Refund of unutilised Input Tax Credit on input services: Rule 89(5) of CGST Rules upheld by Supreme Court

The Supreme Court on Monday upheld the validity of Rule 89(5) of the Central Goods and Service Tax Rules, 2017 (CGST Rules) which prescribes a formula excluding the refund of ‘unutilised input tax’ paid on ‘input services’ as part of ‘input tax credit' (ITC) [Union of India v. VKC Footsteps India Private Ltd]..A Bench of Justices DY Chandrachud and MR Shah held that while the formula suffers from anomalies, it cannot be a ground to strike down a fiscal rule which has been framed in exercise of the power of delegated legislation. "In the field of taxation, this Court has only intervened to read down or interpret a formula if the formula leads to absurd results or is unworkable. In the present case however, the formula is not ambiguous in nature or unworkable, nor is it opposed to the intent of the legislature in granting limited refund on accumulation of unutilised ITC. It is merely the case that the practical effect of the formula might result in certain inequities," the Court observed.The Court, therefore, upheld the Rule and overturned a 2020 judgment of the Gujarat High Court which had held that Rule 89(5) was ultra vires Section 54 (3) of of the CGST Act, 2017. The Court also affirmed the Madras High Court ruling in Tvl. Transtonnelstroy Afcons Joint Venture v. Union of India in this regard."We have come to the conclusion that the judgment of the Madras High Court needs to be affirmed by dismissing the appeals challenging that verdict while the appeals against the judgment of the Gujarat High Court by the Union of India should be allowed," the Court heldPertinently, the Court while upholding Rule 89(5) held that the anomalies in the Rule should be examined by the government,"The formula makes a presumption that the output tax payable on supplies has been entirely discharged from the ITC accumulated on account of input goods and there has been no utilisation of the ITC on input services.The formula prescribed in Rule 89(5) however, seeks to deduct the total output tax from only one component of the ITC, namely ITC on input goods. This in our view is at odds with reality, where the ITC on both input goods and input services is accumulated in the electronic ledger and is then utilised for the payment of output tax," the judgment said.In making such an assumption, the formula tilts the balance in favour of the Revenue by reducing the refund granted, the Court opined.However, these inequities are to be ironed out by the Government in the course of the application of the formula. "We are affirmatively of the view that this Court should not in the exercise of the power of judicial review allow itself to become a one-time arbiter of any and every anomaly of a fiscal regime despite its meeting the jurisdictional framework for the validity of the legislation, including delegated legislation," the Court ruled..Section 54(3) embodies a provision for refund of unutilised ITC in cases involving: (i) zero rated supplies made without payment of tax; and (ii) credit accumulation “on account of rate of tax on inputs being higher than rate of tax on output supplies i.e. an inverted duty structure.Rule 89(5) provides a formula for the refund of ITC, in “a case of refund on account of inverted duty structure.Section 54(3) does not restrict the entitlement of refund only to unutilised ITC which is accumulated due to the rate of tax on inputs being higher than the rate of tax on output supplies.It also allows for refund of unutilised ITC when the rate of tax on input services is higher than the rate of tax on output supplies;.However, while Section 54(3) allows for a refund of ITC originating in inputs as well as input services, Rule 89(5) excludes tax on input services from the purview of the formula.This formed the crux of the challenge instituted before Gujarat and Madras High Courts.The Gujarat High Court ruled that Rule 89(5) to the extent it denies the refund of “unutilised input tax” paid on “input services” as part of “input tax credit” accumulated on account of inverted duty structure is ultra vires Section 54(3).The Madras High Court, however, came to the contrary conclusion in Tvl. Transtonnelstroy Afcons Joint Venture after having noticed the view of the Gujarat High Court, which it declined to follow..Before the Supreme Court, it was contended on behalf of the assessees that the formula creates a distinction between suppliers having a higher component of input goods than those having a higher component of input services, and must be read down accordingly.Additional Solicitor General N Venkataraman, appearing for the Central government, conceded that certain inadequacies might exist in the formula.However, he sought to justify the need for a formula in Rule 89(5). The ASG submitted that under the scheme of the CGST Act, the accumulated ITC arising out of input goods and input services is booked into the electronic credit ledger and is to be utilised thereafter for payment of tax on outward supplies on goods and services in accordance with Section 49 of the CGST Act. Once payments are made from the electronic ledger, the remaining quantum of unutilised ITC becomes one homogeneous nucleus and it is impossible to attribute the unutilised ITC to its source, that is, it cannot be identified whether the balance unutilised ITC is arising from input goods or input services.In order to bifurcate the unutilised ITC into input goods and input services for the purpose of granting refund in accordance with Section 54(3)(ii) on ITC on inputs, Rule 89(5)3 has resorted to prescribing a formula to legally dissect the unutilised ITC. The ASG urged that the prescription of formulae to artificially determine refund or utilisation is a common practice in the field of taxation and was used prior to the enactment of the CGST Act in MODVAT/CENVAT Rules for determining quantum of eligibility of credit. Another instance is Rule 42 and 43 of the CGST Rules 2017 which provide specific formulae in restricting the ITC when a registered supplier uses input goods, input services and capital goods for purpose of business and other than business purposes, he pointed out..Having justified the need for a formula, the ASG then argued that a formula prescribed by delegated legislation may not be perfect and may have certain aberrations. However, a wide discretion is given to the policy makers in this regard and only if the formula is arbitrary and violative of Article 14 of the Constitution, can it be struck down, he contended.The Supreme Court accepted the ASG’s argument and held that the justification of the formula under Rule 89(5) given by the ASG to create a legal bifurcation is valid..The purpose of the formula in Rule 89(5) is to give effect to Section 54(3)(ii) which makes a distinction between input goods and input services for grant of refund. Once the principle behind Section 54(3)(ii) of the CGST Act is upheld, the formula cannot be struck down merely for giving effect to the same, the Court held.“The formula tilts the balance in favour of the Revenue by reducing the refund granted. We are equally cognizant of the fact that the proposed solution, that is prescribing an order of utilisation of the ITC accumulated on input services and input goods, may tilt the balance entirely in favour of the assessee as that would make a contrary assumption that the output tax is discharged by the ITC accumulated on account of input services entirely. Another possible solution could be that the Rule itself provides for a statutory assumption or a deeming fiction of utilisation of a certain percentage of ITC on input services towards the payment of output tax for the purpose of calculation of refund,” the Court observed.However, these are aspects which need to be considered and iron out by the government and not for the Court to exercise judicial review.“The observations in paragraphs 104 to 111 of the judgment shall be considered by the GST Council to enable it to take a considered view in accordance with law,” the Court said..[Read Judgment]