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Seamless Flow of Credit Under GST

March 18, 2017[2017] 79 taxmann.com 179 (Article)
351 Views

Abhay Desai

FCA, LL.B., D.I.S.A.

Introduction

1. Tax credit is the heart of GST. As per OECD guidelines on GST, seamless flow of tax credit is must to ensure that the incidence of tax does not fall on the manufacturers or traders but the entire burden falls on the end consumer in a transparent manner. Sec. 16 of the revised model CGST/SGST law ('model law') contains provisions related to input tax credit. As per Sec. 16(1), every taxable registered person is entitled to credit of tax charged on supply of goods or services to him which are used or intended to be used in the course or furtherance of business. Said credit shall be allowed subject to following conditions:

(a)   he is in possession of a tax invoice or debit note issued by a supplier registered under this Act, or such other taxpaying document(s) as may be prescribed;
(b)   he has received the goods and/or services;
(c)   the tax charged in respect of such supply has been actually paid to the account of the appropriate Government, either in cash or through utilization of input tax credit admissible in respect of the said supply; and
(d)   he has furnished the return under section 34

However, Sec. 17(4) provides list of goods/services on which credit will not be available. Most controversial of the same is sub-clause (g) which is reproduced below for ready reference:

"Sec. 17 (4) Notwithstanding anything contained in sub-section (1) of section 16 and subsection (1), (2), (3) and (4) of section 18, input tax credit shall not be available in respect of the following:

(g) goods lost, stolen, destroyed, written off or disposed of by way of gift or free samples"

Let us examine each case individually.

Goods Lost

2. As per Sec. 17(4)(g) input tax credit shall not be available in respect of goods which are lost. Webster Dictionary defines the word 'lost' as something which is unable to be found. In a manufacturing process goods may be lost due to natural process (e.g. evaporation) or due to human negligence (e.g. loss during production due to lack of proper supervision). Under the present CENVAT Credit Rules, 2004 if the entire quantity of inputs has been received in the factory premises and issued for production, CENVAT credit is not required to be reversed for inputs which are lost during the production process (refer PKPN Spinning Mills Ltd. v. CCE 1996 taxmann.com 37 (CEGAT - Chennai). Whether the provision under model law of non-eligibility of input tax credit will apply only to goods lost due to negligence or it shall also apply to goods lost due to natural process ?

Before we answer the above question let us analyze the ruling of Hon. Madras High Court on a similar provision under Tamil Nadu Value Added Tax Act ('TVAT'), 2006.

Sec. 18 of TVAT Act, 2006 provides that input tax credit shall be available of raw-material used in the manufacture of goods. Sec. 19(9) of TVAT Act, 2006 provides that input tax credit shall not be available if (i) goods are not sold because of any theft, loss or destruction, for any reason, including natural calamity. If a dealer has already availed input tax credit against purchase of such goods, there shall be reversal of tax credit; or (ii) inputs destroyed in fire accident or lost while in storage even before use in the manufacture of final products; or (iii) inputs damaged in transit or destroyed at some intermediary stage of manufacture.

In case of Interfit Techno Products Ltd. v. Principal Secretary Commissioner of Commercial Taxes [2016] 71 taxmann.com 27 (Mad.), petitioners were engaged in the business of manufacture and sales of hosiery garments. The petitioner purchased yarn among other inputs inside the State of Tamil Nadu from various registered dealers on payment of VAT of four per cent/five percent which is converted into fabric in the manufacturing unit of the petitioner and the fabric was thereafter processed and hosiery garments were manufactured. The resultant hosiery garments were exported by the petitioner periodically. During the knitting process, there was a process loss due to the flying of loose fibres and such loss was termed as "invisible waste" of yarn by the trade. Petitioner claimed full credit of tax paid on purchases and claimed refund of unutilized credit on account of exports. After allowing the refund, place of business of the petitioners was inspected and the Inspecting Officers informed the petitioner that they have to pay VAT on the invisible loss, which was arrived at five percent of the total value of the yarn purchased by them. Notices were issued demanding the VAT attributable to invisible loss. Petitioner challenged the notices before the Hon. High Court.

It was canvassed before the Hon. Court that the petitioners are entitled to full credit of tax paid by them on yarn as the same was fully used in the manufacturing process. It was submitted that once the condition that goods have been used in manufacturing process is fulfilled, provisions relating to non-availability of credit u/s. 19(9) are not required to be applied. It was also canvassed that provision u/s. 19(9) shall be attracted when goods are damaged before manufacturing process and the term "loss" used in section 19(9) cannot be isolated for/as invisible loss. It was submitted that in case of zero-rated sales a dealer must be entitled to refund of all the input tax paid by him referring to the scheme of the Act. An alternate plea was also raised with regard to arbitrariness in calculating the percentage of loss. It was submitted that loss percentage of five percent is not based on facts. On the other hand, it was submitted by the Government that the provision of law is unambiguous and clearly provides that credit attributable to goods lost shall not be allowed. Even reference was made to white paper on VAT to contend that even that paper provides for restrictions on tax credits.

It was held by the Hon. Court that set-off provided under the VAT Act is in the nature of concession. Under the VAT regime no dealer has a right to claim input-tax credit independent of the provisions of section 19. It was further held that sub-section (9) of section 19 clearly states that no input-tax credit shall be available to a registered dealer for tax paid or payable at the time of purchase of goods if any one of the circumstances provided u/s. 19(9) stand attracted. Having held that section 19 cannot be read in isolation, benefits which flow to the dealer under section 18 is subject to restrictions and conditions stipulated under section 19 of the Act. Hence it was held that it shall not be sufficient to just show that goods have been used in the production process in order to be eligible for full credit. It is inevitable to also show that any restrictions placed u/s. 19(9) are not attracted to claim full credit. It was however also held that percentage of loss is a question of fact and hence an officer has to consider all the submissions made by the petitioner and cannot assume a loss of five percent.

Hence, the above decision clearly provides that merely because inputs have been used in the manufacturing process, it shall not be sufficient to claim full credit. In view of specific restrictions of non-availability of credit of goods which are lost, the same needs to be reversed if the facts so establish.

Applying the ratio of above decision to the provisions of Sec. 17(4)(g) of model law, input tax credit will not be available of goods which are lost irrespective of the stage at which such loss happens or the reason for which the loss happens. Hence every taxable person will be required to maintain documents to calculate such loss and also carry out corresponding reversal of credit.

It may however be noted that there is a difference between the word 'consumed' and 'lost'. Restriction provided u/s. 17(4)(g) only applies to goods which are lost physically and shall not apply to goods (i.e. consumables) which are consumed during the manufacturing process.

Goods Stolen

3. Sec. 17(4)(g) provides that credit shall not be available of goods which are stolen. Webster Dictionary defines the word 'steal' as to take the property of another wrongfully. Hence credit shall not be available of goods which are pilfered.

Goods Destroyed

4. Sec. 17(4)(g) provides that credit shall not be available of goods which are destroyed. Webster Dictionary defines the word 'destroy' as to ruin something. Hence, a positive act of destruction is necessary as opposed to 'loss' which happens passively. It may be noted that goods are even destroyed due to 'Act of God (e.g. flood). Whether input tax credit is to be denied if goods are destroyed due to Act of God ?

The Gujarat High Court in the case of Rolcon Engg. Co. Ltd. v. State of Gujarat [2009] 21 VST 117 has held that from the language of scheme there will be no violation if one could not run the wind farm for reasons beyond his control. In this case appellant was granted benefit on the condition that he must run the wind farm for continuous period of six years. However due to devastating cyclone he could not run the wind farm for continuous period of six years. Government denied the benefit on the ground that the condition of the scheme has been violated. It was however held by the Hon. Court that the scheme does not explicitly provide for denial of benefit if the wind farm could not be run due to Act of God. Hence it was held that benefit must be allowed.

Similarly, Gujarat High Court in the case of State of Gujarat v. S.A. Himnani Distributors (P.) Ltd. [2014] 43 taxmann.com 358/44 GST 594 held in the context of Gujarat Value Added Tax Act, 2003 that claim of input tax credit cannot be denied on goods destroyed in flood as it was not a disposal otherwise than sale.

It may be noted that in both the above cases there was no specific provision in the law to deny the benefit/credit on the ground of destruction. Hence it was held that benefit/credit must be allowed. Sec. 17(4)(g) of model law explicitly provides that credit shall not be allowed of goods destroyed. Hence both the above judgments cannot be applied to the provision under model law and credit shall not be available on the goods which are destroyed. It may however be noted that GST shall not be payable on the money received under insurance claim as there is no supply of goods against which money has been received.

Goods written of or disposed of by way of gift or free samples

5. Sec. 17(4)(g) also provides that credit shall not be available of goods which are written of or disposed of by way of gift or free samples. In many instances tax payer write off capital goods after their useful life is over. In case of such goods written of whether the provision shall apply ? Our answer is no. It may be noted that there is no comma (,) after the words 'written of'. When a coordinating conjunction is used to connect a dependent clause, a comma is never used. Hence words 'written of or disposed of by way of gift or free samples' must be read as a single clause. Hence credit shall be denied only if the goods are written off due to the same being given as gift or as a free sample. Provision shall not be attracted when used capital goods are written of after use. Due to denial of credit of goods which are given as gifts traders will have to rework their schemes framed to attract sales by converting the free goods as a 'discount' on sales to avoid the disallowance of credit.

Conclusion

6. From the above discussion, it is understood that the flow of credit in the GST regime will not be seamless as widely believed. Credit will in fact be 'seamless' than what one will pay as tax to various vendors. One must clearly understand the provisions contained u/s. 17(4) so that appropriate changes can be made in ERP system to pull out necessary information for reversal of credit.

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