CREDIT BLOCKADES FOR CONVEYANCES

LEGISLATIVE HISTORY

In effect, goods carriers (i.e. dumpers and tippers), special purpose motor vehicles (such as Tractors, Crane Lorries, Concrete-Mixers lorries, Work Trucks, etc.) were permitted as ‘Capital Goods’ credit for manufacturers. This position continued until the sub summation of the Central Excise provisions. Some important observations emerging here are as follows:

(a) There has been a constant progression in granting credit to motor vehicles which have been directly used for value-added activity either by a manufacturer or a service provider.

(b) Passenger vehicles were blocked credits except where they were used as commercial passenger vehicles.

(c) HSN was adopted for describing the nature of motor vehicles that are eligible/ ineligible for CENVAT credit. Even if the ‘principal design’ of the vehicle met the description, credits were permissible.

(d) Under the HSN system, Motor-cycles were a distinct category from Motor-Vehicles.

(e) Use Test was not prominently visible in the provisions, and the reliance on HSN classification contained a presumption that the actual use and registered use were the same.

On the other hand, VAT laws permitted credits only if the goods were either re-sold or used as a direct input in manufacturing activity. In all other cases, Motor vehicles and conveyances were treated as ‘non-creditable goods’.

LEGAL CONTEXT – ORIGINAL LAW

a) supply of such motor vehicles or conveyances

b) transportation of passengers

c) imparting training of such conveyances

In addition, such conveyances were eligible for credit when used for transportation of goods either on own account or as part of any supply (‘qualifying use’). The law was silent on the admissibility of input tax credit on ancillary costs (such as insurance, repair, maintenance, etc.) incurred in respect of such blocked conveyances.

2019 AMENDMENT
In 2018 (w.e.f. 1st February, 2019) the provisions were substituted resulting in the following:

(a) Blocked conveyances list was narrowed to passenger motor vehicles (below 13 capacity), vessels and aircraft. Other modes of conveyances were removed from the blocked list.

(b) Passenger motor vehicles and vessels/ aircraft fell under differently worded provisions.

(c) Clause specifying ‘qualifying use’ for motor vehicles was deleted and merged into the ‘blocked conveyances’ clause – in effect qualifying the nature of the motor vehicles itself rather than specifying a separate qualifying use test.

(d) Credit in respect of the ancillary services (such as insurance, repair and maintenance) were specifically blocked in respect of ‘blocked conveyances’ except when such blocked conveyances were used for credit qualifying supplies.

(e) Credit was made available to manufacturer or insurers of such blocked conveyances as long as they are in the business relatable to such blocked conveyances.

Summary of the eligibility matrix on account of the amendment would be tabulated as follows:

With the amendment in 2019, the use test for motor vehicles has been merged into the Conveyance Test, while the original provisions have been retained for aircraft and vessels (refer subsequent analysis).

INTER-PLAY – USED VS. INTENDED TO BE USED
Section 16(1) grants input tax credit on all inward supplies based on two entry points (a) use or (b) intention of use. Section 17(5) operates as an exception to the general rule of grant of credit and uses the phrase ‘used’ while enabling credit based on the ‘onward supply test’. Is the overriding nature of 17(5) coupled with the absence of the phrase ‘intention of use’ having an impact on credit eligibility of goods used for onward supply?

Section 17(5) expresses that credit in respect of blocked conveyances (say motor vehicles) would be denied. This first level denial is absolute, implying that all blocked conveyances are ineligible for input tax credit – let’s call it a blanket ban. Having placed a banket ban on blocked conveyances, the law now states that it shall permit a narrow escape route when such blocked conveyances are ‘used’ for credit qualifying supplies. Consequently, while a taxable person may have availed credit of blocked conveyances on ‘use’ or even ‘intention of use’, the only escape route to retain the credit is after establishing that such blocked conveyances have been ‘used’ for credit qualifying supplies. This format of the provisions places a larger onus on the taxable person claiming credit on blocked conveyances. However, this stringent test does not appear to be applicable to non-specified conveyances (such as goods vehicles) not featuring as blocked conveyances. Therefore, while goods vehicles are permitted for input tax credit on mere ‘intention of use’ of such vehicles, passenger vehicles may have to undergo the rigour of whether they have been ‘used’ for the specified purpose.

Some may call this interpretation as hyper-technical and defeating the purpose of granting credit at the time of purchase and deferring it until the goods are actually used. No doubt this interpretation appears to be onerous on the taxpayer, and one would weigh the precedents on this. At this juncture, one may recall the decision of the Supreme Court in BPL Display Devices Ltd. vs. CCE1 where it was held that the exemption which was dependent on usage goods should also be interpreted to include intention of use. Despite the goods being lost in transit, the courts granted the benefit of exemption on the basis that use included intention of use. While this decision is attractive to apply, one may also have to consider the context of section 16(1) r/w 17(5). A reasonable interpretation to resolve this deadlock would be to hold that blocked conveyances which are worded under over-riding provisions would not be eligible for input tax credit. Credit would be permitted only on they been used for permitted purposes. Though this test is narrow in comparison to the wide scope of section 16(1), the effect of this test is only to place the onus on the taxpayer to establish the usage when called upon to do so. This test should not be interpreted as a pre-condition to availment of the credit itself. This fine inter-play of words can be framed into a three-layer water-fall test.

3-LAYER WATER-FALL TEST

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1     2004
(174) E.L.T. 5 (S.C.)

Alternatively, motor vehicles can also be understood from the Motor Vehicles Act, 1988, which defines ‘motor vehicles’ as follows:

“(28) “motor vehicle” or “vehicle” means any mechanically propelled vehicle adapted for use upon roads whether the power of propulsion is transmitted thereto from an external or internal source and includes a chassis to which a body has not been attached and a trailer; but does not include a vehicle running upon fixed rails or a vehicle of a special type adapted for use only in a factory or in any other enclosed premises or a vehicle having less than four wheels fitted with engine capacity of not exceeding twenty-five cubic centimeters”

The said definition brings within its ambit any motor vehicle (including tractors, cranes, special purpose motor vehicles, motorcycles, etc) used upon roads and includes chassis or trailers. The coverage of the term under the Motor Vehicle Act, 1988 is wider than the scope envisaged under the HSN schedule, and this may pose some interpretational issues between the taxpayer and the revenue. The HSN schedule appears to be more proximate and contextual reference for understanding ‘motor vehicles for passengers’ on account of its framework and listing based on (a) seating capacity (of thirteen persons) (b) principal design of motor vehicles, and (c) their probable usage. Further, historical background of CENVAT provisions also suggests such a reference.

ANALYSIS OF 17(5)(aa) – CONVEYANCE TEST
Clause (aa) applies to vessels and aircraft when used for further supply of such vessels and aircraft or imparting training of such vessels and aircraft. One of the key effects of the 2019 amendment was that aircraft and vessels were carved out from the motor vehicles provisions and drawn up separately. While fresh provisions were drafted for motor vehicles, aircraft and vessels continued under the pre-amendment wordings. On a close comparative analysis, one could narrow down the difference to the qualification on the ‘nature of the conveyance’. For motor vehicles, the law makers have qualified the conveyance based on the purpose of use (i.e. passenger motor vehicles v/s goods motor vehicles) but for aircraft/ vessels, no such qualification has been made. A separate use test has been prescribed for eligibility of input tax credit on aircraft and vessels based on whether they have been used for the transportation of goods.

DE-JURE USE VS. DE-FACTO USE
This directs us to derive the rationale for distinct provisions for motor vehicles and for aircraft/ vessels. One may consider the ‘de-jure use’ (as per principal design and transport office records) or ‘de-facto use’ (actual use) as a reconciliation of the variance. In the case of motor vehicles, there are instances when passenger vehicles are modified with additional functions or features, though they are legally registered as passenger vehicles (refer vanity van case study below). The question arises whether the vehicles used beyond their registered use are permissible for credit as they are not just passenger vehicles after their modification.

The amendment by merging the use criteria with the blocked conveyance criteria seems to emphasise that this would not be permissible. In effect, the amendment is placing a blanket ban based on the de-jure use of the vehicles (i.e. as a passenger transport vehicle) and does not enable the person to avail credit based on ‘actual use’ of the passenger vehicle for goods transportation purposes.

But this is not the case for aircraft and vessels. The use criteria for aircraft and vessels is independently stated in a separate clause and does not qualify the aircraft or vessels itself i.e. the primary provision does not distinguish between cargo aircraft and passenger aircraft. Blanket ban on credit is placed without consideration of the primary purpose/ design. By way of a separate exclusion, the provision permits credit of aircrafts when used for transportation of goods, overcoming the criteria that they may also be passenger aircrafts. The probable reason could be that aircraft and vessels are subject to strict regulations and also have a separate enclosure of carriage of cargo, in addition to passenger seating facility. Therefore, dually designed aircrafts and vessels which are equipped for multiple use would be eligible for credit.

ANALYSIS OF 17(5)(a) (A), (B) & (C) – ONWARD SUPPLY TEST
Onward supply test permits credit on blocked conveyances by listing the credit qualifying supplies. It is essential that the motor vehicles are used for making further supplies. It is important to note that ‘self or incidental use’ would not make them as credit qualifying supplies. One would have to establish an activity of the specified nature (i.e. further supply or transportation or persons or training), qualifying under section 7, in order to fall within the narrow window to escape the blocked credits. By implication, the ‘identity of the motor vehicle’ on the inward leg of supply and that of the outward leg of supply should be directly co-relatable.

Clause (A) – What are the forms of supply i.e., either goods or services or both, which qualify for credit. In other words, does clause 17(5)(a)(i) permit input tax credit only for ‘automobile dealers’ (who are engaged in trading of motor vehicles) or can it also be applied to car rental or leasing companies. Under the GST scheme, the supply of motor vehicles can be in the form of supply of goods or the form of supply of services. Lawmakers have been explicit about the character of supply (i.e. goods or services) when a differential treatment was intended under such a consolidated law. In the absence of any differential treatment in 17(5)(a), the law appears to be covering both supply of motor vehicles as goods or services for the purpose of enabling input tax credit. Accordingly, cab-rental companies, leasing companies etc that purchase motor vehicles for the purpose of leasing, hiring, etc should be permitted to avail input tax credit on their purchases.

Clause (B) permits input tax credit on motor vehicles which are used for further supply of transportation of passengers. As stated above, mere transportation of persons would not meet the permissive criteria for availment of input tax credit. A factory transporting its own employees in an own vehicle would not be permitted to avail input tax credit unless the factory effects a ‘supply’ in the form of recovering a transportation fee from its employees. A tour operator, in the absence of an identifiable supply of transportation of passenger, may not be entitled to input tax credit even-though it performs transportation of passengers as an element of the overall supply. Though the revenue may claim that only SAC 9964 – Passenger transport services qualifies as ‘credit qualifying supply’, this does not emerge from the literal provisions of law. As long as there appears to be an onward supply from the passenger vehicle, the input tax credit may be available.

Clause (C) permits input tax credit on motor vehicles that are used for imparting training or driving such motor vehicles. This clause is oriented towards training schools etc. that purchase motor vehicles for use in training against a training fee. Supply principles discussed in clause (B) would also be applicable here.

Cumulatively clause (A), (B) and (C) are oriented towards a commercial value-added activity, which involves direct use of motor vehicles and excludes those cases where motor vehicles for transportation are on own account.

PARTIAL USE VS. COMPLETE USE
Instances also arise where the passenger motor vehicles are partially used for ‘passenger transportation services’ as well as ‘own purposes’. The law does not provide any guidance on attributability of such credit towards own purpose and commercial purpose. If the literal wordings are to be sole guiding factor, one could take the view that as long as they are used for passenger transportation activity, albeit partially, full credit should be permissible on such passenger motor vehicles based on the actual use criteria. Until the lawmakers do not provide any attribution methodology, a reversal for partial use towards own purposes does not seem to be expected from taxable persons.

ANALYSIS OF 17(5)(ab)
Section 17(5)(ab) blocks input tax credit on general insurance services and repair and maintenance of motor vehicles. However, credit is not blocked on services in respect of such conveyances, which are otherwise eligible for input tax credit. In addition, manufacturers and general insurance companies are also permitted to avail input tax credit on insurance and repair and maintenance activity for all motor vehicles, including passenger vehicles where they are engaged in the direct activity of such motor vehicles.

Importantly, the blockage of input tax credit is only on the ‘service activity’ of repair and maintenance. As an industry practice vide Circular No. 47/21/2018-GST dated 8th June, 2018, automobile dealers bifurcate their spare parts and labour work into goods and services, and taxes are applied accordingly. Applying the classification at the supplier’s end as conclusive of the nature of activity involved, it appears that the procurement of spare parts as part of repair and maintenance activity would be a supply of goods and hence outside the ambit of the said provisions.

One may note that the said provisions were introduced only during the 2019 amendment. Until then, there was ambiguity on whether ancillary activities pertaining to motor vehicles, such as repair and maintenance, were permissible input tax credit. The amendment fortifies the stand that prior to the amendment, such support services or goods availed on spare parts or repair were permissible credit for all motor vehicles (passenger and goods) without any specific bar u/s 17(5). This also derives support from the fact that the amended section 17(5)(b) specifically provides for blocking input tax credit on motor vehicles that have been obtained on lease, hire or rent. If section 17(5)(a) were to be interpreted to block input tax credit on all inward supplies having a direct or indirect connection with a motor vehicle, section 17(5)(b) would be redundant. Both these aspects would affirm the view that section 17(5)(a) prior to amendment did not block credit on repair, maintenance and insurance services.

SECTION 17(5)(b)
Associated to the aspect of credit, section 17(5)(b) blocks input tax credit on leasing, renting and hiring of conveyances. Two exceptions have been carved out in cases where (a) such inward supply is an element of an outward supply of the same category or a composite category; (b) such inward supply was necessitated on account of statutory provisions.

‘Leasing, renting and hiring’ has not been defined in the law specifically. The SAC/rate notifications provide rates/ exemptions on leasing, renting and hiring. The law has covered all three scenarios for using motor vehicles for purposing of blocked credits. Interestingly availment of passenger transport service (which is a separate SAC) does not feature in the said listing. Thus, where an enterprise avails of services of air or road travel under the passenger transportation category, section 17(5)(b) does not block the credits. In addition, if inward supply forms part of an outward supply, even as an element, the same would be eligible for credit on the basis that the inward supply has generated an onward value-added activity.

CASE STUDIES FOR APPLICATION OF LAW
Case 1 Hotel Cab – A Hotel purchases motor vehicles to transport guests and charges a fee as part of the overall accommodation package. In many cases, such activity is provided as a complimentary package to the accommodation services. Section 17(5)(a) states that motor vehicles are eligible under the Onward Supply Test when generating a passenger transportation activity. The hotel certainly has an element of passenger transportation service bundled in a composite package, but the invoice does not explicitly adopt the corresponding SAC for such activity. A literal reading of the provisions suggests that there must be a ‘taxable supply’ of transportation of passengers. Unless the service activity is taxed as a passenger transportation service credit should not be permissible. However, unlike section 17(5)(b)2, the said provision does not mandate a category-to-category correlation between input and output activity. Therefore, a purposive interpretation of the law could suggest that credit should be eligible in respect of motor vehicles if it is bundled as part of the overall service activity.

Case 2 Vanity Van – A celebrity purchases a vanity van registered as a passenger vehicle with modifications to store its vanity materials. The registered use is a passenger vehicle, but the actual use is for storing and transporting the vanity set-up for use by the celebrity. Section 17(5)(a) does not expressly differentiate between registered use or actual use. The HSN schedule however classifies motor vehicles based on the principal design or principal purpose. Where the motor vehicle is principally designed for transportation of passenger they would be classifiable under 8703 and probably the same test would have to be applied for purpose of section 17(5)(a). Therefore, the vanity van being principally designed for transportation of passengers and registered as a passenger vehicle may not be eligible for claim u/s 17(5)(a).

2     “Provided
that the input tax credit in respect of such goods or services or both shall be
available where an inward supply of such goods or services or both is used by a
registered person for making an outward taxable supply of the same category of goods or services or both
or as an element of a taxable composite or mixed supply”

3     2008
(232) E.L.T. 475 (Tri. – Del.)

Case 4 – Automobile dealers purchase ‘Demo Cars’ for demonstration to the prospective customers at the showroom. These demo cars are first registered (either permanently or temporarily) and then sold after extensive usage to the end customers at lower prices. While the cars are initially intended for own use (i.e. demonstration to prospective customers) they do not expressly fall within the ‘permitted use’ list. Though there may be an intention for resale the same to end customers, credit u/s 17(5)(a) is permissible on actual use of the motor vehicles. Moreover, if the erstwhile law principles of testing conditions of eligibility at the time of original availment, are adopted, credit may be a contentious issue. While there are divergent advance rulings on this aspect, it appears the literal wordings of the provisions do not permit credit on subsequent adoption of the goods for the permitted uses.5 The favourable advance ruling holds that since the cars are eventually sold by the automobile dealer, credit should be permissible and the contrary ruling apply the literal provisions of law at the time of purchase without regard to the future use.

Case 5 – Cash Management Company purchase cash carry vans which are customized with high security features for transportation of invaluable items. Pre-2019, the credit was eligible only on transportation of goods. This raised an issue of whether motor vehicles used for transportation of ‘money’ which were not goods was eligible for input tax credit. While the initial advance ruling6 held that input tax credit is not eligible, the appellate advance ruling authority on remand has directed that input tax credit on the same would be available at par with motor vehicles used for transportation of goods7. Post 2019, such vans are outside the blocked conveyance list at the threshold itself and hence eligible for credit.

4. 2003 (155) E.L.T. 481 (Tri. – Del.) affirmed
in 2007 (216) E.L.T. 133 (Tri. – LB)

5   It
may be noted that there are divergent advance rulings on this aspect – A.M.
Motors [2018 (10) TMI 514]; Chowgule Industries Private Limited [2019 (7) TMI
844]; Khatwani Sales and Services LLP [2021 (1) TMI 692]; Platinum Motocorp LLP
[2019 (3) TMI 1850]

6   CMS
INFO SYSTEMS LTD. [2018 (5) TMI 649] and reversed in 2020 (6) TMI 643

7   Recommendations
made during the 28th meeting of the GST Council on 21^st July, 2018

Case 7 – Cost of ownership and operation of Motor Vehicles may also include expenses towards parking or rental space. If a limited scope is attributed to the phrase ‘in respect of motor vehicles’ u/s 17(5)(a), one may contend that ancillary services of motor vehicles should not be blocked for credit purposes. The revenue would be inclined to interpret the said phrase as being wide enough to cover all credits pertaining to motor vehicles, including costs of operation and maintenance. Going by the preceding analysis and the 2019 amendment, one may take the stand ancillary services are not blocked until they are specifically specified u/s 17(5).

Case 8 Charter of Aircraft – Companies avail aircraft on a charter basis for transportation of their executives. The chartered flight operator charges the company based on the actual flying hours, and in many cases, provides the Company exclusive access to the aircraft. The industry follows the divergent practice of either charging GST as (a) hiring/ renting of aircraft – 9966; or (b) passenger transport service – 9964. Under section 17(5)(b), credit is blocked for hiring or renting of aircraft but permitted for passenger transport service.

The explanatory notes to the service classification explain 9966 as being renting of transport vehicles where the service recipient defines how and when the vehicle will be operated, schedules, routes and other operational considerations. 9964 has been explained to include scheduled as well as non-scheduled air transport of passengers. In the present facts, there appears to be a wafer-thin line of difference between 9966 and 9964. Having said this, from an input tax credit perspective, it is settled law that the classification by the supplier cannot be altered by the recipient unless the supplier either admits to such alteration or the results of legal proceedings warrant such alteration at the supplier’s end (CCE vs. Sarvesh Refractories (P) Ltd8). Therefore, as a recipient of service, the taxable person ought to claim the credit only of invoices classified as 9967 and would have to reverse the credit on invoices classified as 9964. While this may seem unfortunate, such a practice would ensure stability in tax classifications over the longer run.

CONCLUSION
The automobile sector has been the catalyst of economic growth and a major contributor to the tax exchequer. The visible impact of a high GST tax rate and such credit blockades increases the transportation costs of business enterprises. The Government has recognized this and been progressive in liberalizing this input credit stream. While at the policy level, attempts are being made to widen the credit space, the provisions should not be interpreted as a block credit for all motor vehicles without adhering to the purpose of use of the conveyance.