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Does services stick to capital goods or they continue to remain as a separate specie.

Necessity to know whether services stick to capital goods or not, stems from the difference in input tax credit treatment under GST. Most apparent difference in treatment of input tax credit is in respect of manner of determination of input tax credit. While input services are governed by Rule 42 requiring provisional determination at time of availment and final determination at end of financial year; Rule 43 governs capital goods requiring determination on monthly basis over a period of five years from the date of invoice of capital goods.

ITC treatment is analyzed in two segments below:

Segment – A:  Services bundled (naturally) to Capital Goods

In respect of ancillary supply of services received with principal supply of goods (capital) in a composite supply, it can be said that ancillary input services will follow the tax treatment applicable to principal supply of capital goods based on the following:

As per section 8 of CGST Act, 2017:

The tax liability on a composite or a mixed supply shall be determined in the following manner, namely: —

(a) a composite supply comprising two or more supplies, one of which is a principal supply, shall be treated as a supply of such principal supply

As this section determines the tax liability, it is evident that as regards the supplier, there is supply of capital goods and associated services has been merged with the capital goods. In otherwords, services have stuck to the goods qua supplier, but it is necessary to know, whether the same is true qua recipient as ITC is all about recipient.

Definition of capital goods hints that the same can hold true for the recipient too,

(19) “capital goods” means goods, the value of which is capitalised in the books of account of the person claiming the input tax credit and which are used or intended to be used in the course or furtherance of business;

As the value of associated services would be capitalized by recipient along with the capital goods, it would be appropriate for recipient to accord similar treatment for input tax credit for the services as it has been done for the principal supply of goods.

Segment – B: Associated Services but received Separately:

To understand the tax treatment of these input service associated to capital goods, it would be beneficial to run through the policies prevailing in erstwhile taxation era to GST era.

I. Pre-GST era:

Cenvat Credit Rules (CCR) 2004 integrated input tax credit of Excise Duty and Service Tax and permitted cross utilisation of service tax & excise duty. CCR categorized inputs, input services and capital goods separately, similar to the scheme under GST.

While cenvat credit of capital goods were to be availed in two instalments, there was no such restriction on input services associated with capital goods, credit of such input services can be availed in entirety.

 – Services gets consumed and cannot be reused: –

CBEC (now CBIC) was of the stern view that services get consumed and do not attach to the goods to which it associates.  At various occasions, objections were raised by CAG audit in the context of reversal of cenvat credit under Rule 3(5) of CCR in respect of ‘as such’ removal of inputs or capital goods.  The Board took a consistent view that services are consumed and cannot be reused, therefore reversal of cenvat credit on input services while removing inputs or capital goods ‘as such’ does not arise.

CAG highlighted the absence of provisions of reversal of input services in relation to ‘as such’ movements in paragraph 2.7 of its audit report on Central Excise Administration in Automotive Sector.

Tariff Conference of Central Excise dealt with his issue and decided as under:

The conference noted that Rule 3(5) of the CENVAT Credit Rules, 2004 does not provide for reversal in respect of input services for a reason. Input services are consumed once the inputs and capital goods are received in the factory. Thus on receipt of inputs and capital goods, the associated input services have to be considered as consumed within the factory and become a cost to the business. Demand for reversal of the input services credit, when such input services cannot be reused unlike inputs and capital goods which are available for reuse would not be fair to the trade. Therefore, the conference concluded that the present rule represents the correct provision in accordance with the principles of input tax credit. Rule 3(5) of the Cenvat Credit Rules, 2004, does not need any amendment. Audit para may be replied accordingly.

(Para B-26 of CBEC instruction in F.No.96/85/2015-C.X. I. dated 07.12.2015)

This supports the view that services can be treated as consumed and credit gets finally determined in the year of it’s availment itself.

There is also an aberration to this consistent stand of the Board. Under Rule 3(5C) of CCR in  case of remission under Rule 21 of CER,2002 – cenvat credit on input services was also required to be reversed was introduced by an amendment through Notification no.1/2014-C.E.(N.T.) dated 08.01.2014.

However considering the fact that report and conference were recent & subsequent, there is ample reason to treat the input services relating to capital goods separately, as this was how the Revenue and Government have always looked upon it.

II. Transition phase

It will not be out of place to mention that transitional credit provisions in  Model GST law – section 169 enabled credit of eligible duties and taxes in respect of inputs held in stock and inputs contained in semi-finished goods or finished goods held in stock on the appointed day.

While Trade and Industry sought guidance on determination of service tax (taxes) attributable to inputs, inputs contained in semi-finished/finished goods in the stock, law makers took note of the point that this is in digression from their earlier understanding and tweaked, rather curbed the benefit to only duties and it resulted in current section 140(3) of CGST Act, 2017.

This clearly shows that GST law also views that services do not stick to the inputs and capital goods.

III. GST era

Last but not the least, the definition of capital goods emphasizes that it is only goods,

(19) “capital goods” means goods, the value of which is capitalised in the books of account of the person claiming the input tax credit and which are used or intended to be used in the course or furtherance of business;

Therefore, the associated services cannot be construed as capital goods, unless they as a part of composite supply becomes supply of goods (Discussed in Segment-A)

Cenvat Credit vs ITC under GST

It’s all fine in erstwhile law to treat the associated service separately, as it hardly contained any goods with it (Capital goods were also very restrictive in CCR), whereas we now have Schedule -II of CGST which specifies certain supply of goods as services. That being the case, whether it would be appropriate to consider them as services ignoring the goods embedded?

Composite supply of works contract is treated as service and there are also other instances under Schedule-II, where goods are treated as services.

It may be argued that works contract in GST is confined to immovable property, which is already restricted for ITC under section 17(5), hence it does not make any difference. It needs to be noted that plant and machinery has been culled out of the said restriction, hence treating the  goods embedded in this works contract as a supply of service would result in different determination of input tax credit.

Law is aware of the same and has addressed this aspect through an Explanation in Chapter V – Input Tax Credit of CGST Rules, 2017 as under:

Explanation. – For the purposes of this Chapter,- 

(1)  the expressions “capital goods” shall include “plant and machinery” as defined in the Explanation to section 17; 

Rule 42 & Rule 43 falls under this chapter and the expression capital goods appearing thereunder, will include plant and machinery. Through the above explanation, it is ensured that works contract, though a supply of service, if it results in plant and machinery, the same is treated as capital goods as regards ITC treatment.


Except for certain specified cases, it would be just to treat the input services associated to capital goods separately and determine input tax credit in terms of Rule 42 of CGST Rules,2017.

Services don’t stick!!


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July 2024