GST’s ‘inverted’ problem

Niraj Bagri | Updated on September 23, 2021

A revenue neutral rate is the need of the hour

In one of the first cases of the GST era that reached the Supreme Court, the matter was decided in favour of the department. Inverted duty structure, where the output tax paid is lesser than the input tax credit available with the company, has been rankling the industry from a long time. Under the VAT regime, some States permitted refund, subject to conditions.

With GST’s launch the government recognised the industry’s concerns and incorporated provisions enabling the refund of unutilised input tax credit. But the components of the unutilised input tax credit had been a bone of contention from the beginning.

Section 54(3) of the Central GST law postulates refund of any unutilised input tax credit, in cases where the rate of tax on inputs is more than that on output supplies.

Companies pay GST on procurements, consisting of capital goods, inputs i.e. raw materials, consumables etc and input services. The formula that is prescribed in the legislation enables refund of GST paid on inputs. The dispute centres around whether the formula should have also enabled refund of GST paid on input services.

The key question to be addressed was whether the above section provides a condition to be fulfilled for claiming refund of unutilised input tax credit (including input services), or whether it should be viewed as a restriction, meaning thereby that the refund has to be restricted to inputs only.

There were contradictory High Court rulings on this issue. The Gujarat High Court, in the case of VKC Footsteps India Pvt Ltd vs Union of India held that the refund provisions should be interpreted as a condition to be fulfilled for qualifying for refund of excess input tax credit. Thus, a refund of GST paid on input services should be available.

But the Madras High Court, in the case of Tvl. Transtonnelstroy Afcons Joint Venture vs Union of India did not agree with this interpretation and held that the section should be understood to be restricting the gamut of refund. Since it is a restriction, refund can be given of GST paid only on inputs and not input services.

When the matter went ot the Supreme Court, it held that the section does not impose a condition, but provides a restriction. Hence, the meaning of unutilized input tax credit would only include GST paid on inputs. Several other grounds of challenge were made like the law should be interpreted to ensure equivalence between inputs and input services, such interpretation would be discriminatory between two class of companies etc., but the Court recognised the supreme power of the legislative authority in framing the legislation and did not find merit in circumventing it through judicial process.

However, the Supreme Court agreed that the prescribed formula, which assumes that all output taxes are paid using GST paid on inputs only may not be the appropriate mechanism. It has left it to the wisdom of the GST Council to propose amendments to address this imbalance.

The way forward

The Supreme Court’s decision to let the GST Council address the issue of imbalance in the prescribed formula offers a ray of hope.

The pending applications will now be rejected based on the Supreme Court decision and it would be prudent for companies that have received refunds to return them to avoid incurring interest costs.

Companies may also seek rate adjustments on their output supplies to get around the inverted duty structure. The challenge would be to find the sweet spot of revenue neutral rate whereby tax outflow is equivalent to tax paid on procurements. The use of an abated rate of tax on output supplies may provide a lasting solution.

An inverted duty structure does add to companies’ costs so it would be desirable to permit the refund of unutilised credit without restrictions or prescribe a revenue neutral rate to overcome the hidden costs.

The writer is Partner Dhruva Advisors LLP. The views expressed are personal

Published on September 23, 2021

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