OCTOBER 16, 2024

By CA Hunny Munjal

1. Introduction:

THE Supreme Court of India has recently upheld the constitutional validity of Section 17(5)(c) and (d) of the Central Goods and Services Tax Act, 2017 ("CGST Act"), in the landmark Judgment of M/s Safari Retreats Private Ltd & Ors. (2024-TIOL-101-SC-GST). The Supreme Court, while affirming the legal foundation of the CGST Act, introduced the "functionality test" as a key principle for determining the scope of "plant or machinery" under Section 17(5)(d), which is discussed in the later sections of this article.

A critical issue in this case was whether the term "plant or machinery" as used in Section 17(5)(d) should be interpreted differently from "plant and machinery" as defined in the Explanation to Section 17(5)(c) of the CGST Act, and, if not, how the term "plant or machinery" should be construed within the framework of Section 17(5)(d). This article delves into these questions, providing an in-depth analysis of the Apex Court's rationale and its implications.

2. Background:

Approximately five years ago, a taxpayer in the state of Orissa filed a writ petition in the case of Safari Retreats Private Limited Vs. Chief Commissioner of CGST (2019-TIOL-1088-HC-ORISSA-GST) challenging the denial of Input Tax Credit ("ITC") by the GST authorities. The case revolved around the interpretation of Section 17(5)(d) of the CGST Act, which restricts ITC on goods and services used for the construction of immovable property, even if such property is used for business purposes. The taxpayer contended that since GST was being levied on the rental income from a commercial mall, ITC on the construction costs of the same mall should be allowed.

The Orissa High Court ruled in favour of the taxpayer, holding that:

- If a taxpayer is required to pay GST on rental income from a mall, it is entitled to claim ITC on GST paid for the construction of the mall.

- A narrow interpretation of Section 17(5)(d) would frustrate the very purpose of the CGST Act.

3. Legal Provisions under Scrutiny:

"Section 17: Apportionment of credit and blocked credits.

(5) Notwithstanding anything contained in sub-section (1) of section 16 and sub-section (1) of section 18, input tax credit shall not be available in respect of the following, namely:-

(c) Works contract services when supplied for construction of an immovable property (other than plant and machinery) except where it is an input service for further supply of works contract service;

(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 clauses (c) and (d), the expression "construction" includes re-construction, renovation, additions or alterations or repairs, to the extent of capitalisation, to the said immovable property.

Explanation- For the purposes of this Chapter 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.

4. Distinctions between Section 17(5)(c), (d), and the Definition of "Plant and Machinery":

- Section 17(5)(c): Bars ITC on works contract services specifically when used for construction of immovable property, excluding plant and machinery. The restriction is limited to construction, and the provision allows for ITC if the works contract is not for construction purposes.

- Section 17(5)(d): This provision is broader and applies to goods and services used for the construction of immovable property on the recipient's own account. It also uses the term "plant or machinery," which has been central to the Supreme Court's analysis in the present case.

- Explanation to Section 17: The explanation to "plant and machinery" defines it as apparatus and equipment fixed to the earth, excluding certain types of civil structures like buildings and telecommunication towers. However, the Court held that this definition does not necessarily apply to the term "plant or machinery" used in Section 17(5)(d).

5. Apex Court's Verdict:

A. Interpretation of Section 17(5)(d) and Applicability of Explanation to "Plant and Machinery"

The Supreme Court concluded that the explanation defining "plant and machinery" in Section 17 does not apply to the term "plant or machinery" in Section 17(5)(d). Relying on established principles of statutory interpretation, the Court emphasized that a "taxing statute should be read as it is, without any additions or subtractions based on assumed legislative intent". The Court noted the conscious use of the phrase "plant or machinery" in Section 17(5)(d) rather than "plant and machinery," as found elsewhere in the CGST Act. This distinction was critical in determining the scope of the restriction under Section 17(5)(d).

The Court also clarified that the exclusion of "plant or machinery" from the ITC restriction applies only when the construction is not undertaken on the taxable person's own account, such as in cases where the property is intended for sale or lease.

B. The Functionality Test

The Court introduced the "functionality test" to determine whether a building could qualify as a "plant" under Section 17(5)(d). Since the CGST Act does not define the term "plant," the Court held that whether a building qualifies as a "plant" depends on its role in the taxpayer's business operations. This determination must be made on a case-by-case basis, considering whether the building serves as an essential tool for the taxpayer's business or merely provides the setting in which business activities take place.

Several examples were provided to illustrate the application of the functionality test:

- A building specifically designed to attract customers, or constructed with special features for the taxpayer's business, could be considered a "plant."

- A power-generating station or a pond used for aquaculture could also be considered a "plant" due to their functional roles in business operations.

While the functionality test provides some relief from the otherwise strict ITC restrictions under Section 17(5)(d), its application will be determined through future adjudication, making it a complex and evolving area of law.

6. Conclusion:

The Supreme Court's ruling in Safari Retreats is significant for taxpayers engaged in the construction of immovable property, particularly in industries where properties are leased or rented. By upholding the constitutionality of Section 17(5)(d) and introducing the functionality test, the Court has provided much-needed clarity on the availability of ITC for construction-related expenses. However, the scope of this judgment is far-reaching, and the practical application of the functionality test will undoubtedly shape future legal discourse on ITC restrictions in the CGST regime.

This decision, while reaffirming the legislative intent behind the CGST Act, also opens the door for taxpayers to argue for ITC eligibility based on the specific role of buildings in their business operations, potentially altering the landscape of GST litigation in India.

[The views expressed are strictly personal.]