AUGUST 24 , 2020

By Ms Dipti Nayak - Associate Director & Ms Sonal Kawdia - Manager, Grant Thornton India LLP

THE Goods and Services Tax (GST) was introduced in July 2017 to subsume the plethora of indirect taxes and replace the multiple system of taxation with single tax regime. The prime feature of GST system is to ensure uninterrupted and seamless chain of Input Tax Credit (ITC) and levy tax only on value addition.

The GST Act has prescribed multiple tax rates on supply of goods or services depending upon the nature of supply. However, there are instances wherein the rates of tax on inward supplies are higher than the rate of tax on outward supply. This has resulted in accumulation of ITC in taxpayer's electronic credit ledger and thereby blockage of working capital. Such situation has been referred as "Inverted Duty Structure" (IDS). This anomaly has been primarily witnessed in certain sectors such as textiles sector, fertilizers, e-commerce, mobiles, etc.

The issue of IDS has already been deliberated in GST council meetings and government is exploring various ways and means to address this anomaly in the law. In the long run, rationalization of tax rates seems to be the only viable solution. The government can consider a gradual increase in the output tax rates where inverted duty structure is applicable. Further, identifying major inputs leading to inverted duty structure and reduction in the tax rates for those inputs can also be done in a phased manner. Besides, reduction in present four-slab GST rates to three-slab GST rates would also help in correcting the inverted duty structure. An average tax rate can be worked out from present 5% and 12% tax rate. The government may also consider introducing Composition Scheme for such sectors with revenue neutral tax rate without ITC.

However, at this juncture, obtaining the refund is the only solution to this issue. The government has prescribed refund mechanism for unutilized ITC under inverted rate structure vide Section 54 of Central Goods and Services Tax (CGST), Act 2017. The formula for determining such refund on input and input services has been prescribed under Rule 89(5) of the CGST Rules, 2017. However, the formula for determining the refund amount was retrospectively amended ¹ restricting refund only on inputs (by deleting input services from the formula).

Implication of the Amendment - Rule 89(5)

Due to such amendment, the maximum amount of refund appears as follows:

Maximum Refund Amount = {(Turnover of inverted rated supply of goods and services) x Net ITC ÷ Adjusted Total Turnover} - tax payable on such inverted rated supply of goods and services.

Pursuant to the amendment, explanation for above formula has been substituted to include Net ITC mean input tax credit availed on inputs during the relevant period.

However, the refund enabling provision Section 54(3) states that ‘registered person may claim refund of any unutilized input tax credit'. Such provision grants refund on zero-rated supply and supply involving inverted rate structure. The question lies is when Section 54(3) of the CGST Act principally enables refund of any unutilised credit (including input services and capital goods), does Rule 89(5) have powers to go beyond the Act by restricting the refund to inputs only. The amendment has put the industries which are procuring input and input services at a disadvantage vis-à-vis the industries procuring only inputs.

Recently, the Honorable Gujarat High Court in case of VKC Footsteps India Private Limited - 2020-TIOL-1273-HC-AHM-GST has struck down the above provision which restricts the benefit of refund of ITC on inputs only and disallows the refund for tax credit relating to input services.

Brief background of the case - The petitioner, VKC Footsteps India Private Limited is engaged in the business of manufacture and supply of footwear, which attracts GST at the rate of 5%. The majority of inputs and input services used by the petitioner attracted GST at the rate of 12% or 18%, thereby resulting in accumulation of unutilised credit in electronic credit ledger on account of IDS. The tax authorities allowed refund of accumulated ITC of tax paid on inputs however, refund of accumulated ITC of tax paid on procurement of input services was denied.

The petitioner, therefore, challenged validity of the relevant provisions under the GST law to the extent it denies refund of ITC relatable to input services

Key Observations of Gujarat High Court -  

1. Refund cannot be restricted to inputs excluding input services: The scope of supply includes all forms of supply of goods or services, further, input tax means the tax charged on any supply of goods or services or both made to any registered person. The refund enabling provision of Section 54(3) of the CGST Act, 2017 specifically allows refund of any unutilized input tax credit (ITC). The term ‘ITC' means credit of Input Tax and the word ‘input' is defined as any goods other than capital goods. On conjoint reading of all the provision including the definition, input and input service both are part of input tax credit, thus, such refund claim cannot be restricted only to input.

2. Denial of refund for input services is violative of GST provisions: The denial of refund for ITC on input services is violative of the refund provisions prescribed under GST law, which entitles the registered person to claim refund of "any" unutilized ITC.

3. Rules cannot contradict the Act

Section 54(3) of the Act makes no distinction between Zero Rated Supply and IDS which allows refund of both inputs and input services. The law provides that a registered person can claim refund of "any unutilised input tax", therefore, by way of Rule 89(5) of the CGST Rules, 2017, such claim of the refund cannot be restricted only to "input" excluding the "input services". Thus, the explanation to Rule 89(5) denying refund of "unutilised input tax" paid on "input services" as part of "input tax credit" accumulated on account of inverted duty structure is ultra vires the provision of Section 54(3) of the CGST Act, 2017.

4. Refund of ITC of input services allowed - The HC stated that keeping in mind the scheme and object of the GST law, denying a registered person refund of tax paid on input services as part of refund of unutilized ITC cannot be the intent of law. The Gujarat HC directed the tax department to allow petitioner's refund claim considering the unutilised ITC of input services as part of the net ITC for the purpose of calculation of refund claim.

The above ruling has been a welcoming ruling for the taxpayers who are engaged in outward supply under IDS. However, its applicability on other taxpayers and whether the same is to be applied retrospectively still remains unanswered. Further, it will be interesting to observe the stance of the revenue as to whether they will move the Apex court against this judgment or consider making necessary amendments in the law.

Recently, writ petition has also been filed before Madras High Court challenging refund-denial on input services under inverted duty structure and it will be interesting to observe the final verdict of the court.

[The views expressed are strictly personal.]

¹vide Notification number 21/2018-CT dated 18 April 2018