Input Tax Credit on Construction Cost in relation to Immovable Property- an analysis based upon the recent Supreme Court’s Judgement in Safari Retreat’s case

[CAJOYDEB BHATTACHARYA]

Executive Summary

The decision of the Hon’ble Supreme Court in the case “Chief Commissioner of Central Goods and Service Tax & Ors. Vs Safari Retreats Private Ltd. & Ors. - 2024 (10) TMI 286 - SUPREME COURT (Supreme Court of India)” is an eye opener for all taxpayers in regard to availability of Input Tax Credits on Construction Cost. Though the credit of the same is blocked under Section 17(5), clause (c) and (d), however, the Hon’ble Apex Court has very carefully analysed the meaning of ‘plant and machinery’ and ‘plant or machinery’ and analysed the availability ITC. In the following paragraphs, the judgement and its implication and grey areas are analysed in detail.

The Hon’ble Supreme Court of India made several key observations regarding the constitutional validity of Section 17(5)(c) and (d) of the CGST Act, 2017, and the issue of Input Tax Credit (ITC) in the case of the “Chief Commissioner of Central Goods and Service Tax & Ors. Vs Safari Retreats Private Ltd. & Ors. - 2024 (10) TMI 286 - SUPREME COURT. (Supreme Court of India)”. The decisions of the Hon’ble Apex Court may be a game changer in relation to availability of Input Tax Credits on Construction Cost. In this regard, I wish to highlight some of the Key Observations of the Hon’ble Apex Court in the following paragraphs.

Issues for consideration before the Apex Court

1. Whether the definition of “plant and machinery” in the explanation appended to Section 17 of the CGST Act applies to the expression “plant or machinery” used in clause (d) of sub-section (5) of Section 17?

2. If it is held that the explanation does not apply to “plant or machinery”, what is the meaning of the word “plant”? and

3. Whether clauses (c) and (d) of Section 17(5) and Section 16(4) of the CGST Act are unconstitutional?

Relevant Provisions of the CGST Act,2017

“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:

……………..

(c) works contract services when supplied for construction of an immovable property (other than plant and machinery) except where it is an input service for further supply of works contract service;

(d) goods or services or both received by a taxable person for construction of an immovable property (other than plant or machinery) on his own account including when such goods or services or both are used in the course or furtherance of business.

Explanation.—For the purposes of clauses (c) and (d), the expression “construction” includes re construction, renovation, additions or alterations or repairs, to the extent of capitalisation, to the said immovable property;”

Key Observations by the Hon’ble Apex Court

1. The explanation to Section 17(5) defines “ plant and machinery”. However, no where in the CGST Act “plant or machinery” is defined Clause ( c) and clause (d) of the CGST Act do not exclude every classes of immovable properties from the applicability of ITC. As per clause (c) if the construction is of “plant and machinery”, the benefit of ITC will accrue. Similarly, under clause (d) if the construction is of “plant or machinery”, ITC will be available.

2. As per the well settled principle of interpretation of taxing statute, there is no scope to give any meaning to clause (c) of Section 17(5) other than its plain and natural meaning. The “plant and machinery” is defined in the explanation to Section 17(5) of the CGST Act, 2017. Works contract service is also defined in the CGST Act. Therefore, there is nothing to add or subtract from the clause (c) of Section 17 of the CGST Act. As ITC is a creation of legislature, it can exclude specific categories of goods or services from ITC and such exclusion, per se will not defeat the object of the CGST Act.

3. The phrase “plant and machinery” is used in the CGST Act at several different places. However, the term “plant or machinery” is only used in Section 17(5)(d) of the CGST Act. Therefore, it has been inferred that the legislature has intentionally used the expression “ plant or machinery” in clause (d) of Section 17(5) of the CGST Act,2017. Therefore, the expression “plant and machinery” and “plant or machinery” cannot have the same meaning.

4. The expression “plant or machinery” can either be “plant” or “machinery”. No where in the GST Laws, the word “plant” is defined. In this regard the Apex Court has held that dominant functionality test shall be carried out to determine whether a building can be considered as a “plant” or not. If it is found on facts that a building has been so planned and constructed so as to serve assessee’s special technical requirements, it will qualify to be treated as ‘plant’. For the purpose of Section 17(5)(d) ‘plant’ should not be given a restrictive meaning to exclude land, buildings etc.

5. Activity of Renting or leasing buildings is already covered under Schedule-II of the CGST Act,2017 as supply of service. Even the activity of construction of building is a supply of service if the total consideration is collected before getting Completion Certificate. Therefore, building can be considered as “plant” and ITC can be availed for construction of such building if the same is used for further supply of services like renting, leasing etc. However, if the building is used for own use, then ITC will not be available.

6. Further, in regard to the constitutional validity of Section 17(5) clause ( c) and (d), the Apex Court has relied upon the decision in the case of VKC Footsteps and held that the provisions of Section 17(5), clause (c ) and clause (d) do not meet the test of reasonable classification, which is a Part of Article-14 of the Constitution of India. To satisfy the test, there must be an intelligible differentia forming the basis of the classification, and the differentia should have a rational nexus with the object of legislation. It is further held that the right of ITC is conferred only by the Statute; therefore, unless there is a statutory provision, ITC cannot be enforced. It is a creation of a statute, and thus, no one can claim ITC as a matter of right unless it is expressly provided in the statute. It cannot be disputed that the legislature can always carve out exceptions to the entitlement of ITC under Section 16 of the CGST Act.

This judgement is landmark decision in regard to availability of ITC on construction activity, which are blocked under Section 17(5) clause ( c) and (d) of the CGST Act. It is observed that the Hon’ble Apex Court has settled the position of clause (c) of Section 17(5) and stated that the legislature has the power to disallow ITC in relation to certain categories of Goods and/or services. The said clause disallows ITC on Works Contract Services if used for Construction of Immovable Property other than “Plant and Machinery”. Therefore, ITC on Works Contract Services used for Construction of Plant and Machinery is allowed.

However, ITC in relation to Goods and/or Services procured separately for construction of Immovable Property other than Plant or Machinery are disallowed under clause (d) of the CGST Act. In this case the Hon’ble Apex Court has categorically decided that ITC shall be eligible in respect of construction of Malls or other buildings which were constructed with the objective of giving it on rent or lease. The Hon’ble Apex Court has also decided that functionality test shall be applied to determine whether a building is a ‘plant’ on case to case basis.

Though, the Hon’ble Court is silent in respect of construction of Factory Buildings where taxable goods are manufactured or construction of office building from where services are provided, however, the principle of functionality test, as applied by the Hon’ble Apex Court may be used to determine the eligibility of ITC in respect of Factory Building or Office Buildings.

In this regard, different situations can be envisaged which are as below:

Situations	Availability of ITC
X Ltd. Constructs a Factory Shed/Factory Building for starting manufacturing production. For this purpose X Ltd has given a Works Contract[ Both Materials and Services shall be Supplied] to Y Ltd to construct the Factory Shed or Factory Building. Y Ltd is a GST Registered party and charges GST at an applicable rate.	In this case the ITC is blocked as per Section 17(5) clause ( c) of the CGST Act,2017. Only exception in the said clause is construction of “plant and machinery” which is also defined in the explanation to Section 17(5). Works Contract is also defined in Section 2(119) of the CGST Act,2017.The Hon’ble Apex Court also has stated that the legislature has the power to disallow certain categories of ITC and ITC is not a vested right as it is a creation of the legislature. Therefore, even after the judgment of the Hon’ble Apex Court, such ITC remains disallowable.
X Ltd. Constructs an office building from where taxable services would be provided. For this purpose X Ltd has given a Works Contract [Both Materials and Services shall be Supplied] to Y Ltd to construct the . Y Ltd is a GST Registered party and charges GST at an applicable rate.	The same position, as aforesaid shall be held. No ITC shall be allowed as per clause ( c) of Section 17(5).
X Ltd. Constructs a Factory Shed/Factory Building for starting manufacturing operation of production of taxable goods. For this purpose X Ltd has purchased construction materials from Y Ltd at an agreed upon rate and has given the construction/installation contract to Z Ltd. Both the suppliers, X Ltd and Z Ltd are registered under GST.	In this kind of situation functionality test, as observed by the Hon’ble Apex Court may be applied. The aforesaid judgment did not envisaged anything about Factory Building/Shed. However, if taxable goods are manufactured from the said factory shed, then as envisaged by the Hon’ble Court, it can be analysed whether the same falls under ‘plant’ or not. As envisaged by the Apex Court, the definition ‘plant’ has a direct nexus with the generation of revenue in case of lease, rent etc. However, in case of Factory Shed/Factory Building the nexus is indirect in nature. However, for the purpose of manufacturing such shed/building is a pre-requisite and therefore, the company may take a stand to avail ITC on the same.
What if, in the aforesaid case is a Office Building for provision of service is constructed?	As envisaged by the Hon’ble Apex Court, if the building is used directly for providing service like renting or leasing, then ITC is allowed. However, in case where services are provided by a team, say in the case of CA’s Service, where a group of people provides service to clients, a office space is a pre-requisite for providing seating arrangement of the team. So, ITC shall be allowed in such cases also though the same would be subject to litigation.

Conclusion

The Judgement of the Hon’ble Supreme Court is a welcome judgement which can be an eye opener for all of us in the industry and profession. It cannot be a striate jacket case the credit is not available on construction of immovable property. We need to analyse each and every case and decide whether credit can be availed or not.

Discussions to this article

[deepak gulati]

What will be implication of GST at the time of sale of a building, if we take ITC on same treating it as as plant 

[Sadanand Bulbule]

Dear Deepak

SCHEDULE 03 - ACTIVITIES OR TRANSACTIONS WHICH SHALL BE TREATED NEITHER AS A SUPPLY OF GOODS NOR A SUPPLY OF SERVICES. 

Your query is covered by following entry No. 5: 

5. Sale of land and, subject to clause (b) of paragraph 5 of Schedule II, sale of building.

Eligibility of ITC on goods/services used in the construction of a building to be used exclusively as "plant" is available and not on sale of building, being immovable property. In my opinion, ITC needs to be reversed, if availed, as sale of building is outside the ambit of GST Act.

[CAJOYDEB BHATTACHARYA]

I think Supreme Court is very clear about the definition of plant per se. If the Building is directly used for generating taxable revenue then ITC shall be eligible. Please keep in mind that ITC disallowed under clause (d) of Section 17(5) is arguable. If the same is disallowable under clause (c) then you have no merit in arguing the case because the apex court have not stated anything on clause (c). Further if the building is used as office of supplier then the apex court is silent on that issue. So I would suggest to take a legal opinion from expert before taking any decision because every case is unique.

[Sadanand Bulbule]

Sagacious suggestion.