Section 17(5)(c) / (d) of the CGST Act, 2017 Embargo or Entitlement – A different Perspective on Supreme Court’s Judgment in Safari Retreats
Purpose of Analysis – This write up has two parts.
The first part is on analysis of the judgment in a very limited manner.
Whereas, the second part deals only with the implications and what is next for the business in light of the judgment of Supreme Court in Safari Retreats.
Part -I
Issue
An embargo exists under Section 17(5)(c) and Section 17(5)(d) of the CGST Act, 2017 (the CGST Act) whereby Petitioners were unable to avail the credit on GST paid on goods and services used in the construction of factory premises, buildings, etc against the GST received by them for the renting/leasing/letting out etc. of the premises. They end up paying GST on the supply of goods and services used in the construction of commercial office buildings, and also on the collected rentals.
Arguments
The assessees argued that the provisions violated Articles 14, 19(1)(g), and 300A of the Constitution. They contended that the restriction imposed by Section 17(5) breaks the credit chain, contrary to the GST regime’s objective of seamless credit flow and tax neutrality. On the other hand, the revenue emphasized the wide latitude given to the legislature in taxation matters, including the power to classify and determine the scope of tax and ITC.
Analysis
The Supreme Court upheld the constitutional validity of clauses (c) and (d) of Section 17(5) and Section 16(4) of the CGST Act. The Court reiterated the principle that the legislature has broad discretion in taxation matters, including the classification of goods and services for tax purposes. The Court dealt with the expression of “plant or machinery” in Section 17(5)(d) of the CGST Act, stating that each case must be decided on its merits, applying the functionality test to determine if a building qualifies as a “plant” for ITC purposes.
Judgment
The Supreme Court partly allowed the appeals, setting aside the High Court judgment in Civil Appeal Nos. 2948 and 2949 of 2023, and remanded the case for further proceedings. The writ petitions challenging the constitutional validity of specific CGST Act provisions were rejected.
Meaning of “Plant” in Safari
Interpretation of “plant or machinery” : The Supreme Court in Safari clarified that “plant or machinery” in clause (d) of Section 17(5) of CGST Act should not be interpreted in the same manner as “plant and machinery” defined elsewhere in the CGST Act. The Court emphasized that the term “plant or machinery” has a broader connotation and could include buildings or structures that are essential for carrying out a business activity, subject to the functionality test.
The judgment in Safari will be a subjective factor in the times to come and perhaps a review cannot be ruled out. We can also expect an extended wing of clarification coming out on this judgment in upcoming SC decisions where same or similar issues will be before the Court. It must be noted that a common expression to the effect “in the course or furtherance of the business” exists both under Section 7 and Section 16 of the CGST Act.
Hence, the bedrock of supply will be germane of ITC vis-a-vis the embargo or entitlement of ITC under the ambit of Section 17(5) (d) of the CGST Act.
Why “Plant or Machinery”?
Interpretation of “Plant or Machinery” : The introduction of GST resulted into a pragmatic shift from the concept of “manufacture” or “sale” or “services” to “supply” which included everything as an inclusive concept.
Further, the expression of “plant and machinery is more relevant for a ”manufacturer” but when it comes to supply of services, it is not necessary a business should have both plant and machinery. It can have either plant or machinery and in few cases “plant and machinery” both.
Hence, the legislation has consciously chosen the expression “plant or machinery” in clause (d) of sub-section (5) of Section 17 of the CGST Act, since it never intends to waste any words or expression deployed or used in any of its provision. This could be one of the reasons.
Meaning of Plant in Scientific & Elecon
Though many decisions were relied upon in Safari supra, but a very important SC decision in Scientific Engineering House (P) Ltd vs Commissioner Of Income Tax, Andhra, 1986 (157) ITR 0086 S.C, remained to be dealt in Safari. This decision while dealing with Income Tax held that,
2.1 Plant would include any article or object fixed or movable, live or dead, used by businessman for carrying on his business and it is not necessarily confined to an apparatus which is used for mechanical operations or processes or is employed in mechanical or industrial business. In order to qualify as plant the article must have some degree or durability.
2.2 An Article to be treated as a “Plant” within the meaning of Section 43(3) of the Act must answer in the affirmative the functional test, namely does article fulfil the function of a plant in the assessee’s trading activity? And is it a tool of his trade with which he carries on his business?
This decision also approved the ratio laid down in Commissioner of Income Tax, Gujarat v. Elecon Engineering Co. Ltd., 96 I.T.R. 672 (Gujarat).
It is pertinent to also refer to Commissioner Of Income-Tax v. Elecon Engineering Co. Ltd. (Gujarat), which was approved by SC in Scientific supra, and has not only laid down an in-depth analysis of plant but also referred to the classic decision of definition of plant in Yarmouth’s case which was further expanded in Jarrold’s case that furnishes the true apposite test for judging whether a given article is plant.
28. The locus classicus for the definition of plant is in the words of Lindley L.J., in Yarmouth’s case, which despite the great technological advances since those days is still of great help and has been adopted for the purposes of the income-tax law. The question in that case was whether a horse could be regarded as plant and the main issue was whether the word “plant” must be confined to inanimate objects or whether it would also include animate objects. The learned judge said at page 658 of the report:
“There is no definition of plant in the Act : but, in its ordinary sense, it includes whatever apparatus is used by a businessman for carrying on his business, – not his stock-in-trade which he buys or makes for sale; but all goods and chattels, fixed or movable, live or dead, which he keeps for permanent employment in his business” : see Blake v. Shaw.
It should be understood that it is the ratio of Yamouth which laid down the functional test for the first time and which was later adopted and expanded in Jarrold with further clarification. The SC in Taj Mahal Hotel, discussed on Jarrold and was in turn relied upon in Safari Retreat by SC.
Part – II
Functionality Test
In the case at hand, the Supreme Court of India applied the concept of a “functionality test”. This test was used to determine whether a building or an immovable property can be classified as a “plant” within the meaning of the expression “plant or machinery” used in Section 17(5)(d) of the CGST Act.
The outcome of this test is crucial for determining the eligibility for availing Input Tax Credit (ITC) on goods and services used in the construction of such immovable property. This test emphasizes the functional importance of the asset in the business’s supply of services, offering a pathway for businesses.
Key Aspects of the Functionality Test
Purpose and Role in Business : The functionality test requires examining whether the construction of a building was essential for carrying out the business activity of supplying services, such as renting or leasing. The building’s role in the business and how it contributes to the business operations are critical factors.
Application to Various Buildings : The test applies to malls, warehouses, and other buildings, excluding hotels and cinema theatres, to determine if they can be considered as “plants” for the purposes of clause (d) of Section 17(5) of CGST Act.
Exclusion from Exception : If a building qualifies as a plant based on the functionality test, it is taken out of the exception carved out by clause (d) of Section 17(5) of the CGST Act, thereby allowing the eligibility for ITC under sub-section (1) of Section 16 of the CGST Act.
Criteria for Consideration : The construction must be integral to the service provision covered by entries (2) and (5) of Schedule II of the CGST Act, which includes activities like renting or leasing of the building or part thereof.
Fact-based Determination : The determination of whether a building is a plant is a factual question that must be decided on a case-by-case basis, applying the functionality test.
Specific Determination : In cases where the classification of a building as a plant is in question, the matter may need to be checked with the relevant authority or court for a decision based on the specific facts of the case.
Implications for Businesses
Case-by-Case Analysis: Whether a building qualifies as a “plant” under the functionality test is a factual question that must be determined on a case-by-case basis. Businesses engaged in the construction of immovable properties for specific operational purposes should assess whether these constructions meet the criteria set out under the functionality test.
Claiming ITC: If a building or immovable property is determined to be a “plant” under the functionality test, the business may be eligible to claim ITC on goods and services used in its construction, subject to fulfilling other conditions and restrictions prescribed under the CGST Act.
Legal Precedent: The Supreme Court’s judgment provides a legal precedent that businesses and tax authorities can refer to when assessing the eligibility for ITC in cases involving the construction of immovable properties.
What is Next for Businesses?
Businesses should look for the following: Potential for ITC: Businesses may now have the opportunity to claim ITC on construction costs for buildings that are integral to their service-providing operations.
Need for Documentation: Businesses should maintain comprehensive documentation demonstrating how a building is essential to their business operations to support potential ITC claims.
Case-Specific Evaluation: Each construction project will need to be evaluated individually to determine if it meets the functionality test for ITC eligibility.
Potential for Litigation: Given the case-by-case nature of the determination, there may be increased litigation as businesses seek to establish their constructions as “plants” for ITC purposes.
Review of Past Projects: Businesses may want to review past construction projects to see if they could potentially qualify for ITC under this new interpretation.
Future Planning: When planning new construction projects, businesses should consider how to structure and document them to potentially qualify for ITC under this judgment.
This judgment potentially opens up avenues for businesses to claim ITC on certain construction projects, but also introduces complexity in determining eligibility. Businesses should consult with tax experts to navigate these new implications under the CGST Act.
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