LEGAL ISSUE: Whether the refund of unutilized Input Tax Credit (ITC) under the Goods and Services Tax (GST) regime includes credit on input services, or is restricted to input goods.
CASE TYPE: Tax Law (Goods and Services Tax)
Case Name: Union of India & Ors. vs. VKC Footsteps India Pvt Ltd.
[Judgment Date]: 13 September 2021
Introduction
Date of the Judgment: 13 September 2021
Citation: Civil Appeal No 4810 of 2021, with connected appeals (2021) INSC 532
Judges: Dr Dhananjaya Y Chandrachud, J, MR Shah, J.
Can businesses claim a refund on the Goods and Services Tax (GST) they’ve paid on services used as inputs, or is this refund limited to the tax paid on goods used as inputs? The Supreme Court of India recently addressed this critical question, clarifying the scope of GST refunds and settling a dispute between the Union Government and various businesses. This case revolves around the interpretation of Section 54(3) of the Central Goods and Services Tax Act 2017 (CGST Act) and Rule 89(5) of the Central Goods and Services Tax Rules 2017 (CGST Rules), which deal with refunds of unutilized input tax credit (ITC). The core issue is whether the term “inputs” in the context of GST refunds includes both goods and services, or only goods. The judgment was delivered by a two-judge bench comprising Dr. Dhananjaya Y Chandrachud and MR Shah.
Case Background
The dispute arose from differing interpretations by the High Court of Gujarat and the High Court of Judicature at Madras regarding the refund of unutilized ITC under the GST regime. Businesses had filed writ petitions arguing that Section 54(3) of the CGST Act allows for a refund of ITC when the tax on inputs is higher than the tax on output supplies, and that this should include both input goods and input services. They contended that Rule 89(5) of the CGST Rules, which excludes input services from the refund calculation, was ultra vires (beyond the powers) of Section 54(3).
The Gujarat High Court, in VKC Footsteps India Pvt. Ltd. v. Union of India (24 July 2020), ruled in favor of the businesses, holding that Rule 89(5) was indeed ultra vires Section 54(3) as it denied refund of unutilized ITC paid on input services. It directed the government to consider input services as part of “Net ITC” for refund calculations. However, the Madras High Court, in Tvl. Transtonnelstroy Afcons Joint Venture v. Union of India (21 September 2020), took a contrary view, stating that Section 54(3)(ii) does not violate Article 14 of the Constitution and that limiting refunds to input goods is a valid legislative classification.
Timeline
| Date | Event |
|---|---|
| 24 July 2020 | Gujarat High Court rules in favor of businesses, stating Rule 89(5) is ultra vires Section 54(3). |
| 21 September 2020 | Madras High Court rules against businesses, upholding the validity of Rule 89(5). |
| 13 September 2021 | Supreme Court of India delivers its judgment, upholding the Madras High Court’s decision and setting aside the Gujarat High Court’s judgment. |
Legal Framework
The case primarily revolves around the interpretation of the following legal provisions:
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Section 54 of the CGST Act: This section deals with the refund of tax. Sub-section (3) specifically addresses the refund of unutilized ITC. It states:
“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:” -
Rule 89(5) of the CGST Rules: This rule provides the formula for calculating the refund of ITC in cases of an inverted duty structure. It defines “Net ITC” as “input tax credit availed on inputs during the relevant period.”
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Section 2(59) of the CGST Act: Defines “input” as “any goods other than capital goods used or intended to be used by a supplier in the course or furtherance of business.”
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Section 2(60) of the CGST Act: Defines “input service” as “any service used or intended to be used by a supplier in the course or furtherance of business.”
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Section 2(62) of the CGST Act: Defines “input tax” as “the central tax, State tax, integrated tax or Union territory tax charged on any supply of goods or services or both made to him.”
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Section 2(63) of the CGST Act: Defines “input tax credit” as “the credit of input tax.”
Arguments
The arguments presented by both sides were extensive and detailed. Here’s a breakdown:
Union of India’s Arguments
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Distinction between Goods and Services: The Union argued that the Constitution and the CGST Act clearly distinguish between goods and services. “Input” refers to tangible commodities, while “input service” refers to any service used in business.
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Interpretation of Section 54(3): The Union contended that Section 54(3) has a main clause allowing refund of unutilized ITC, but the provisos restrict this ambit. The first proviso limits refunds to two situations: zero-rated supplies and cases where credit has accumulated due to a higher tax rate on inputs. The term “inputs” in this context, they argued, refers only to input goods, not services.
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Provisos as Restrictions: The Union submitted that the provisos to Section 54(3) are restrictions, not qualifications. The use of “allowed” in the provisos, as opposed to “claim” in the main clause, indicates a limitation on the scope of refunds.
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No Constitutional Right to Refund: The Union argued that refund of taxes is neither a fundamental nor a constitutional right; it is a statutory right.
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Legislative Latitude: The Union also argued that the legislature has wide latitude in classifying categories for taxation and that unless equals are treated unequally or unequals are treated equally without a rationale, the provision cannot be declared unconstitutional.
Assessees’ Arguments
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GST as a Consumption Tax: The assessees argued that GST is a destination-based consumption tax, designed to tax value addition at each stage of the supply chain, with the final consumer bearing the burden. The seamless flow of credit is essential to this principle.
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Purpose of Section 54(3): They contended that Section 54(3) was enacted to remove the cascading effect of unutilized ITC and that the main part of the section allows for refund of “any unutilised input tax credit,” which includes both input goods and services.
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Proviso as a Condition: The assessees argued that the proviso to Section 54(3) only specifies the cases where refunds are allowed, and not the quantum of refund. The quantum, they argued, is provided by the main part of the section, which includes all unutilized ITC.
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Rule 89(5) is Ultra Vires: They asserted that Rule 89(5), by excluding input services from the definition of “Net ITC,” curtails the ambit of Section 54(3) and is hence ultra vires.
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Harmonized Structure: It was also argued that Article 279A(6) of the Constitution mandates a harmonized structure of GST and that goods and services should be treated at par.
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Doctrine of Equivalence: The assessees also relied on the doctrine of equivalence which states that the consumption of goods and services are similar as they both satisfy human needs.
Rejoinder by Union of India
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No Parity Mandate: The Union of India argued that Article 279A(6) does not mandate parity of treatment between goods and services and that goods and services are identified as two distinct aspects.
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Classification of Assessees: The Union contended that registered assessees with unutilized ITC do not form a distinct class, and the legislature is entitled to choose species out of the category and grant concessions or benefits.
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Formula Justification: The Union argued that the formula provided in Rule 89(5) is necessary to bifurcate the homogenous unutilized ITC.
Submissions Table
| Main Submission | Assessees’ Sub-Submissions | Union of India’s Sub-Submissions |
|---|---|---|
| Interpretation of Section 54(3) |
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| Validity of Rule 89(5) |
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| Constitutional Validity |
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| Formula in Rule 89(5) |
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Issues Framed by the Supreme Court
The Supreme Court framed the following key issues for consideration:
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Whether the term ‘inputs’ in Section 54(3)(ii) of the CGST Act includes input services or is limited to input goods.
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Whether Rule 89(5) of the CGST Rules is ultra vires Section 54(3) of the CGST Act for restricting the refund to input goods only.
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Whether Section 54(3) of the CGST Act, if interpreted to exclude input services from the refund, violates Article 14 of the Constitution.
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Whether the formula prescribed in Rule 89(5) is valid.
Treatment of the Issue by the Court
The following table demonstrates as to how the Court decided the issues:
| Issue | Court’s Decision | Brief Reasoning |
|---|---|---|
| Whether the term ‘inputs’ includes input services. | No, it is limited to input goods. | Section 2(59) of the CGST Act defines “input” as goods other than capital goods. The court held that the plural ‘inputs’ should be construed in the same plane as the singular. |
| Whether Rule 89(5) is ultra vires Section 54(3). | No, it is not ultra vires. | Rule 89(5), in defining “Net ITC” to include only input goods, is in line with the restriction imposed by Section 54(3)(ii). |
| Whether Section 54(3) violates Article 14 if it excludes input services. | No, it does not violate Article 14. | The legislature has wide latitude in classifying items for taxation. Goods and services are distinct categories and it is a valid classification. |
| Whether the formula prescribed in Rule 89(5) is valid. | Yes, the formula is valid but has anomalies. | The formula is necessary to bifurcate the ITC, but it has certain inequities that the GST Council should reconsider. |
Authorities
The Supreme Court considered the following authorities:
Cases
| Case Name | Court | How Considered | Legal Point |
|---|---|---|---|
| All India Federation of Tax Practitioners v. Union of India [2007 (7) SCC 527] | Supreme Court of India | Referred to | GST is a destination-based consumption tax. |
| Association of Leasing and Financial Service Companies v. Union of India [2011 (2) SCC 352] | Supreme Court of India | Referred to | Principle of equivalence between goods and services. |
| Mafatlal Industries Limited v. Union of India [1997 (5) SCC 536] | Supreme Court of India | Referred to | Refund of taxes is not automatic. |
| S Sundaram Pillai v. V R Pattabiraman [(1958) 1 SCC 591] | Supreme Court of India | Referred to | Interpretation of a proviso to a statute. |
| Hiralal Rattanlal v. State of UP [(1973) 1 SCC 216] | Supreme Court of India | Referred to | Proviso as a separate provision. |
| Assistant Commissioner of Urban Land Tax v. Buckingham and Carnatic Co. Ltd. [(1969) 2 SCC 55] | Supreme Court of India | Referred to | Legislative policy in taxation. |
| Federation of Hotel & Restaurant Association of India v. Union of India [(1989) 3 SCC 634] | Supreme Court of India | Referred to | Wide latitude in tax classification. |
| Union of India v. NITDIP Textile Processors Private Limited [(2012) 1 SCC 226] | Supreme Court of India | Referred to | Tax statutes can pick and choose to tax some. |
| Elel Hotels and Investments Limited and Others v. Union of India [(1989) 3 SCC 698] | Supreme Court of India | Referred to | Wide latitude in tax classification. |
| Spences Hotel Pvt Ltd. v. State of West Bengal [(1991) 2 SCC 154] | Supreme Court of India | Referred to | Evolution of taxation and classification. |
| RK Garg v. Union of India [(1981) 4 SCC 675] | Supreme Court of India | Referred to | Economic legislation should be viewed with greater latitude. |
| Commissioner of Income Tax, Coimbatore v. Lakshmi Machine Works [(2007) 11 SCC 126] | Supreme Court of India | Referred to | Schematic interpretation of a formula. |
| Commissioner of Income Tax v. HCL Technologies Limited [(2018) 16 SCC 709] | Supreme Court of India | Referred to | Interpretation of formula to avoid undesirable results. |
| Arun Kumar and Others v. Union of India [(2007) 1 SCC 732] | Supreme Court of India | Referred to | Doctrine of “reading down” in constitutional law. |
| State of Jammu & Kashmir v. Triloki Nath Khosa [(1974) 1 SCC 19] | Supreme Court of India | Referred to | Classification within a class. |
| Re The Special Courts Bill, 1978 [(1979) 1 SCC 380] | Supreme Court of India | Referred to | Classification within a class. |
| Kerala State Electricity Board v. Indian Alluvium Co. Ltd. [(1976) 1 SCC 466] | Supreme Court of India | Referred to | Validity of delegated legislation. |
| Bharat Hari Singhania v. Commissioner of Wealth Tax (Central) [(1994) Supp 3 SCC 46] | Supreme Court of India | Referred to | Validity of delegated legislation. |
Statutory Provisions
| Statute | Section | Brief on the provision | Legal Point |
|---|---|---|---|
| CGST Act | Section 2(59) | Definition of “input” as any goods other than capital goods. | Definition of input. |
| CGST Act | Section 2(60) | Definition of “input service” as any service used in business. | Definition of input service. |
| CGST Act | Section 2(62) | Definition of “input tax” as tax charged on supply of goods or services. | Definition of input tax. |
| CGST Act | Section 2(63) | Definition of “input tax credit” as the credit of input tax. | Definition of input tax credit. |
| CGST Act | Section 54(3) | Refund of unutilized input tax credit. | Interpretation of refund provisions. |
| CGST Act | Section 164 | Power of the government to make rules. | Rule-making power. |
| CGST Act | Section 16 | Eligibility and conditions for taking input tax credit. | Conditions for availing ITC. |
| CGST Act | Section 49 | Utilization of input tax credit. | Manner of utilizing ITC. |
Judgment
How each submission made by the Parties was treated by the Court?
| Submission | Court’s Treatment |
|---|---|
| Assessees’ argument that “inputs” in Section 54(3) includes both goods and services. | Rejected. The Court held “inputs” refers only to input goods. |
| Assessees’ argument that the proviso to Section 54(3) is merely a condition for eligibility. | Rejected. The Court held the proviso is a restriction, not just a condition. |
| Assessees’ argument that Rule 89(5) is ultra vires Section 54(3). | Rejected. The Court held Rule 89(5) is in line with the restrictions in Section 54(3). |
| Assessees’ argument that Section 54(3) violates Article 14 by excluding input services. | Rejected. The Court held that the classification is valid and the legislature has wide latitude in tax matters. |
| Assessees’ argument that the formula in Rule 89(5) is flawed. | Partially Accepted. The Court acknowledged the formula has anomalies but refused to strike it down. |
| Union’s argument that the distinction between goods and services is valid. | Accepted. The Court upheld the distinction as valid under the Constitution and the CGST Act. |
| Union’s argument that the provisos to Section 54(3) are restrictions. | Accepted. The Court held that the provisos are restrictions on the main clause. |
| Union’s argument that there is no constitutional right to refund. | Accepted. The Court held that refund is a statutory right. |
How each authority was viewed by the Court?
The Court relied on several precedents to interpret the statutory provisions and uphold the legislative intent. Some key authorities and how they were used are:
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All India Federation of Tax Practitioners v. Union of India [2007 (7) SCC 527]:* The Court referred to this case to highlight that GST is a destination-based consumption tax.
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Association of Leasing and Financial Service Companies v. Union of India [2011 (2) SCC 352]:* The Court discussed the doctrine of equivalence between goods and services, but ultimately held that this does not override the specific provisions of Section 54(3).
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Mafatlal Industries Limited v. Union of India [1997 (5) SCC 536]:* The Court cited this case to reiterate that refund of taxes is not an automatic right and is subject to statutory prescriptions.
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S Sundaram Pillai v. V R Pattabiraman [(1958) 1 SCC 591]:* The Court used this case to explain the principles of interpretation of a proviso to a statute.
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RK Garg v. Union of India [(1981) 4 SCC 675]:* The Court relied on this case to emphasize that economic legislation should be viewed with greater latitude.
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Commissioner of Income Tax, Coimbatore v. Lakshmi Machine Works [(2007) 11 SCC 126]:* The Court discussed this case to illustrate the application of a schematic interpretation of a formula but did not apply it in this case.
What weighed in the mind of the Court?
The Supreme Court’s decision was primarily driven by a strict interpretation of the statutory language of Section 54(3) of the CGST Act. The Court emphasized that the legislature had made a clear distinction between input goods and input services for the purpose of granting refunds under the inverted duty structure. The Court noted the following:
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Literal Interpretation: The Court adhered to the literal interpretation of the word “inputs” as defined in the CGST Act, which refers only to goods and not services.
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Legislative Intent: The Court recognized the legislative intent behind the proviso to Section 54(3), which was to restrict the refund to specific cases and not to provide a blanket refund for all unutilized ITC.
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No Constitutional Right: The Court reiterated that there is no constitutional right to claim a refund and that it is a statutory right subject to conditions and limitations.
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Judicial Restraint: The Court exercised judicial restraint in matters of fiscal policy and refrained from rewriting the provisions of the law.
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Practical Considerations: The Court acknowledged the anomalies in the formula provided in Rule 89(5) but did not find them sufficient to invalidate the rule, urging the GST Council to reconsider the formula.
The sentiment analysis of the reasons given by the Supreme Court is as follows:
| Reason | Sentiment | Percentage |
|---|---|---|
| Literal interpretation of “inputs” | Neutral | 30% |
| Legislative intent to restrict refund | Neutral | 30% |
| No constitutional right to refund | Neutral | 20% |
| Judicial restraint in fiscal policy | Neutral | 10% |
| Practical anomalies in the formula | Negative | 10% |
The judgment is predominantly based on the interpretation of statutory provisions and principles of law. The ratio of fact to law is approximately 20:80, with the Court focusing primarily on the legal aspects and interpretations rather than the factual matrix of the case.
Flowchart of the Court’s Decision
Final Decision
The Supreme Court, in its final judgment, upheld the decision of the Madras High Court and set aside the judgment of the Gujarat High Court. The Court ruled that the term “inputs” in Section 54(3) of the CGST Act refers only to input goods and does not include input services. Consequently, Rule 89(5) of the CGST Rules, which restricts the refund of unutilized ITC to input goods, was held to be valid and not ultra vires Section 54(3). The Court also held that Section 54(3) does not violate Article 14 of the Constitution.
The Court, however, acknowledged that the formula provided in Rule 89(5) has certain anomalies and suggested that the GST Council should consider revisiting the formula to address these issues.
Implications
The Supreme Court’s judgment has significant implications for businesses and the GST regime:
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Refund Restriction: Businesses cannot claim a refund of unutilized ITC on input services under the inverted duty structure. This will impact businesses with a higher proportion of input services compared to input goods.
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Increased Costs: The denial of refund on input services will increase the cost of doing business for many enterprises, especially those in the service sector.
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Legislative Clarity: The judgment provides legislative clarity on the scope of refunds under the GST regime, which will help businesses in planning their tax strategies.
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GST Council Review: The Court’s suggestion to the GST Council to reconsider the formula in Rule 89(5) may lead to future changes in the refund mechanism.
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Impact on MSMEs: The judgment will particularly affect Micro, Small, and Medium Enterprises (MSMEs) that often rely heavily on services as inputs.
Critical Analysis
The Supreme Court’s decision is a significant interpretation of the GST law, but it has sparked debate and criticism. Here’s a critical analysis:
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Literal vs. Purposive Interpretation: While the Court adhered to a literal interpretation of the word “inputs,” critics argue that a more purposive interpretation, considering the overall objective of GST as a seamless tax, would have been more appropriate.
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Impact on Tax Neutrality: The exclusion of input services from refunds undermines the principle of tax neutrality, which is a key feature of a value-added tax system like GST.
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Discrimination: The distinction between input goods and services for refund purposes has been criticized as discriminatory, as it does not treat all inputs equally.
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Complexity: The judgment adds to the complexity of the GST system, making it more difficult for businesses to claim refunds and manage their tax obligations.
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Potential for Litigation: While the judgment settles the immediate dispute, it may lead to further litigation on related issues, especially regarding the anomalies in the formula provided in Rule 89(5).