| May-06-2021

Is It Unpreventable to Reverse ITC on Goods & Services used entirely for Exempt Supplies?

Stance in Erstwhile Laws:

The provisions of Input Tax Credit in the erstwhile laws, especially Service Tax and Central Excise were governed by Cenvat Credit Rules. While the provisions relating to the eligibility and availing of Cenvat Credit themselves were prescribed in such Rules, the provisions relating to the apportionment & reversals thereof were also prescribed through Cenvat Credit Rules.

Rule 6 of CCR explicitly set forth that the manufacturer or the service provider shall not be permitted the credit on inputs or input services used in or in relation to manufacture of the exempted goods or in the provision of exempted services. Further, Rule 6(3A) provides that when the manufacturer is engaged in the manufacturing of both exempt goods or non-exempt goods or service provider engaged in providing both the exempt services or non-exempt service, as the case may be, it shall be required to indemnify the Cenvat Credit, attributable to inputs and inputs services, used exclusively in or relation to the manufacturer of exempt goods removed or for provision of exempted services as well as the common credit attributable to the exempted goods removed or the exempted services provided.

In consequence, erstwhile Cenvat Credit rules explicitly affirms for the reversal of the Cenvat Credit on Input and Input Services, used exclusively in the manufacture of exempt goods or provision of exempt services where an entry is engaged in the supply of both taxable as well as exempt goods and services.

Stance in GST Regime

Contrary to the Cenvat Credit Rules in earlier laws, the enabling provisions of eligibility, availing, apportionment, reversals, etc have been prescribed in GST Act itself.

With reference to the eligibility, Section 16(1) of CGST Act 2017, ‘Every registered person, subject to such conditions and restrictions as prescribed and in the manner specified in Section 49, shall be entitled to take credit on input tax credit charged on any supply of goods or services or both to him, which are used or intended to be used in the course or furtherance of his business and the said amount shall be credited to the electronic credit ledger of such person.

Distinctly, the aforesaid provision grants ITC on any supply used for business and does not put any sort of restriction on the ITC with respect to input tax charged on goods or services, used exclusively for exempt supplies. Further, when one digs in for the search of a provision for ineligibility or reversal of ITC on goods or services exclusively used for exempt supplies, it comes as a surprise that there is no such provision in the entire Act.

As far as Section 17(2) of CGST Act 2017 is concerned, it merely deals with the common ITC i.e ITC on goods and services used partly for effecting taxable supplies and partly exempt supplies and restrict such common ITC to ITC attributable to taxable supplies only. Section 17(2) of CGST Act 2017 does not in any way provide for reversal of ITC, in cases where there is no common ITC. Section 17(2) is produced hereunder for reference.

S.17(2) Where the goods or services or both are used by the registered person partly for effecting taxable supplies including zero-rated supplies under this Act or under the Integrated Goods and Services Tax Act and partly for effecting exempt supplies under the said Acts, the amount of credit shall be restricted to so much of the input tax as is attributable to the said taxable supplies including zero-rated supplies

As matter of fact, Rule 42 & Rule 43 of CGST Rules 2017 prescribed for the apportionment, does not aim to reverse the ITC used exclusively in effecting exempt supplies. These rules only provide the manner for attribution of ITC on common inputs, input services and capital goods which attract provisions of Section 17(2) of CGST Act 2017 to the extent that they are used in relation to the exempt supplies for reversal thereof. The extract of the relevant rules is also produced hereunder:

Rule 42 Manner of determination of input tax credit in respect of inputs or input services and reversal thereof.-(1) The input tax credit in respect of inputs or input services, which attract the provisions of sub-section (1) or sub-section (2) of section 17, being partly used for the purposes of business and partly for other purposes, or partly used for effecting taxable supplies including zero rated supplies and partly for effecting exempt supplies, shall be attributed to the purposes of business or for effecting taxable supplies in the following manner...

Rule 43 Manner of determination of input tax credit in respect of capital goods and reversal thereof in certain cases.-( 1) Subject to the provisions of sub-section (3) of section 16, the input tax credit in respect of capital goods, which attract the provisions of sub-sections (1) and (2) of section 17, being partly used for the purposes of business and partly for other purposes, or partly used for effecting taxable supplies including zero rated supplies and partly for effecting exempt supplies, shall be attributed to the purposes of business or for effecting taxable supplies in the following manner…

One may dispute that these rules deny ITC on goods and services used exclusively in affecting the exempt supplies, as they primarily compute the ITC to be credited to the Electronic Credit Ledger (C1), by eliminating the ITC on goods and services used exclusively in affecting exempt supplies (T2) and therefore, such credit is ineligible. However, based on understanding, it can be believed that computation of C1 i.e ITC to be credited to the Electronic Credit Ledger is done only for ascertaining common ITC attributable to exempt supplies (D1) and common ITC attributable to non-business purpose (D2). D1 & D2 could not be ascertained without determining the value of C1.

The authority of these rules makes it comprehensive that these rules can only prescribe the mechanism for computation of common ITC attributable to exempt supplies or non-business purpose and their reversal. In other words, these rules do not have any authority to prescribe reversal of ITC on inputs, inputs services and capital goods attributable to exempt supplies, where there is no common ITC. Even if there is some common ITC attributable to both taxable as well as exempt supplies as well as some ITC attributable exclusively to the exempt supplies, even then these rules can be applied for the reversal of only common ITC, and not for the reversal of ITC attributable, exclusively for the exempt supplies.

Without prejudice, even if it’s assumed that Rule 42 & Rule 43 of CGST Rules implicitly deny the ITC on goods and services used exclusively in affecting exempt supplies, the validity of these rules can be challenged before the courts. Therefore, anything which is not intended or missed by the legislature in the statute cannot be brought into the authority by these rules.

Perusal of the aforesaid paras makes it quite clear, that the enabling provision for restricting ITC on goods and services exclusively used for exempt supplies are definitely missing in the GST Law. Whether it is merely a miss or intentionally omitted by the legislature, whatever be the case, it is a well settled position of law that strict interpretation of the statute has to be made. When the words in a statute are clear, plain and unambiguous only one meaning can be inferred. In view of the above, it can be said that there is no infirmity in availing of such ITC as there is no explicit restriction in the law.

About the Author

CA Devam Sheth –Managing Partner at M/s A D S Sheth & Co., Active Speaker and Trainer in the field of Indirect Taxes.

Phone : 94272 78101 | Email: devam@adssheth.com.