Supreme Court clarifies GST input tax credit can be claimed on construction for rental services

A bench comprising Justices Abhay Oka and Sanjay Karol noted that the functionality test must be applied on a case-by-case basis to determine whether a building qualifies as a plant for tax purposes.

The Supreme Court of India ruled  that if a building’s construction is essential for providing services like leasing or renting, it could fall under the ‘plant’ exception to Section 17(5)(d) of the CGST Act. This section typically prohibits claiming Input Tax Credit (ITC) for construction materials used in the construction of immovable property, except for plant and machinery.

The Court clarified, “If the construction of a building is essential for the activity of supplying services like renting or leasing, as outlined in clauses 2 and 5 of Schedule 2 of the CGST Act, the building may be considered a plant. A functionality test must be applied to determine if the building qualifies as a plant.” 
A bench comprising Justices Abhay Oka and Sanjay Karol noted that the functionality test must be applied on a case-by-case basis to determine whether a building qualifies as a plant for tax purposes.

“The Orissa High Court’s ruling in the Safari Retreats case marks a significant development regarding input tax credit for immovable properties. Despite Section 17(5)(d) of the CGST Act restricting credits for construction of immovable properties, the Court allowed input tax credit for inputs used in constructing a mall. This decision emphasises the functional use of these structures across various industries—malls, ports, airports, hotels, and multiplexes—where their absence would hinder business operations,” Gyanendra Tripathi, Partner & Leader (West), Indirect Tax at BDO India, said.

No need to read down Section 17(5)(d)

The Court held that Section 17(5)(d) of the CGST Act need not be interpreted differently to exclude cases where immovable property is built for rental purposes. The challenge to Section 17(5)(d) was rejected, and the case was remitted to the High Court to decide whether the “plant” exception applies, potentially allowing the petitioner to claim ITC. A detailed judgment is awaited.

Orissa High Court’s 2019 judgment

In 2019, the Orissa High Court had ruled that ITC for construction materials cannot be denied under Section 17(5)(d) of the CGST Act, 2017, for developers constructing properties for renting out.

Section 17(5)(d) specifies that ITC is not available on goods and services used to construct immovable property (excluding plant and machinery) for the builder’s own use, even if such goods or services are used for business purposes.

Background of the case

The petitioners, M/s. Safari Retreats Pvt. Ltd. and another, constructed a shopping mall in Bhubaneswar with the intent of leasing it to tenants. To build the mall, they incurred expenses on goods and services such as cement, steel, air-conditioning systems, and architectural services, and paid GST on these purchases. They sought to claim ITC of Rs. 34.4 crores on the GST paid to offset their GST liability from rental income. However, tax authorities denied the ITC based on Section 17(5)(d) of the CGST and OGST Acts, which restricts ITC for goods and services used in the construction of immovable property for one’s own account.

Key legal issue

The primary issue before the court was whether the petitioners were entitled to claim ITC for GST paid on goods and services used to construct a shopping mall that was intended for rental purposes, under Section 17(5)(d) of the CGST Act.

Orissa HC’s analysis of ITC and cascading effect

The Orissa High Court observed that the CGST Act was designed to eliminate the cascading effect of taxes by allowing ITC. It follows the VAT principle, allowing taxpayers to offset input taxes against output taxes. Section 16 of the CGST and OGST Acts allows registered persons to claim ITC for goods or services used in the course or furtherance of business, subject to conditions in Section 49.

Double taxation and continuity of tax chain

The High Court noted that denying ITC in this case would result in double taxation, as GST was paid on both the inputs used to construct the mall and the rental income derived from the mall. Since the mall was built for rental purposes, not for sale, there was no break in the tax chain.

The HC held that the purpose of the GST regime is to prevent the cascading effect of taxes by allowing ITC. Denying ITC for properties constructed for rent contradicts the fundamental rationale of the GST system.

The HC ruled that Section 17(5)(d) should be interpreted in line with the purpose of the GST laws, which is to prevent the cascading effect of taxes. The provision, in its plain reading, was intended for properties constructed for sale, as GST is not applicable post-completion certificate. Applying it to rental properties would lead to unfair outcomes.

Violation of Article 14 and classification of properties

The High Court further noted that denying ITC in this case violated the petitioners’ fundamental right to equality under Article 14 of the Constitution. It argued that differentiating between properties constructed for sale and rental purposes was necessary, as the current classification unjustly favored some taxpayers while penalizing others with similar business activities.

The court also noted that denying ITC would make newly constructed rental properties less competitive compared to older properties, adversely affecting the developers’ business. 

The Orissa HC read down Section 17(5)(d) to exclude rental properties from its scope, entitling the petitioners to claim ITC for the GST paid on goods and services used in constructing the shopping mall intended for rent.

Source:-  Financial Express