BACKGROUND
Inverted duty structure refers to a situation where a registered person procures Inputs and Input services at a higher tax rate and undertakes outward supply of the same at a lower tax rate which leads to accumulation of unutilized credit in their electronic credit ledger.
The matter that is of subject interest is where the Refund of ITC of Input services that is accumulated on account of inverted duty structure. The pilgrimage to the High Courts happened in two cases where
The Hon’ble Gujarat High Court held that Explanation (a) to Rule 89(5) which denies the refund of “unutilised input tax” paid on “input services” as part of “input tax credit” accumulated on account of inverted duty structure is ultra-vires the provision of Section 54(3) of the CGST Act, 2017, whereas. (Emphasis supplied)
The Hon’ble Madras High Court held that the amended rule 89(5) is in conformity with section 54(3) and that Inputs under net ITC would exclude Input services and the Court also held that Section 54(3)(ii) does not infringe article 14; it qualifies, curtails, and imposes a restriction on the quantum and entitlement of refund claim and a valid exercise of legislative power.
The matter was taken up by the Hon’ble Supreme Court and this is the synopsis of the Order passed.
LEGISLATIVE PROVISIONS
Section 54 (1) of the CGST Act, 2017 that deals with the refund states that:
“Any person claiming refund of any tax and interest, if any, paid on such tax or any other amount paid by him, may make an application before the expiry of two years from the relevant date in such form and manner as may be prescribed:
Provided that a registered person, claiming refund of any balance in the electronic cash ledger in accordance with the provisions of sub-section (6) of section 49, may claim such refund in the return furnished under section 39 in such manner as may be prescribed.”
This is provision provides for refund of balance in the electronic cash in the form and manner prescribed within 2 years of the date on such form.
Section 54 (3) of the CGST Act, 2017 that provides for refund of unutilised credit mandates that:
“Subject to the provisions of sub-section (10), a registered person may claim refund of any unutilised input tax credit at the end of any tax period:
Provided that no refund of unutilised input tax credit shall be allowed in cases other than––
(i) zero rated supplies made without payment of tax.
(ii) where the credit has accumulated on account of rate of tax on inputs being higher than the rate of tax on output supplies (other than nil rated or fully exempt supplies), except supplies of goods or services or both as may be notified by the Government on the recommendations of the Council:
Provided further that no refund of unutilised input tax credit shall be allowed in cases where the goods exported out of India are subjected to export duty:
Provided also that no refund of input tax credit shall be allowed, if the supplier of goods or services or both avails of drawback in respect of central tax or claims refund of the integrated tax paid on such supplies.”
The above referred provision which provides for refund of unutilized input tax credit where the credit is accumulated on the account of inverted duty structure. In order to be eligible for the grant of refund on account of inverted duty structure the registered person shall not have exported goods out of India paying export duty and shall not have availed duty drawbacks.
SUBMISSIONS AND FINDINGS OF THE CASE
The very critical judgement of the Hon’ble SC runs to about 140 pages. Therefore, it is pertinent to capture the salient features of the findings of the Apex Court.
On submissions made on the Interpretation of Section 54(3) of the CGST Act
- Substantive part of Section 54(3), Parliament has contemplated that the claim of refund may extend to any unutilized ITC. ITC means credit of input tax and since ‘input tax’ is defined with reference to the tax charged on the supply of goods or services or both, a refund may be claimed not only of the tax charged on input goods but also input services as a whole.
- The first proviso sets out only a condition or provision for eligibility and once it is fulfilled, the refund is available on the entirety of the unutilized ITC including the credit which is relatable to tax paid on input goods and input services and it is not a restriction.
- Section 54(3) constitutes one homogenous class of registered persons who have unutilized ITC
The Court held that while interpreting the provisions of Section 54(3) must give effect to its plain terms and that it cannot redraw legislative boundaries on the basis of an ideal which the law was intended to pursue. Further the Court stated that an abstract doctrine cannot be a ground for the Court to undertake the task of redrawing the text or context of a statutory provision.
The Court held judicial interpretation cannot be ahead of policy makers and if they intended that the equivalence between goods and services should be progressively realized and that for the purpose of determining whether refund should be provided, a restriction of the kind which has been imposed in clause (ii) of the proviso could enacted.
The Court explained that the expression at the beginning of the first proviso – “no refund of unutilized ITC shall be allowed in cases other than” which is followed by clauses (i) and (ii) signified that a refund can be allowed only in the eventualities envisaged in clauses (i) and (ii) and expression ‘other than’ operates as a limitation or restriction. Clause (ii) of the first proviso therefore is a restriction and not a mere condition of eligibility
The Court held that Registered persons with unutilized ITC may conceivably form one class, but it is not possible to ignore that this class consists of species of different hues. It stated that with the intrinsic complexities, the legislature necessarily has to draw the balance when it decides upon granting a refund of accumulated ITC which has remained unutilized and has stipulated that no refund of unutilized ITC shall be allowed except for situations specified clauses (i) and (ii) of the first proviso.
On submissions made on Construing the proviso to section 54(3):
- the first proviso to Section 54(3) is in the nature of an eligibility condition as distinct from a restriction on the substantive part (contained in the opening words) of the provision
- Clause (ii) of the first proviso referring to “rate of tax” as distinct from the quantum of tax
- The use of expression “in cases other than where…”, “on account of” “inputs” vis a vis “input”, “output supplies” vis a vis “outward supply” in relation to Circular issued by ministry of finance dated 31.12.2018 and the Act
- No distinction between a credit relatable to goods or to services in terms of refund of balance in electronic credit ledger as provided under Section 54(8) and Section 49(6)
The Court held that it is not possible to restrict the ambit of clause (ii) of the proviso, based on a circular issued as it cannot take the Departmental understanding as basis of interpreting a statutory provision and that input services cannot be read into the term “inputs”. The Court further explains that such an exercise would be impermissible, when its effect is to expand the area of refund contemplated by the first proviso to cover input services in addition to input goods despite statutory language to the contrary.
The Court also held that the intention of the parliament was to confine the grant of refund to the two categories specified in clauses (i) and (ii) of the first proviso Sub-Section (3) with the use of a double – negative format “no refund of unutilised input tax credit shall be allowed in cases other than” although Section 54 begins with the stipulation that a registered person may claim refund of any ‘unutilised ITC at the end of any tax period’.
The Court held that Clause (ii) of the proviso, when it refers to “on account of” clearly intends the meaning which can ordinarily be said to imply ‘because of or due to’. When proviso (ii) refers to “rate of tax”, it indicates a clear intent that a refund would be allowed where and only if the inverted duty structure has arisen due to the rate of tax on input being higher than the rate of tax on output supplies.
The Court also held that reading the expression ‘input’ to cover input goods and input services would lead to recognising an entitlement to refund, beyond what was contemplated by Parliament.
The Court held that Parliament was within its legislative authority in determining whether refunds should be allowed of unutilised ITC tracing its origin both to input goods and input services or, as it has legislated, input goods alone and the legislature is open to define the circumstances in which a refund can be claimed. Therefore, the proviso to Section 54(3) is not a condition of eligibility but a restriction which must govern the grant of refund under Section 54(3).
On submissions made on the Constitutional validity of section 54(3): The ultra vires doctrine
- if Section 54(3) is construed to confine a refund of unutilised ITC only to the extent that the accumulation arises on account of the rate of tax on inputs (meaning input goods) exceeding the rate of tax on outward supplies, the principles underlying Article 14 of the Constitution would be attracted and the statutory provision would suffer from the vice of arbitrariness.
- Differentiating between goods and services is not permissible and does not have a reasonable nexus to the object sought to be achieved.
- It is paradoxical to posit those goods and services are pari materia for the purpose of levy, collection, and penalty but, that a distinction is made between them for the purpose of refund.
The Court stated that a cause of invalidity arises where equals are treated as unequally and unequals are treated as equals and held that both under the Constitution and the CGST Act, goods and services and input goods and input services are not treated as one and the same and they are distinct species.
The Court then relied on various other orders and held that attaining perfect equality in taxation impossible and unattainable but an approximation to it can be had. Further, the principle of equality does not preclude the classification of property, trade, profession, and events for taxation and the same is not hit by article 14 therefore, the state may impose different specific taxes upon different species which it seeks to regulate.
The Court rejected the submission on the validity of section 54(3) reasoning that a claim to refund is governed by statute [Clause (i) and (ii) of first proviso to Section 54(3)] and that there is no constitutional entitlement to seek a refund, but it is a matter of a statutory prescription, due to which accepting such a submission would lead to unforeseen circumstances.
The Court further explained that all Courts are averse to entering the area of policy matters on fiscal issues as levy of taxes and their collection are based on many underlying considerations on complex balances drawn between political, economic, and social needs and aspirations.
On submissions made on the validity of Rule 89(5) of CGST Rules in exercise of the rule-making power under Section 164 of the CGST Act:
- The rule-making power under Section 164 of the CGST Act can only be used if specific authority for making the rule is granted by the particular section of the CGST Act and that the government cannot exercise its authority under Section 164 of the CGST Act to frame rules for other sections in the absence of the words “as may be prescribed,
The Court refused to accept the submission and held that Section 164(1), confers an express power on the Central Government to make rules for carrying out the provisions of the CGST Act on the recommendations of the GST Council and it is open to the rule making authority to frame rules, so long as they are consistent with the provisions of the parent enactment as long as the authority which frames the rules has not transgressed a provision of the statute. The Court found that that the absence of the words “as may be prescribed” in Section 54(3) does not deprive the rule making authority to make rules for carrying out the provisions of the Act.
On submissions made on the vires of Rule 89(5) vis-à-vis Section 54(3) of the CGST Act
- Rule 89(5) is not in line with Section 54(3). The rule, as retrospectively amended, is asserted to be ultra vires Section 54(3) in as much as it restricts the computation of refund by taking into account only the credit availed on input goods. Section 54(3) allows for a refund of unutilized ITC as a result of an inverted duty structure due to input goods as well as input services.
The Hon’ble Court did not accept the submission as it was impermissible and stated that Explanation (a) to Rule 89(5) in defining ‘Net ITC’ to mean ITC availed on inputs (goods) is entirely in line with the main provision, Section 54(3). And if it were to accept the submission it would be expanding the ambit of Rule 89(5) beyond the terms governing the admissibility of a refund under Section 54(3).
On submissions made on the validity of the formula prescribed in Rule 89(5):
- The formula being inherently flawed, ultra vires to the provisions of Section 54(3)
- The proposition of an order of utilisation in the formula by which the ITC accumulated on account of input services is used first for discharging the tax liability and only then is the ITC accumulated on account of input goods used and a possible reading down of the provisions
- The formula creating a distinction between suppliers of services having a higher component of input goods than input services as against suppliers of services having a higher component of input services than input goods.
The Court agreed that a formula prescribed by delegated legislation may not be perfect and may have certain aberrations, but an anomaly cannot result in the invalidation of a fiscal rule which has been framed in exercise of the power of delegated legislation and the same may be struck down only if the formula is arbitrary and violative of Article 14 of the Constitution. The Court also held that a formula is used for the purpose of attribution in a post assimilated scenario. The use of such formulae is a familiar terrain in fiscal legislation including delegated legislation under parent norms and is neither untoward nor ultra vires.
The Court rejected the submission that the formula creates a distinction between suppliers having a higher component of input goods than those having a higher component of input services and reading down of the same and held that the purpose of the formula in Rule 89(5) is to give effect to Section 54(3)(ii) which makes a distinction between input goods and input services for grant of refund, the principle behind Section 54(3)(ii) of the CGST Act is upheld.
The Court is of the view that it should not in the exercise of the power of judicial review allow itself to become a one-time arbiter of any and every anomaly of a fiscal regime despite its meeting the jurisdictional framework for the validity of the legislation, including delegated legislation and shall refrain from replacing the wisdom of the legislature or its delegate.
The Court states that it has only intervened to read down or interpret a formula if the formula leads to absurd results or is unworkable whereas in the current case the formula is not ambiguous in nature or unworkable, nor is it opposed to the intent of the legislature in granting limited refund on accumulation of unutilised ITC and has urged the GST Council to reconsider the formula and take a policy decision regarding the same.
ORDER
The Hon’ble Supreme Court concluded that the judgment of the Madras High Court needs to be affirmed by dismissing the appeals challenging that verdict while the appeals against the judgment of the Gujarat High Court by the Union of India should be allowed.
Further the order and direction is that:
(i) The appeals filed by the Union of India against the judgment of the Gujarat High Court dated 4 July 2020 in VKC Footsteps India Pvt. Ltd. and connected cases be allowed and that the judgment shall be set aside.
(ii) The appeals filed by the assessees against the judgment of the Madras High Court in Tvl. Transtonnelstroy Afcons Joint Venture and connected cases dated 21 September 2020 shall stand dismissed. Also, the writ petition filed by the assessees shall also stand dismissed.
(iii) The observations in respect of the formula prescribed under Rule 89(5) shall be considered by the GST Council to enable it to take a considered view in accordance with law.
NOVELLO COMMENTS:
The Hon’ble Supreme Court stepped into the matter to provide clarity on the contradicting judgements passed by the Hon’able Gujarat High Court and the Hon’able Madras High Court on Restriction of Refund of ITC on Input Services under Inverted Duty Structure.
The Hon’ble Supreme Court has also reaffirmed the heights of wisdom without giving a runaway verdict while holding that it should not allow itself to become a one time arbiter of any and every anomaly and shall refrain from replacing the wisdom of the legislature or its delegate
The saving grace for India Inc. is that the matter on revision of formula under Rule 89(5) has been left up to the GST council to decide if any amendment is required to remove the inequalities present. India Inc has to hope for an amendment in the formula by the GST council.
Of course, given the current collection crunch of GST Revenue and the everlasting compensation structure being deliberated, it would be highly doubtful to expect any optimistic legislative changes in the near future.