Analysis of Input Tax Credit (Revised Provisions in the Act and Draft ITC Rules)

Introduction:

The Central GST Act, Union Territory GST Act, Integrated GST
Act and GST Compensation Act passed by the Central Government and received
presidential assent on 29^th March 2017 contain several changes vis a
vis the provisions contained in the draft Model GST Law which was released in
November 2016 (‘Earlier Draft Law’). Further various draft rules have also come
in public domain recently which include rules relating to ITC as well. In the
April 2017 issue of the BCAJ, the provisions relating to ITC contained in
Earlier Draft Law were discussed. The objective of this Article is to highlight
the changes in the ITC related provisions contained in the Earlier Draft Law
and in the enacted law (Revised Law) and also to discuss the draft rules
dealing with ITC.

I.    Changes in the Earlier Draft Law and Revised
Law

1.   Non- Payment of Value of Supply along with
Taxes to Supplier of Goods/Services.

      Earlier Draft Law provided that, where the
recipient fails to pay to the supplier of services, the amount towards the
value of supply of services along with tax payable thereon within a period of 3
months from the date of issue of invoice by the supplier, an amount equal to
the Input Tax Credit (ITC) availed by the recipient shall be added to his
output tax liability, along with interest thereon.

      Under the Revised Law provisions, this
time limit has been extended from 3 months to 180 days. The scope of provision
is expanded to cover not only the inward supply of services, but also inward
supply of goods. It’s further provided that, recipient shall be re-entitled to
avail the credit of such input tax on payment of amount towards the value of supply
of goods or services along with tax payable thereon. However, the recipient
shall not be entitled to re-claim the amount paid towards interest.

2.   Meaning of “Exempt Supply” for the purpose of
Computation of goods/services used partly or fully for the purpose of exempt
supply.

      Under the Earlier Draft Law, the term
“Exempt Supply” included (i) supply of goods/services not taxable under the Act
(ii) supply of goods/services which attract Nil rate of tax and (iii) supply of
goods/service exempted under the Act. However, “exempt supply” for the purpose
of ascertaining quantum of ineligible ITC also included the supplies on which
supplier was not liable to pay tax due to reverse charge mechanism.

      Under the Revised Law, the definition of
exempt supply has remained the same. However, besides supplies covered under
RCM, it has now been explicitly provided that, such ‘exempt supply’ shall also
include transactions in securities, sale of land and sale of building (except
activity covered as deemed supply of service under Para 5(b) of Schedule II),
although in terms of Revised Law, they are neither regarded as
goods/services. 

3.   Non- Reversal of 50% ITC in case of banking
company or Financial Institution / Non-Banking Financial institution for
supplies made between ‘distinct persons’

      The Revised law, provides that, although
banking companies or financial institutions or NBFCs, engaged in supplying
services by way of accepting deposits, extending loans or advances has availed
the option of availing only 50% of the ITC every month, such restrictions shall
not apply to tax paid on supplies made by one registered person to another
registered person having same PAN. (i.e. distinct persons covered u/s. 25(4)
& 25(5)). This is a welcome provision.

4.   Rent-a-cab, life insurance and health
insurance services – the scope of Negative List of ITC reduced.

      As regards rent-a-cab services, the
Earlier Draft Law provided that, ITC in respect of such services would be
allowed, where the Government notifies such services as obligatory for an
employer to provide its employee under any law. In the Revised Law, the ITC of
such services is permitted also in respect of cases where such services are
availed by the registered person for providing outward supplies of the same
category of goods or services or as the case may be mixed or composite
supplies.

5.   The ITC available to non-resident taxable
person is reduced:

      The Revised Law disentitles a non-resident
taxable person to avail ITC in respect of goods or services received by him
except on the goods imported by him.

6.   The credit in respect of telecommunication
towers and pipelines laid outside the factory premises will not be eligible for
ITC

      The Earlier Draft Law included pipelines
and telecommunication tower fixed to the earth by foundation a structural
support as “plant and machinery” and consequently the ITC in respect thereof
was allowed. In the Revised Law, they are specifically excluded from the
definition of “plant and machinery”. It therefore appears that, ITC of works
contract services or other goods or services for construction of
telecommunication towers and pipelines laid outside the factory premises would
not be an eligible credit.

II.   Model Draft Input Tax Rules.

      Although the Central GST Act and
Integrated GST Act has been enacted, the State GST Acts are yet to be enacted.
Besides the Rules discussed below are only draft rules and hence are subject to
change.

1.   Rule 1 – General Rule – The ITC u/s.
16(1) shall be available subject to prescribed conditions. General conditions
are contained in Rule 1. As per Rule 1 following are regarded as eligible duty
paying documents:

(a)  an invoice issued by the supplier of goods or
services or both in accordance with the provisions of section 31;

(b)  a debit note issued by a supplier in
accordance with the provisions of section 34;

(c)  a bill of entry;

(d)  an invoice issued in accordance with the
provisions of section 31(3)(f) (i.e. in case of inward supplies on which tax is
payable under RCM);

(e)  a document issued by an Input Service
Distributor in accordance with the provisions of Invoice Rule 7(1) ;

(f)   a document issued by an Input Service
Distributor, as prescribed in Rule 4(1)(g) – [clause (f) seems to be a
duplication of clause (e)]

      The aforesaid documents will qualify as
duty paying documents only if all the applicable particulars as prescribed in
Invoice rules are contained in the said documents and the relevant information
is furnished in GSTR-2. (However, it’s felt that, this condition is no longer
required especially in view of the fact that, authenticity of such invoices,
will no longer be an issue since these invoices will be ‘matched’ on GSTN
portal which already contains all the requisite particulars)

      No ITC shall be availed by a registered
person in respect of any tax that has been paid in pursuance of any order where
any demand has been raised on account of any fraud, willful misstatement or
suppression of facts.

2.   Rule 2 – Reversal of ITC in case of
non-payment of consideration

      Section 16(2) mandates reversal of ITC,
where the supplier fails to pay the amount towards value of the goods/services
and taxes thereon within 180 days of the date of issue of invoice. The details
of such supply and the amount of credit availed shall be furnished in form
GSTR-2 for the month immediately following the period of 180 days from the date
of issue of invoice. Such amount shall then be added to the output tax
liability of the registered person for the month in which the details are
furnished. The interest shall be payable on such amount from the date of
availing credit on such supplies till the date when the amount added to the
output tax liability. [Author is of the view that, there is no need for such
kind of provision in the Act or in the Rules. It’s only creating additional
compliance burden on the business community as also the burden of additional
interest. The law should not be drafted in a manner that would interfere with
the contractual relations between the parties. There will be various issues as
to non-payment of disputed amounts, retention amounts, the contracts allowing
the parties credit period beyond 180 days, settlement of accounts by way of
adjustment of debts, credit relating to deemed value (i.e. value of
non-monetary consideration or value as a result of deemed supply without
consideration, in which cases no monetary payment is involved)]

3.   Rule 3 – Claim of credit by a banking company
or a financial institution

Banking company /NBFC / Financial institutions which are in
the business of supplying services by way of accepting deposits, extending
loans or advances, and opting to pay 50% ITC, shall avail ITC using following
formula.

*There is however no guideline as to how to compute the
credit of tax paid attributable to non-business purpose, in case of banking and
financial institution. It’s not clear whether it includes only those
input/input services which are exclusively used for non-business purpose or
also those common credits which are used partly for non-business purpose.

4.   Rule 4 – Manner of distribution of ITC by
Input Service Distributor (ISD).

The draft rules require that, an ISD shall distribute the tax
credit in the same month in which it’s available for distribution. The ISD
shall separately distribute ineligible ITC as well as eligible ITC. The
particulars to be included in ISD invoice, are prescribed in sub-rule (1) of
rule invoice-7 and such invoice shall clearly indicate that it is issued only
for distribution of ITC. The credit on account of central tax, State tax, Union
territory tax and integrated tax shall be distributed separately. The manner of
distribution of ITC is similar to the one contained in current provisions of
rule 7 of the CENVAT credit Rules. The credit shall be distributed to all units
whether registered or not including the recipient(s) who are engaged in making
exempt supply, or are otherwise not registered for any reason. The ISD can
distribute the credit by issuing debit notes / credit notes. Any additional
amount of ITC on account of issuance of a debit note to an Input Service
Distributor by the supplier shall be distributed in the month in which the
debit note has been included in the return. However, any ITC required to be
reduced on account of issuance of a credit note to the Input Service
Distributor by the supplier shall be apportioned to each recipient in the same
ratio in which ITC contained in the original invoice was distributed. The ITC
shall be distributed under ISD mechanism as under:

a)   The ITC on account of integrated tax shall be
distributed as ITC of integrated tax to every recipient.

b)   If the recipient and ISD are located in the
same State, then the ITC on account of central tax and State tax shall be
distributed as ITC of central tax and State tax respectively.

c)   If the recipient and ISD are located in the
different State, then the ITC on account of central tax and State tax shall be
distributed as integrated tax and the amount to be so distributed shall be
equal to the aggregate of the amount of ITC of central tax and State tax that
qualifies for distribution to such recipient.

[It’s felt that, distribution of ineligible credit u/s.
177(5) of the Act, to the units by the ISD is an unwanted exercise of
distributing the credit by issuing a separate invoice and then reversing the
credit as the end of each of the units. This will lead to increased compliance.
Such ineligible credit are never added to the electronic credit ledger of any
registered persons and therefore, such credits shall be deducted and only
balance credit shall be allowed to be distributed to the units.]

5.   Rule 5 provides for conditions for the
purpose of availment of ITC for the purpose of section 18(1). Section 18(1)
covers the following four situations:

a)   a person applying for registration within 30
days from the date on which he becomes liable to pay tax.

b)   A person applying for voluntary registration.

c)   A registered person who switches from
composition levy to normal levy u/s. 9.

d)   A registered person who supplies good /
services which were exempt earlier and becomes taxable subsequently.

In case of (a) and (b), ITC of only inputs will be eligible,
whereas in case of (c) and (d) ITC of input as well as capital goods would
become admissible. In case of capital goods, tax paid on such goods shall be
reduced by 5 % per quarter or part thereof from the date of invoice shall be
available. A registered person shall in such case make a declaration in Form
GST ITC 01 within 30 days from the date of his becoming eligible to avail of
ITC u/s. 18(1), to the effect that he is eligible to avail ITC specifying
details of eligible stock and such details shall be duly certified by a
practicing chartered account or cost accountant if the aggregate value of claim
on account of central tax, State tax and integrated tax exceeds two lakh rupees. 

6.   Rule 6 provides for transfer of
credit on sale, merger, amalgamation, lease or transfer of a business for cases
covered u/s. 18(3). In the case of demerger, the ITC shall be apportioned in
the ratio of the value of assets of the new units as specified in the demerger
scheme. CA Certificate shall also be required the sale, merger, de-merger,
amalgamation, lease or transfer of business has been done with a specific
provision for transfer of liabilities. Transferor shall submit the details in
form GST ITC 02 and Transferee shall accept such details. Upon such acceptance
the un-utilised credit specified in FORM GST ITC-02 shall be credited to
electronic credit ledger of the transferee. 

7.   Rule 9 provides for reversal of ITC in
special circumstances mentioned in section 18(4) and section 29(5). Section
18(4) deals with a case where a registered person shifts from normal levy to
composition levy or where the goods /services supplied by him become wholly
exempt. Section 29(5) deals with cancellation of registration. In all these
cases, such person is required to determine ITC in respect of inputs held in
stock and inputs contained in semi-finished or finished goods held in stock and
on capital goods. Rule 9 provides for manner of computation as under:

(a)  For inputs – ITC shall be proportionate
on the basis of corresponding invoices on which credit had been availed by
registered taxable person. For determining the amount contained in
semi-finished or finished goods, the registered person shall be required to
maintain the record of input-output ratio. There is no proper guideline in the
rules, as to how to determine the same. In many cases, such records would not
be available to identify the corresponding invoices. In such cases, it is not
clear whether the assessee can use methods like FIFO/LIFO to identify such
invoices. However, the rule provides that, where the tax invoices related to
such inputs are not available, the registered person shall estimate the amount,
based on prevailing market price of goods on such date of happening of event
mentioned in section 18(4) or section 29(5).

(b)  For Capital Goods – The useful life
shall be regarded as 5 years and the ITC involved in the remaining useful life,
if any, shall be computed on pro-rata basis and will be accordingly reversed.
For example, if ITC pertaining to capital goods is ‘C”, and remaining useful
life is 12 month and 15 days, then ITC pertaining to 12 months shall be
reversed as C x 12 / 60                        
                        

Details of such amount shall be furnished in Form GST-ITC 03
[in cases covered u/s. 18(4)] or as the case may be in Form GSTR-10 [in cases
covered u/s. 29(5)]

8.   Rule 7 – Computation of ITC attributable to
Inputs and Input Services.

      As per section 17(1) where the goods /
services are used “partly for the purpose of business and partly for other
purposes”, the amount of credit shall be restricted to so much of the input
tax as is attributable to the purposes of business. As per section 17(2) where
the goods / services are used by the registered person “partly for effecting
taxable supplies (including zero-rated supplies) and partly for effecting
exempt supplies”, the amount of credit shall be restricted to so much of
the input tax as is attributable to the said taxable supplies including
zero-rated supplies. The manner of computation of ITC of input and input
services, for the purposes of section 17(1) and section 17 (2) is contained in
Rule 7 & Rule 8 of the Draft Input Tax Rules. Rule 7 covers a situation,
where input/input services are used exclusively for making taxable
supplies zero rated supplies or exempt supplies. Further, it appears that the
expression “partly for the purpose of business and partly for other purposes”
is wide enough to cover supplies which are exclusively used for the other than
purposes also. It’s not applicable to ITC in respect of capital goods. The
computation of such credit that is required to be reversed is as under:

Step – 1 Identification of ITC relating to input/input
services:

Step – 2 Apportionment of Common ITC attributable to
input/ input services.

The Balance amount of ITC attributable to input/input
services after deducting the amounts mentioned above 1 to 5 shall be regarded
as “Common ITC” used partly for the purpose of business and partly for other
business as also the credit which is used partly for effecting taxable supplies
and partly for exempt supplies. Of the said amount the ineligible is computed
as under:

Ineligible common credit relating to exempt supplies =
Common ITC (multiplied by) aggregate value of “exempt supplies” during
the tax period (divided by) total turnover of the registered person
during the tax period.

Where the registered person does not have any turnover during
the said tax period or the aforesaid information is not available, the ratio of
exempt supplies to total turnover of the last tax period for which details of
such turnover are available, previous to the month for which calculation is to
be made, shall be considered. In such case, the reversal of amount shall be
calculated finally for the financial year before the due date for filing the
return for the month of September following the end of the financial year to
which such credit relates. In case of short reversal, the interest becomes
payable from 1^st April of next financial year till the date of
reversal/payment. Similarly, excess amount of reversal, if any, shall be
claimed as credit.  [Author is of the
view that, levy of interest on such amount from April onward of the next
financial year is not correct. Even today, in service tax law, interest is
levied only if the excess ineligible credit is not paid up to June of the next
financial year.] 

Ineligible common credit relating to non-business purposes
= Common ITC x 5%

It may be noted that,
reversal of 5% of the common input credit is warranted only when there is use
of such common credit for non-business purpose. The rule does not presume that
in all cases, 5% of the common ITC is towards non-business purposes. [Readers
may compare this provision with the practice of voluntary disallowance of
certain expenses as non-business expenses in the Income-tax Act]

The remainder of the common credit shall be the eligible ITC
attributed to the purposes of business and for effecting taxable supplies
including zero rated supplies

The aforesaid computations shall be made separately for ITC
of central tax, State tax, UT tax and integrated tax.

9.   Rule 8 – Computation of ITC attributable to
capital goods.

Rule 8 provides for manner of determination of ITC in case of
capital goods and reversal thereof u/s. 17(1)/(2) of the Act as under:

Note
1:.Where
capital goods covered under (1) and (2) above are subsequently used for common
purposes, from the total input tax attributable to such capital goods, 5% shall
be reduced for every quarter or part thereof for which they were used
exclusively for making taxable or zero rated supplies, and the balance ITC
shall be treated as common ITC for that tax period, and shall accordingly be
reversed, every month ( upto 5 years) as per the computation explained in Step
2 to 4 below.

Note
2: Where
capital goods covered in (3) and (4) above are subsequently used for common
purposes, from the total input tax attributable to such capital goods, 5% shall
be reduced for every quarter or part thereof for which they was used
exclusively for making non-business or exempted supplies, and the balance ITC
shall be re-credited to the electronic credit ledger and added to the common
ITC for that tax period.

It may be noted that, the rule does not provide for any
adjustment, where the capital goods earlier used exclusively for exempted or
non-business supplies are subsequently used exclusively for making taxable or
zero rated supplies and vice versa. The only adjustment which is
provided is when such capital goods are subsequently used for common purpose.

Step – 2 Apportionment of ITC attributable to other
Capital Goods used for common purpose.

The balance ITC attributable to other capital goods, shall be
treated as “Common ITC” and shall be credited to electronic ledger and the
useful life of such goods shall be taken as 5 years. It shall include, ITC
availed during the tax period in respect of such capital goods which are not
exclusively used for making taxable supply or zero rated supply or exempt
supply. The opening balance of the tax period shall also include, balance
credit (computed in the prescribed manner) in respect of capital goods received
earlier and used earlier for exclusively making exempt supply or taxable supply
or zero rated supply, and now intended to be used for making common supply. It
appears that, the remaining useful life of such already used capital goods
shall also be deemed as 5 years for the purpose of computation.

Step- 3 Computation of common ITC for a tax period.

Total common ITC permissible during tax period shall be
computed as under:

Total common ITC for a tax period = Total common ITC / 60.

Step-4 Computation of Common ITC attributable towards
exempt supplies.

Common ITC attributable towards exempt supplies =
Total common ITC for a tax period (multiplied by) aggregate value of
exempt supplies during tax period (divided by) total turnover of the
registered person during the tax period

Since the ITC attributable to common capital goods are
already credited to the electronic ledger (as a part of opening balance), the
monthly ineligible amount of such common credit computed in Step – 4 shall be
added to output tax liability of the person making the claim, every month along
with applicable interest, during the period of residual life of the concerned
capital goods.[The author is of the view that, the tax payer should be given
an option to pay the entire amount in the same tax period in which such assets
are used for common purpose. In that case, the question of making payment of
interest every month would not arise]

10. Rule 10 deals with conditions and
restrictions in respect of inputs and capital goods sent to the job-worker.
Every Principal taking ITC in respect of goods sent to job-worker shall send
such goods under the cover of a delivery challan and such challan shall be
reflected in Form GSTR -1. If the goods are not returned within prescribed time
u/s. 143, such challan shall be deemed to be invoice. Surprisingly, section
143 only allows the Principal to avail the ITC but does not deal with reversal
of ITC, and therefore author is of the view that, Rule 10 should not form part
of ITC Rules. 

Conclusion: