Supreme Court (SC) strikes down the verdict of Gujarat High Court (HC) on refund of input tax credit (ITC) on input services.
Division Bench of the Gujarat High Court in the case of VKC Footsteps India Pvt Ltd passed a favourable judgement in favour of the assessee and held that “Explanation (a) to Rule 89(5) which denies the refund of “unutilised 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.”
Division Bench of the Madras High Court in the case of Tvl. Transtonnelstroy Afcons Joint Venture however passed a contrary judgement and held that –
“(1) Section 54(3)(ii) does not infringe Article 14.
(2) Refund is a statutory right and the extension of the benefit of refund only to the unutilised 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.”
Supreme Court on its landmark judgement on September 13th 2021 rejected the order of Gujarat High Court and confirmed the judgement of the Madras High Court, thereby rejecting the refund of input services in the case of inverted duty structure.
The interesting facts presented by the Attorney General of India representing the Union of India are:
♦ Article 265 of the Constitution provides that no tax shall be levied or collected except by authority of law. There being no challenge either to the levy or collection of taxes in these cases, taxes paid into the coffers of the Union Government or the States become the property of the Union/States;
♦ The refund of taxes is neither a fundamental right nor a constitutional right. The Constitution only guarantees that the levy should be legal and that the collection should be in accordance with law. There is no constitutional right to refund. Refund is always a matter of a statutory prescription and can be regulated by the statute subject to conditions and limitations;
♦ Even in the case of an illegal levy or a levy which is unconstitutional, the decision of the nine judges Bench in Mafatlal Industries Limited v. Union of India held that the right of refund is not automatic. The burden of proof lies on the claimant to establish that it would not cause unjust enrichment;
♦ Discriminatory treatment under tax laws is not per se invalid. It is invalid only when equals are treated unequally or unequals are treated equally. Both under the Constitution and the CGST Act, goods, services, input (goods) and input services are not one and the same. These are distinct species, though covered by a common code;
♦ Accepting the submission of the assessees that goods and services must be treated at par can lead to drastic consequences in terms of:
(a) rates of taxes;
(b) concessions, benefits and exemptions;
(c) intervention in the areas of political, economic and legislative policies
♦ Refund of taxes is one form of granting exemption
♦ Once a refund is construed as a form of exemption from taxes, the provision has to attract strict interpretation
♦ ITC is not a matter of right and the burden of proof is on the assessee to establish a claim for a concession or benefit;
The argument presented by the assessee was:
♦ GST is a destination-based consumption tax. The fundamental principle of GST laws worldwide is that it is a multistage tax. Each point in a supply chain is potentially taxed. However, suppliers are entitled to avail credit of taxes paid at an anterior stage. This feature of GST leads to its description as being a tax on value addition, with the final consumer alone ultimately bearing the tax. The GST laws enacted in India are also based on this principle;
♦ In All India Federation of Tax Practitioners v. Union of India, this Court held that excise duty, service tax and value added tax legislation provide for taxes on value addition and are destination based-consumption taxes. These are not charges on the business but on the consumer. Though the erstwhile tax legislation, prior to the enforcement of the Constitution (One Hundred and First Amendment) Act 2016, was based on the principle of value addition and consumption tax, there was no seamless flow of credit between Central and State levies. This anomaly was sought to be addressed by the constitutional amendment and by the legislation which has been enacted in pursuance of it;
♦ The Statement of Objects and Reasons accompanying the bill introducing the CGST Act also emphasised that there would be a seamless transfer of ITC from one stage to another in the chain of value addition;
♦ The purpose of the One Hundred and First Constitutional Amendment was:
(a) to replace a number of indirect taxes being levied by the Union Government and the State Governments;
(b) to obviate and remove the cascading effect of taxes; and
(c) to provide for a common national market for goods and services.
♦ These principles reaffirmed the guidelines issued by the Organisation of Economic Co-operation and Development which emphasise that
(a) value added tax systems are designed to tax final consumption;
(b) only the consumers should bear the tax burden; and
(c) the main characteristic of a value added tax is of preserving neutrality in the value chain.
♦ In a tax regime which was not based on value added tax, ensuring refund of tax paid at various stages of manufacturing would be cumbersome and complicated. It was to obviate the problems of the earlier regime that GST legislation was enacted by various countries including India to fully effectuate the principle underlying value-added destination-based consumption tax;
♦ The situation in which the quantum of input taxes exceeds output tax is an anomaly, aberration and distortion resulting from various sources of taxes and conflicts with the fundamental principles of GST. The impact of these distortions can be revealed by practical examples involving situations such as
(a) Intermediate products attracting a lower rate of tax; and
(b) Intermediate products attracting a higher rate of tax.
♦ As a result, varied situations of economic distortion resulting from a cascading effect of taxes in the form of unabsorbed ITC emerged due to variations in the rate of taxes. This is against the basic tenets of GST. GST being a consumption tax, postulates that the only tax in the entire chain should be the tax charged to the end customer without any ‘sticking’ or unabsorbed ITC;
♦ A near perfect GST legislation provides for refund of ITC in a situation involving an inverted duty structure. The provisions for refund ensure that anomalies in tax rates do not result in distortions to the fundamental features of GST which remains a true consumption tax. ITC may accumulate for a variety of reasons including (a) inverted duty structure, that is, GST on output supplies is less than the GST on the input supplies; (b) stock accumulation; (c) capital goods; and (d) partial reverse charge mechanism for certain services;
♦ The cascading effect or sticking credit may arise on account of higher taxes paid on input goods or input services. Refund of unutilized ITC will ensure the elimination of the cascading effect of taxes in a true sense;
♦ Section 54(3) has been enacted to achieve the objective of removing the cascading effect of unutilized ITC. Section 54(3) provides for refund of “any unutilised input tax credit” but the refund is available in only two situations namely, (a) zero rated supplies; and (b) inverted duty structure. The quantum of refund is provided by the main part of Section 54(3) which stipulates the refund of any unutilised ITC. This includes credit availed on input goods as well as on input services having regard to the definitions contained in Sections 2(62) and 2(63);
♦ The proviso only provides for cases in which the refund under the main provisions of Section 54(3) will be available. Once the requirement of inverted duty structure in proviso (ii) is fulfilled, the entire unutilised ITC has to be refunded. The reason why proviso (ii) defines the inverted duty structure with reference to only input (goods) vis-a-vis output supplies may be that while services (barring a few) were leviable to tax at 18 per cent, goods were subject to various categories of rates. If input services were also considered for determining inverted duty structure, refund may be required to be granted practically to all the assessees. Hence, the legislature defined inverted duty structure only with reference to ‘inputs’ (input goods). However, once a case fulfils the condition of an inverted duty structure, refund of the entire unutilised ITC which is attributable to inverted duty structure supplies is allowed, including the credit availed on input goods and input services;
♦ Rule 89(5) in the garb of fixing a formula for determining pro-rata the amount of credit relatable to the inverted duty structure vis-à-vis total turnover has restricted the refund to ITC on input goods by denying it on input services. This has been done by defining ‘Net ITC’ to mean ITC availed on all ‘inputs’, thus overlooking ITC relatable to input services. Such a rule cannot be treated as one for carrying out the purpose of the CGST Act;
♦ A delegated legislation can be struck down as ultra vires of a principal statute. The laying of delegated legislation before Parliament does not confer any validity on such ultra vires rules. The process of laying rules before Parliament and making them subject to modification or annulment cannot be equated with legislation which has the assent of the President, or the Governor, as the case may be. The doctrine of ultra vires will apply even if a resolution is passed by Parliament approving or modifying the rules. Though, the CGST Rules have been laid before Parliament, any part which is ultra vires the CGST Act is liable to be struck down;
♦ By virtue of the doctrine of severability that portion of Rule 89(5) which is ultra vires may be struck down. This would not constitute judicial legislation. The challenge to the vires of Rule 89(5) is only because of the definition of ‘Net ITC’ in the explanation to the rule. The explanation defines net ITC to mean ITC availed on inputs during relevant period. Section 54(3) allows refund of any unutilized ITC and not only credit on input goods. Consequently, only if the expression “on inputs” employed in Explanation (a) to Rule 89(5) is struck down, will Rule 89(5) be in line with Section 54(3).
♦ The expression ‘accumulated’ signifies the credit balance which is unutilized after credit has been availed and utilised for making payments on output tax on outward supplies. Accumulation of credit may occur due to various reasons such as absence of outward supplies in a tax period, supplies made at a loss, bulk purchase of inputs, excess opening balance of credit, and change in the rate of tax during the tax period A rule which provides for the identification of unutilised ITC which is attributable to supplies having an inverted duty structure and bifurcating it from credit accumulating due to other causes would be for the purpose of carrying out the provisions of the CGST Act.
♦ After the amendment in terms of the formula, the ratio of proportionate turnover is applied only to ITC availed on input goods. However, after arriving at the proportionate value, the entire amount of tax paid on output supplies is deducted. The formula erroneously assumes that the entire output tax will be paid from ITC availed on input goods and the credit on input services will not be utilised for payment of output tax. If the rule took into computation ITC availed on both input goods and input services, both parts of the formula would be comparable and would result in a correct amount of unutilised ITC attributable to an inverted duty structure.
♦ The rule is ultra vires Section 54(3) since it restricts the computation of refund only by taking into account the credit availed on input goods. Section 54(3) provides for entitlement to refund, its quantum and the cases in which the refund is to be granted. Section 54(3) being a code in itself, there is no reference to a provision enabling the Government to frame rules in this regard. Hence, with reference to Section 54(3), any exercise of the rule making power is unwarranted.
After hearing both the sides Honourable Supreme Court considering the complexity of the issue, went in favour of Madras High Court, but with a recommendation to the GST Council to remove this anomaly of law. It further added “Every legislation particularly in economic matters is essentially empiric and it is based on experimentation or what one may call trial and error method and therefore it cannot provide for all possible situations or anticipate all possible abuses. There may be crudities and inequities in complicated experimental economic legislation but on that account alone it cannot be struck down as invalid. The courts cannot, as pointed out by the United States Supreme Court in Secretary of Agriculture v. Central Roig Refining Company [94 L Ed 381 : 338 US 604 (1950)] be converted into tribunals for relief from such crudities and inequities. There may even be possibilities of abuse, but that too cannot of itself be a ground for invalidating the legislation, because it is not possible for any legislature to anticipate as if by some divine prescience, distortions and abuses of its legislation which may be made by those subject to its provisions and to provide against such distortions and abuses. Indeed, howsoever great may be the care bestowed on its framing, it is difficult to conceive of a legislation which is not capable of being abused by perverted human ingenuity”.
Is this the end of the tunnel? Will there be more action in this subject? It is a wait and watch.
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