Section 54 on inverted duty structure in GST does not violate Article 14 – HC

Inverted duty structure basically occurs when the tax chargeable on inputs is higher than the tax chargeable on outputs.

For instance, Mr A is in the manufacturer of air conditioners. He pays GST of Rs 1,00,000 on purchase of raw materials at 18%. After carrying out the manufacturing process, the finished product (air conditioner) is sold. Tax payable on the same is Rs 80,000 which is chargeable at 12%.  Mr A is paying more GST on the input materials than the GST which is chargeable on the final product. This is a situation of inverted duty structure.

What is the unutilised input tax credit w.r.t Inverted Duty Structure?

“Input Tax” in relation to a taxable person, means the GST charged on him for any supply of goods and/or services to him, which are used or are intended to be used, for the furtherance of his business. In simple words, input tax credit (ITC) means at the time of paying tax on output, you can reduce the tax you have already paid on inputs and pay the balance amount.

Now in a situation of ‘Inverted Duty Structure’ the GST paid on inputs exceeds the GST on the outputs which leads to unutilised ITC (Rs 20,000 in the above example). As per Section 54(3) of the CGST Act, 2017, a registered person may claim a refund of the unutilized input tax credit on account of Inverted Duty Structure at the end of any tax period.

An existing legitimate example of Inverted Duty Structure is the non-woven fabric bags industry. The inputs being non-woven fabric is being charged at 12% GST while the output of fabric bags is being charged at 5% GST.

How to compute refund of input credit?

Provisions underRule 89 of CGST Rules, 2017pertain to“Application for Refund of Tax, Interest, Penalty, Fees or any Other Amount”. According to Rule 89(5), In the case of refund on account ofinverted duty structure, refund of input tax credit shall be granted as per the following formula:

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.

Where,

• Net ITC shall mean ITC availed on inputs during the relevant period other than the input tax credit availed for which refund is claimed under sub-rules (4A) or (4B) or both.
• Turnover of inverted rated supply of goods means the value of the inverted supply of goods made during the relevant period.
• Tax payable on such inverted rated supply of goods means the tax payable on such inverted rated supply of goods under the same head, i.e. IGST, CGST, SGST.
• Adjusted Total turnover means the turnover in a State or a Union territory, as defined under section 2(112) of CGST Act, excluding the value of exempt supplies other than inverted-ratedsupplies, during the relevant period.
• Relevant period means the period for which the claim has been filed.

Now in the above formula, Net ITC means ITC availed on inputs. But what about ITC availed on Input services? Does that formula mean that unutilized ITC on Input Services will not be available in case of inverted duty structure? Let us refer to the case of Transtonnelstroy Afcons Joint venture Vs Union of India (Madras High Court) where the issue under consideration is whether the Petitioners are entitled to a refund of the entire unutilised ITC that each of them has accumulated on account of being subjected to an inverted duty structure.

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Facts of the Case:

• All the Petitioners were engaged in businesses wherein the rate of tax on input goods and/or input services exceeds the rate of tax on output supplies.
• Therefore, the registered person was unable to adjust the available ITC fully against the tax payable on output supplies and there was an accumulation of unutilised ITC.
• The case of the Petitioners was that they were entitled to a refund of the entire unutilised ITC, irrespective of whether such credit accumulated on account of procurement of input goods and/or input services by paying tax at a higher rate than that paid on output supplies.
• On the contrary, the case of the Union of India and the Tax Department, was that refund of unutilised ITC was permissible only in respect of the quantum of credit accumulated due to the procurement of input goods at a higher rate than that paid on output supplies.
• Credit accumulation on account of procuring input services at a rate of tax higher than that paid on output supplies is liable to be disregarded for refund purposes.

Interpretation of Section 54 by the High Court (HC)

• Section 54 is a generic refund provision. Section 54(3) is specific to refund of unutilised ITC.
• HC found that Section 54(3) enabled a registered person to claim refund of any unutilised ITC. However, the principal or enacting clause was qualified by the proviso which stated that “provided that no refund of unutilised ITC shall be allowed in cases other than”.
• According to proviso to Section 54(3), no refund of unutilised input tax credit shall be allowed in cases other than:
• zero rated supplies made without payment of tax;
• 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
• Parliament used a double negative in this proviso thereby making it clear that unless a registered person meets the requirements of clause (i) or (ii) of Section 54(3), no refund would be allowed.
• On further examining sub-clause (ii), HC found that it uses the phrase “where the credit accumulated on account of rate of tax on inputs being higher than the rate of tax on output supplies”.
• While interpreting any statute, one of the cardinal rules of interpretation is that every word of the statute should be given meaning and one should not construe a statute in such a way as to render certain words redundant.
• As explained above, sub-clause (ii) would have merely stated “where the rate of tax on inputs being higher than the rate of tax on output supplies” and the words “credit has accumulated on account of” would not have been introduced if the intention was not to identify the source from which – i.e. input goods and the rate of tax thereon – unutilised ITC should accumulate for entitlement to refund, if the intention was to provide a refund of the entire unutilised ITC.
• Therefore, HC concluded that Section 54(3)(ii) qualified the enacting clause by also limiting the source/type and, consequently, quantity of unutilised ITC in respect of which refund is permissible.
• Hence, the proviso to Section 54(3) did not merely set out the two cases in which registered persons become eligible for a refund of unutilised ITC.
• The proviso performed the larger function of also limiting the entitlement of refund to credit that accumulates as a result of the rate of tax on input goods being higher than the rate of tax on output supplies.

Is Rule 89(5) is ultra vires Section 54(3)?

• As HC concluded that Section 54(3)(ii) enabled a registered person to claim a refund of unutilised ITC only to the extent that such credit had accumulated on account of the rate of tax on input goods being higher than the rate of tax on output supplies, the issue was whether Rule 89(5) was ultra vires Section 54(3).
• Section 164 conferred power on the Central Government to frame rules for carrying out the provisions of the CGST Act and no restrictions were visible except that the rules should be in furtherance of the purposes of the CGST Act.
• Rule 89(5) would be intra vires the CGST Act and the rule making power if it was in line with Section 54(3)(ii) and ultra vires both Sections 54(3)(ii) and 164 if it was not.
• HC noted that Section 54(1) contained the form and manner to claim refund and Section 54(4) contained procedural requirements as regards the application for refund.
• Rule 89 dealt with applications for refund of tax, interest, penalty, fees or any other amount.
• Rule 89(5) was amended on two occasions. In the amended Rule 89(5), the expression “Net ITC” was defined as meaning ITC availed on “inputs” during the relevant period.
• On the contrary, the expression Net ITC in Rule 89(5), as it stood between 01.07.2017 and 18.04.2018, defined the term the Net ITC as per the meaning in Rule 89(4) which defined Net ITC as ITC availed on inputs and input services during the relevant period.
• When amended Rule 89(5) was analysed in the context of Section 54(3)(ii), it was clear that Net ITC was re-defined to provide for a refund only on unutilised ITC that accumulated on account of input goods, whereas, as per the unamended Rule 89(5), Net ITC covered not only ITC availed on input goods but also on input services.

• Therefore, as refund was permitted only in respect of unutilised ITC that accrued or accumulated as a result of the higher rate of tax on input goods vis-a-vis output supplies, HC was of the view that the amended Rule 89(5) was in conformity with the statute.
• On the other hand, the unamended Rule 89(5) exceeded the scope of Section 54(3)(ii) and extended the benefit of refund to the credit that accumulates both on account of the rate of tax on “inputs” and “input services” being higher than the rate of tax on output supplies.
• HC concluded that Rule 89(5), as amended, was intra vires both the general rule making power and Section 54(3).

Observations of HC on the question pertaining to the constitutionality of Section 54(3)(ii)

• Article 14 of the Constitution of India provides for equality before the law or equal protection of the laws within the territory of India. 
• The contention of the petitioners was that Section 54(3) would violate Article 14 of the Constitution unless the word “inputs” used therein, included input services.
• This contention premised on the ground that the classification of registered persons for purposes of entitlement to refund into two classes – those who avail ITC on input goods and those who avail ITC on input services, was an arbitrary and unfair classification.
• The correct meaning of the word “inputs”, as used in Section 54(3)(ii) of the CGST Act should be drawn by applying the afore-stated principles.
• Section 2(59) defines inputs as “any goods other than capital goods used or intended to be used by a supplier in the course or furtherance of business”.
• In our view, there are multiple factors that discourage against reading the word “inputs” against the meaning per definition.
• The first is that the definition expressly excludes capital goods, whereas if the common parlance meaning, as advocated by petitioners, is adopted, capital goods would be included and one would be drawing conclusions that are contrary to the text.
• The second reason is that Section 54 contains more than a few usages of the terms “inputs” and “input services” in other sub-sections.
• Reference may be made to Section 54(8)(a) which uses the words “inputs” and “input services” separately and distinctively in the context of refund of tax paid to exporters.
• Similarly, Explanation to Section 54 uses the terms “inputs” and “input services” separately and distinctively, thereby indicating the legislative intent to distinguish one from the other.
• Keeping in mind the aforesaid factors, HC was unable to allow petitioners submission that the word “inputs” should be read so as to include “input services”.
• Hence, HC concluded that the word “inputs” encompasses all input goods, other than capital goods, and excludes input services.

Observations of HC on the rival contentions on classification for the purposes of refund

• Petitioner contended that a person who availed input services at a higher rate of tax than the rate of tax on output supplies was also entitled to ITC and therefore accumulated ITC.
• In other words, there was no restriction on the accrual or accumulation of ITC. The differential treatment was limited to entitlement to refund.
• According to him, the Parliament/legislature was entitled to make a classification provided such classification was not arbitrary and had a rational nexus to the object of the enactment, and the GST laws were introduced so as to treat both goods and services alike and depart from the historical practice of treating goods and services differently.
• He contended that the charging provisions, the machinery provisions, the penal provisions, the enforcement provisions all applied equally to goods and services under GST.
• In fact, even the provisions related to ITC applies equally both to goods and services, and the differentiation only for purposes of refund of unutilised ITC violated Article 14.
• On the contrary, respondents contended that Parliament had the right to make a classification and that a classification based on the distinction between goods and services was rational. CGST Act was designed to consolidate the laws relating to tax on goods and services.
• However, he contended that the consolidation did not mean that the distinction between goods and services was obliterated.
• Thus, the question that arose for consideration was whether the classification for purposes of refund was liable to be struck down as being in violation of Article 14.
• It was also pertinent to bear in mind that the Court was required to begin with the presumption that the statute was constitutionally valid. This was a rebuttable presumption.
• Upon considering the rival contentions on this issue, HC noted the following features of ITC and its refund:

1. Registered persons who utilise input services, in their output supplies, were permitted to avail ITC, which was reflected in their ledger.
2. The unutilised ITC did not lapse if refund was not granted. However, it was possible that it may have to be written down on account of applicable accounting standards if the probability of utilization is low.
3. The differentiation between input goods and input services was only with regard to entitlement to refund. Section 54(3)(ii), as interpreted by the HC, limited the entitlement to refund to the credit that accumulates on account of the rate of tax on input goods being higher than the rate of tax on output supplies.
4. Inter se registered persons who avail input services, the treatment is uniform as also inter se registered persons who procure input goods.
5. It should also be borne in mind that the refund of unutilised ITC entailed the outflow of cash from the Government’s pockets.

• A right of refund was purely statutory and, therefore, cannot be availed of except strictly in accordance with the conditions prescribed for the same.
• HC found that there was a classification of sources of unutilised ITC into sources that gave rise to a right to refund, i.e. input goods, and those that did not, i.e. input services.
• Registered persons may be entitled to full, partial or nil refund as regards unutilised ITC accumulating on account of being subject to an inverted duty structure.
• The scope to make classification in matters related to taxation was wider than in other forms of legislation.
• In the context of the CGST Act, HC noted that the legislation was intended to consolidate the indirect taxes on goods and services under a common umbrella.
• There was no doubt that the object and purpose of the present GST laws was to avoid the cascading of taxes and to impose a tax on consumption, be it goods or services.
• The subject matter of controversy was the entitlement to refund of unutilised ITC and not the availing of ITC.
• Under Section 54(3)(ii), Parliament provided the right of refund only in respect of unutilised credit that accumulated on account of the rate of tax on input goods being higher than the rate of tax on output supplies.
• HC concluded that the classification was valid, non-arbitrary and far from invidious and Section 54(3)(ii), on a plain reading, did not violate Article 14.

In conclusion:

• Section 54(3)(ii) does not violate Article 14.
• Refund was a statutory right and the extension of the benefit of refund only to the unutilised credit that accumulated on account of the rate of tax on input goods being higher than the rate of tax on output supplies by excluding unutilised ITC that accumulated on account of input services was a valid classification and a valid exercise of legislative power.
• Therefore, there is no necessity to adopt the interpretive device of reading down so as to save the constitutionality of Section 54(3)(ii).
• Section 54(3)(ii) restricts a refund claim to the unutilised credit that accumulated only on account of the tax rate on input goods being higher than the rate of tax on output supplies.
• Rule 89(5) of the CGST Rules, as amended, was in conformity with Section 54(3)(ii). It was not necessary to interpret Rule 89(5) and, in particular, the definition of Net ITC therein so as to include the words input services.

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