Supply of Capital Goods under GST: A Different Perspective

At the outset, I would like to state that this article is purely based on my (liberal) interpretation of the CGST Act and CGST Rules. I would not like to go into the vires or the rationality of the provisions discussed herein. I will, however, try my best to provide my understanding of the possible intention of the lawmakers and the logic of my interpretation.

1. The Central Goods and Services Tax Act, 2017 (hereinafter referred to as “CGST Act”) lays down the fundamental provisions of chargeability of the GST and the input tax credit (hereinafter referred to as “ITC”) of such GST, which are the concepts that form the backbone of the GST laws in India. These provisions are further governed by the procedures laid down in the Central Goods and Services Tax Rules, 2017 (hereinafter referred to as “CGST Rules”), which provide the practical procedures, methods or calculation formulae for the provisions contained in the CGST Act. More often than not, the CGST Rules have to be read in conjunction with the CGST Act to identify and interpret the exact provisions under which the Rules have been framed. In this article, I will be discussing a certain set of such Rules which are relevant to the transactions involving capital goods purchased after the advent of the GST law and sold thereafter.

1.1 Chapter III of the CGST Act lays down the provisions for levy and collection of GST. Section 7 defines the scope of the term “Supply” by way of an inclusive definition, where sub-section (1)(a) provides that “all forms of supply of goods or services or both such as sale, transfer, barter, exchange, licence, rental, lease or disposal made or agreed to be made for a consideration by a person in the course or furtherance of business;” shall be considered as a “supply”. Under the GST law, the term “goods” encompasses every kind of movable property other than money and securities. In fact, “capital goods” are defined under the CGST Act as “goods, the value of which is capitalised in the books of account of the person claiming the input tax credit and which are used or intended to be used in the course or furtherance of business;” (emphasis supplied). Therefore, any sale, transfer, barter, exchange, licence, rental, lease or disposal of capital goods is covered under the definition of “supply”.

1.2 Section 9 of the CGST Act lays down the taxability of supplies, wherein it is stated that “there shall be levied a tax called the central goods and services tax on all intra-State supplies of goods or services or both, except on the supply of alcoholic liquor for human consumption, on the value determined under section 15….” (emphasis supplied). This implies that CGST (and SGST/IGST, under the other GST laws) shall be levied on supply of capital goods, as per the value determined under Section 15 of the CGST Act.

1.3 Chapter IV of the CGST Act deals with the time and value of “supply”, which is referred to once the taxability of a transaction is determined under Chapter III. I think it is prudent to mention here that this article revolves around the assumption that certain goods have been purchased after the advent of the GST era, they have been capitalized by the taxpayer in his books of accounts and the ITC on such goods has been availed by the taxpayer. With that context in mind, one can state that the taxability of supply of capital goods would usually arise at the general time of supply of goods, i.e. at the time of issue of invoice. For example, XYZ Co. purchased goods on 1st July, 2017 for Rs. 3,00,000 plus GST of Rs. 54,000 and capitalised such goods in their books of accounts. Such capital goods were than agreed to be sold to ABC Ltd. and a tax invoice was raised accordingly on 30th June, 2020. The time of supply is this case would be 30th June, 2020.

1.4 The next step would be to determine the value of supply, guided by the provisions of Section 15 of the CGST Act. Generally and simply put, the value of supply of capital goods shall be transaction value, which is the actual price paid for the supply of such goods, provided that the price is the sole consideration and the parties are not related. In our example, let us assume that XYZ Co. agrees to sell the capital goods to ABC Ltd. for a fully monetary consideration of Rs. 1,00,000 and they are not “related persons” as per the Explanation to Section 15. Therefore, the value of supply in our example would be Rs. 1,00,000.

1.5 Therefore, XYZ Co. is liable to pay output GST on the date of issuing the tax invoice i.e. 30th June, 2020, on transaction value of Rs. 1,00,000, on the sale of capital goods purchased on 1st July, 2017 and sold to ABC Ltd. The outward GST payable @ 18% on this transaction would be Rs. 18,000. This summary is a result of the conjoint reading of Chapters III and IV of the GST law, which deal with the levy, collection and valuation of transactions for the purpose of GST.

2. Now I will go through the provisions for Input Tax Credit contained in Chapter V of the CGST Act which are specific to supply of used capital goods. I would like to reiterate here that Chapter V of the CGST Act only deals with ITC and Chapters III and IV deal with the taxability of transactions.

2.1 Section 18 of the CGST Act deals with the “availability of credit in special circumstances.” It is natural, therefore, that sub-section (6) of Section 18 provides for the treatment of ITC in case of supply of capital goods on which ITC has been availed earlier. Section 18(6) lays down that the registered person supplying capital goods on which ITC has been taken, shall be liable to “pay” GST – 1. At the specified tax rate, on the transaction value OR 2. Equal to the ITC reversal determined as per Rule 44 of the CGST Rules, whichever of the two amounts is higher. The term “pay” used in Section 18(6) is what usually causes confusion. Section 18 is provided under Chapter V of the CGST Act which only deals with ITC. This Chapter can not override the provisions of the charging sections contained in Chapter III and IV. Therefore, Section 18 cannot dictate the chargeability or valuation of tax payable on a transaction. It can only provide for availability or restriction of ITC on a transaction. As such, Section 18(6) only provides for tax payable by way of reversal of ITC, the amount of which is either equivalent to the tax payable on the transaction as per Section 15 OR the amount calculated as per Rule 44, whichever is higher.

2.2 The above implies that in addition to the tax payable on outward supply of capital goods under provisions of Chapters III and IV, a registered person is also required to reverse ITC availed on such capital goods. This makes sense from a revenue perspective too – The useful life of a capital good is deemed to be 5 years / 60 months / 20 quarters under GST. This useful life is static across all capital goods and does not get renewed on subsequent sales. On this premise, the taxpayer is allowed to avail the entire ITC (which is usually a large amount being capital goods) at the time of purchase of the capital good and there is no deferment of such ITC. However, if the taxpayer fails to use the capital good for the entirety of its deemed useful life, it is fair on the legislature to demand that the full ITC availed by him earlier should be reversed in proportion to the unused period. This maintains the revenue neutrality. Therefore, any supply of capital goods on which ITC has already been availed earlier shall attract output GST on the transaction value determined under Section 15 and additionally, shall be liable for reversal of ITC by virtue of Section 18(6) read with Rule 44. In our example, the tax payable under Section 15 is Rs. 18,000. As per Rule 44(6), the reversal of ITC works out to (54,000*24 months / 60 months) = Rs. 21,600. Since this amount is higher, XYZ Co. shall have to reverse ITC of Rs. 21,600 under Section 18(6) in addition to outward tax payable of Rs. 18,000 by virtue of Section 9 on the supply of used capital goods.

3. Now I come to the controversial part of this discussion. The discussion so far was focused on the implications of outward supply of capital goods by the seller. What about the implications for the recipient of such supplies? Are there any conditions envisaged by the GST law for the recipient?

3.1 In my peer discussions, it is most often regarded that Rule 40(2) and Rule 44(6) have both been provided under Section 18(6) for calculation of ITC reversal on outward supply of capital goods. It is believed that providing two different Rules for the same provision is a drafting error by the lawmakers and one of these Rules should be omitted. Despite this widespread belief, there has been no action on these Rules by the Government for the past 4 years, during which the CGST Rules have been amended countless times. It begs the question as to why? It is entirely possible that there is an alternate explanation for this inaction.

3.2 Rule 40 of the CGST Rules provides for manner of claiming ITC in special circumstances. Sub-rule (2) of Rule 40, which specifically refers to Section 18(6) of the CGST Act, provides that ITC shall be determined after reducing a specific proportionate amount, as prescribed. Further, this proportionate amount has to be calculated “from the date of the issue of invoice for such goods.”

3.3 Rule 40 has been laid down for the manner of claiming ITC as per the header of the Rule, whereas Rule 44 has been provided for manner of reversal of ITC as per its header. Therefore, the two Rules seem to be independent of each other. ITC reversal is applicable only to the supplier of capital goods who has already availed the ITC, whereas the claim of ITC lies with the recipient of such supplies. Therefore, it is very much possible that a single Section 18(6) provides for two different scenarios – one for the supplier and one for the recipient of supply of capital goods.

3.4 As per my interpretation, Rule 40(2) only provides for the manner of claiming of ITC by the recipient of supplies of capital goods. The Rule implies that a recipient of supply of capital goods shall be eligible to claim ITC only to the extent of remaining useful life of the capital goods, from the date of its original purchase by the supplier of such capital goods. This seems to be in line with the assumption that the useful life of any capital goods under GST is 5 years / 60 months / 20 quarters. This useful life can not get renewed for every subsequent sale, as it would go against the very capital nature of such goods. If this holds true, it automatically makes sense that the ITC on used capital goods should be available only for the remaining useful life of such capital goods. Continuing our example basis of this interpretation, ABC Ltd., the recipient of capital goods, shall be eligible to claim only that ITC which is attributable to the unused life of the asset i.e. 2 years or 8 quarters. As per Rule 40(2), ABC Ltd. shall be eligible to claim (18,000*(5%*8 quarters)) = Rs. 7,200 only.

3.5 I understand that the above interpretation may seem farfetched, but it starts to make sense when all the provisions are considered together with actual figures in hand. For example, the condition of considering higher value of ITC reversal or tax payable under Section 18(6) has been drafted as such so that there is never a scenario where the Government ends up giving a benefit of ITC which is higher in amount than the tax collected by the Government. The same provisions also mitigate the possibilities of passing on fraudulent ITC by manipulating the transaction values. Of course, the interpretation above seems unworkable as well in the regular course of business. There also seems to be an apparent loss of ITC to the recipient of such capital goods. These points can definitely be taken up as a matter of litigation, if indeed the interpretation stands validated.

4. The drafting of Section 18(6) together with Rules 40(2) and 44(6) leaves a lot to be desired. Some of the words and phrases used in these provisions are highly ambiguous, which has led to differences in interpretations by practitioners. Of course, the views expressed hereinabove also may be a product of my liberal interpretation. However, as I mentioned earlier, the interpretation starts to make sense in the chain of events, when an actual transaction is subjected to it. I would be very much interested in discussing divergent views on this, if any and look forward to the same. We can connect at [email protected].