JUNE 22, 2019

By Krishnamachari Srinivasan, IRS (Retd.)

WHETHER Capitalization should be according to accounting standards as envisioned in the GST Act as per Sec 17(5) or is it a mere treatment in account, which cannot have a say in deciding admissibility of ITC?

Whether all construction activity, if not capitalized, would be disallowed for ITC?

Examples: Foundation is disallowed for ITC, but structures are allowed for ITC?

If foundation is not capitalized then will it be allowed, since it would appear to fall outside the scope of sec 17(5)?

No, it will still fall within the scope of Sec 17(5).

If company builds a wall, such wall is not going to be capitalized (i.e. expenses that occur in normal course which is considered revenue in nature) whether it will be allowed for ITC?

Perhaps not!

For the simple reason, it is part of an Immovable property.

If construction is disallowed for ITC, then if repair or reconstruction is done as per explanation to Section 17(5), then whether ITC would be allowed on the extent to which, the said expense is not capitalized to the said immovable property?

Further if such expenses are genuinely treated as revenue in nature?

The answer perhaps is again not, for the reason that it attracts the mischief of Sec 17(5), still.

Repairs may perhaps be specifically allowed, until it is not prohibited like in the case of repairs of motorcar, but not reconstruction.

That's why a small extent of such expense is still open to interpretation, if it can be proved satisfactorily, that it is not a capital expenditure and consequently eligible for ITC.

In a recent advance ruling in the case of Jabalpur Entertainment Complexes (P) Ltd. 2018-TIOL-169-AAR-GST, some of these issues happened to be considered, to which we can turn to below, to acquaint us with for some of their thoughts -

Whether ITC on GST paid on goods purchased in the course of maintenance such as ACP Sheets, Steel plates, TMT, TOR, Brick, Cement, Paint, Chemicals, Sanitary Wares & toilet accessories, can be claimed in full?

The purpose of procurement of the above said items are for the purpose of maintenance/ renovation of a Mall building, which is undoubtedly an immovable property.

Broadly speaking, the extant legislation i.e. CGST Act 2017 prohibits such ITC in terms of clause (d) of sec 17(5).

Capitalization of expenditures depends on the nature of the expenditure and the period of benefit from such expenditure.

Elucidation of the nature of expenditure i.e. capital or revenue must not be short but must be detailed.

Be that as it may.

Going by the text of the explanation, the ITC on the expenses to the extent not capitalized could be arguably allowed as ITC.

But the eligibility of ITC must not depend on the treatment given to the expenditure.

If the expenditure is revenue in nature but subsequently capitalized in the Books of account, it should not make it eligible for ITC on such goods.

Therefore, the ITC on such goods used in the maintenance/repair/renovation of an immovable property, Mall building in this example, shall not be available, ab initio .

What emerges from the key observations of the judgment, are as follows;

+ Explanation to sub- sec (5) of the sec 17 of the Act, defines the term "Construction" to encompass all the above activities to the extent of capitalization to immovable property".

+ It can be argued that ITC of materials used for maintenance can be claimed for ITC in full if the cost of maintenance is not capitalized, provided the said materials are used in Construction of a wall as addition, is in the form of repairs & maintenance to the existing building.

+ Expenses on construction/ maintenance/renovation/re-construction/repairs are in the nature of Capital expenditure. Notwithstanding the fact whether such expenses are capitalized in the books of accounts or not, ITC is not allowed.

The rationale that underlies the above discussion is the wording of sec 17(5) used in the explanation as, to the extent of capitalization, to the said immovable property of such expenses incurred would be disallowed as the same is construed as "Construction of the immovable property" itself, hence covered under its mischief, including its variant forms such as re-construction, renovation, addition, alteration or repairs.

Hence, the extent to which said expenses are not capitalized, is not at all a question and hence not to be read down the expression "expenses of revenue in nature" when incurred in relation to construction, repair, renovation, etc. to mean that same would then be allowed to ITC.

The extent to which capitalized, only suggests that the extent of such expenses are expected to be capitalized or else will be treated as capitalized to such immovable property directly connected with its maintenance, renovation, repair, reconstruction and the like kind/variants of construction.

The fact that the accounting convention is to capitalize such expenses, but one intends to treat it as a revenue expenditure, does not appear to have any consideration or bearing on the Act, to decide the allowability of ITC.

Such expenses are capital in nature always and, therefore, to the extent capitalized, is an expression to encompass not only the above activity connected with the Immovable property but also the ineligible nature of the ITC involved thereon, for disallowance under the said clause (d) of sec 17(5) of the Act, even if treated as revenue expenditure in the account books at one's own instance.

Further, it would be highly advisable not to go on with this new form of concurrent litigation practice of seeking opinions of the AAR/AAAR and creating unwanted adverse jurisprudence against one's own business, is the humble view of the Author.

I must think that it would rather splendidly do with a sound legal opinion, when in doubt, as obtained by trade and industry in the past, as the latter is not any less sacrosanct than the former.

(The Author is a Former Assistant Commissioner of GST, Chennai and a CBIC Master Trainer GST, and currently a Senior Associate, Indirect & Corporate Taxes, at a Chennai-based Law Firm, RANK Associates. The views of the Author are purely personal.)