prpri Meaning of Full Input Tax Credit in 2nd proviso to Rule 28 Meaning of Full Input Tax Credit in 2nd proviso to Rule 28

The supplies between distinct persons and related persons are subject to derogate measure, such that the transaction value is discarded at the very outset and the valuation of the supplies should be on the basis of objective rules. The first objective criteria is ‘open market value’ [Rule 28], a value not easily available, if at all available in number of situations. Fortunately, 2nd proviso to Rule 28 provide exclusion from the derogate measure stating;

Provided further that where the recipient is eligible for full input tax credit, the value declared in the invoice shall be deemed to be the open market value of the goods or services.

Qua supplier or qua supplies: Much like the other provisions in the GST law, ‘full input tax credit’ is controversial, principally because it is not clear that whether this exclusion is applicable qua recipient or qua transaction? For example, ‘A’ supplies accounting services on payment of GST to its related persons B [who makes both taxable as well as exempt supplies]. The question is if B can avail the ITC of the GST because the services are admittedly not blocked (and eligible) or if only B can avail ITC because he is not entitled to ITC on his inward supplies fully. Some of the aspects that bears relevance to the above controversy, are deduced below;

Reflections from overseas jurisdiction: The phrase ‘full ITC’, may have likely been borrowed from the Singapore GST legislation, which the same phrase in somewhat same context. The Singapore GST calls for application of compulsory reverse charge, where the taxpayer is not entitled for full ITC. The objective is to relieve, those persons who are entitled to avail ITC and application of reverse charge would merely be a compliance exercise.

Similarly, is the case with Rule 28, the 2nd proviso seeks to relieve those persons from the valuation exercise, where such exercise is ultimately revenue neutral. Similar rules, exists in number of other jurisdictions, such as Australia, Netherlands, South Africa to name a few.

Interpretation under the Singapore law: The Singapore GST law in clear stated terms defines when a person is not entitled for ‘full ITC’. And the exclusions are [1] when the person carries out non-business activities (charities) [2] the person fails the de minimis test i.e. the exempt supplies are more than 5% of the total turnover or SGD 40,000 p.m. [3] The exempted supplies are those against which the ITC is anyways eligible [for e.g. Schedule III (except land) supplies in Indian context. Accordingly, the Singapore law pegs ‘full input tax credit’ to all inward supplies of the recipient i.e. the provision is applicable qua person.

De minimis: The common law doctrine is often used in statute to exclude the immaterial things from the broad gamut, see to that effect Section 95 of the IPC. The exclusion of de minimis is well accepted in the trade remedies regulations, Rule 42 (1) (j) of the CGS Rules and 80% reverse charge condition in case of construction players are, notable application de minimis under the GST. All things said and done, it is possible that if 2nd proviso is to be seen qua recipient, then the litigants can surely find some comfort in de minimis. The obvious difficulty is that there is no codified threshold, and the tax-base would have to wait till some jurisprudence in this regard is developed.

Surrounding circumstance test: Said otherwise, it is possible to contest that, the provision is applicable on transactions to transaction basis. In the Indian context, whether a provision is qua supplier or qua transaction, the Courts apply surrounding circumstances test. The provision should be seen objectively considering the intention behind its insertion and what guidance does the surrounding circumstances give. A view made out of surrounding circumstance is adoptable, if the plain text is ambiguous [Casio India Company AIR 2016 SC 1690].

In the instant case, the principal objective is to narrow down the valuation disputes, where the position is revenue neutral. Additionally, by reversal of ITC proportionate to exempt supplies can be carved [Rule 42, Rule 43], making even the person who has common inputs to a position where he can claim credits proportionate to his taxable supplies. The scope of manipulation still exist, however, objectively, 2nd proviso is something which bears fruit, if it is applied qua transaction. On the other hand, if 2nd proviso is accepted qua supplier, it would leave a majority population out of ambit.

To complete the context, the AAAR in GKB Lens had also upheld the applicability of 2nd proviso on transaction basis, but for obvious reasons, the ruling is just are half the truth.

Other exclusions: Assuming that, 2nd proviso applies qua recipient, it would be available for the recipients who are engaged in extending loans/ deposits (earning interest) or supplying transactions covered in the Schedule III to the CGST Act, to seek coverage under 2nd proviso [see Expl 1 to Rule 42, and Expl. to Section 17 (3)].

Banks: The difficulty however would be for financial institutions and the banking companies (‘the banks’) who are availing the option under Section 17 (4) of the CGST Act. Evidently, the banks are having the exempt supplies, and therefore taking 50% of the total ITC. However, does the compliance to 50% rule, makes put them into the bracket of ‘full ITC’, is one difficult question to answer.

Logically, if the banks are anyway availing 50% of the ITC, it is likely that they are going to forgo the other 50% of the portion of the ITC charged by their suppliers, so they are in anyway demerit position to influence the price (of the supplier) in anyway given they are still entitled to half the cut. Therefore, it is implicit in Section 17 (4) that 2nd proviso benefit should be available, more particularly in the light that banks work under highly regulated environment.

Gaps in statute – tax period: Another seemingly controversial gaps in 2nd proviso is that, it fails to identify the tax period apropos full Input tax credit. Even if this clause has to be seen qua transaction, it is possible that the recipient might be in ‘full ITC position’ in one tax period and not in such position in the other tax period.

Obviously, this derogate measure cannot be apply to a person for lifetime, it is permissible for him to say that, after a certain period he has come out of the ‘non-full ITC position’ and therefore 2nd proviso benefit should be available to him going forward [Dunlop India Ltd. 1993 (13) ELT 1566 (SC)]. The logical conclusion is that the recipient should carefully watch their position (and potentially make use of it) regularly.

It is expected that the tax authorities are likely to countenance the INR 1 approach (initially adopted by some organizations), where the recipients are not in full ITC position. With increasing days, the valuation is piling up year on year and also the need for revisiting the original tax positions is also increasing.

Manish Sachdeva /

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July 2021