OCTOBER 14, 2024

By Anshul Mittal, Partner, RSA Legal Solutions

Introduction

THE Supreme Court's recent decision in M/s Safari Retreats Private Ltd. [2024-TIOL-101-SC-GST], has provided a significant interpretation of Section 17(5)(d) of the Central Goods and Services Tax (CGST) Act, specifically regarding the availability of Input Tax Credit (ITC) on immovable properties. This judgment has introduced a functionality test to assess whether a building or structure could qualify as a "plant" under the Act, thereby enabling taxpayers to claim ITC on construction costs for such properties.

While this decision offers clarity on certain aspects of ITC eligibility, it also paves the way for a Pandora's box of litigation, with potential disputes arising over the classification of immovable properties as "plant." At the same time, the judgment invites constructive debate on legislative intent and the application of tax provisions, particularly by the adjudicating officers responsible for implementing these laws.

1. Background of the Case

The case revolved around the denial of ITC to the assessees (M/s Safari Retreats Pvt. Ltd. and others) who constructed shopping malls and leased out units for commercial use. The central issue was the interpretation of Section 17(5)(d) of the CGST Act, which disallows ITC on goods or services used for the construction of immovable property. The assessees contended that such a denial of credit, despite their properties being used for taxable purposes (leasing and renting), amounted to discrimination and violated their right to ITC.

The petitioners argued that the immovable properties used to generate taxable supplies (such as rental income) should be eligible for ITC. They challenged the constitutional validity of Section 17(5)(d), asserting that it created an unjust distinction between taxpayers who use immovable property for commercial purposes and others who benefit from ITC.

2. Supreme Court's Interpretation and the Introduction of the Functionality Test

In a significant move, the Supreme Court introduced the functionality test to determine whether a building or immovable property can be classified as a "plant" under Section 17(5)(d). This test examines:

- Whether the structure or property serves a direct functional purpose in the taxpayer's business operations.

- Whether the immovable property is essential for generating taxable services, such as leasing, renting, or conducting other taxable commercial activities.

The Court concluded that the blanket denial of ITC on immovable properties is not appropriate when such properties are instrumental to the taxpayer's business. This allows for a more flexible interpretation of the term "plant," making it possible for certain commercial properties to qualify for ITC if they meet the functionality criteria.

However, the Court rejected the argument that the use of "or" instead of "and" in Section 17(5)(d) was a drafting error, affirming that the legislature's intentional distinction between "plant or machinery" and "plant and machinery" must be respected.

3. Analysis of Key Issues and Concerns

A. Legislative Intent and Judicial Interpretation

The Supreme Court's ruling highlights the delicate balance between judicial interpretation and legislative intent. By refusing to read down Section 17(5)(d), the Court respected the legislature's power to limit ITC in certain cases. At the same time, the introduction of the functionality test gives businesses an avenue to claim ITC, ensuring that the legislation's purpose is upheld while recognizing the practicalities of running a commercial enterprise.

This ruling, however, places the onus on tax officers to correctly interpret the legislative intent behind the denial of ITC in specific cases. Often, officers tend to err on the side of caution, denying credit without fully considering the nuances of the law. This judgment sends a clear signal that denying ITC arbitrarily is not in line with the true spirit of the GST framework, which is intended to support businesses that legitimately use properties for taxable purposes.

B. The Inherent Complexity of the Functionality Test

While the functionality test offers a pragmatic solution, its application is inherently fact-dependent. Different adjudicating authorities may apply this test in varying ways, leading to inconsistent interpretations across jurisdictions. For instance, a shopping mall used primarily for leasing might qualify as a plant under the test, while a similar building used for non-commercial purposes might not.

This inconsistency is likely to spark litigation as taxpayers and tax authorities contest the classification of various properties. The discretionary nature of this test may also lead to differing outcomes based on individual facts, which will need to be carefully examined on a case-by-case basis.

C. Expanding the Scope of ITC for Commercial Properties

One of the key takeaways from the ruling is the Court's recognition that ITC may be claimed for properties that are constructed for leasing or renting purposes, even though they fall under the immovable property category. This creates a positive precedent for businesses engaged in real estate, allowing them to benefit from ITC in cases where the property is not sold but is used to generate taxable income.

However, this also leads to potential grey areas in cases where properties serve dual purposes - partly for own use and partly for generating taxable supplies. Taxpayers may attempt to stretch the interpretation to claim ITC on properties that partially serve commercial purposes, adding to the complexity of future disputes.

D. The Pandora's Box of Litigation

The Supreme Court's judgment, while providing clarity, also opens the floodgates for litigation. Businesses engaged in real estate, infrastructure development, and commercial leasing may now challenge the denial of ITC under Section 17(5)(d), leading to a surge of ITC disputes. The ruling could also trigger protracted legal battles, especially where taxpayers seek to apply the functionality test to a wide range of immovable properties, such as warehouses, factories, and shopping malls.

E. A Cautious Appreciation of the Judgment

While this landmark ruling is a step forward, it also calls for caution. The Supreme Court's intervention is necessary for refining legislative ambiguities, but it also highlights the importance of genuine interpretations by tax officers. Officers must resist the temptation to deny credit indiscriminately, instead applying the functionality test thoughtfully and in line with legislative intent.

The ruling fosters healthy legal discussions that are essential for tax law evolution. However, tax authorities must be mindful that excessive litigation may create uncertainty for businesses and hamper economic activity. Proper exercise of discretion by tax officers can prevent unnecessary disputes and ensure that the spirit of the law is upheld.

Conclusion:

The Supreme Court's decision has offered much-needed clarity on the interpretation of Section 17(5)(d). The introduction of the functionality test provides businesses with a legitimate avenue to argue for their right to claim ITC, ensuring that properties used for generating taxable supplies are not unfairly excluded from credit eligibility.

Ultimately, while the judgment may lead to increased legal disputes, it also fosters a constructive debate on the application of GST provisions, helping to clarify grey areas and refine the law in a manner that benefits both tax authorities and taxpayers in the long run.

[The views expressed are strictly personal.]