OCTOBER 14, 2024

By Gopal Krishna Mundhra, Partner & Priyadarshini Shekhawat, Associate, Economic Laws Practice

THE eagerly awaited judgment in the Safari Retreats Pvt. Limited ¹ case has finally been handed down by the Supreme Court of India. At the heart of this legal showdown lay a seemingly simple question: Could a shopping mall be considered a 'plant' under Section 17(5)(d) of the Central Goods and Services Tax Act, 2017? While the above question still remains unanswered, the Apex court has prescribed the "functionality test" to ascertain the eligibility as a 'plant'. In this course, the judgment also upheld the constitutional validity of Section 17(5)(c) and (d) of the Central Goods and Services Tax Act, 2017 ('CGST Act') and clarified the difference between the phrase "plant and machinery" and "plant or machinery".

The case originated from multiple appeals and writ petitions challenging the denial of ITC for goods and services used in constructing immovable properties like shopping malls and warehouses. The Revenue Department argued that despite paying GST on construction materials used in construction of the property/building, the current interpretation of Section 17(5)(d) prevented them from claiming ITC against the GST collected on rental income derived from these properties.

The Respondent argued that denying ITC to businesses constructing immovable property for rent was arbitrary and violated constitutional equality, as both rental and sale immovable properties generate taxable activities. They advocated for a broader interpretation of "plant or machinery" and "own account" to include buildings integral to business operations. Conversely, the Revenue Department contended that the phrasing of 'or' in "plant or machinery" was a drafting error, and allowing ITC for property construction could lead to revenue loss and inconsistencies. They emphasized that ITC is a statutory privilege, not a fundamental right, and its scope can be defined by the legislature.

Difference between "plant or machinery" and "plant and machinery"

The Supreme Court distinguished between the terms "plant or machinery" and "plant and machinery", noting that while the CGST Act defines the latter, it does not provide a definition for the former. The Court ruled that these terms are not interchangeable and carry different meanings for availment of ITC. The Supreme Court rejected the Revenue Department's claim of a drafting error with finding that the legislature's use of "plant or machinery" is intentional and distinct from "plant and machinery."

Introduction of Functionality Test

A key aspect of the judgment was the introduction of the "functionality test" to determine if a building can be considered a 'plant' under Section 17(5)(d). This test assesses whether the building's construction was essential for carrying out the taxable activity i.e. renting or leasing the property in the instant case. The court emphasized that a building merely providing a setting for a business, without being integral to its operation, would not meet this test.

The judgment stressed the importance of a fact-specific determination in classifying a building as a 'plant.' It requires a detailed analysis of the building's specific features, purpose, and role in the business. This approach avoids broad generalizations and ensures that each case is assessed on its own merits.

In its final decision, the Supreme Court did not make a definitive ruling on whether the specific mall in question met the criteria of a 'plant.' Instead, it remanded the case back to the Orissa High Court, instructing it to conduct a fact-finding inquiry and apply the "functionality test" based on the specific characteristics and use of the shopping mall.

Functionality Test as made applicable under the Income Tax Act, 1961

Classification of a building as a 'plant' under Section 43(3) of the Income Tax Act carries significant financial implications, because assets categorized as 'plant' are eligible for higher depreciation rates compared to standard buildings. To determine whether a building qualifies as a plant, courts have prescribed the functionality test which requires evaluation of the role of the immovable property in the business process rather than its mere physical characteristics.

To simplify, if a building or structure or part thereof is such by which the business activities are carried on then it would amount to plant. But where the structure plays no part in carrying on the business activities and is used as the place for carrying on the business, it will fall within the category of a building, and it cannot be called as plant. Where part of the construction of the building is specially designed and meant for carrying on the mechanical process, it will be a plant and where part of it is used for various activities like research, office or the like, such construction could not be treated as a plant.

The Supreme Court in CIT v. Venkata Rao (Dr B) - 2002-TIOL-522-SC-IT held that a nursing home was a plant because of operation theatre, sterilisation rooms, etc. being substantial part of the building specifically designed for a nursing home was eligible to be treated as a plant and not building simpliciter.

Carr (H.M. Inspector of Taxes) v Sayer [65 TC 15], elucidated for a building to be treated as a plant it has to be a tool for running the business and not a mere shelter.

The Supreme Court of India in CIT v. Anand Theatres - 2002-TIOL-910-SC-IT, while holding that theatres and hotel buildings are not 'plant', endorsed the principle of the functional test and some English decisions on the subject. These decisions showed that the functional test would still have application, though limited in scope, to the cases where the structure itself serves as an apparatus for carrying out the operation instead of merely housing it. In such limited circumstances, the functional test could justify the treatment of a building as a plant.

Additionally, the Patna High Court in Cachet Pharmaceuticals Private Limited v. Commissioner of Income Tax and another - 2016-TIOL-785-HC-PATNA-IT, held that a factory building used solely for medicine manufacturing qualified as a 'plant' because it was integral to the business's operation. The building wasn't just shell housing the business; it was the very environment where the core business activity took place and therefore, it is to be construed as a 'plant'.

TO SUM UP

This judgment has significant implications for businesses involved in constructing and using immovable property for commercial activities. It highlights that simply conducting taxable activities within a building is not sufficient to claim ITC. Businesses must now demonstrate that the building itself is a "plant" by proving its essentiality to their core operations using the functionality test.

The judgment emphasizes the need for a more robust, evidence-based approach when claiming ITC on construction of building. Businesses need to be prepared to provide detailed documentation and arguments demonstrating the building's unique features, design purpose, and indispensable role in their taxable activities. This fact-specific approach may lead to variations in how tax authorities and courts apply these concepts to different types of properties and businesses, underscoring the need for clear guidance and potential future clarifications on these provisions. Furthermore, once the assesses pass the functionality test, they will be eligible to claim ITC for past periods, subject to the limitation specified in Section 16(4).

In conclusion, this decision is likely to have far-reaching implications on how businesses approach ITC claims for immovable property and will contribute to shaping future legislative and judicial decisions in this area of tax law.

[The views expressed are strictly personal.]

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¹ Chief Commissioner of Central Goods and Service Tax & Ors. v. M/s Safari Retreats Private Ltd. & Ors. = 2024-TIOL-101-SC-GST