Input Tax Credit — Applicability of Rule 53(6) —A Few controversies

    Value Added Tax System (VAT) has been made applicable for levy of Sales Tax in India from 1.4.2005. Though one of the objects to introduce VAT was to have uniformity in the Taxation Provisions in all the States of India, it is a well known fact that this object has not been achieved and almost all the States have their own levy systems. In Maharashtra, the VAT is being levied under Maharashtra Value Added Tax Act, 2002 (MVAT Act).

    Input Tax Credit (ITC, also referred to as set off) is the backbone of VAT system. Therefore the ITC mechanism should be as simple as possible. The VAT system is considered to be ideal for avoiding cascading effect. Therefore dealers should get set off on all the purchases connected with his business. However, as per the current provisions under the MVAT Act, there are many restrictions as well as negative list about set off. In other words, set off is not allowed on all the purchases. Several purchases relating to the business are outside the scope of set off, like: purchases used for erection of immovable properties, purchase of passenger motor car, etc. There are also provisions to restrict setoff under certain circumstances. The reference here is to Rule 53(6) of MVAT Rules, 2005.

    Under MVAT Act, section 48 provides for grant of set off to dealers. It also authorises the State Government to draft necessary rules. The State Government, under its authority, made the Rules about grant of set off. The said rules are contained in Rules 52 to 55 of MVAT Rules, 2005. Rule 52 speaks about eligibility to set off, Rule 54 gives negative list on which set off is debarred and Rule 53 provides for reductions from set off. Sub-rule (6) of Rule 53 is one of the most complicated and frequently amended Sub-rules providing for reduction/restriction in set off. The said Sub-rule, which was on the statute book since 1.4.2005, was substituted on 8.9.2006. And it was substituted once again, on 23.10.2008. The second substitution has been made effective from 8.9.2006. Thus, Rule 53(6) is now to be seen in its new form with effect from 8.9.2006. The said rule is reproduced below for ready reference.

53. Reduction in set-off

(A) The set-off available under any rule shall be reduced and shall accordingly be disallowed in part or full in the event of any of the contingencies specified below and to the extent specified. (1) to (5) . . . .

(6) If out of the gross receipts of a dealer, in any year, receipts on account of sale are less than fifty per cent of the total receipts, —

(a) then to the extent that the dealer is a hotel or club, not being covered under composition scheme, the dealer shall be entitled to claim set-off only, —

            (i) on the purchases corresponding to the food and drinks (whether alcoholic or not) which are served, supplied or, as the case may be, resold or sold, and

            (ii) on the purchases of capital assets and consumables pertaining to the kitchens and sale, service or supply of the said food or drinks, and

(b) in so far as the dealer is not a hotel or restaurant, the dealer shall be entitled to claim set-off only on those purchases effected in that year where the corresponding goods are sold or resold within six months of the date of purchase or are consigned within the said period, not by way of sale to another State, to oneself or one’s agent or purchases of packing materials used for packing of such goods sold, resold or consigned :

Provided that for the purposes of clause (b), the dealer who is a manufacturer of goods, not being a dealer principally engaged in doing job work or labour work, shall be entitled to claim set-off on his purchases of plant and machinery which are treated as capital assets and purchases of parts, components and accessories of the said capital assets, and on purchases of consumables, stores and packing materials in respect of a period of three years starting from the end of the year containing the date of effect of the certificate of registration.

    Some important implications of the above rule can be considered as under :

    i) If out of the gross receipts, the receipts from the sale of goods are less than 50% of the gross receipts, then this rule will apply. Therefore finding out above ratio is important. The comparison is to be done on yearly basis. This concept of making yearly comparison itself is against the very system of ITC under VAT. The setoff system should have free flow. Normally on entering the purchase in the records, the dealer should be entitled to claim set off of the same. In other words, set off should be eligible as soon as the purchase is entered in the books of account. However, as per above rule, this is not so.

    Though the dealer claims the set off on effecting the purchase, he will be required to find out the correctness of the said claim after the end of the year. If the receipts from the sales are less than 50% of gross receipts, then the set off will be restricted to the purchases, as indicated in above rule. Amongst others, in case of dealers other than hotels, the set off will get disallowed on the capital assets as well as expenditure items debited to P & L A/c. Thus the original claim of the dealer will be wrong and such a dealer will be required to recalculate and reduce the setoff already taken by him, after the end of the year. Thus the very purpose of allowing set off as per the date of purchase gets defeated.

An issue again arises that if the set off is to be reduced after the end of the year, due to above application of rule 53(6), then in which returns the reduction is to be made. As per set off Rules the dealer is entitled to claim set off as soon as the purchase is entered into the books of accounts. As per rule 53(8) the reduction in setoff, due to contingency contained in rule 53, is to be given effect in the return period in which such contingency arises. In relation to rule 53(6) the contingency arises after the end of the year. Therefore, at the most, the effect to reduction in light of rule 53(6) can be given in the last return only. Hence the last return of the year can be revised to give effect to the above rule 53(6).

ii) The other issue arises as to the meaning of gross receipts. In the earlier un-amended rule the meaning of gross receipts for the purpose of rule 53(6) was explained by way of Explanation under the Rule. However, the said Explanation is now not appearing in this substituted rule. Therefore, the meaning remains to be ascertained by the dealer. Several issues may arise in this respect.

a) Whether only the receipts of Maharashtra are to be considered or all the activities, including activities in other States, are also to be considered ?

It is an important  issue as the receipts from sale will certainly be relating to Maharashtra. The word ‘sale’ is defined in the MYAT Act and as per the said definition ‘sale’ means sale within the state of Maharashtra. Therefore, so far as. the receipts from sales are concerned they will mean only receipts of sales effected in the State of Maharashtra. Though the meaning of ‘gross receipt’ is not given, it is an accepted principle that only comparables can be compared. Therefore, if in relation to sales, receipts from sales effected only in Maharashtra are to be considered, then for gross receipts also receipts only from Maharashtra should be considered. Though this can be a fair interpretation it is better that the law itself provides for the meaning to avoid litigation in future.

b) The other issue in this respect is, what is to be included in gross receipts. One view can be that items appearing on the credit side of Trading A/c. and P & L A/c. should be considered. The other view can be that all receipts, on whatever account, should be considered. As per this view receipts on account of dealing in assets like sale of assets etc. should also be considered for gross receipts. In this respect also a clarification from the department is most welcome to avoid un-necessary debate. Normally, gross receipts should be restricted to receipts appearing on credit side of Trading and P & L Accounts excluding dealings in assets, etc. Receipts from sale of assets forming part of turnover of sales may also be considered for gross receipts. However receipts from sale of assets not covered by MYAT Act like sale of immovable properties or sale of shares etc., cannot get covered in gross receipts. However clarification from the Department on above aspect is necessary.

iii) Another important issue is that if this rule applies then in relation to dealers, other than hotels, set off is eligible only on purchases which are sold within six months from the date of purchase. This will require identification of purchase and sale. This condition also is not as per the spirit of ITC under VAT. Although in case of reseller the issue may not bother much as identification in such a case will normally be available, but in case of manufacturers, this kind of identification may pose several difficulties. The dealer will be required to adopt the system as permissible on the facts and circumstances of the case.

iv) This sub-rule may hit hard, manufacturers. It provides that a manufacturer will be eligible to get set off on plant and machinery etc., even if the sales are less than 50% of the gross receipts. However, this concession is given only for three years from the end of the year in which the registration has been granted. It can be said that this exception is provided for new manufacturing dealers. However, in these initial years existing dealers can also avail the benefit. The MVAT Act has been brought into effect from 1.4.2005. The registration granted under the BST Act, 1959 is deemed to have come to an end on 31.3.2005 due to abolition of the said Act. The registration numbers granted under the BST Act, 1959 continued in the VAT period also because of specific provision to that effect in the MV ATAct, 2002. Reference can be made to section 96 (1) (b) of MVAT Act, 2002, which reads as under.

96. Savings

1) Notwithstanding the repeal by section 95 of any of the laws referred to therein, —

“(b) any registration certificate issued under the Bombay Sales Tax Act, 1959, being a registration certificate in force immediately before the appointed day shall, in so far as the liability to pay tax under sub-section (1) of section 3 of this Act exists, be deemed on the appointed day to be the certificate of registration issued under this Act, and accordingly the dealer holding such registration certificate immediately before the appointed day, shall, until the certificate is duly cancelled under this Act, be deemed to be a registered dealer liable to pay tax under
this Act and all the provisions of this Act shall apply to him as they apply to a dealer liable to pay tax under this Act.”

In light of above, it can be said that the continuation of registration granted under BST Act in the MVAT period is as good as grant of new registration under the MVAT Act, 2002. Therefore, in case of existing dealers the three years from the end of the year in which registration is granted, is to be considered from 2005-06. In other words, existing dealers will get the benefit of above exception for three years from 2005-06 i.e. upto 2008-09.

The real difficulty arises after the three years are over. In such cases, inspite of fact that there are purchases of machinery etc., the dealers will not be entitled for any set off of taxes paid on purchase of such machineries. This will certainly be against the very purpose and spirit of the MYAT Act and the scheme of ITC under VAT.

v) One more issue which arises in respect of this sub-rule, is due to retrospective effect to the amended rule. Though the rule is substituted in October 2008, the effect is given from 8.9.2006. For example, a dealer might have claimed set off for the year 2006-07/2007-08 etc. in light of earlier Rule and would have claimed the set off accordingly in the returns. A situation may arise for reducing set off for earlier years in light of substituted rule due to retrospective effect given to it. The issue is who is responsible to carry out such reduction. There can be different situations. If the returns were already filed before the amendment date and VAT Audit was also carried out, then is there a responsibility on the dealer to file revised returns etc. ? The statutory time limit for filing revised returns is only 9 months from the end of the year. Therefore the department cannot insist for revising returns to give effect to retrospective effect after the end of the period for revising returns. There is also no obligation on the dealer to revise the returns after the end of the period for revising the returns, to give effect to the adverse amendment. In the amended rules also, there is no obligation or direction to the dealer to file revised returns to give effect to the amended rule for prior period. Therefore, the dealer is not required to take any action. However, the department can take action and by making    assessment, give the due  effect.

In fact there are number of such ambiguities in relation to rule 53(6). All are not discussed here for sake of brevity. The above are a few important ones and readers may also come across further issues in relation to above rule. We expect that the Government will come out with proper clarification on various issues, in above rule, keeping into account the prime role of ITC in a successful VAT system.