FEBRUARY 15, 2023

By Jigar Doshi, Founding Partner & Sunil Kumar, Senior Manager at TMSL

Introduction

FINANCE Bill, 2023 has created a buzz in Industry by proposing the requirement for Input Tax Credit ('ITC') reversal on the supply of bonded warehoused goods. Many believe that the amendment targets the supplies made by duty-free shops to inbound passengers. In this article, we do not wish to debate on who will be impacted by this proposed amendment.

Instead, we want to draw attention to the technicality of the amendment. A careful reading of the proposed amendment suggests that the Government has introduced an incomplete amendment. An amendment which, we understand, on the technical front, may not achieve its objective of requiring reversal of ITC on the supply of bonded warehouse goods; thus, we referred to the impugned proposed amendment in our subject as a half-baked amendment.

In this regard, let us quickly look at the provisions relating to ITC reversal before discussing the details of the issue.

1. Relevant Legal Provisions and their interpretations

The GST law allows the registered person to claim ITC in respect of the inward supply of goods or services or both used by him in the course or furtherance of his business subject to satisfying some conditions and restrictions provided under the law in this regard.

One of the restrictions for claiming ITC provided under the law is where the taxable person uses the goods or services for effecting taxable and exempt supply. In this regard, the law provides that ITC would be permitted proportionate to the taxable supplies. In other words, the supplier would be required to reverse the ITC pertaining to the exempt supply.

1.1. Pre-amendment

The relevant provision of Section 17 of the CGST Act in this regard reads as under:

Section 17 Apportionment of credit and Blocked Credit

(1) ….

(2) Where the goods or services or both are used by the registered person partly for effecting taxable supplies including zero-rated supplies under this Act or under the Integrated Goods and Services Tax Act and partly for effecting exempt supplies under the said Acts, the amount of credit shall be restricted to so much of the input tax as is attributable to the said taxable supplies including zero-rated supplies.

(3) The value of exempt supply under sub-section (2) shall be such as may be prescribed, and shall include supplies on which the recipient is liable to pay tax on reverse charge basis, transactions in securities, sale of land and, subject to clause ( b ) of paragraph 5 of  Schedule II, sale of building.

Explanation.- For the purposes of this sub-section, the expression "value of exempt supply" shall not include the value of activities or transactions specified in  Schedule III, except those specified in paragraph 5 of the said schedule

Section 17(2) requires the ITC reversal in respect of exempt supply, and Section 17(3) provides that for the purpose of ITC reversal, the value of exempt supply would include the following transactions:

(a) Supplies subject to GST under reverse charge (say sponsorship services by an event company)

(b) Transactions in security (say sale of shares)

(c) Sale of Land

(d) Sale of Building (except under-construction building)

In this context, we would like to bring to notice that Section 17(3) is not providing that the above transactions would be treated as exempt supply. Instead, it merely provides that for ITC reversal, the value of exempt supply would include the value of the above transactions.

Further, the explanation to Section 17(3) provides that the value of exempt supply shall not include the value of activities/transactions specified in Schedule III except those specified in paragraph 5 of the said Schedule. Paragraph 5 of Schedule III covers the transaction sale of land and sale of the building (except under construction). Therefore, as per the explanation, except for the sale of land and constructed building, value of other transactions/activities of Schedule III is not included in the value of exempt supply.

1.2. Amendment proposed by Finance Bill, 2023

The Finance Bill, 2023 has proposed amendment to the above explanation. The amended explanation would be read as under:

Explanation.- For the purposes of this sub-section, the expression "value of exempt supply" shall not include the value of activities or transactions specified in  Schedule III, except

(i) The value of activities or transactions specified in paragraph 5 of the said schedule; and

(ii) The value of such activities or transactions as may be prescribed in respect of clause (a) of paragraph 8 of the said schedule

The Finance Bill, 2023 has proposed an amendment in the explanation to Section 17(3) of the CGST Act, which provides that for the purpose of Section 17(3), the value of transactions/activities of Schedule III except for the value of activities or transactions as may be prescribed in respect of clause 8(a) would be excluded from the value of exempt supply. Entry 8(a) covers  the supply of warehoused goods to any person before clearance for home consumption. Therefore, as per the proposed amendment, the value of the warehoused goods, as prescribed in the rules, would be excluded from Schedule III for Section 17(3).

2. Our comments

On a conjoint reading of the provision and explanation, a question arises: how does this amendment lead to the conclusion that the value of the supply of warehoused goods will be added to the value of the exempt supply for ITC reversal? Does excluding the supply of warehoused goods from the scope of Schedule III through the said explanation make the given transaction an exempt supply?

Where has it been mentioned that the transaction of clause 8(a) is an "exempt supply" under GST?

We may note that the term 'exempt supply' has been defined as the 'supply of any goods or services or both' which attracts a 'nil rate of tax' which may be 'wholly exempt' from tax and includes 'non-taxable supply'. Further, the term 'non-taxable supply' has been defined as the supply of goods or services or both which is not leviable to tax under the GST laws.

As per the above definitions, for a transaction to be called an exempt supply, it must first involve either a supply of goods or a supply of services. But, under the GST law, the transactions under Schedule III are neither treated as a supply of goods nor a supply of services. Therefore, as per the definition, the transactions enlisted in Schedule III may not be referred to as an exempt supply.

Now the question arises: Should the legislature not include the given transaction in the value of exempt supply under section 17(3), which has not been done?

In our view, one can well argue that although the explanation to Section 17(3) excludes the value of the supply of warehoused goods from the scope of Schedule III, it may not lead to the conclusion that it will be treated as an exempt supply.

Notably, the memorandum explaining the Finance Bill, 2023 has provided that reversal would be needed for the impugned transaction. The relevant part of the memorandum reads as under:

Explanation to sub-section (3) of section 17 of the CGST Act is being amended so as to restrict availment of input tax credit in respect of certain transactions specified in para 8(a) of Schedule III of the said Act, as may be prescribed, by including the value of such transactions in the value of exempt supply.

The above explanation given by the memorandum explicitly indicates that the Government intends ITC reversal for the supply of warehoused goods in the specified cases (to be prescribed by Rules). However, the way the law is proposed to be amended, it may not achieve its objective. The legislature should have added the given transaction to the value of exempt supply under section 17(3), which has not been done.

3. Conclusion

Given the above discussion, we believe the reversal requirement would face litigation unless corrective measures are undertaken before the Bill is enacted.

A prompt response by the Government is the need of the hour.

[The views expressed are strictly personal.]