Indirect Tax Alert

Section 54 of the CGST Act, 2017 (the Act) provides for ‘refund of tax’. Second proviso to Section 54(3) embodies a provision for refund of unutilised ITC in cases involving credit accumulation ‘on account of rate of tax on inputs being higher than rate of tax on output supplies’.

Rule 89(5) provides a formula for the refund of ITC, in case of ‘refund on account of inverted duty structure’. The said formula limits scope of refund on ‘Net ITC’. In defining the expression ‘Net ITC’, Rule 89(5) speaks of ‘input tax credit availed on inputs’ and without reference to ‘services’ thereby confining the refund only on unutilised ITC of inputs.

On account of the above restriction on unutilised ITC of input services, Writ petitions were filed before the High Courts of Gujarat as well as Madras. Interestingly each Court pronounced divergent judgments on the same matter.

On one hand the Gujarat High Court held that by prescribing a formula in Rule 89(5) of the Rules to execute the refund of unutilised input tax credit accumulated on account of input services, the delegate of the legislature had acted contrary to the provisions of Section 54(3) of the Act, which provides for a claim of refund of any unutilized ITC.
On the other hand, the Madras High Court had upheld the vires of Section 54(3) and concluded 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 ITC that accumulated on account of input services is a valid classification and a valid exercise of legislative power.

The issue was appealed before the Supreme Court on account of the appeals filed against the aforesaid contradictory judgments of the respective High Courts. The Apex Court identified that the crux of the dispute in the case pertains to interpretation of Section 54(3). The fulcrum of the argument of the assessees is that clause (ii) of the first proviso of Section 54(3) prescribes a condition of eligibility and not a restriction on the entitlement to refund. Based on analysis of the provisions as well as the constitutionality, the Court made the following observations in so far as Section 54(3) is concerned:

The Court while interpreting the provisions of Section 54(3) must give effect to its plain terms. The Court cannot redraw legislative boundaries based on an ideal which the law was intended to pursue. Fiscal policy ought not be dictated through the judgments of the High Courts or this Court, for it is not the function of the Court.
If the legislature has intended that the equivalence between goods and services should be progressively realized and that for the purpose of determining whether refund should be provided, a restriction of the kind which has been imposed in clause (ii) of the proviso should be enacted, it lies within the realm of policy.
Parliament while enacting Section 54(3) has stipulated that no refund of unutilized ITC shall be allowed other than in the two specific situations envisaged in clauses (i) and (ii) of the first proviso. While clause (i) has dealt with zero rated supplies made without the payment of tax, clause (ii), which governs domestic supplies, has envisaged a more restricted ambit where the credit has accumulated on account of the rate of tax on inputs being higher than the rate of tax on output supplies. While the CGST Act defines the expression ‘input’ in Section 2(59) by bracketing it with goods other than capital goods, it is true that the plural expression ‘inputs’ has not been specifically defined. But there is no reason why the ordinary principle of construing the plural in the same plane as the singular should not be applied. To construe ‘inputs’ so as to include both input goods and input services would do violence to the provisions of Section 54(3).
The submission that registered persons constitute a class within the meaning of Section 54(3) and each of them is entitled to claim a refund of unutilised ITC whether its origin lies in input goods or input services. In other words, it has been urged that Section 54(3) constitutes one homogenous class of registered persons who have unutilized ITC. The fallacy of the argument is in the hypothesis that unutilised ITC cannot be unbundled for the purpose of fiscal legislation. In an ideal tax regime, with a uniform rate of taxes on inputs goods, input services and outward supplies, the chance of accumulating unutilised ITC as a result of an inverted rate structure would be minimal. An inverted duty structure arises where the rate of tax on inputs exceeds the rate of tax on output supplies as a result of which the unutilised ITC may get accumulated. The jurisprudential material which has been relied upon by the assesses portrays an ideal state of GST legislation.
The proviso to Section 54(3) is not a condition of eligibility, but a restriction which must govern the grant of refund under Section 54(3).
In enacting a provision, Parliament is entitled to make policy choices and adopt appropriate classifications, given the latitude which our constitutional jurisprudence allows it in matters involving tax legislation and to provide for exemptions, concessions and benefits on terms, as it considers appropriate.
When there is neither a constitutional guarantee nor a statutory entitlement to refund, the submission that goods and services must necessarily be treated at par on a matter of a refund of unutilised ITC cannot be accepted. Such an interpretation, if carried to its logical conclusion would involve unforeseen consequences, circumscribing the legislative discretion of Parliament to fashion the rate of tax, concessions and exemptions. If the judiciary were to do so, it would run the risk of encroaching upon legislative choices, and on policy decisions which are the prerogative of the executive.

The Apex Court also made detailed analysis on the vires of Rule 89(5) of the CGST Rules and made the following observations:

Section 164(1) confers an express power on the Central Government to make rules for carrying out the provisions of the Act on the recommendations of the GST Council. It may be true that in certain specific statutory provisions, the Act recognizes, by using the expression ‘prescribes’, that rules may be framed for that purpose. But the converse cannot be assumed inferentially, by presuming that in other areas, recourse to the rule making power cannot be taken. By its very nature, a statutory provision may not visualize every eventuality which may arise in implementing the provisions of the Act. Hence it is open to the rule making authority to frame rules, so long as they are consistent with the provisions of the parent enactment. The rules may interstitially fill-up gaps which are unattended in the main legislation or introduce provisions for implementing the legislation.
Rule 89(5) in defining Net ITC to mean “input tax credit availed on inputs” does not transgress the statutory restriction which is contained in proviso (ii) of Section 54(3). The challenge to Rule 89(5) as a piece of delegated legislation on the ground that it is ultra vires Clause (ii) of the first proviso to Section 54(3) is therefore lacking in substance.
The formula prescribed in Rule 89(5) seeks to identify the quantum of ITC availed on input goods. The use of such formulae is a familiar terrain in fiscal legislation including delegated legislation under parent norms and is neither untoward nor ultra vires.
The purpose of the formula in Rule 89(5) is to give effect to Section 54(3)(ii) which makes a distinction between input goods and input services for grant of refund. Once the principle behind Section 54(3)(ii) of the CGST Act is upheld, the formula cannot be struck down merely for giving effect to the same.

It is interesting to note that while the Court has upheld the constitutional validity of the Rule, the Court has recognised the anomaly of the formula and observed that practical effect of the formula might result in certain inequities. It has urged the GST council to reconsider the formula and take a policy decision.

The formula prescribed in Rule 89(5), seeks to deduct the total output tax from only one component of the ITC, namely ITC on input goods. This is at odds with reality, where the ITC on both input goods and input services is accumulated in the electronic ledger and is then utilised for the payment of output tax. In making such an assumption, the formula tilts the balance in favour of the revenue by reducing the refund granted.
Further, prescribing an order of utilisation of the ITC accumulated on input services and input goods, may tilt the balance entirely in favour of the assessee as that would make a contrary assumption that the output tax is discharged by the ITC accumulated on account of input services entirely.
Another possible solution could be that the Rule itself provides for a statutory assumption or a deeming fiction of utilisation of a certain percentage of ITC on input services towards the payment of output tax for the purpose of calculation of refund.
The reading down of the formula as proposed by assessees by prescribing an order of utilisation would take this Court down the path of recrafting the formula and walk into the shoes of the executive or the legislature, which is impermissible.

Refund claim of unutilised input tax credit pertaining to input services, on account of inverted duty structure was a highly debatable issue, especially with two divergent judgments of two separate High courts. The Apex Court may have denied the refund of ITC on input services in case of inverted duty structure, however the observations on the anomaly in the prescribed formula, may go a long way in taking up the matter before the GST council to frame a fair proposition.

[Union of India and Others Vs. VKC Footsteps India Private Limited (2021-TIOL-237-SC-GST)]

Subscribe to receive the latest BDO News and Insights

Please fill out the following form to access the download.