AUGUST 10, 2020

By Jigar Doshi and Pratik Shah

THE HC has in the case of VKC Footsteps India Private Limited vs Union of India - 2020-TIOL-1273-HC-AHM-GST provided enormous relief to the taxpayers operating in industries facing Inverted Duty Structure (IDS) by allowing refund of Input Tax Credit (ITC) pertaining to input services.

While there are several writ petitions filed on the same matter before different courts, this is the first instance where the Court has reached a conclusion and pronounced a ruling. Similar matter questioning vires of Rule 89(5) of CGST Rules, 2017 have also been discussed in the following cases -

+ Shree Rama Newsprint Ltd. vs UOI - 2018-TIOL-2865-HC-AHM-GST

+ Quarry Owners Association vs. Union of India - 2019-TIOL-1726-HC-AHM-GST

+ Raymond UCO Denim P. Ltd vs UOI - 2019-TIOL-1900-HC-MUM-GST

In the present case, Gujarat HC has held the explanation to Rule 89(5) of CGST Rules, 2017 as ultra vires to Section 54(3) of CGST Act, 2017, and expressed a view stating that rules cannot override the law; while amending the rules, the Government should take cognizance of the Statute and its interpretations. Basis this pronouncement, the aggrieved parties in the aforementioned cases are sure to approach respective HCs with additional submissions.

Our top 7 takeaways from this landmark ruling are below -

1. Rules are subordinate to Statute : In India, the Parliament has the power to make and pass laws. The Executive have been entrusted with the responsibility of implementing them, and the Judiciary is assigned with the task of interpreting a law. Rules framed under the law are legally known as subordinate legislations. Such subordinate legislations are formed to aid the primary legislation. In the present case, CGST Act, 2017 is the primary legislation. Any rules framed thereunder are subordinate legislations. The term subordinate legislations itself gives out the fact that rules are secondary in nature when compared with the Statute. Therefore, rules need to be aligned with the Statute and fulfil the objectives of a Statute. They cannot restrict or limit benefits granted by the Statute. Further, unless the statute gives out the power to frame rules, such rule may not be valid. In the instant scenario, Section 54 does not give a reference to in the statute to prescribe rules. Thus, whether Rule 89(5) of CGST Rules, 2017 is valid and effective needs an answer. The HC read down the rule partially, but did not comment on this aspect.

2. Horizon of Sec. 164 for making rules : Recently, the powers of Government to frame and enact retrospective rules has been talk of the town. Section 164 gives a blanket power to the Government to frame rules for all or any of the provisions of the Act. Further, this rule also provides a wide supremacy to the Government to enact such rules with retrospective effect, not earlier than the date when the Act came into force. The Statute, by the virtue of rule-making power directs the Government to carry out the provisions of the Act. The petitioner in the present case rightly pointed out that the rules are for the purpose of carrying out the provisions of the Act; not for the purpose of restricting the provisions of the Act. Thus, if the statute is granting any relief or benefits to a taxpayer, the rules cannot take it away.

3. Intelligible differentia needs to be maintained : Article 14 of the Constitution of India (COI) gives the right to every citizen to be equal before the law. Therefore, the COI does not favour any single person for any reason whatsoever. The guiding principle here is that all people in similar situations shall be treated alike; meaning if circumstances are different then people may be treated differently. The expression 'intelligible differentia' means a difference which is capable of being understood or a difference which is reasonable and justified. In the instant case, the HC found the differentia created by the rule, between inputs and input services as unintelligible. Therefore, as per the HC, since there was no reason to create a distinction between inputs and input services, such difference shall violate Article 14 of COI. Further, the petitioner also highlighted the dissimilarity suggested by such rule between zero-rated suppliers (i.e. exports and supplies to SEZ) and IDS suppliers contending that a parity needs to be maintained within the trade.

4. Reading of a statute in case of conflict: The HC gave specific importance to the scheme and object of GST Act in the said case. They opined that the intent of the scheme does not match with the interpretation specified in the Circular No. 79/53/2018-GST dated 31 December 2018 to deny the refund of unutilised credit pertaining to input services. Here, it is important to note that taxing statutes must follow the rule of strict interpretation; there is no equity in tax. However, when there are two reasonable interpretations possible, the one that favours the assessee must be accepted. Even if the revenue feels that 'tax on inputs' as given in the proviso, has to be read literally, one can point towards the text of the main section which reads - '54 (3) Subject to the provisions of sub-section (10), a registered person may claim refund of any unutilised input tax credit at the end of any tax period'. As discussed by the High Court, input tax credit is defined u/s 2(63) to mean credit of input tax. Input tax has been defined u/s 2(62) to mean tax charged on any supply of goods or services or both made to a registered person. From a combined reading of these provisions, it can be construed that the main Section 54(3) allows refund of unutilised credit pertaining to both inputs and input services. Therefore, the embargo created in the proviso can be said to be a reverse interpretation. Thus, this is a classic case where two reasonable interpretations are possible, and the one favouring the taxpayer (i.e. refund of both inputs and input services) should be accepted.

5. Sectors benefitting from the judgement: Typically, there are a quite a few sectors which suffer from the inverted duty structure. Of course, footwear being the subject in this case, a significant benefit is also expected for e-commerce industry as they avail significant amount of input services. Textile, solar and handloom are some other examples.

6. Feeling of déjà vu: This judgement gives a déjà vu feeling, as we experienced a similar feeling of respite, when the Delhi HC passed the Brand Equity Treaties judgement - 2020-TIOL-900-HC-DEL-GST [stayed by Supreme Court - 2020-TIOL-115-SC-GST-LB. However, sooner than one would have thought, the feeling of relief was washed away by the CBIC, when they introduced a retrospective Notification No.   43/2020-CT   dated 16/05/2020, by virtue of which the Delhi HC ruling along with other rulings on similar lines stood null and void. A similar outcome is expected in the Gujarat HC ruling as well. It is almost certain that the revenue will retrospectively amend Section 54(3) or shall knock the doors of Supreme Court. Revenue may approach Supreme Court, and which may be justified, as massive amounts are involved. Also, the judiciary being independent of the Executive in India, makes this a fair process.

7. Rightness of retrospective amendments: Retrospective amendments are now becoming a trend. The taxpayers when exasperated by the narrow interpretations of tax laws adopted by revenue, file writ petitions before the courts. The Courts analyses provisions of law and grievances of taxpayers to conclude whether the provision is ultra vires the law and needs to be read down. In case, the decision is in favour of the revenue, the matter gets settled. However, if in a case, the court gives a judgement favourable to the taxpayer, the revenue goes ahead and retrospectively amends the provision itself.

The Supreme Court in the case of The State of Karnataka vs The Karnataka Pawn Brokers Assn and others [Civil Appeal No. 2874-2878 of 2018] held that the legislature cannot overrule judgments by amending a law retrospectively, this will amount to violation of the principle of separation of powers among the three organs of the State, which is impermissible. The Hon'ble judges in the said judgement stated that the legislature could be amended to fix the loophole pointed by the courts, but the same cannot be done retrospectively as the same would nullify the judgement. In 2014, the Constitutional Bench of Supreme Court in the case of CIT vs Vatika Township Private Limited - 2014-TIOL-78-SC-IT-CB discussed retrospective amendments at length. The Constitutional Bench held that "If a legislation confers a benefit on some persons but without inflicting a corresponding detriment on some other person or on the public generally, and where to confer such benefit appears to have been the legislators object, then the presumption would be that such a legislation, giving it a purposive construction, would warrant it to be given a retrospective effect." There are plethora of judgements which have reiterated time and again that retrospective amendments should be made in the rarest of rare cases and to remove anomalies in law. The power to pass retrospective amendments has not been given to the Government to overturn the Court rulings and enhance their revenue base by denying the assesses their due benefits. This power must be used judiciously and not for the benefit of revenue.

Way forward

- For taxpayers who have not yet applied for refund under Inverted Duty Structure, may think about including unutilised credit pertaining to input services in their refund claim. However, in case, refund for 2017-18 has already been applied for, a taxpayer may try filing a manual refund application with respect to incremental credit pertaining to input services. The amount of refund involved would be humongous and hence it seems difficult that the past incremental refunds would be granted.

- The refund of unutilised credit of capital goods may also be explored. Considering that the same principle shall apply to capital goods, one may approach the High Court with the VKC footsteps precedent.

Author's note

While everybody is talking about the intent of the legislation, one thought needs to be given to the intent of the amendment also. Is the 2018 amendment which removes input services from the refund formula, a lacuna? Or is it a well-thought-of step taken by the Government? It doesn't seem that this is a flaw which was created mistakenly. In April 2018, the Notification to amend Rule 89(5) was issued. In June, 2018, it was made retrospective and the necessary clarification was issued in December 2018. Therefore, the GST Council took its own sweet time to think it through. Allowing refund of inputs only would in most cases help manufacturers as there are very few services providers who use inputs to render output service such as job-workers.

The issues that arises here is that why was input services removed from the formula. What are the criteria to fit into the box created by Rule 89(5) r/w Section 54(3)? The proviso to Section 54(3) reads as 'where the credit has accumulated on account of rate of tax on inputs being higher than the rate of tax on output supplies.' The role of a proviso is to limit the applicability of a Section. Thus, creating an exception from the main Section. A view could be taken that this proviso is doing the same. It is creating an exception from the main section (which reads - 'a registered person may claim refund of any unutilised input tax credit at the end of any tax period'). The main section allows refund of unutilised input tax credit; the proviso limits such refund in case of IDS, to tax on inputs only. Can it not be said that this was always the intent of law and was encrypted in the Statute since day one. The subsequent Notifications and Circulars were only clarificatory in nature and hence retrospective. The Sector affected by IDS has always been in the spotlight as far as GST Council is concerned. There have been innumerable discussions, representations and amendments to the rates and provisions affecting this sector. Therefore, it seems unlikely that the Council missed to fix this so-called anomaly. One possibility for denying refund of input services could be that the cost of inputs used is generally more or less fixed, depending on the quality used. However, the cost of input services may vary to a large extent and is subjective in nature.

While this could be one side of the coin, there is no denying that the law seems to be harsh for genuine suppliers on this front. Time and again, it has been discussed that credit is a vested right and the same cannot be taken away by any executive. In the present case, though the Government is allowing credit of input services to be availed by a supplier engaged in IDS supplies, the restriction is placed on the refund of such credit. Therefore, the contention that input tax credit is a vested right may not stand tall here. Having discussed both sides of the coin, we are hopeful that the pronouncement shall prevail and benefits can be reaped by the industry.

[The authors are Founding Partners at TMSL and the views expressed are strictly personal.]