Goods & Services Tax (GST) in IndiaRefund of Unutilised Input Tax Credit cannot be claimed on Input Services

September 14, 20210

In the case of Union of India v. VKC Footsteps India Pvt. Ltd. [Civil Appeal No 4810 of 2021], the Supreme Court held that refund of unutilized input tax credit cannot be claimed on input services.

FACTS

The present case pertains to refund of unutilized Input Tax Credit (ITC) on input services arising out of Inverted Duty Structure under Goods and Services tax (GST).

In the present case, Writ Petitions were filed by the Respondents under Article 226 of the Constitution of India which were instituted before the High Court of Gujarat and Madras (together referred to as High Courts) regarding Section 54(3) of the Central Goods and Service Tax Act, 2017 (CGST Act). Section 54(3) of the CGST Act provides for refund of unutilised ITC in different cases.

Before the High Courts, the Respondents submitted that Section 54(3) of the CGST Act allows for a refund of ITC where the accumulation is due to an inverted duty structure.

The Respondents further submitted that Section 54(3) of the CGST Act does not restrict the entitlement of refund only to unutilised ITC which is accumulated due to the rate of tax on inputs being higher than the rate of tax on output supplies. Section 54 (3) of the CGST Act also allows for refund of unutilised ITC when the rate of tax on input services is higher than the rate of tax on output supplies.

The Respondents stated that, while Section 54(3) of the CGST Act allows for a refund of ITC originating in inputs as well as input services, Rule 89(5) of the Central Goods and Services Tax Rules, 2017 (CGST Rules) is ultra vires in so far as the Rule excludes tax on input services from the purview of the formula.

The High Court of Gujarat in the case VKC Footsteps India Pvt. Ltd. v. Union of India [R/ Special Civil Application No. 2792 of 2019] (VKC Case) 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.”

The High Court of Gujarat considered unutilised ITC on input services as part of “Net ITC” for the purpose of calculating refund in terms of Rule 89(5) of the CGST Rules, in furtherance of Section 54(3) of the CGST Act.

The High Court of Gujarat considered unutilised ITC on input services as part of “Net ITC” for the purpose of calculating refund in terms of Rule 89(5) of the CGST Rules, in furtherance of Section 54(3) of the CGST Act.

The High Court of Madras in the case Tvl. Transtonnelstroy Afcons Joint Venture v. Union of India [Writ Petition Nos 8596, 8597, 8602, 8603, 8605 and 8608 of 2019] (‘Tvl. Transtonnelstroy case‘) has contradicted the decision of the Gujarat High Court and held that Section 54(3)(ii) of the CGST Act does not infringe Article 14 of the Constitution of India.

The Madras High Court also held that

“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.”

Since the views of the High Courts were divergent on the issue in the Writ Petitions, this divergence forms the subject matter of the Appeal filed before the Supreme Court.

ISSUE BEFORE THE SUPREME COURT

Whether Rule 89(5) of the CGST Rules is ultra vires to the provision of Section 54(3) of the CGST Act

CONTENTIONS OF THE PARTIES

The Appellants assailed the correctness of the decision of the Gujarat High Court, and supported the decision of Madras High Court.

The Appellants contended that the terms ‘goods’ and ‘services’, and ‘inputs’ and ‘input services’ have distinct definitions and interpretations under the Constitution of India and under the CGST Act. The Appellants further contended that taxes on input goods and input services are to be integrated to enable credit on a single pool for further cross utilisation on both goods and services.

The Appellants pleaded that the provisos to Section 54(3) of the CGST Act should be construed as restrictions, and not conditions or qualifications as the provisos contain restrictive or negative expressions which limit the ambit of refund under Section 54(3).

The Appellants submitted that the right to refund of taxes is neither a fundamental nor constitutional right. The Constitution of India only guarantees the legal imposition of taxes and collection is accordance with law. Refund is a matter of statutory prescription which can be subject to conditions and limitations.

The Appellants placed reliance on the judgment of the nine judges Bench in Mafatlal Industries Limited v. Union of India [1997 (5) SCC 536] wherein it was held that the right to refund is not automatic; and that the burden of proof to establish that the refund would not cause unjust enrichment lies on the Claimant.

The Respondents contended that the Rule 89(5) of the CGST Rules as originally enacted provided for refund of ITC availed on both inputs, i.e., input goods and input services; and was in line with Section 54(3) of the CGST Act.

The Respondents submitted that Rule 89(5) of the CGST Rules to the extent, to which it denies refund of ITC relatable to input services, is ultra vires Section 54 of the CGST Act.

The Respondents emphasised that GST is a destination-based consumption tax levied on value addition, where the ultimate tax liability is borne by the final consumer.

The Respondents placed reliance on the judgment the Supreme Court in All India Federation of Tax Practitioners v. Union of India [2007 (7) SCC 527] wherein it was held that excise duty, service tax and value added tax legislation are destination-based consumption taxes which are levied on value addition.

The Respondents further submitted that a situation where input taxes are higher than the output tax is an aberration and is against the concept of GST, where tax is levied on consumption on the end consumer. However, such aberration may arise in two situations, first, where the tax on intermediate products is lower; and second, where the tax on intermediate products is higher. The Government may also levy less tax on certain products in public interest, which may lead to accumulation of unutilised ITC. The object of the Government is frustrated if the inputs for such products are taxed at a higher rate and no refund of unutilised credit is granted.

The Respondents contended that Rule 89(5) of CGST Rules cuts down the scope of Section 54(3) of the CGST Act, and hence is ultra vires. The Respondents submitted that the power of issuing Rules under Section 164(1) of the CGST Act is to execute the provisions of CGST Act, and not to affront them.

Respondents pleaded that the definition of ‘unutilised ITC’ under Section 2(62) and 2(63) of the CGST Act includes both goods and services. Further, Section 54(3) of the principal legislation of CGST Act, without Rule 89(5) of the delegated legislation of CGST Rules, provides for the refund of ITC of both the input and input services. Hence, the delegated legislation of CGST Rules restricts Section 54(3) of the CGST Act, and hence is liable to be struck down as ultra vires to the CGST Act.

The Respondents submitted that the objective of Section 54(3) of the CGST Act is to enforce doctrine of equivalence and neutrality. The CGST Act beholds the conditions and restrictions to be distinct. Moreover, the Parliament could have created separate provision for zero rated supplies and domestic supplies if the proviso was meant to address the amount of refund.

The Respondents also submitted that tax credited to the electronic ledger forms a combined credit pool, which cannot be separated on the basis of credit of input and credit of input services. Hence, it is impossible to determine the origin of unabsorbed ITC.

DECISION AND FINDINGS

The Supreme Court upheld the Judgment of the Madras High Court in the Tvl. Transtonnelstory Case by dismissing the appeals challenging the said Judgment and allowed the appeals by the Union of India against the Judgment of the Gujarat High Court in the VKC Case.

The Supreme Court while upholding the validity of Rule 89(5) of the CGST Rules read with Section 54(3)(ii) of the CGST Act also observed that justification of the formula under Rule 89(5) of the CGST Rules to create a legal bifurcation is valid and the use of such formulae is a familiar terrain in fiscal legislation including the delegated legislation and is not ultra vires.

The Supreme Court held 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. While a similar formula is provided in Rule 89(4) with regard to zero rated supplies, in that case, the ‘Net ITC’ includes input goods and input services and thus, there is no imbalance between the different components of the formula.”

The Supreme Court further observed that the purpose of the formula in Rule 89(5) of the CGST Rules is to give effect to Section 54(3)(ii) of the CGST Act, which differentiates between input goods and input services for the purpose of granting a refund. Once the principle underlying Section 54(3)(ii) of the CGST Act is upheld, the formula cannot be struck down simply for carrying it out.

The Supreme Court held that it shall not allow itself to become a one-time arbiter of any and every anomaly of a fiscal regime in the exercise of its judicial review power, despite meeting the jurisdictional framework for the validity of the legislation, including the delegated legislation;

“We are affirmatively of the view that this Court should not in the exercise of the power of judicial review allow itself to become a one-time arbiter of any and every anomaly of a fiscal regime despite its meeting the jurisdictional framework for the validity of the legislation, including delegated legislation.”

Further, it held that the Supreme Court only steps into such matters to read down or interpret a formula in case the end result of application of such formula is absurd. The Court accordingly relied upon the ruling of  Arun Kumar and Others v. Union of India-(2007) 1 SCC 732 on reading down of a statute;

“But it is equally well settled that if the provision of law is explicitly clear, language unambiguous and interpretation leaves no room for more than one construction, it has to be read as it is. In that case, the provision of law has to be tested on the touchstone of the relevant provisions of law or of the Constitution and it is not open to a court to invoke the doctrine of “reading down” with a view to save the statute from declaring it ultra vires by carrying it to the point of “perverting the purposes of the statute.”

In the present set of facts, the formula under contention is neither ambiguous in nature nor unworkable.It affirmed that the said formula under Rule 89(5) of the CGST Rules does not oppose the intent of the Legislature in granting limited refund on accumulation of unutilized ITC.

AMLEGALS REMARKS

The Supreme Court, through this decision, upheld the validity of Rule 89(5) of the CGST Rules and observed that although the formula for refund under Rule 89(5) of the CGST Rules suffers from anomalies, it cannot be a ground to strike down Rule 89(5) of the CGST Rules framed in exercise of the power of delegated legislation.

By virtue of this judgment, numerous debates surrounding the restriction imposed by Rule 89(5) of the CGST Rules on Section 54(3) of the CGST Act have been settled.

The Supreme Court also addressed the contradiction raised in the decisions of the Madras High Court and the Gujarat High Court regarding the validity of Rule 89(5) of the CGST Rules. However, it affirmed the view of the Madras High Court in the Tvl. Transtonnelstroy Case and disapproved the opinion of the Gujarat High Court in the VKC Case.

Though the Supreme Court has not endorsed the availment of refund on unutilised ITC on input services but it has strongly advised the GST Council to reconsider the formula under Rule 89(5) of the CGST Rules and issue a policy decision in this regard.

This order can have far reaching impact on the industry and perhaps GST Council will address the issue to remove such anomaly otherwise the intent of creating a seamless ecosystem under GST will be greatly hampered.

– Team AMLEGALS, assisted by Ms. Akshita Bansal, Ms. Chhavi Sompura and Ms. Raashi Goyal (Interns)


For any query or feedback, please feel free to connect with aditi.tiwari@amlegals.com or  riddhi.dutta@amlegals.com

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