Key take away from Supreme Court ruling in matter of Inverted Duty Structure

[Abhishek Raja]

1. Introduction

The GST Act does not define anything like Inverted duty structure. The term ‘Inverted Tax Structure’ refers to a situation 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. In such cases, the taxpayer having accumulated ITC needs to carry this forward to the next financial year until such accumulated ITC is utilized to discharge output tax liability. In such cases also, refund can be applied under Section 54 of the CGST Act, 2017 read with Rule 89 of the CGST Rules, 2017.

2.  What is the difference in Inverted Duty Structure in PRE-GST Regime and GST Regime?

In Pre-GST Regime Inverted Duty Structure is applicable under cases where import duty on raw materials used in the production of finished goods is higher than the import duty of finished goods.

But Under GST Regime the Inverted Duty Structure refers to the cases where the rate of tax on inputs received are higher than the rate of tax on paid on outward Supplies.

However, the Inverted Duty Structure have wider scope as compared to Pre-GST regime because now it includes input services also.

3.  Refund of ITC in case of Inverted Tax Structure under GST

A registered person may claim a refund of unutilised Input Tax Credit (ITC). The ITC on account of inverted tax structure can be claimed at the end of any tax period where the credit has accumulated on account of the rate of tax on inputs being higher than the rate of tax on output supplies. A tax period is a period for which a return is required to be furnished.

Exceptions where the refund of the unutilised input tax credit cannot be claimed, are as follows:

• Output supplies are “Nil” rated or fully exempt supplies except for supplies of goods or services or both as may be notified by the Government on the recommendations of the GST Council.
• If the goods exported out of India are subject to export duty.
• If supplier claims refund of output tax paid under IGST Act.
• If the supplier avails duty drawback or refund of IGST on such supplies.

4.  Net ITC on Inverted Duty Structure

Parliament while enacting the Central Goods and Services Tax Act 2017, has incorporated a provision for refund of tax in Section 54. Sub-Section (3) embodies a provision for refund of unutilised input tax credit in cases involving:

(i) zero rated supplies made without payment of tax; and

(ii) credit accumulation “on account of rate of tax on inputs being higher than rate of tax on output supplies”.

While envisaging a refund in the latter of the above two situations, Parliament was cognizant of the fact that ITC may accumulate due to a variety of reasons.

However, Parliament envisaged a specific situation where the credit has accumulated due to an inverted duty structure, that is where the accumulation of ITC is because the rate of tax on inputs is higher than the rate of tax on output supplies.

Taking legislative note of this situation, a provision for refund has been provided for in Section 54(3). The Central Goods and Service Tax Rules 2017 have been formulated in pursuance of the rule making power conferred by Section 164 of the CGST Act. Rule 89(5) provides a formula for the refund of ITC, in “a case of refund on account of inverted duty structure”. The said formula uses the term “Net ITC”. In defining the expression “Net ITC”, Rule 89(5) speaks of “input tax credit availed on inputs”.

5. High Court of Gujarat & Madras

Writ petitions under Article 226 of the Constitution were instituted before the High Court of Gujarat and the High Court of Judicature at Madras for Inverted Duty Structure.

VKC FOOTSTEPS INDIA PVT. LTD. VERSUS UNION OF INDIA & 2 OTHER (S) [2020 (7) TMI 726 - GUJARAT HIGH COURT]

The Judgement passed by HC in this case is a welcome Judgement in favour of suppliers having inverted duty structure. This judgement has categorically stated that -the explanation (a) to Rule 89(5) which denies the refund of “unutilised input tax” paid on “input service” as part of “input tax credit” accumulated on account of inverted duty structure is ultra vires the provision of sec-54(3) of the CGST Act,2017.

In the case held that the above Explanation is ultra vires to the provisions of the Act as the CGST Act categorically provides that refund of ‘unutilized Input tax credit’ and Rules cannot go to disallow a benefit which is granted by the parent legislation.Hence this judgement is quite loudable judgement in the favour of the taxpayer having inverted duty structure.

TVL. TRANSTONNELSTROY AFCONS JOINT VENTURE, TVL. ESSA GARMENTS PRIVATE LIMITED, INDIA DYEING MILLS (P) LIMITED, M/S. VEEKESY FOOTCARE (INDIA) PVT. LTD., KALEESUWARI REFINERY PVT LTD., VICTUR DYEINGS VERSUS UNION OF INDIA, THE GOODS AND SERVICES TAX COUNCIL, ASSISTANT COMMISSIONER ST AND OTHERS [2020 (9) TMI 931 - MADRAS HIGH COURT]

The Madras High Court has concluded that Section 54(3)(ii) does not infringe Article 14  and Refund is a statutory right and the benefit of refund can be availed only to the extent of unutilized ITC that accumulates on ‘goods’, thereby exclusion of unutilized ITC accumulated on ‘services’ in case of inverted rate structure is valid.

This judgement of the Madras HC comes as a huge disappointment for a number of taxpayers in the industries where inverted duty structure is prevalent, such as those executing turnkey projects.

The difference in views of  two High Courts became the subject matter of set of appeals before Honourable Supreme Court.

6.  Order By The  Supreme Court

As there were contrary judgements by High Court of Gujarat & Madras matter went to Supreme Court. Various discussions and Court Verdict of Supreme Court is as follows:

The Supreme Court held that provisions of the Central Goods and Services Act excludes unutilised input tax credit accumulated on account of input services and also held that refund is entitled only for credit accumulating on inputs under inverted duty structure in GST Act.

The Object & Purpose of Refund in Inverted Duty structure is:

(a) The purpose of the provision is to give effect to the doctrine of equivalence or neutrality which is the basic objective of the GST and this is sought to be achieved by granting seamless credit through Section 16;

(b) The legislative background and preparatory material duly support the purpose of the legislation;

(c) The State does not want the taxpayers to suffer the ill effect of tax cascading solely because of its decision to offer a reduced rate of tax on outputs, relative to the tax rate on inputs;

(d) Section 54(3) is not intended to cover a situation where the inverted duty structure is created by assesse due to its own actions such as discount/distress/non-supply as distinguished from the rate structure created by the State.

“The GST inverted duty refunds is limited by Rule 89(5) of CGST Rules to only input materials. Hence the excess GST paid on input services like job work, professional charges, factory repairs, etc. on the one hand and on capital goods like machinery on the other hand, is not available for refund,”

The court refused to accept the challenge to the constitutional validity of Section 89 (5) as it felt that such an interpretation, if carried to its logical conclusion, would involve unforeseen consequences, circumscribing the legislative discretion of Parliament to fashion the rate of tax, concessions and exemptions.

The SC, however, accepted that the GST Council needed to take a relook at the refund calculation formula.

7.  Key Benefits of Supreme Court Ruling

The key benefit of this Supreme Court Ruling is that Honorable Court accepted that there are anomalies in the Formulae of Refund in Inverted Duty Structure. Honorable Court said 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 therefore it must be rejected. The formula makes a presumption that the output tax payable on supplies has been entirely discharged from the ITC accumulated on account of input goods and there has been no utilisation of the ITC on input services. The GST Council to reconsider the formula and take a policy decision regarding the same. This matter should be considered by the GST Council and anomalies as pointed out by the Supreme Court should be removed at earliest.

Discussions to this article

[balu kv]

Can an assesee who has accumulated ITC write of the same as tax expense since it is final that no refund is possible.

K V Balasubramanian

[Yellapu SivaPrasad]

If the assessee having two different rate of tax in outward supplies I. E 28% and 18% wherein inputs having both 18%and 28% were utilized as inputs. Can he claim refund for full inputs or proportionate inputs