Is Power to Make Rules for Carrying out the provisions can also be used to carrying cut the same: In a Judgement of Gujarat HC

Whether sub-rule (5) to Rule 89 is ultra vires to Section 54(3) and proviso (ii) thereto?

In the case of VKC FOOTSTEPS INDIA PVT. LTD. Versus UNION OF INDIA & 2 other(s), Hon’ble Gujarat High Court has analyzed the controversy as to whether Rule 89(5) of the CGST Rules, 2017 is ultra vires or not. The supplies made to/by petitioner falls under the motif of ‘inverted duty structure’, which is well-versed in jurisprudence. In the GST regime, section 54 of the CGST Act is the one which dealt with ‘Refunds’, and its sub-section (3) along with proviso specifically deals with refunds in case of ‘inverted duty structure’. The provisions of amended sub-rule (5) of Rule 89 prescribes a revised ‘formula’ for determining the amount of refund, on account of ‘inverted duty structure’ which is as follows:

Maximum Refund Amount = {(Turnover of inverted rated supply of goods and services) x Net ITC ÷ Adjusted Total Turnover} – tax payable on such inverted rated supply of goods and services.

Explanation: – For the purposes of this sub-rule, the expressions –

a) “Net ITC” shall mean input tax credit availed on inputs during the relevant period other than the input tax credit availed for which refund is claimed under sub-rules (4A) or (4B) or both;

The whole fight is on the meaning of the term “Net ITC” provided in the explanation to the sub-rule which does not include ‘input tax credit on input services’ but only on inputs. Accordingly, the petitioner has prayed to allow it the refund of the input tax credit in respect of both ‘input and input services’ as it is its fundamental right, even as per the Constitution. Now, let us interpret the complete story, step-by-step, in a more indebt manner.

What is ‘Inverted Duty Structure’ (IDS)? and why it occurs?

  • Where the input tax credit is get accumulated in the e-credit ledger on the account of the tax rate on inputs being higher than the tax rate on output supplies, then such a situation has been referred to as an inverted duty structure.

Credit Ledger

  • Let’s create a scenario to understand IDS:

VKC Footsteps are engaged in the business of manufacture and supply of footwear which attracts Goods and Service Tax (for short the “GST”) at the rate of 5%. It procures input services such as job work service, goods transport agency service, etc. and inputs such as synthetic leather, PU Polyol, etc., on payment of applicable GST for use in the course of business and avails input tax credit of the GST paid thereon.

The majority of the inputs and input services attract GST at the rate of 12% or 18%. Thus, the GST rate paid by the Petitioner on procurement of input is higher than the rate of tax payable on their outward supply of footwear. Therefore, despite the utilization of credit for payment of GST on outward supply, there is an accumulation of unutilized credit in electronic credit ledger.

  • It occurs when the Government in public interest impose a lower rate of tax on products like fertilizer, tractors, low-priced footwear, etc. from time to time. It is only on account of prevalent rates that some industries would face an inverted duty structure while others do not.

How Inverted Duty Structure affects the free flow of the taxation system?

“The fundamental feature of any indirect tax regime is the ‘effective taxation’ of the goods/services takes place at the stage of supply to the final consumer only and all taxes paid at the anterior stages should be fully absorbed in the tax on outward supply.”

The fundamental principle of GST laws worldwide is that it is a multi-stage tax. Each point in a supply chain is potentially taxed. However, suppliers do not bear the burden of the tax since the suppliers are allowed to take credit of the tax paid on anterior supplies received by them. This feature of GST leads to its description as being a tax on value addition, with the final consumer alone ultimately bearing the tax.

In such a system, at any stage before final sell, if the credit is not allowed to the business, then it will become part of the cost and will lead to cascading effects. For instance, A tractor attracts a GST rate of 12%. ‘D’, a supplier of tractors will supply the tractor at Rs.300 (value of supply) + Rs.36 (amount of GST at 12% on Rs.300) to the ultimate consumer. ‘D’, the supplier of the tractor would have availed input tax credit of Rs.56 (tax paid to ‘B’, the supplier of the vehicle body). This input tax credit would be used to pay GST on tractors of Rs.36. It was submitted that in such a case, there will be an accumulation of input tax credit of Rs.20 (Rs.56 -36) to C.

It is the case of ‘inverted duty structure’, as the rate of GST on inward supplies i.e. tractor body is higher (being 28%) then the rate of GST on outward supplies of tractors (being 12%) results in cascading effect of taxes in the form of unabsorbed excess tax on inputs with a consequent increase in the cost of the product which is against the very tenet of GST being consumption tax (namely, only tax in the entire chain is the tax charged to end customer and in the entire supply chain there should not be any sticking or unabsorbed input tax credit).

What is the solution in the case of an Inverted Duty Structure?

In order to mitigate this anomaly, a mature GST law provides for a “refund” of the accumulated unutilized excess input tax credit. Such refund would ensure that anomalies in the tax rate which do not lead to distortions to the fundamental features of GST and GST remain a true consumption tax.

“Refund” of accumulated unutilized credit can alone achieve the object of ‘effective taxation’ only at the stage of supply to the final consumer. Thus, the supplier gets free from any kind of tax burden and the fundamental objective of the indirect tax regime, i.e. tax ONLY on the value addition can easily be carried along.

First Discussion Paper on GST in India by the Empowered Committee of State Finance Ministry published on 10.11.2009 had acknowledged the problem of accumulation of input tax credit on account of rate of input tax being higher than output tax and suggested that refund be provided of the accumulated input tax credit.

Is there any such provision for ‘Refund’ under GST Law?

  • Sub-section 3 of Section 54 of the Central Goods and Service Tax Act, 2017 (for short “CGST Act”) is inspired by this principle as it provides for refund of ‘any unutilized input tax credit’ of any tax period in the following cases: –

(i) zero-rated supplies made without payment of tax.

(ii) where the credit has accumulated on account of the rate of tax on inputs being higher than the rate of tax on output supplies.

Section 54(3) (ii) of the CGST Act lays down the eligibility criteria for the grant of refund, on account of the inverted duty structure or condition precedent. The criterion being, that the ‘rate of tax on inputs being higher than the rate of tax on output supplies’. Thus, as per these provisions, it provides the circumstance under which the refund of unutilized credit will be granted.

  • Circular No. 79/53/2018-GST dated 31.12.2018 provides example at para 4(b) which is informative,
    • if, the rate of GST on some inputs is higher than the rate of GST applicable on the output supply, while the rate of GST on some other inputs is lower than the rate of GST applicable on the said output supply, then that is a situation of inverted duty structure governed by Section 54(3) of the CGST Act,
    • if, assessee supplies goods and none of which involve inverted duty structure, it is not entitled to any refund of the unutilized input tax credit,
    • if, assessee supplies goods involving only inverted duty structure, then entire unutilized credit is refundable to it and
    • if, an assessee is engaged in making two supplies, one involving inverted duty structure and other not involving inverted duty structure, then it is not entitled to refund for the second category of supplies and eligible for a refund only for the first category of supplies.

Meaning of the terms ‘input’, ‘input services’, ‘input tax’, and ‘input tax credit’.

‘Input’ is defined under section 2(59) of the CGST Act, 2017 means any goods other than capital goods used or intended to be used by a supplier in the course or furtherance of business.

‘Input Service’ is defined under section 2(60) of the CGST Act, 2017 means any service used or intended to be used by a supplier in the course or furtherance of business.

‘Input Tax’ is defined under section 2(62) of the CGST Act, 2017 means the tax charged on any supply of goods or services or both made to any registered person.

‘Input Tax Credit’ is defined under section 2(63) of the CGST Act, 2017 means the credit of input tax.

From where the meaning of a ‘term’ is derived in a law?

It is well settled that when an expression employed in the body of the Act is defined in the Act, that definition will apply whenever the expression is employed in the body of the Act, therefore, the expression ‘input tax credit’ appearing in main Section 54(3) would include both i.e., credit on inputs and input services as well.

Whether section 54(3) can get governed by any rule?

There is no reference/or provision in entire Section 54(3) enabling the Central Government/ Executive to frame/enact Rule in this regard. This is unlike numerous other sections in the CGST Act, which expressly employ the word “prescribed”Ǥ For example, Section 9 provides that tax is to be collected may be prescribed, Section 16(1) provides that conditions and restrictions for availing input tax credit may be prescribed, Section 31(2) provides that the time within which a person supplying taxable service shall issue invoice may be prescribed.

In other words, in the context of Section 54(3), any exercise of any power by the Rulemaking authority to frame Rule in this regard is entirely unnecessary and unwarranted.

What is the rationale behind the introduction of Rule 89(5)?

The chief reason for the introduction of Rule 89(5) is that if an assessee has output supplies having inverted duty structure and also has output supplies not having inverted duty structure, the refund is to be given only for the former supplies and refund is not to be given for latter supplies and the proportionate formula is provided to confine refund to inverted duty structure supplies only with no refund for other (i.e. non-inverted duty) outward supplies.

“(5) In the case of refund on account of inverted duty structure, refund of input tax credit shall be granted as per the following formula:

Maximum Refund Amount = {(Turnover of inverted rated supply of goods and services) x Net ITC ÷ Adjusted Total Turnover}- tax payable on such inverted rated supply of goods and services.

Explanation: For the purposes of this sub-rule, the expressions –

(a) Net ITC shall mean input tax credit availed on inputs during the relevant period other than the input tax credit availed for which refund is claimed under sub-rules (4A) or (4B) or both;

Estimating refund attributable/relatable to inverted duty structure supplies by adopting proportionate turn over basis formula is the sole and only purpose for enabling Rule 89(5).

If a provision exists for ‘Refund’, then what is the ‘Issue’?

  • As we have already discussed above that VKC procures input and input services both to use them in the course of its business and thus eligible for an input tax credit of taxes paid It means that the accumulated unutilized credit comprises of the credit of input and input services both and therefore the refund of both (accumulated unutilized credit of input and input services) is required to be allowed in the solution to the above problem.
  • Issue: The provision of Rule 89(5) of the CGST Rules, 2017 as originally introduced was substituted vide Notification No. 21 /2018-CT dated 18.4.2018 prescribing a revised formula for determining the refund on account of inverted duty structure which was given retrospective effect from 1.7.2017 vide Notification No. 26/201 8-CT dated 13.6.2018.

The substituted Rule 89(5) in the garb of fixing formula for determining pro-rata amount of credit relatable to inverted duty structure turnover vis-a-vis total turnover, has restricted the refund to an input tax credit on inputs and denying input tax credit on input services by defining ‘Net ITC’ to mean input tax credit availed on inputs only which consequently ignores/overlooks input tax credit relatable to input services.

Thus, in the case of VKC, a refund of the accumulated input tax credit of tax paid on inputs such as synthetic leather, PU Polyol, etc. is only allowed whereas refund of accumulated credit of tax paid on procurement of input services such as job work service, goods transport agency service, etc. is being denied.

Whether sub-rule (5) to Rule 89 is ultra vires to Section 54(3) and proviso (ii) thereto?

  • It was submitted by the petitioner that excluding refunds on input services in the formula prescribed in Rule 89(5) is plainly contrary to main Section 54(3) and proviso (ii) thereto and therefore to this extent Rule 89(5) is ultra vires.
  • Is Input Tax Credit means only the credit of ‘Inputs’?

ITC means the credit of input tax and input tax means the tax charged on any supply of goods or services or both made to any registered person.

Whereas the word “input” is defined in Section 2(59) means any goods other than capital goods and “input service” as per Section 2(60) means any service used or intended to be used by a supplier.

Thus “input” and “input service” are both part of the “input tax” and “input tax credit”Ǥ

  • Moreover, explanation (a) to Section 54 defines refund’ to include “refund of the unutilised input tax credit as provided under subsection (3)”. ‘Input tax credit’ and ‘input tax’ is defined under section 2(63) and 2(62) – please refer the same above, and therefore, Explanation (a) to Rule 89(5) has narrowed down Section 54(3) by employing the expression “input tax credit availed on inputs. Thus rule 89(5) has the effect of granting refund only on inputs and not on input services hence, its ultra vires Section 54(3).
  • The use of the word “ANY”: It is well-settled law that Rule made by the executive cannot curtail or whittle down the provisions of the Act. Explanation (a) to Rule 89(5) also whittles down the effect of the word “any” in the phrase ‘any unutilized input tax credit’ employed in Section 54(3) as the word ‘any’ would obviously mean “all” input tax credit including input services.

In the case of Shri Balaganesan Metals v. M.N. Shanmugham Chetty reported in (1987) 2 SCC 707, Hon’ble Supreme Court analyzed the meaning of the word “any” as:

Word “any” has a diversity of meaning and may be employed to indicate “all” or “every” as well as “some” or “one” and its meaning in a given statute depends upon the context and the subject matter of the statute.

It is often synonymous with “either”, “every” or “all”. Its generality may be restricted by context; (Black’s Law Dictionary; Fifth Edition).

  • Thus, what is to be refunded is “unutilized input tax credit and is so stated in main Section 54(3) itself. Therefore, Rule 89(5) is ultra vires to that extent.

Power to make rules under section 164(1) for carrying out the provisions of this Act, can also be used to restricts the provisions of the Act?

Section 164(1) of the CGST Act confers a general rulemaking power on the Government as under:

“164. (1) The Government may, on the recommendation of the Council, by notification, make rules for carrying out the provisions of this Act.”

Thus, the government can make rules only for the purpose of carrying out the provisions of the Act whereas Rule 89(5) restricts the refund to an input tax credit on inputs alone and denies in respect of input services, therefore, such a rule is not for the purpose of carrying out the provisions of the Act but for the purpose of restricting the provision of the Act namely section 54(3) which provides a credit of any unutilized input tax credit and as such explanation (a) to the Rule 89(5) cannot be sustained even under the general rulemaking power conferred by Section 164(1).

Is Rule 89(5) is also violative of Article 14 of the Constitution of India?

  • There is absolutely no rationale for allowing refund of the unutilised input tax credit in respect of tax paid on inputs but not unutilized input tax credit in respect of tax paid on input services.
  • It is also discriminatory since a refund of the unutilised input tax credit in respect of tax paid on input services is permitted in the case of zero-rated supplies (exports or supplies to SEZs). No intelligible differentia which has a rational nexus to the object sought to the achieved is perceptible.
  • Those industries which face an inverted duty structure and whose input services are taxed at a higher rate than the tax on their outward supplies are not entitled to refund of unutilized input tax credit (which remains unutilized not on account of any action or inaction of the industry but on account of the rate structure set by the Government) while those industries which do not face an inverted duty structure are not met with losing any
    part of their input tax credit.
  • Those industries which are engaged in making outward supplies wholly using inputs would get a full refund of unutilized input tax credit while putting at a disadvantage those industries which substantially use input services for making outward supplies.
  • If a manufacturer gets any part of his manufacturing done on a job work basis, tax paid on job work charges would be treated a tax on input services which would not be refunded while other manufacturers of identical goods which do not use job work services would get the refund of the entire unutilized input tax credit.

The Analysis and Decision of the Hon’ble High Court

  • The Circular No. 79/53/2018 – GST dated 31.12.2018 prescribes the calculation of claims for refund of accumulated Input Tax Credit (ITC) on account of inverted duty structure and misinterpretation of the meaning of the term “inputs”. Under the heading “Refund of accumulated ITC of input services and capital goods arising on account of inverted duty structure” it is provided that:

“Section 54(3) of the CGST Act provides that refund of any unutilized ITC may be claimed where the credit has accumulated on account of rate of tax on inputs being higher than the rate of tax on output supplies (other than nil rated or fully exempt supplies). Further, section 2(59) of the CGST Act defines inputs as any goods other than capital goods used or intended to be used by a supplier in the course or furtherance of business. Thus, inputs do not include services or capital goods. Therefore, clearly, the intent of the law is not to allow refund of tax paid on input services or capital goods as part of refund of unutilized input tax credit. Accordingly, in order to align the CGST Rules with the CGST Act, notification No. 26/2018-Central Tax dated 13.06.2018 was issued wherein it was stated that the term Net ITC, as used in the formula for calculating the maximum refund amount under rule 89(5) of the CGST Rules, shall mean input tax credit availed on inputs during the relevant period other than the input tax credit availed for which refund is claimed under sub-rules (4A) or (4B) or both. In view of the above, it is clarified that both the law and the related rules clearly prevent the refund of tax paid on input services and capital goods as part of refund of input tax credit accumulated on account of inverted duty structure.”

  • After analyzing the definitions involved and the meaning of the term “Supply” under section 7 of the CGST Act, 2017 along with relevant case laws, the hon’ble court said that:

From the conjoint reading of the provisions of Act and Rules, it appears that by prescribing the formula in Sub-rule 5 of Rule 89 of the CGGST Rules,2017 to exclude refund of tax paid on “input service” as part of the refund of the unutilised input tax credit is contrary to the provisions of Sub-section 3 of Section 54 of the CGST Act, 2017 which provides for a claim of refund of “any unutilized input tax credit”. Thus “input” and “input service” are both part of the “input tax” and “input tax credit”.

Therefore, as per provision of sub-section 3 of Section 54 of the CGST Act,2017, the legislature has provided that registered person may claim a refund of “any unutilized input tax”, therefore, by way of Rule 89(5)of the CGST Rules,2017, such claim of the refund cannot be restricted only to “input” excluding the “input services” from the purview of “Input tax credit”. Moreover, clause (ii) of the proviso to Sub-section 3 of Section 54 also refers to both supply of goods or services and not the only supply of goods as per amended Rule 89(5) of the CGST, Rules 2017.

In view of the above analysis of the provisions of the Act and Rules keeping in mind scheme and object of the CGST Act, the intent of the Government by framing the Rule restricting the statutory provision cannot be the intent of the law as interpreted in the Circular No.79/53/2018-GST dated 31.12.2018 to deny the registered person refund of tax paid on “input services” as part of a refund of the unutilised input tax credit.

We are of the opinion that Explanation (a) to Rule 89(5) which denies the refund of “unutilized 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.

In view of the above, Explanation (a) to the Rule 89(5) is read down to the extent that Explanation (a) which defines “Net Input Tax Credit’ means “input tax credit” only.

In the result, for the foregoing reasons, the petitions are accordingly allowed. Rule is made absolute to the aforesaid extent.

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