NOVEMBER 25, 2019

By Jigar Doshi

THE refund of input tax credit under inverted duty structure is governed by the provisions of Section 54(3) of CGST Act, 2017 read with Rule 89(5) of CGST Rules, 2017.

In April 2018, Rule 89(5) of CGST Rules was amended vide Notification No. 21/2018-CT dated April 18, 2018, which was made effective retrospectively from July 1, 2017 vide Notification No. 26/2018-CT dated June 13, 2018.

The amendments essentially aimed at following changes in the scheme of refund for inverted duty structure –

(a)  Extension of benefit to outward supplies of 'services'. Prior thereto, the formula for computing maximum refund amount only considered the turnover of supply of 'goods'.

(b)   Exclusion of 'input services' from the definition of 'Net ITC'. Prior to amendment, the definition was borrowed from Rule 89(4), which included within its ambit 'inputs' and 'input services'.

Industry concern:

The ineligibility to refund of input services which generally attract 18% GST, under the inverted duty structure scenario, where the resultant goods are chargeable at 5%, results in accumulation of input tax credit in the books. The inability to fully set-off the credit vis-à-vis output GST liability, in turn, blocks the working capital for registered persons and eventually, in cases were the credit remains unutilised, they are required to factor the same in the production costs, thereby increasing the prices of final products.

For the pharmaceutical industry whose primary objective is to deliver low cost health-saving vaccines and drugs, absorbing the cost of higher rated inward supplies (particularly services) becomes cumbersome. This seems to be against the basic principle of GST, i.e. seamless flow of credit at each stage, as envisaged in the Statement of Objects and Reasons of CGST Bill, 2017. Moreover, the inverted duty structure should not differentiate between sectors which are heavily dependent on inputs vis-à-vis sectors that require substantial input services.

A case for grant of refund can be made on the following grounds:

1.   Entitlement to Input Tax Credit

The GST law has extended the scope for availment of input tax credit in respect of supplies used in the course or furtherance of business (subject to blocked credit & reversals in specified cases), unlike the erstwhile indirect tax regime.

Hence, a similar treatment should be provided so as to allow the refund of otherwise eligible credit which remains unutilised owing to tax rate for output supplies being lower than that for inward supplies (except nil rated or fully exempt or notified exceptions).

2.   Refund scheme under GST law

As per Section 54, refund of unutilised input tax credit can be claimed in two instances, as stated above. In case of inverted duty structure, the section provides sweeping benefit on entire unutilised balance of input tax credit without any discrimination between inputs, input services and capital goods.

The first proviso to Section 54(3) reads as follows -

"Provided that no refund of unutilised input tax credit shall be allowed in cases other than ––

(i) zero rated supplies made without payment of tax;

(ii) where the credit has accumulated on account of rate of tax on inputs being higher than the rate of tax on output supplies (other than nil rated or fully exempt supplies), except supplies of goods or services or both as may be notified by the Government on the recommendations of the Council:"

As per the said proviso, the test required to be fulfilled is that input tax credit accumulation is on account of rate of tax on inputs being higher than rate of tax on outward supplies. The said proviso, thus, does not limit the refund only to inputs.

In the event the statute intended to impose certain conditions or restrictions on the quantum of refund to be granted, the provision itself would have expressly provided the same. Alternatively, the CGST Act would provide specific stipulation to the effect that condition prescribed in CGST Rules should apply for determining the amount of refund. However, Section 54(3) in no manner provides or stipulates that the refund would be granted subject to restrictions specified in the Rules.

In the case of Shabnam Petrofils Pvt. Ltd. vs. Union of India - 2019-TIOL-1656-HC-AHM-GST , the Hon'ble Gujarat High Court, while considering the challenge to the validity of Notification No. 20/2018-CT (R) dated July 26, 2018¹, has observed that Section 54(3) does not inherently empower the Government to provide for lapsing of unutilised credit accumulated on account of inverted duty structure. Accordingly, it held that since it is a trite law that delegated legislation must be in conformity with the provisions of parent statute, Notification No. 5/2017-CT (R) dated June 28, 2017 as amended by Notification No. 20/2018-CT (R) exceeded the power delegated under Section 54(3)(ii) of the Act.

3. Sector specific relief

The Government and the GST Council have found solutions to sector-specific problems and provided reprieve in the past two years of GST regime. Relief has particularly been granted to the pharmaceutical industry, an organised sector, by way of clarifications on GST implications as well as guidelines on various aspects.

One such example is the recent Notification No. 4/2019-IT dated September 30, 2019 specifying the place of supply of specified Research & Development services related to pharmaceutical sector as per Section 13(13) of the IGST Act, 2017

Given the above, the Government/GST Council could consider extending the benefit of refund of unutilised input tax credit of input services specifically to the pharmaceutical industry where medicines/vaccines/drugs are exigible to lower GST rate of 5%.

4.   National Health Mission

India is among the countries with highest expenses on health care. Expenditure on drugs constitutes over 67% of expenditure on health care² . As part of the NHM's effort at strengthening the health system to enable increased access and coverage, the Government of India has introduced the Free Essential Drugs initiative. The key goal of the initiative is to eliminate cost barriers to drug availability for the poor and improve quality in public health facilities.

Hence, to ably support the Ministry of Health and Family Welfare's vision and endeavour to improve the public health system of the country, it becomes imperative to mitigate the adverse impact GST may have on the pharmaceutical industry. One such impact is the inability to utilise the input tax credit in entirety towards discharge of output liability.

5.   Global outlook

The World Health Organisation's (WHO) Guideline on Country Pharmaceutical Pricing Policies³ recommends inter alia that countries should reduce the taxes on medicines which would consequently have the effect of reducing costs to the patient/purchaser. The WHO Expert Panel has referred to WHO/HAI policy review which highlights that indirect taxes on medicines, such as sales tax or VAT, are regressive and therefore inequitable, since the amount paid is a percentage of price and is the same for everyone, rich or poor.

Many countries use a lower VAT rate on medicines than the standard VAT rate. For instance, countries like Ireland, Malta, Nigeria, Saudi Arabia, Sweden, and United Kingdom have zero rated the VAT on medicines/pharmaceutical products.

While in India, the GST rate varies between Nil, 5% and 12% on pharmaceutical products, the cost of production remains relatively high owing to non-utilisation of input tax credit. Therefore, it would be expedient to align with WHO's guidelines and provide the medicines/vaccines/drugs at reduced costs to the patient/purchaser. Refund of credit pertaining to input services is an optimum way of doing so.

6.  Issue subjected to judicial scrutiny

It would be worthwhile to note that this issue has also been subjected to judicial scrutiny by aggrieved taxpayers, with several writ petitions having been filed and admitted before Hon'ble High Courts.Some of such instances include –

Quarry Owners Association - 2019-TIOL-1726-HC-AHM-GST

Shree Rama Newsprint Limited - 2018-TIOL-2865-HC-AHM-GST

Raymond UCO Denim Private Limited - 2019-TIOL-1900-HC-MUM-GST

The issue has been referred to the Maharashtra Authority for Advance Ruling in the case of Daewoo-TPL JV - 2019-TIOL-233-AAR-GST . While the advance ruling answers the question in the negative, it would be prudent to note that in terms of Section 103of CGST Act, the ruling is not binding on the industry at large.

Recommendation:

Given the aforesaid rationale, the Government should grant refund of input services credit under inverted duty structure, for the pharmaceutical sector and or vaccines covered under HSN Code 3002.

In this respect, legislature could suitably amend the definition of "Net ITC" as appearing in Explanation (a) to Rule 89(5) of CGST Rules to include input tax credit availed on input services during the relevant period, with prospective effect (if not retrospectively from July 1, 2017).

Alternatively, the Government may allow the past refund claims filed prior to the amendment and accordance of retrospective effect vide Notification Nos. 21/2018-CT and 26/2018-CT respectively.

(The author is Executive Director, SKP and the article has been co-authored by Aditya Nadkarni, Manager.)

¹ Notification mandates that the accumulated Input Tax Credit lying unutilized in balance in respect of certain specified goods, after payment of tax for and upto July 31, 2018 on inward supplies received upto such date, would lapse.

² http://nhsrcindia.org/sites/default/files/Operational%20Guidelines%20-%20Free%20Drugs%20Service%20Initiative.pdf

³https://apps.who.int/medicinedocs/documents/s21016en/s21016en.pdf