Madras High Court: ‘Scope of Section 17(5)(h) shall not extend to cover the loss of inputs which is inherent to the manufacturing process’

This is to apprise you with a recent judgement by Hon’ble Madras High Court in the Case of ARS Steels & Alloy International Pvt. Ltd. Vs The State Tax Officer as follows:

Writ Petition: Challenge before Hon’ble Madras High Court by M/s ARS Steels & Alloy International Pvt. Ltd. (‘Petitioner’) to the assessment orders issued for the periods 2017-18, 2018-19 and 2019-20 by the State Tax Officer (‘Respondent’) to the extent of it directing the Petitioner for making a proportionate reversal of Input Tax Credit (ITC) claimed in relation to the loss arising from manufacturing process referring to the provisions of Section 17(5)(h) of the GST Act’.

Background: The petitioners are engaged in the manufacture of MS Billets and Ingots. MS scrap is an input in the manufacture of MS Billets and the latter, in turn, constitutes an input for manufacture of TMT/CTD Bars. There is a loss of a small portion of the inputs, inherent to the manufacturing process.

Hon’ble Judge’s opinion- ‘Scope of Section 17(5)(h) shall not extend to cover the loss of inputs which is inherent to the manufacturing process’:

  • Erstwhile Tamil Nadu Value Added Tax Act, 2006 (‘TNVAT Act’) contained an equivalent provision in Section 19 thereof, which deals with various situations arising from the grant and reversal of ITC. 
  • Section 19(9) sets out situations where such ITC shall be denied. Relevant extract of the same being:

‘No input tax credit shall be available to a registered dealer for tax paid at the time of purchase of goods, if such-

1. goods are not sold because of any theft, loss or destruction, for any reason, including natural calamity ..…….; or

2. inputs destroyed in fire accident or lost while in storage even before use in the manufacture of final products; or

3. inputs damaged in transit or destroyed at some intermediary stage of manufacture.’ 

  • Above provisions of Section 19 are echoed in the provisions of Section 17 of the GST Act. Section 17(1) to 17(4) set out the entitlement of the assessee to ITC.

Sub-section (5) and its sub-clauses provide for situations where ITC claimed shall be restricted and read as follows:

‘Notwithstanding anything contained in sub-section (1) of section 16 and sub-section (1) of section 18, input tax credit shall not be available in respect of the following, namely:

(h) goods lost, stolen, destroyed, written off or disposed of by way of gift or free samples.’ 

  • Loss in the case of Petitioner is occasioned by the process of manufacture cannot be equated to any of the instances set out in clause (h) above. The situations as set out above in clause (h) indicate loss of inputs that are quantifiable and involve external factors or compulsions. A loss that is occasioned by consumption in the process of manufacture is one which is inherent to the process of manufacture itself.
  • Reference was also drawn from the case of Rupa & Co. Ltd. V. Cestat, Chennai (2015 (324) ELT 295), wherein a Division Bench of Madras High Court decided a question of law with respect to reversal of CENVAT credit on the difference between the original quantity of input and the input in the finished product. The Bench noticed that:

Some amount of consumption of the input was inevitable in the manufacturing process, held that CENVAT credit should be granted on the original amount of input used notwithstanding that the entire amount of input would not figure in the finished product.

To say that the finished product shall have exactly the similar weight as that of the inputs used into it is merely theoretical in nature and incorrect since the same would imply that there is no inherent loss evaporation, creation of by-products, etc. in the process of manufacture. Thus, the total quantity of inputs that went into the making of the finished product represents the inputs of such products in entirety.

Held: In the light of the discussion as above, I am of the view that the reversal of ITC involving Section 17(5)(h) by the revenue, in cases of loss by consumption of input which is inherent to manufacturing loss is misconceived, as such loss is not contemplated or covered by the situations adumbrated under Section 17(5)(h).

Our remarks:

This judgement shall act as an aide to all the taxpayers engaged into manufacturing of some product wherein the manufacturing process leads to some loss (in the nature of consumption of inputs) inherent and unavoidable to the manufacturing process and are served notices/demand orders seeking proportionate reversal of ITC.

It is also imperative to notice that the Hon’ble Madras High Court did not explain the exact meaning and scope of the provision of section 17(5)(h) and only opined for a scenario where ‘any inherent loss to the inputs is caused during consumption in the manufacturing process’ and held that the same shall not tantamount to fall under the ambit of section 17(5)(h) and therefore, no requirement to make proportionate reversals.

Should you require any further clarifications or details, please feel free to revert:

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