the composition levy. Therefore ITC of the tax paid under the composition scheme (1% or 6%) shall not be available.

Non-resident taxable person

47. Sec. 17(5)(f) of the CGST Act, 2017 provides that ITC for goods or services or both received by a non-resident taxable person except on goods imported by him shall not be eligible. A non-resident taxable person has been defined u/s 2(77) to mean any person who occasionally undertakes transactions involving the supply of goods or services or both, whether as principal or agent or in any other capacity, but who has no fixed place of business or residence in India. Therefore, the restrictions u/s 17(5)(f) allows ITC to such persons only concerning the import of goods. Hence ITC for domestic supplies as well as the import of services by such person shall not be available. This will appear to be contrary to the basic design of GST. Be as it may because of the given restriction the possibility of obtaining a regular registration by such person can be explored to avoid the GST costs. Of course, the implications under other laws (e.g. Income Tax Laws) needs to be kept in mind.

Personal consumption

48. Sec. 17(5)(g) of the CGST Act, 2017 provides that ITC for goods or services or both used for personal consumption shall not be eligible. Now Sec. 16(1) permits ITC only if the goods or services are used or intended to be used for business. Further Sec. 17(1) provides that ITC attributable to use other than business shall be restricted. And now Sec. 17(5)(g) provides that ITC concerning personal consumption shall not be eligible. Hence an issue may arise as to how to interpret such overlapping provisions? We submit that Sec. 16(1) permits availment of ITC even if the goods or services are intended for use and not actually used for business. Therefore Sec. 17(1) provides that if it is found that the goods or services are actually used for other than business the attributable ITC for such use shall be restricted. This now brings us to Sec. 17(5)(g). A careful reading of the said provision will entail that the personal use contemplated is only by the registered person who is capable of making a personal use. This is because the words personal consumption “by any employee” are missing u/s 17(5)(g) unlike Rule 2(l) and (k) under the erstwhile CENVAT Credit Rules, 2004 wherein even personal use by an employee was specifically covered. Therefore we submit that Sec. 17(5)(g) shall apply only if the registered person in question is a natural person (i.e. individual) who is capable of making a personal use. In case of body corporate, the said restriction shall not apply. However the body corporate shall be covered u/s 17(1) and ITC shall be restricted if the same is not attributable to business use.

49. Another issue to ponder is whether the ITC related to expenses appearing to be of personal nature (guest house expense) but used for business shall be restricted? It is submitted that such use will have to be considered as in the course of business if maintaining such guest house is a need of the business in peculiar facts. In such a situation, ITC shall not be restricted as it would no longer be merely for personal consumption.

Goods lost/stolen/destroyed/written off/free samples/gifts

50. Sec. 17(5)(h) of the CGST Act, 2017 provides that ITC with respect to goods lost, stolen, destroyed, written off or disposed of by way of gift or free samples shall not be eligible. Many issues shall arise while applying the said provisions to real-world scenarios. Let us understand the same one by one.

51. Issue can be whether the ITC concerning the goods lost during the production process shall be eligible or not? This is because the word “lost” is not qualified with the word “preproduction”, “during production”, “post-production”, “normal” or “abnormal”. We submit that there is a difference between the word “consumed” and the word “lost”. Goods which get consumed during the production process and may not be found to be physically present in the end product cannot be termed as the goods lost. Therefore it can be contended that ITC for goods consumed shall not be restricted.

52. Another issue to consider is whether ITC shall be restricted in case the goods are not fully destroyed? It may happen that partially damaged goods may still be in existence and maybe supplied at scrap value on payment of the applicable tax. We submit that the word “destroyed” u/s 17(5)(h) will cover only full destruction wherein no tax is realizable by the Government for such goods. Therefore in case of partial destruction, ITC shall not be restricted.

53. Also, an issue to consider is whether the word “written off” is to be considered as a separate situation inviting the restriction or the said word should be read along with “or disposed of by way of gift or free samples” and hence only the write off on account of gifts and samples will invite the ITC restriction? Said issue arises because there is no comma (,) after the word “written off”. In case of Mohd. Shabbir v. State of Maharashtra AIR 1979 SC 564 an issue came up before the Hon’ble Supreme Court concerning the construction of Sec. 27 of the Drugs and Cosmetics Act, 1940. By the said section whoever “manufactures for sale, sells, stocks or exhibits for sale or distributes” a drug without a licence was liable for punishment. In holding that mere stocking is not an offence, the Court pointed out the presence of comma (,) after “manufactures for sale” and “sells” and the absence of any comma after “stocks”. It was therefore held that only stocking for sale could amount to offence and not mere stocking. The ratio of the said decision can be applied while construing Sec. 17(5)(h) to restrict the ineligibility only when the goods are written off on account of giving the same as gifts or free samples. Therefore write off of goods due to obsolesce may not invite the given restriction.

54. Another issue to consider is whether the word “gift” will also include the goods given for promotion of business (e.g. diaries with brand logo, etc.)? The word “gift” has been understood by Hon’ble Supreme Court in the case of Sonia Bhatia v. State of UP 1981 (2) SCC 585 as something given on voluntary basis against emotional considerations (natural love and affection). Therefore it can be contended that goods given for the promotion of business are not like “gifts” and hence ITC of the same shall not be restricted. Also the given restriction is only qua the goods which are given as “gifts” and not services which might be given as “gifts” in the course or furtherance of business.

55. Another issue to consider is whether the ITC restriction u/s 17(5)(h) apply to the inputs/input services/capital goods which would have been used in/for the manufacture of goods which have been lost, stolen, destroyed, written off or disposed of by way of gift or free samples? The words “in respect of” has been interpreted as “on” in the context of taxing statute by Hon’ble Supreme Court in the case of State of Madras v. M/s. Swastik Tobacco Factory [AIR-1966-SC-1000]. Also wherever the Statute wanted to restrict ITC concerning inputs/services which goes into something it has been provided specifically (e.g. goods/services used for the construction of immovable property u/s 17(5)(d)). Even the method of attributing the ITC in respect of inputs/input services/capital goods to the goods which have been lost, stolen, destroyed, written off or disposed of by way of gift or free samples has not been provided by the Statute. Hence it can be contended that the restriction u/s 17(5)(h) shall apply only to those goods which have been as such lost, stolen, destroyed, written off or disposed of by way of gift or free samples.

56. Another issue to consider is whether the goods given under various sales promotion schemes (e.g. 1 + 1) will invite ITC restrictions or not? We submit that the supply under such schemes is contractual and hence the same cannot be termed as “gifts” per se. Therefore ITC shall not be restricted in such a situation. Circular No. 92/11/2019 dated 07.03.2019 concurs with the said view.

57. The last issue to consider is whether ITC related to CSR expenses shall be restricted under the said provisions or not? It is submitted that CSR expenses incurred as an obligation under any law cannot be considered as gifts. Therefore the ITC concerning such expenses shall be permitted. One may also refer to the ruling under the erstwhile regime in the case of

Essel Propack v. Commissioner [2018-TIOL-3257-CESTAT-Mumbai] for further support wherein CENVAT credit has been allowed even in the situation where incurring such expense was not mandatory under law.

Tax paid u/s 74, 129 and 130

58. Sec. 17(5)(i) of the CGST Act, 2017 provides that ITC for any tax paid under the provisions of sections 74, 129 and 130 shall not be eligible. An issue therefore to consider is whether the registered supplier who has paid the output tax u/s 129 on the detention of the goods for securing the release of the same shall again be required to pay the tax while filing the return? It may be noted that restriction u/s 17(5)(i) is only concerning the ITC and not the output tax. Hence it can be contended that the payment of output tax by the given supplier shall be considered as a valid discharge of the liability and hence he shall not be required to make the payment again. The restriction u/s 17(5)(i) if at all can apply only for the recipient in such situation who may intend to avail the ITC of the tax discharged by his supplier u/s 129.

Availability of credit in special circumstances

59. Sec. 18(1) of the CGST Act, 2017 provides for taking the ITC in certain special circumstances even if the concerned person otherwise would not have been eligible to take the same as per the normal provisions contained u/s 16. Situations covered are as under:

Provision Situation
Sec. 18(1)(a) A person who has applied for registration within thirty days from the date on which he becomes liable to registration shall be entitled to take ITC respect of inputs held in stock and inputs contained in semi-finished or finished goods held in stock on the day immediately preceding the date from which he becomes liable to pay tax.
Sec. 18(1)(b) A person obtaining voluntary registration u/s 25(3) shall be entitled to take ITC respect of inputs held in stock and inputs contained in semi-finished or finished goods held in stock on the day immediately preceding the actual date of the grant of registration.
Sec. 18(1)(c) A registered person ceasing to pay the tax under the composition scheme shall be entitled to take ITC in respect of inputs held in stock, inputs contained in semi-finished or finished goods held in stock and on capital goods on the day immediately preceding the date from which he becomes liable to pay tax under normal provisions. However, ITC on capital goods shall be reduced by such percentage points as may be prescribed (5% per quarter or part thereof).
Sec. 18(1)(d) Where an exempt supply becomes taxable, the registered person shall be entitled to take ITC in respect of inputs held in stock and inputs contained in semi-finished or finished goods held in stock relatable to such exempt supply and on capital goods exclusively used for such exempt supply on the day immediately preceding the date from which such supply becomes taxable. However, ITC on capital goods shall be reduced by such percentage points as may be prescribed (5% per quarter or part thereof).

60. Sec. 18(2) provides that a registered person shall not be entitled to take the ITC in all the above-given situations in respect of any supply of goods or services or both to him after the expiry of one year from the date of issue of tax invoice relating to such supply. An issue shall, therefore, arise in case of ITC in respect of capital goods which is permissible u/s 18(1)(c)/(d) supra. Can Sec. 18(2) restrict the ITC for past invoices issued beyond the time limit of one year in case of capital goods when Sec. 18(1)(c)/(d) specifically permits the same after reducing the same @ 5% per quarter for the past period which may run beyond the given one year? Language will suggest that the one-year time limit shall also apply to capital goods. Manner for claiming the ITC has been prescribed under Rule 40 of the CGST Rules, 2017.

61. Sec. 18(3) provides that where there is a change in the constitution of a registered person on account of the sale, merger, demerger, amalgamation, lease or transfer of the business with the specific provisions for transfer of liabilities, the said registered person shall be allowed to transfer the ITC which remains unutilised in his electronic credit ledger to such sold, merged, demerged, amalgamated, leased or transferred business in such manner as may be prescribed. The manner for the same has been prescribed under Rule 41 of the CGST Rules, 2017.

62. Sec. 18(4) deals with situation wherein a registered person is required to pay an amount for the ITC availed earlier on the inputs held in stock and inputs contained in semi-finished or finished goods held in stock and on capital goods (subject to adjustment of 5% per quarter or part thereof) on the date of opting for the composition scheme from the regular scheme. Sec. 18(6) is in the context of the supply of capital goods or plant and machinery, on which input tax credit has been taken in the past. Said provisions are not discussed at length as the focus of the present article is on the issues related to claiming the ITC.

Job-work

63. Sec. 19 of the CGST Act, 2017 contains provisions related to taking of the ITC in respect of inputs or capital goods sent for job work. Sec. 19(2) as well as Sec. 19(5) provides that the principal can take the ITC even if the inputs/capital goods respectively are directly sent to a job worker for job work without being first brought to his place of business. Aspects related to inputs/capital goods not received back within the stipulated time are not discussed as the same is beyond the subject of the present article as it only deals with the issues related to claiming the ITC.

Input Service Distributor

64. Sec. 20 and 21 of the CGST Act, 2017 contains provisions related to input service distributor (ISD). ISD is defined u/s 2(61) to mean an office of the supplier of goods or services or both which receives tax invoices issued under section 31 towards the receipt of input services and issues a prescribed document for the purposes of distributing the credit of central tax, State tax, integrated tax or Union territory tax paid on the said services to a supplier of taxable goods or services or both having the same Permanent Account Number as that of the said office. Therefore the concept of ISD shall entail only distribution of ITC for services and will not include ITC concerning goods. As the present article is on the topic of claiming the ITC we shall not go into the aspect of whether the distribution of ITC via ISD is mandatory or not and whether cross-charge can suffice in place of ISD.

65. An issue however to consider is whether ISD is also required to even distribute ineligible ITC or not? In the erstwhile regime only eligible CENVAT credit was required to be distributed by the ISD. A perusal of Rule 39(1)(b) of the CGST Rules, 2017 will show that the ISD shall separately distribute even ineligible ITC. The reasoning seems to be that as ISD is only a pass-through registration, even ineligible ITC should reach the place of consumption so that the proportionate concerned revenue accrues to the appropriate State.

66. The last issue to consider is whether it can be said that the ISD avails ITC and hence shall be liable for adjudication and recovery if ineligible ITC is availed? Perusal of the definition of ISD as well as provisions u/s 20 will show that ISD merely “distributes” the ITC and does not avail the same. Also as discussed above ISD is even required to distribute ineligible ITC. Hence it can be contended that ISD cannot be said to have availed any ITC and hence no consequences can fall on the same. Consequences, if any, can only fall on the units who avail the ITC which is distributed by the ISD.

Conclusion

67. Adam Smith known as the father of modern economics in his magnum opus ‘The Wealth of Nations’ has propounded certain canons of taxation which if applied can lead to an equal and a prosperous State. One of the most important canons is of certainty. Said canon not only helps the taxpayer but also the Government in planning for the finances. Deliberations and discussions under Part – I as well as current Part – II shows that the provisions related to ITC are laden with many uncertainties. It is hoped that the resolution of the same by an appropriate forum at the earliest will lead to certainty. And for a businessman certainty is certainly the security when it comes to the matters of taxation.”

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2 Comments

  1. B C BHAT says:

    Excellent article and gives full information. Pl clarify
    1. Whether we have to pay IGST if the exports proceeds not received from the foreign customer?
    2. Whether IGST under RCM has to pay for Foreign Bank commission for Export proceeds.
    Your valued opinion is requested pl.

  2. mukesh says:

    Hats off to your patience for such an analytical article ~ I feel even the of Gst law makers are not aware of this analysis. ~ By reading the article we learn that GST is surely not a Simple and Good Tax but leaves many questions unanswered and hanging. Clarifications are far off dreams and business will have to live with this. Moreover Sir i feel the law has really been complicated and needs to be really and truly simplified, to really become GOOD & SIMPLE TAX. At present it is GST = God Save Tax Payer. ~

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