OCTOBER 15, 2024

By Dr Sanjay Kalra, LLM., Ph.D.(GST Law), Advocate, KPS Legal

1. Introduction:

DEBATE over the availability of Input Tax Credit of GST paid in Construction of a Building has triggered once again in light of the Hon'ble Supreme Court's recent judgement passed in case of Safari Retreats Pvt. Ltd. [2024-TIOL-101-SC-GST], concerning the constitutional validity of Sections 17(5)(c) and 17(5)(d) of the CGST Act, 2017, which restricts the availment of ITC on goods and services used for the construction of immovable property. Let us understand the relevant law position and judgements delivered so far.

2. Law Provisions:

Relevant provisions of the CGST Act, 2017 are referred below:

Schedule II- "Activities or Transactions to be treated as 'Supply of Goods' or 'Supply of Services"

(2). Land and Building:

(a) any lease, tenancy, easement, licence to occupy land is a supply of services;

(b) any lease or letting out of the building including a commercial, industrial or residential complex for business or commerce, either wholly or partly, is a supply of services.

(5). Supply of Services: The following shall be treated as supply of services, namely:-

(a) renting of immovable property.

(b) Construction of a complex, building, civil structure or a part thereof, including a complex or building intended for sale to a buyer, wholly or partially, except where the entire consideration has been received after issuance of completion certificate, where required, by the competent authority or after its first occupation, whichever is earlier.

Schedule-III: "Activities or Transactions which shall be treated Neither as a 'Supply of Goods' Nor a 'Supply of Services"

(5). Sale of land and, subject to clause (b) of paragraph 5 of Schedule II, sale of building

Section 16(1): A registered person is entitled to take credit of the input tax charged on any supply of goods or services or both to him, which are used or intended to be used in the course of or in furtherance of his business.

Section 17(1): Where the goods or services or both are used by the registered person for the purpose other than business, input tax credit is not allowed.

Section 17(5): Notwithstanding anything contained in Section 16(1) and Section 18(1) of the Act, ITC shall not be available in respect of -

clause (c): works contract services when supplied for construction of an immovable property (other than plant and machinery);

clause (d): goods or services or both received by a taxable person for construction of an immovable property (other than plant or machinery) on his own account including when such goods or services or both are used in the course or furtherance of business.

Explanation.- For the purposes of Chapter V and Chapter VI, the expression "plant and machinery" means apparatus, equipment, and machinery fixed to earth by foundation or structural support that are used for making outward supply of goods or services or both and includes such foundation and structural supports but excludes-

(i) land, building or any other civil structures;

(ii) telecommunication towers; and

(iii) pipelines laid outside the factory premises."

3. Gist of law provisions:

(A) Analysis of the provisions of Section 7 read with Schedule II and III of CGST Act, 2017 shows that the following activities or transactions are deemed 'supply of services' and are liable to GST:-

(i) Any lease, tenancy, easement or licence to occupy land is a supply of services. But the sale of a land is not a supply of service;

(ii) Any lease or letting out of buildings for business or commerce, wholly or partly, is a supply of services. Further, Clause 2(b) of Schedule II, will not apply if the lease or letting out of a building is for a residential purpose;

(iii) Renting of an immovable property is a supply of service;

(iv) Construction of a complex, building, civil structure or a part thereof, including a complex, building or civil structure intended for sale to a buyer, wholly or partly, is a supply of service, if such supply is made before the issuance of the completion certificate and the same will be liable to GST.

(B) Analysis of provisions of Section 16(1) read with Section17 shows that the input tax credit for construction of an immovable property is not available for the reasons that -

(i) sub-section (5) to Section 17 of the CGST Act, begins with a non-obstante clause giving it overriding effect over Section 16(1) and Sec. 18(1) ibid. Therefore, in cases covered by sub- section (5) to Section 17, ITC is not available.

(ii) In view of clause (c) to Sec. 17(5), ITC is not available if 'works contract services' are supplied for the construction of immovable property. However, as per exception to clause (c), ITC is available when such goods or services or both, are received by a taxable person for the construction of "plant and machinery", as defined in the explanation to Section 17. Secondly, ITC also available where the works contract service supplied for the construction of immovable property is an input service for further supply of the works contract.

(iii) In terms of clause (d) to Sec. 17(5) : ITC not available if goods or services or both received by a taxable person for construction of an immovable property on his own account. However, as per two exceptions to this clause(d), ITC is available if such goods or services or both are received to construct "plant or machinery". Secondly, ITC also available if such goods and services or both are received by a taxable person for the construction of an immovable property made not on his own account.

4. Debatable Issue on the subject:

Now the issue arises in cases where leasing or renting out of a building for business or commerce is subject to levy of GST, as explained above at Para 3(A), whether Input Tax Credit of GST paid in construction of such building is allowed in terms of sub-Section (5) of Section 17 of the CGST Act, 2017.

As explained above at Para 3(B), the ITC may be available for constructions of a building rented or leased out for business purpose, in the following circumstances:

(i) if construction of such building, as a works contract service, is covered under expression 'plant and machinery' as an exception under clause (c); or

(ii) if construction of such building, is covered under expression plant or machinery, as an exception under clause (d); or

(iii) if construction of such building is not on taxable person's own account, as restricted under clause (d);

5. Judicial Interpretation:

Before we reach at some conclusion, let us understand some of the relevant judgements.

(1) Hon'ble Supreme Court in 'Commissioner of Income Tax v. Anand Theatres etc. etc. - 2002-TIOL-910-SC-IT, interpreted the term "Plant" wherein it has been held that the "basic tools of the assessee trade" are covered as a plant. The court referred to the functional test to determine: Does the article fulfil the function of a plant in the assessee's trading activity? Is it a tool of his trade with which he carries on his business? If the answer is in the affirmative, it will be a plant.

(2) Apex Court in 'CIT v. Karnataka Power Corporation' - 2002-TIOL-950-SC-IT-LB held that a power-generating station could be considered 'a plant' - supporting the functionality test.

(3) Hon'ble Orissa High Court in the case of Safari Retreats (P.) Ltd. v. Chief Commissioner of Central Goods & Service tax, [2019-TIOL-1088-HC-ORISSA-GST] held that if the assessee is required to pay GST on the rental income arising out of the investment on which he has paid GST, it is required to have the input credit on the GST, which is required to pay under Section 17(5)(d) of the CGST Act. Section 17(5)(d), which disallows Input Tax Credit (ITC) on the construction of immovable properties, must be read down in cases where the immovable property is intended for leasing. The purpose of ITC is to prevent tax cascading and, thus, it should be allowed if GST is being paid on the rental income from such properties. Restricting ITC in such cases would frustrate the objective of GST. Businesses should be allowed to claim ITC for goods and services used in constructing buildings meant for rental, as they pay GST on the rental income.

(4) Now, Hon'ble Supreme Court in case of Safari Retreats Pvt. Ltd. [2024-TIOL-101-SC-GST] held as below:

(a) Whether 'Building' is a 'plant': Apex Court has laid down the functionality test. Apex Court held that whether a building is a plant is a question of fact. If it is found on facts that a building has been so planned and constructed as to serve an assessee's special technical requirements, it will qualify to be treated as a plant for the purposes of investment allowance. The word 'plant' used in a bracketed portion of Section 17(5)(d) cannot be given the restricted meaning provided in the definition of "plant and machinery", which excludes land, buildings or any other civil structures. Therefore, in a given case, a building can also be treated as a plant, covered by the expression "plant or machinery" used in clause (d) of the Section 17(5).

The question whether a mall, warehouse or any building other than a hotel or a cinema theatre can be classified as a plant within the meaning of the expression "plant or machinery" used in Section 17(5)(d) is a factual question which has to be determined keeping in mind the business of the registered person and the role that building plays in the said business. If the construction of a building was essential for carrying out the activity of supplying services, such as renting or giving on lease or other transactions in respect of the building or a part thereof, which are covered by clauses (2) and (5) of Schedule II of the CGST Act, the building could be held to be a plant. Then, it is taken out of the exception carved out by clause (d) of Section 17(5) to sub-section (1) of Section 16. Functionality test will have to be applied to decide whether a building is a plant. Therefore, by using the functionality test, in each case, on facts, in the light of what we have held earlier, it will have to be decided whether the construction of an immovable property is a "plant" for the purposes of clause (d) of Section 17(5).

(b) Regarding 'taxable person's own account': Apex Court held that "construction is said to be on a taxable person's "own account" when (i) it is made for his personal use and not for service or (ii) it is to be used by the person constructing as a setting in which business is carried out. However, construction cannot be said to be on taxable person's "own account" if it is intended to be sold or given on lease or license.

5. Conclusion:

(i) Definition of "plant and machinery" as given in 'Explanation', excludes land, buildings or any other civil structures. So, Construction of a Building, falling under 'Works Contract' is not covered by 'plant and machinery' as an exception to clause (c) to sub-section 5 of Section 17. Thus, ITC for construction of a building, as work contracts, not allowed here.

(ii) As held by the Hon'ble Apex Court decision in case of Safari Retreats Pvt. Ltd., supra, by applying the functionality test, if it is found on facts that the subject building has been so planned and constructed as to serve an assessee's special technical requirements, it will qualify to be treated as a plant covered by the expression "plant or machinery" used in clause (d) of the Section 17(5). Then, ITC for construction of such building, qualifying as a plant, is available as an exception to clause (d) to sub-section 5 of Section 17 of the Act.

(iii) Apex Court held that construction of such building cannot be said to be on taxable person's "own account" if it is intended to be sold or given on lease or license. Therefore, in case of construction of such building, qualifying as a plant and intended to be rented out, ITC is available.

6. Author's Opinion:

GST is levied on the supply of goods and services used in the construction of an immovable property, including building etc. Also, the renting of such immovable property, including a building or a part thereof, for business purpose, is deemed to be a 'Supply of Service' which attracts levy of GST. Denial of ITC for construction of such building, intended for renting out, would lead to a cascading effect of taxation, which is contrary to the objectives of GST. By blocking the ITC on the rentals collected by the assessee who has constructed the building, the State is unjustly enriching itself and violating the right to avail ITC flowing from Section 300A of the Constitution of India. Purpose of ITC is to prevent tax cascading and, thus, it should be allowed if GST is being paid on the rental income from such properties. Restricting ITC in such cases would frustrate the objective of GST.

[The views expressed are strictly personal.]