SEPTEMBER 25, 2020

By Jigar Doshi & Rebecca Pinto

AFTER a batch of petitions were filed before the Madras High Court seeking refund of Input Tax Credit (ITC) in respect of input services used in supplies attracting Inverted Duty Structure (IDS), the HC recently passed a ruling - 2020-TIOL-1599-HC-MAD-GST and dismissed the petitions and the associated refund claims.

The Madras High Court in this defining judgement has held Rule 89(5) of the CGST Rules, 2017 as intra-vires Section 54 of the CGST Act, 2017 (the Act) and Section 54 as non-violative of Article 14 of the Constitution of India (CoI).

This comes after the much touted Gujarat HC decision in the case of VKC Footsteps India Private Limited v. UOI - 2020-TIOL-1273-HC-AHM-GST wherein the HC had held that the explanation to Rule 89(5) of CGST Rules, 2017 is ultra vires to Section 54(3) of CGST Act, 2017 , hence allowing refund of input services used in supplies made under IDS.

In brief, the issue revolves around refund of ITC pertaining to input services used in supplying output supplies attracting IDS. Section 54 and Rule 89 are the go-to provisions in refund cases. Notification no 21/2018-CT dated 18 April 2018 which prescribed revised formula (excluding input services) was enacted retrospectively w.e.f. 1 July 2017. Further, Circular no. 79/53/2018-GST dated 31 December 2018 also clarified that Section 54(3) of CGST Act, 2017 allows refund only in case where "credit has accumulated on account of rate of tax on inputs being higher than the rate of tax on output supplies." The circular stated that inputs do not include input services or capital goods. Therefore, no refund of the same shall be allowed. Plethora of writ petitions were filed before High Courts pleading to strike down the said amendment and allow refund pertaining to input services as well.

Top 5 Focal Points noted by the Madras High Court

The Madras HC in the case of Tvl. Transtonnelstroy AFCONS Joint Venture vs. UOI - 2020-TIOL-1599-HC-MAD-GST laid down 9 questions for its consideration:

1. Whether Section 54(3) is unconstitutional and infringes Article 14 of CoI?

2. Whether 'Inputs' as given in Section 54(3)(ii) encompasses both goods and services?

3. Whether 'Input services' can be read into 'Inputs' by reading down the statue?

4. Whether 'Input services' can be read into Section 54(3)(ii) as an exception to general rule of casus omissus ?

5. Whether proviso to Section 54(3) curtails the scope of the main section?

6. Whether the sub-clause (ii) only prescribes conditions to be eligible to claim refund or it also limits the entitlement to claim refund?

7. Does Section 164 empowers the Government to amend Rule 89(5)?

8. Is Rule 89(5) ultra vires Section 54(3)?

9. Net ITC as given in Rule 89(5) is to be read to include both input services and inputs?

The HC while pronouncing the verdict noted the 5 key points:

1. Reference to Gujarat HC judgement : The Madras HC at the outset analysed the judgement of Gujarat HC in the case of VKC Footsteps (supra) and noted that the Gujarat HC had failed to take into consideration the proviso to Section 54(3). It is not very common for one HC to discuss the ruling of another HC on a similar matter in its judgement. However, the Madras HC has painstakingly taken the effort to analyse and evaluate the views of Gujarat HC in the VKC judgement which needs appreciation.

2. Contextual and textual analysis of Section 54(3): The Court relied on various precedents to note the scope and functions of a proviso. It was observed that Section 54(3) enables a registered person to claim refund of unutilised ITC. However, the proviso to the said Section qualifies the enacting clause by providing a double negative. Thus, the proviso limits the source/type and consequently, quantity of unutilised ITC in respect of which refund is permissible. Proviso in this case performs a larger function of limiting the entitlement of refund. Thus, the Court concluded that Section 54(3) (ii) allows refund only of unutilised ITC to the extent of inputs and not input services. The Court opined that reading down a proviso means to narrow it further, not to expand its limits.

3. Legality of Rule 89(5): Section 164 of the Act confers power on the Government to frame Rules for carrying out the provisions of the Act. The said section does not limit these powers except that the Rules so framed should be in furtherance of the Act. Considering that the amended Rule 89(5) was in line with Section 54, the said rule was held to be intra vires. In fact, the Court went ahead to note that if the said Rule was not amended, it would then be ultra vires Section 54 as it would exceed the statute and would grant refund of unutilised ITC in respect of input services also which was not envisaged under Section 54.

4. Inputs includes input services: The High Court remarked that the definition of the term 'inputs' cannot be perceived as per common parlance when there is a statutory definition available in the law u/s 2(59) of the Act. Further, Section 54 at various places used the words inputs and input services distinctively and separately thereby indicating the legislative intent to distinguish one from the other. Therefore, the scope of inputs cannot be enlarged to include input services or capital goods.

5. Constitutionality of Section 54 in accordance with Article 14: The Court is required to begin the proceedings with a presumption that the statute is constitutionally valid. The HC stated that there is no restriction on availment of ITC in case of input services. The differential treatment is limited to refund of accumulated ITC. Therefore, there is no differentiation as regards to availability of ITC as far as inputs and input services are considered. Further, so far the refund is considered, refund is a statutory right and, therefore, can be availed only in accordance with the conditions prescribed. Hence, there is no discrimination done in terms of Section 54, making it constitutionally valid. Consequently, Rule 89(5) also becomes constitutionally valid. In this regard, the Court elaborated that though goods and services are treated similarly in certain respects under GST, there are differences in other respects such as GST rates.

Authors view

It is quite endearing to see a HC spend its valuable time to decide a matter which has already been decided by another jurisdictional HC. In a 12 day long proceedings, the Madras HC analysed and appraised the legislation at length and noted that Section 54(3) does not create a differentia between inputs and input services; Section 54(3) and Rule 89 are hence constitutionally valid.

The aforesaid judgement takes into consideration all the relevant sections, rules and intent of Parliament. The observation that refund of inverted duty structure is a benefit or concession and not a vested right summarises the stance of Madras HC. When the GST Council amended Rule 89(4) vide Notification no 21/2018-CT, the trade was initially of the view that an error has been committed. The issue was raised and later a circular followed in December clarifying that the Notification was not an error but a well thought out step. This persuades one to think of reasons as to why the refund of input services has been kept out of the formula. One of the reasons which comes to the mind is the idiosyncratic difference between input goods and services. While goods used as inputs are pre-defined in terms of quantity and value, input services to be used tend to be more personal choice specific. For instance, an organisation may choose to run its operations from a simple premises, while others may have a swanky office with all amenities or the basic difference of hiring security staff or cleaning staff from an established vendor or from a local supplier could make a difference. Since refund goes out of the coffers of the Government, they want to be cautious of the amounts that are involved. While it may be easy to determine and forecast the refund in terms of goods, the same may not be true for services.

Undoubtedly, the Madras HC has given a technically justified decision with its own reasoning; however, the Court did not guide the trade on what is to be done with the accumulated credit of input services. Clearly, refund is not an option as per Madras HC, then the accumulated balance in electronic credit ledger will keep piling and cannot be put to any use unless the business is diversified in other areas so as to enable utilisation of such credit. Further, the fate of refunds granted in the past (i.e. July 2017 to April 2018) was also untouched in the ruling.

One may also be perturbed by the fact that the disallowance of refund pertaining to input services seems to be out of place considering the scheme of GST. One of the key points which was rightly pointed out by the Gujarat HC in the VKC judgement was that intelligible differentia needs to be maintained. Considering that both inputs and input services are being used for the same purpose, the idea of giving refund for one and ignoring the other seems bizarre and unfair to the service providers who seldom use input goods in providing output supplies but a lot of input services are used while providing the output service.

This is a classic case where two States have their own jurisdictional rulings available. These States would follow their HC rulings respectively. However, the taxpayers in rest of the country would rely on VKC judgement and revenue shall rely on Madras HC ruling.

With two converse HC rulings on an identical subject, we may have hit a wall unless the Supreme Court intervenes or the GST Council clarifies. The sooner, the better.

Though, the sectors suffering IDS have always found place in the GST Council meetings, the topic for discussion has mostly been rate rationalisation. However, the next time somebody speaks of IDS, it will be difficult to stray away from the subject of refund of ITC pertaining to input services.

[The author Founding Partner at TMSL - a tax, technology firm. The article is co-authored by Rebecca Pinto - Director at TMSL. The views expressed are strictly personal.]