Supreme Court ratifies Section 54(3) of CGST Act, 2017 & Rule 89(5) of CGST Rules, 2017

Inequities in Rule 89(5) are to be ironed out by the Government in the course of the application of the formula for computation of Refund in case of Inverted Tax structure

The Supreme Court on Monday 13th September 14, 2021, held that Section 54(3)(ii) of the CGST Act, 2017 excludes unutilised ITC which is accumulated w.r.t. the Input services, Union of India v. VKC Footsteps India Private Ltd.

THE CASE IN THE COURT OF LAW

The case of VKC Footsteps India Private Ltd had been creating quite an uproar, ever since the Gujrat high court held that a part of Rule 89 of CGST Rule,2017 which denies refund of unutilized credit on input services is ultra vires Section 54 of the Act

  • The Gujarat High Court had in 2020 in the case of Union of India v. VKC Footsteps India Private Ltd., held that “Explanation (a) to Rule 89(5) which denies the refund of ‘unutilised ITC’ paid on input services as part of eligible ITC accumulated on account of inverted duty structure is ultra vires the provision of Section 54(3) of the CGST Act, 2017
  • However , the the Madras High Court, in the case of ‘TVL. Transtonnelstroy Afcons Joint Venture Vs. Union of India’, held that Section 54 provides for benefit only on unutilized credit that accumulates on account of the rate of tax on input goods being higher than the rate of tax on output supplies by excluding unutilised input tax credit that accumulated on account of input services is a valid classification and a valid exercise of legislative power

LEGAL PROVISIONS INVOLVED

Now, lets break down the relevant provisions in question here ,

Section 54 of CGST At, 2017 : REFUND OF TAX

Sub-Section 3 of Section 54 states that, a registered person may claim refund of any unutilised ITC at the end of any tax period:

Provided that no refund of unutilised input tax credit shall be allowed in cases other than––

  • zero rated supplies made without payment of tax;
  • 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) I.e., INVERTED TAX STRUCTURE

Provided further that no refund of unutilised ITC shall be allowed in cases where the goods exported out of India are subjected to export duty

Provided also that no refund of ITC shall be allowed, if the supplier of goods or services or both avails of drawback in respect of central tax or claims refund of the integrated tax paid on such supplies.

Rule 89(5) of CGST Rule, 2017

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 &  services  X   Net ITC )  /  Adjusted Total Turnover ]  less:   tax payable on such inverted rated supply of goods and services.

Explanation:-

  • Net ITC shall mean ITC availed on inputs during the relevant period other than the ITC availed for which refund is claimed under rule 85 (4A) & /or (4B) ;and
  • Adjusted Total turnover and relevant period shall have the same meaning as assigned to them in rule 85(4)

Definitions

Section 2(59) : Input : any goods other than capital goods used or intended to be used by a supplier in the course or furtherance of business

 Section 2(60) : Input Service: any service used or intended to be used by a supplier in the course or furtherance of business 

 Section 2(62): Input tax : in relation to a registered person, it means the central tax, State tax, integrated tax charged on any supply of goods & / or services made to him and includes—

  • the integrated goods and services tax charged on import of goods;
  • the tax payable under the provisions of sub-sections (3) and (4) of section 9;
  • the tax payable under the provisions of sub-sections (3) and (4) of section 5 of the Integrated Goods and Services Tax Act;
  • the tax payable under the provisions of sub-sections (3) and (4) of section 9 of the respective State Goods and Services Tax Act; or
  • the tax payable under the provisions of sub-sections (3) and (4) of section 7 of the Union Territory Goods and Services Tax Act,

but does not include the tax paid under the composition levy;

Section 2(63): Input tax credit : means the credit of input tax

Rule 89(4)(E) : Adjusted Total Turnover,for the purpose of Rule 89(5)

The sum total of the value of

  • the turnover in a State or a Union territory, as defined under clause (112) of section 2, excluding the turnover of services; and
  • the turnover of zero-rated supply of services and non-zero-rated supply of services, excluding-
  • the value of exempt supplies other than zero-rated supplies; and .
  • the turnover of supplies in respect of which refund is claimed if any, during the relevant period

Rule 89(4)(F) : Relevant period for the purpose of Rule 89(5), means the period for which the claim has been filed.

WHAT CAUSED THE CHAOS ??

LACK OF SYMMYTRY BETWEEN SECTION 54(3) & RULE 89(5)

 The crux of the dispute in the case ia as to how Section 54(3) and Rule 89(5) are to be understood and interpreted.

 Section 54(3) allows for refund of unutilised ITC when the rate of tax on input supplies is higher than the rate of tax on output supplies. So, it considers both Input goods & input services.

However, while Section 54(3) allows for a refund of ITC originating in input goods as well as input services, Rule 89(5) excludes tax on input services from the purview of the formula.

Rule 89(5) provides a formula for the refund of Input Tax Credit, in “a case of refund on account of inverted duty structure” which inter alia specifically doesn’t includes ‘input services’ in the scope of ‘Net ITC’ for computation of the refund amount.

It is construed, that Rule 89(5) of the CGST Rules denies refund on the unutilised ITC availed on input services and allows relief of refund of ITC availed on input goods alone

CONSTITUTIONAL VADITY OF LEGAL PROVISIONS

Para 81 of the judgement speaks about constitutional validity of Section 54(3)

Parliament while enacting the provisions of Section 54(3), legislated within the fold of the GST regime to prescribe a refund. While doing so, it has confined the grant of refund in terms of the first proviso to Section 54(3) to the two categories which are governed by clauses (i) and (ii). A claim to refund is governed by statute. There is no constitutional entitlement to seek a refund. Parliament has in clause (i) of the first proviso allowed a refund of the unutilized ITC in the case of zero-rated supplies made without payment of tax. Under clause (ii) of the first proviso, Parliament has envisaged a refund of unutilized ITC, where the credit has accumulated on account of the rate of tax on inputs being higher than the rate of tax on output supplies. When there is neither a constitutional guarantee nor a statutory entitlement to refund, the submission that goods and services must necessarily be treated at par on a matter of a refund of unutilized ITC cannot be accepted. Such an interpretation, if carried to its logical conclusion would involve unforeseen consequences, circumscribing the legislative discretion of Parliament to fashion the rate of tax, concessions and exemptions. If the judiciary were to do so, it would run the risk of encroaching upon legislative choices, and on policy decisions which are the prerogative of the executive. Many of the considerations which underlie these choices are based on complex balances drawn between political, economic and social needs and aspirations and are a result of careful analysis of the data and information regarding the levy of taxes and their collection. That is precisely the reason why courts are averse to entering the area of policy matters on fiscal issues. We are therefore unable to accept the challenge to the constitutional validity of Section 54(3).”

Para 103 of the judgement speaks about the constitutional validity of Rule 89(5) ,

“In our view, the justification of the formula under Rule 89(5) given by the ASG to create a legal bifurcation is valid. In this context, it would be material to advert to the provisions of Rule 42. Rule 42(1) provides that the ITC in respect of input goods or input services which attract the provisions of sub-Section (1) or sub-Section (2) of Section 17 being partly used for the purpose of business and partly for other purposes or partly used for affecting taxable supplies including zero rated supplies and partly for effecting exempts supplies shall be attributed for the purposes of business or for effecting taxable supplies in the manner which is indicated in the Rule. Sub-Section (1) of Section 17 provides that where the goods and services or both are used by a registered person partly for the purposes of any business and partly for any other purpose, the amount of credit shall be restricted to so much of the input tax as is attributable to the purpose of its business. Sub-Section (2) of Section 17 provides that where the goods or services or both are used by a registered person partly for effecting taxable supplies including zero rated supplies under the CGST Act or under the IGST Act and partly for effecting exempt supplies the amount of credit shall be restricted to so much of the input tax as is attributable to the taxable supplies including zero rated supplies. Rule 42, in other words, provides for the manner in which the attributions of ITC in respect of the input or input services under sub-Sections (1) or (2) of Section 17 shall be carried out. Rule 43 similarly provides the manner in which ITC in respect of capital goods attracting the provisions of sub-Section (1) of Section 17, used partly for business and partly for other purposes or partly for effecting taxable supplies including zero rated supplies and partly for effecting exempt supplies would be attracted to the purpose of business or for effecting taxable supplies. Both Rules 42 and 43 provide for a formula for attribution. Rule 86 provides for the maintenance of an electronic credit ledger. Rule 89(5) provides for a refund. In both sets of rule clusters, Rules 42 and 43 on the one hand and Rule 89(5) on the other hand, a formula is used for the purpose of attribution in a post assimilated scenario. The use of such formulae is a familiar terrain in fiscal legislation including delegated legislation under parent norms and is neither untoward nor ultra vires.”

CONCLUSION

On 13.09.21 , the Supreme court squashed the judgement of Gujrat High court and upheld the view taken by Madras High court in case of  ‘TVL. Transtonnelstroy Afcons Joint Venture Vs. Union of India’.

Having devoted our attention to the submissions at the Bar, we have come to the conclusion that the judgment of the Madras High Court needs to be affirmed by dismissing the appeals challenging that verdict while the appeals against the judgment of the Gujarat High Court by the Union of India should be allowed.

  •  The judgement of the honourable bench of Justice DY Chandrachud and Justice MR Shah , in para 106  states that, “While we are alive to the anomalies of the formula, an anomaly per se cannot result in the invalidation of a fiscal rulewhich has been framed in exercise of the power of delegated legislation.”
  • The judgement emphasized upon imbalance of Rule 89(5) that, The formula makes a presumption that the output tax payable on supplies has been entirely discharged from the ITC accumulated on account of input goods and there has been no utilisation of the ITC on input services.The formula prescribed in Rule 89(5) however, seeks to deduct the total output tax from only one component of the ITC, namely ITC on input goods. This in our view is at odds with reality, where the ITC on both input goods and input services is accumulated in the electronic ledger and is then utilised for the payment of output tax.
  •  The honourable court also stated in para 104 that The purpose of the formula in Rule 89(5) is to give effect to Section 54(3)(ii) which makes a distinction between input goods and input services for grant of refund. Once the principle behind Section 54(3)(ii) of the CGST Act is upheld, the formula cannot be struck down merely for giving effect to the same.  +

Read: 

1. VKC Footsteps India Pvt. Ltd. Vs. Union of India (Gujarat High Court) :Denial of ITC (inverted duty structure) invalid; Rule 89(5) ultra vires section 54(3) Provisions: Gujarat HC

2. Tvl. Transtonnelstroy Afcons Joint venture Vs Union of India (Madras High Court) :GST-Inverted duty structure- Section 54 not violates Article 14- HC

3. Union of India & Ors. Vs VKC Footsteps India Pvt Ltd. (Supreme Court of India) :SC upheld CGST rule 89(5) validity

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