Unresolved issue of ITC on demo vehicles

[Dinesh Singhal]

Introduction

Our country has moved in a new indirect tax regime five years back called the Goods & Services Tax (GST). It was established on the principles of destination-based consumption tax wherein credit of tax paid on inward supplies would be available for set off against the output GST liability, thereby removing the tax cascading. However, the provisions relating to blocked credit and their liberal interpretation by authorities has been a cause of concern. One of the peculiar issue has been the availability of ITC on demo cars where multiple contrary rulings by Advance ruling authorities have added to the confusion.

Background

Recently West Bengal AAR in the matter of M/s Toplink Motorcar Private Limited (2022 (7) TMI 181 - AUTHORITY FOR ADVANCE RULING, WEST BENGAL) has given a ruling wherein it has been ruled that input tax credit on purchase of Demo vehicles would be available. Authority has treated the subsequent sale of demo vehicles satisfactory for being carved out as exception given under section 17(5)(a)(A) i.e., treating it as “further supply of such motor vehicles”. Though this issue has been in the light for long due to contrary rulings time and again however no clarifications have been issued by Board on this yet.

In the Motor Vehicle industry, demonstration vehicle (demo vehicles) is an indispensable tool for promotion of sales by using it for display of features & providing trial run to the prospective customers. It is a business necessity that motor car dealer shall compulsorily acquire the demo vehicles from principal supplier/ manufacturer. After a specific period, these vehicles are sold off. The Demo vehicle is purchased against tax invoice and reflected in the books as capital assets.

Demo Cars are used for giving demonstration and feel of car to a prospective buyer before actual sale of cars and hence is essential to business of a car dealer.  As per trade practice, without giving demonstration to a prospective buyer, business of a car dealer will suffer immensely. Further there is a mandatory requirement from manufacturers to maintain specified fleet of demo cars and after a specified time gap, these vehicles are required to be replaced with new vehicles/ latest model. Thus, used demo vehicles are accordingly sold by the dealer. There is no question raised on the business usage and coverage of this being incurred in the course or furtherance of business. Only debate has been on whether this ITC is hit by Section 17(5)(a) or not.

We shall go through the rationale extended in various rulings so far and analyze the present legal position.

Sum & Substance of rulings so far

Sl. No.	Name of Authority and details of order	Particulars of Applicant	Brief of Ruling and rationale extended	Outcome of appeal before AAAR if any
1.	Kerala - Order No. KER/10/2018 dated 19th September 2018	M/s A. M. Motors - 2018 (10) TMI 514 - AUTHORITY FOR ADVANCE RULINGS, KERALA	ITC allowed since activity does not fall in negative clause	-
2.	Maharashtra – Order No.GST/ARA/ 2019-20/B-121 dated 26th December 2019	M/s Chowgule Industries Private Limited - 2020 (1) TMI 741 - AUTHORITY FOR ADVANCE RULING, MAHARASHTRA	ITC allowed	-
3.	Goa – Order No. GOA/GAAR/07 of 2018-19 dated 26th March 2019	M/s Chowgule Industries Private Limited - 2019 (7) TMI 844 - AUTHORITY FOR ADVANCE RULING, GOA	ITC allowed	-
4.	Madhya Pradesh – Order No. 13/2020 dated 23rd April 2020	M/s Khatwani Sales & Services LLP - 2021 (1) TMI 692 - AUTHORITY FOR ADVANCE RULING, MADHYA PRADESH	ITC not allowed AAR has differentiated from earlier rulings citing amendment in section 17(5)(a) effective 1st February 2019 however essentially the amendment has not posed any change in the given matter. AAR has taken strict interpretation of the clause and not considered the effective use of the motor vehicle by applicant.	-
5.	Haryana – Order No. HAR/HAAR/R/2018-19/17 dated 9th October 2018.	M/s BMW India Private Limited - 2018 (10) TMI 1873 - AUTHORITY FOR ADVANCE RULING, HARYANA	ITC Not allowed AAR has taken literal interpretation of section 17(5)(a) and ruled that ITC not permissible of vehicles used as Marketing Fleet, Sales Fleet, Press Fleet and Training Fleet.	AAAR confirmed the ruling of AAR vide its order dated 28th June 2021
6.	Haryana – Order No. HAR/HAAR/2018-19/40 dated 1st March 2019	M/s Platinum Motocorp LLP - 2019 (3) TMI 1850 - AUTHORITY FOR ADVANCE RULING, HARYANA	ITC not allowed. AAR held that ITC is not available both on the motor vehicle and ancillary insurance & maintenance expenses

Analysis and way forward

AARs giving unfavorable rulings have categorically stated that subsequent sales of these vehicles after usage will not have any impact on applicability of section 17(5)(a)(A). Similarly, usage of motor vehicle for training/ test driving/ demonstration purposes of customers do prove that the motor vehicle is used in the course or furtherance of business but fails to take this out from specific restriction placed by section 17(5)(a) of CGST Act.

Aforesaid section is reproduced below:

Section 17(5) - Notwithstanding anything contained in sub-section (1) of section 16 and sub- section (1) of section 18, input tax credit shall not be available in respect of the following, namely :-

1. motor vehicles for transportation of persons having approved seating capacity of not more than thirteen persons (including the driver), except when they are used for making the following taxable supplies, namely:-

(A)       further supply of such motor vehicles; or

(B)       transportation of passengers; or

(C)       imparting training on driving such motor vehicles;”

Section 17(5)(a)(A) of the CGST Act carves out an exception to blocking of ITC on motor vehicles with the use of words 'further supply of such motor vehicle', which means that motor vehicles are used for supply of such motor vehicles. AARs who have allowed the ITC, have considered subsequent sales in satisfaction of this exception. However, we need to also appreciate the intention behind the purchase as there is a difference between selling a new vehicle and selling of vehicle post usage as a “Used Vehicle”.

AAR in the matter of Platinum Motorcorp has observed that 'Demo Vehicles in respect of which the Question about admissibility of ITC has been raised for Advance Ruling, have been used for the purpose of demonstration before the prospective customers. Then they are sold like second hand goods. The law provides for ITC in case of "further Supply" of said vehicles. But here, first the vehicles are purchased, then they are diverted and used for Demonstration of 2 years or so, and in the first demonstration run it loses the character of the new vehicle and demo vehicles is sold akin to second hand goods and which is different from new Vehicle and accordingly treated differently under GST law. Thus it cannot be said that the demo vehicle is for further supply of such motor vehicles'. This very restricted and specific provision has been provided in law for Motor Vehicles. The purpose and intent of the law is thus very clear. Thus, by allowing the ITC this way will be ultra vires the basic provisions of 'further supply of such motor vehicles'.

The demonstration of the vehicle is a common business practice and an integral part of the marketing of any vehicle; hence, it very well qualifies to be input. However, provisions of section 17(5) are having overriding effect which restricts the ITC even in cases where the input, input service or capital goods are used in the course of or furtherance of business. All the AARs have agreed to this fact though some have allowed the ITC and some not.

ITC in respect of motor vehicles is available only when it is used for making the further supply of such motor vehicles. If the rationale for allowing the ITC by Kerala, Maharashtra & Goa AAR is accepted, then eventually all the motor vehicles are sold after usage by businesses and thus we can put them at PAR with demo vehicles and ITC in general should be available. The criteria for allowing ITC due to usage of demo Motor vehicle for sales & marketing purposes is also flawed as provisions of section 17(5) are overriding section 16(1). Thus, even after it is established beyond doubt that inputs, input service and capital goods are used in the course or furtherance of business, provisions of section 17(5) would play the deciding role to determine the availability of ITC.

We need to appreciate that motor vehicles being used as Demo vehicle by dealers are not bought strictly for being used for passenger transportation and thus should not be hit by section 17(5)(a) which is primarily to block the ITC on vehicles used for transportation of passengers. Concept of demo products is prevalent across industries and the ITC on those demo products is very much allowed. ITC on these demo vehicles has been a point of contention only due to specific entry restricting ITC on motor vehicles. Parliament in its wisdom has given three exceptions however usage as demo vehicles has yet not been included in those exceptions. It is high time that this important aspect be clarified by board in accordance with the spirit of GST to allow the ITC on expenses incurred in the course or furtherance of business.

In our considered view, till the time appropriate clarification is issued, suggestive course should be to not take the ITC at the time of purchase and rather pay tax under margin scheme at the time of sale of demo cars.