Treatment of Input Tax Credit pertaining to Trading Turnover while calculating Net Input Tax Credit for computing refunds on account of inverted duty structure under Section 54(3)(ii) of the CGST Act, 2017

[Dhruv Chhabra]

The concept “inverted duty structure” has emerged on account of accumulation of input tax credit resulting from the rate of tax on inputs being higher than the rate of tax on output supplies (other than nil rated or fully exempt supplies). The Government has slated a mechanism which is prescribed under Rule 89(5) of the CGST Rules, 2017 whereby refunds of unutilized input tax credit can be granted to the assesse taxpayer for input tax credit accumulated owing to duty inversion causing working capital blockage.

Things that we have to note here:

1. The refunds are permissible only for inputs and not for input services and the capital goods.
2. Net input tax credit does not include input tax credit pertaining to trading turnover i.e. the rate of tax on inputs and outward supply is same.
3. No refund of input tax credit is available if the assesse claims drawback in respect of Central Tax or State Tax or claims refund of integrated tax paid on such supplies.

The Formula prescribed under Rule 89(5) of the CGST Rules, 2017 for computation of refund:

Maximum Refund Amount = {(Turnover of inverted rated supply of goods and services) x (Net ITC) ÷ Adjusted Total Turnover} - tax payable on such inverted rated supply of goods and services.

Conundrum surmounting the calculation of refunds as per the aforementioned formula.

We have seen show cause notices being issued by the authorities alleging that the inputs are being traded as such merely on the ground that both inputs and output are classified under the same four digit HSN code* with same tax rates without examining the nature of business and operations of the taxpayer.

For example: Solar Cells (8541) which constitutes major component of the Solar Modules (8541) manufactured and sold by a taxpayer are deemed as one only by relying on the HSN Code, and such sales have been treated as Trading Sales. The input tax credit pertaining to such Solar Cells (8541) is hence excluded from the computation of “Net ITC” on account of same four digit HSN code i.e. (8541) without making any corresponding reduction of trading turnover from the “adjusted total turnover”.

The afore-stated example will present two challenges before the taxpayers:

1. Is it legitimate that only by relying on the HSN Code, the Solar Cells and Solar Modules are deemed as one and such sales be construed as Trading Sales.
2. The exclusion from “Net ITC” that ITC pertaining to trading sales without corresponding reduction of trading turnover from the “adjusted total turnover.

*Prior to April 2021, the assesse taxpayers can adopt four digit HSN Codes

The law is amply clear that where the rate of taxes are same on inputs and outward supplies the inversion cannot be said to have taken place but only by relying on the HSN Codes two different products are treated as one and further regarded as trading sales is bad in law.  The reduction in Net ITC for the amount of input tax credit pertaining to the such trading sales without corresponding reduction in the “inverted duty turnover” and “adjusted total turnover” is only hampering the overall essence of the formula prescribed under Rule 89(5) of the CGST Rules, 2017 and is further adding to the problem of disproportionate refund being sanctioned by adjudicating authorities. The formula that the adjudicating authorities are adopting is:

Maximum Refund Amount = {(Turnover of inverted rated supply of goods and services) x (Net ITC-ITC of Trading items*) ÷ Adjusted Total Turnover} - tax payable on such inverted rated supply of goods and services.

*includes those deemed as trading items in SCN’s

Even if the same is accepted, once the ITC pertaining to deemed trading turnover is reduced, such deemed trading turnover is also required to be reduced from the “inverted duty turnover” and “adjusted total turnover” in order to compute refund of inverted turnover pertaining to manufacturing sales only.

That the taxpayers may besides regular sales of manufactured items, at times when there is specific customer order may undertake to supply the inputs as such with due payment of taxes under the GST Law and the same won’t constitute the part of inverted duty turnover while filing the refund application, however forms part of the “adjusted total turnover” and the “Net ITC” includes input tax credit pertaining to traded inputs while calculating the refunds as per the formula prescribed under the law at the time of filing the refund application. However adjustments by the adjudicating authorities in the formula prescribed under law are made and formula adopted by them is specified above.

That the formula adopted by the adjudicating authorities without any corresponding adjustment to the “adjusted total turnover” is prejudicial to the taxpayer and is only resulting in disproportionate reduction in the refund the taxpayer is rightfully entitled to.

That in fact where a specific formula has been prescribed under the law for computation of proportionate refund where the taxpayer is engaged in Inverted as well as Non-Inverted Turnover, any adjustment or tampering with the prescribed formula is bad in law.

That Circular No. 125/44/2019 dated 18.11.2019 has clarified that where there are multiple inputs attracting different rates of tax (equal or lower rate of tax), in the formula provided in rule 89(5) of the CGST Rules, the term “Net ITC‟ covers the ITC availed on all inputs in the relevant period, irrespective of their rate of tax. When a specific clarification to cover the situation discussed above is already available as a direction to adjudicating authorities not adhering the same is a cause of concern.

Further the intention of the formula prescribed under the law is to calculate refund in proportion to inverted rated supply of goods and services. That reducing the value of ITC of Trading items while calculating “Net ITC” would result in reducing the proportionate benefit of refund to the taxpayer, thus defeating the object and purpose of refund of unutilized credit accumulated on account of inverted duty structure under Section 54(3)(ii) of the CGST Act, 2017. Thus if value of “Net ITC” is calculated by reducing the ITC of trading items then the value of “turnover of trading items” should also be reduced to determine “adjusted total turnover”.

That the refund claim is in respect of accumulated ITC pertaining to supplies having inverted rated duty structure. The goods which do not fall under the category will automatically be eliminated from the inverted duty structure as their HSN and rate of tax is same and hence neither the input tax credit nor the connected turnover will come into picture so far as it is in relation to calculation of refund claim on account of accumulated ITC. This will lead to a scenario where the trading operations of the taxpayer will be segregated from the manufacturing activities.

That in line with the foregoing discussion the adjudicating authorities should appreciate that even though the adjustment in the prescribed formula is needed the same should not only be restricted to “Net ITC” and should extend to cover the exclusion of trading turnover from “inverted rated turnover” and “adjusted total turnover”. The adjustments carried in such manner will promote the overall essence of the formula and shall also result in fair sanction of refunds to the taxpayers. This method of adjustment where trading turnover has been segregated or treated as separate unit from the manufacturing activities, the refunds of accumulated Net ITC will be computed only for inverted rated turnover.

Disclaimer:

The above discussion is only meant to apprise the tax payer of the pertinent issues surmounting the calculation of refund on account of inverted duty structure. The examples or illustrations used in write up is only meant for better clarity of the readers. The tax position should be analyzed keeping in view the business and operations of the taxpayers concerned.