Eligibility of Input Tax Credit on Expenses involving Employee Recoveries

Input tax credit (“ITC”) is a mechanism in the Goods and Services Tax (GST) system that allows businesses to claim credit of the tax paid on their inputs (goods and services) against the GST they are required to pay on their outputs (products or services supplied to customers). This helps to reduce the overall tax burden on businesses and prevent the cascading effect of taxes (tax on tax). ITC also helps to ensure that businesses are only paying GST on the value added by them, rather than on the entire value of the goods or services they are supplying.

The eligibility to avail credit by a registered person flows from Section 16(1) of the CGST Act if goods or services or both on which ITC is to be taken are used or intended to be used in the course or furtherance of business. The said credit availment is subject to further conditions and restrictions as provided in Section 16(2) and Section 17 of the CGST Act. For some of the expenses like food and beverages, outdoor catering, leasing, renting or hiring of motor vehicles, life insurance, health insurance, club membership, etc, ITC is blocked under Section 17(5)(b). Additionally, Section 17(5)(g) also restricts ITC in respect of goods or services, or both used for personal consumption.

Circular No. 172/04/2022-GST (“Circular”) dated 06.07.2022 was issued by the CBIC which clarified various ITC related issues. In terms of Sl. No. 3 of the Circular, it was clarified that the proviso after sub-clause (iii) of Section 17(5)(b) of the CGST Act is applicable to the whole of clause (b) of Section 17(5). Resultantly, the employer can take ITC in respect of goods and services prescribed under Section 17(5)(b) wherever there is a legal obligation for the employer to provide such goods or services to its employees.

In terms of Sl. No. 5 of the Circular, CBIC also clarified that the perquisites provided by the employer to its employees in terms of the contractual agreement entered into between them are in lieu of the services provided by employee to the employer in relation to his employment and the same will not be subjected to GST. However, the said clarification does not discuss the cases involving partial recovery from the employees by the employer as part of the contractual agreement. The Circular is also silent on the eligibility of ITC of GST paid by the employer incurring such expenses.

In this article, we wish to highlight and discuss in detail the eligibility of ITC on such services wherein partial recovery is made by the employer.

Before diving into the topic, it is important to understand what is ‘perquisite?’ In simple terms, a perquisite is a non-cash benefit such as transportation, canteen, healthcare, insurance, etc granted by an employer to the employee. According to standard industry practice, the perks are given either without charge or for a nominal fee that is then recovered from the employees. If the employer makes partial recovery, then the value of perquisite is restricted to the extent of the amount borne by the employer and the same is generally accounted as business expenses in the books of account.

It is interesting to note that certain services such as telephone/internet facility, rent free accommodation, interest free loan, creche facility, etc. on which ITC is not specifically blocked under Section 17(5)(b), provided as perquisites to employees are accounted as business expenses of the employer as the same are not for the personal consumption of employees but for the fulfilment of business requirement.

In such a case, a question arises whether the ITC of GST paid by the employer should be available to the extent of amount borne by the company as its expenses even if the employer is under no legal obligation to provide such goods/services to its employees? In the case of credit being restricted to the extent of recovery from employees, the employer is considered as the recipient of the goods or services and is responsible for paying the GST. The employer can then claim the ITC for the GST paid, but only to the extent that the GST is borne by it as its business expense.

In this regard, let us discuss one of the most debated services provided by the employers to its employees, i.e., Canteen services. Canteen services are provided by the employers as a mandate provided under Section 46 of the Factories Act, 1948. Vide various divergent Advance Rulings pronounced by different Authority for Advance Rulings (“AAR”), the issue of canteen services has never reached a certainty.

The Gujarat AAR in the case of Emcure Pharmaceuticals Limited and the Madhya Pradesh AAR in the case of Bharat Oman Refineries Limited ruled that GST in not leviable on the recoveries made from the employees towards canteen services. However, in the case of Caltech Polymers Pvt. Ltd, the Kerela AAR held that supply of food items to the employees for consideration in the canteen constitutes ‘supply’ and would be taxable under GST.

ITC is not eligible with respect to goods used for personal consumption by virtue of Section 17(5)(g) of the CGST Act. Further, section 17(5)(b)(i) provides that ITC with respect to food and beverages and outdoor catering is not eligible. However, as per the proviso to the Section, ITC will be eligible with respect to goods or services where it is obligatory for an employer to provide the same to its employees under any law for the time being in force. The issue of availing credit for such service has always been a moot question. Can the credit be availed merely by virtue of the proviso under Section 17(5)(b) or the same will be restricted under Section 17(5)(g) of the CGST Act?

In terms of Sl. No. 7 of Notification No. 11/2017-C.T. (R) (“Notification”), dated 28.06.2017, outward supply of food and beverages is taxable @ 5% provided ITC on procurement is not taken, which has to be determined in terms of Explanation (iv).

By the virtue of above discussion, we are of the view that there are two options available for availing credit for the provision of canteen services.

Option 1: Entire ITC of GST paid on input services will be restricted in terms of above Notification which provides that the rate of GST on outward supply of canteen services will be 5% provided input tax credit on the inward supplies has not been taken.

Option 2: Credit will be eligible in proportion to the value paid to canteen contractor which is being treated as perquisite. As the credit is allowed in terms of the Proviso to Section 17(5)(b), its reversal in terms of Section 17(2) is not generally applicable; however, the reversal is indirectly made applicable by virtue of Explanation in para (iv)(b) to the Notification.

However, if one is to proceed with Option 2, then will the ITC be taken in full and subsequently reversed to the extent of employee recovery or ITC should be restricted in proportion of the amount treated by the company as a perquisite?

According to the aforementioned circular, benefits provided by the employer to the employee under a contractual agreement are not subject to GST. This circular may put a stop to the situation where perquisites are provided by the employers in accordance with employment contracts, given the uncertainty caused by contradictory AARs. The industry was expecting clarity on this issue through Budget 2023. The scepticism over eligibility of ITC needs to be addressed and certain clarity needs to be provided in order to avoid possible disputes and issue put to rest. The industry expects the next GST Council meeting to throw light on the eligibility of ITC on expenses involving employee recoveries.

Brijesh Kothary is Associate Partner and Saundarya Sinha is Associate at Lakshmikumaran & Sridharan attorneys