Business Laws

The ITC conundrum in GST

K. Vaitheeswaran | Updated on December 27, 2020

If the system were to work, artificial curbs that deny input tax credit have to go

The central point of GST – the biggest tax reform in India – is to avoid cascading effect of taxes, which is done by the mechanism of input tax credit (ITC). Across the world, the philosophy of GST (or VAT) is that the output would be taxed and all inputs would qualify for input tax credit. However, several niggling issues have arisen around ITC.

Blocked credits

The first blow to this concept of a liberalised system of ITC came in the form of Section 17(5) of the CGST Act, 2017 which chose to declare certain items as ineligible and identified as blocked credits.

For example, a manufacturer who puts up a factory building or a person who puts up a mall or a warehouse is denied input tax credit on the GST paid for construction services.

The Odisha High Court in the case of Safari Retreats noted this aspect and read down the relevant provisions to enable the mall owner to claim the input tax credit. The matter is now pending before the Supreme Court.

While one can argue that granting of ITC is a policy decision, the said principle may no longer be relevant in a GST regime. India competes with all its neighbours for investments and if the GST system is not as simple with seamless credit as available in other countries, India would not be an attractive destination for investments.

In fact, the elimination of cascading effect of taxes is one of the key objectives of GST as set out in the Statement of Objects in the Bill to amend the Constitution for introduction of GST. Given the objective of the government to have an efficient and lean tax system, the artificial restrictions which deny ITC for various items in Section 17(5) will have to go.

Fake invoices

As in any system, frauds entered and the menace of fake invoices erupted. Fake invoice is not alien to India and countries which have introduced GST have faced similar problems with ‘carousel trading’.

The government rightly wanted to get rid of this menace and while there cannot be any debate on the action to be taken against the fraudsters who raise fake invoices without underlying supply of goods, certain key questions remain unanswered. If A has issued a fake invoice and charged GST, if action is taken against A and B, the recipient, and B is called upon to reverse the credit, what happens to the GST already paid by A.

If the transaction is not genuine and there is no supply, then the GST paid by A does not have the character of GST and should be refunded or credited to the Consumer Welfare Fund.

The State cannot retain it as GST and still proceed to recover the amount from the recipient. Secondly, if B has availed input tax credit but has not utilised it or not claimed refund of the same, can there be interest and penal consequences?

Percentage formula

When suppliers defaulted in filing of returns or delayed their payment of taxes, instead of going behind the suppliers, the government went behind the recipients and Rule 36(4) was brought in to artificially provide percentage limits for invoices which have not been uploaded by suppliers. This rule has caused untold misery on the MSMEs.

Fearing the loss of ITC, buyers refuse to deal with suppliers who have not uploaded the data. A small supplier on account of cash flow issues would not have been in a position to file his returns. This is because of the fact, that even though the law does not provide for it, the portal does not permit a return to be filed unless the tax is paid.

Disproportionate action

Rule 86A of the CGST Rules, 2017 which empowers the authority to prevent an assessee from utilising his ITC to pay GST is widely couched and is highly disproportionate to the menace it seeks to address. In fact, certain action taken against bonafide assessees have affected their cash flow significantly compelling them to rush to the Courts to seek relief.

New year gift

The latest development is a new year gift in the form of introduction of Rule 86B w.e.f. 01.01.2021, to provide that assessees would not be eligible to use more than 99 per cent of the ITC in case the value of taxable supplies other than zero-rated supplies and exempt supplies exceed ₹50 lakh in a month. There are exceptions including categories that require payment of income tax of a certain amount. While the percentage is minuscule the very thought process of restricting ITC usage is against the philosophy of GST. Creating exceptions would only lead to restrictions first and then call for information to check whether exception is applicable.

Way forward

Denial of ITC or restriction of ITC or artificial percentage of utilisation would only increase cost and in turn prices and defeat the objective of elimination of cascading effect of taxes. Going forward, it is time for a re-set and course correction.

A pragmatic view has to be taken and some of these provisions have to be withdrawn to make GST an efficient system.

(The author is a Chennai-based advocate and tax consultant)

Published on December 27, 2020

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