Refund of ITC on closure of business: A legal conundrum

The Goods and Services Tax Laws was introduced in India in 2017 aiming to simplify the tax structure by subsuming various central and state levies. One of its key objectives was to eliminate the cascading effect of taxes. GST allows businesses to claim a credit of the tax paid by them on their inputs/ input services, ensuring that tax is levied only on the value addition undertaken by each business, assisting in eliminating the cascading effect of taxes.

However, from the time GST laws have been introduced, various ITC related disputes have been consistently arising. In recent times, the High Court of Sikkim examined and ruled on the eligibility of refund of ITC available in the credit ledger upon closure of business. This article will explore the eligibility of refund of ITC upon closure of business under the GST laws in light of the rulings of the High Court of Sikkim.

The statutory framework under the GST laws allows for the refund of the balance in the electronic cash ledger or credit ledger under Section 49(6) of the CGST Act. However, such a right to refunds is not absolute in nature and is subject to the conditions provided under the provisions of Section 54 of the CGST Act.

The language of Section 54(3) of the CGST Act, which provides for the refund of amounts in the credit ledger, is very restrictive and allows the refund of unutilised ITC under two circumstances:

(i) when the supplier undertakes zero-rated supplies (export or supplies to SEZ) without payment of tax or

(ii) In cases of inverted duty structure where the rate of tax on inputs is higher than the rate of tax on outputs, which leads to accumulation of credit.

Thus, as per Section 49(6) read with Section 54(3) of the CGST Act, the scope of refund of unutilised ITC is very narrow and is limited to the two circumstances as provided above. The statute does not explicitly spell out the availability of a refund on unutilised ITC in case of closure/ winding up of business.

Additionally, the legislative intent behind the refund of balance ITC available at the time of closure of business under the GST laws becomes more apparent in light of provisions of Section 29(5) of the Central Goods and Services Tax Act, 2017, as per which, a registered person is mandatorily required by law to pay an amount equivalent to the debit balance in the electronic cash or credit ledger on inputs or goods held in stock or capital goods on the day immediately preceding the date of cancellation of registration or their output tax liability whichever is higher. This essentially implies that, if there is any credit balance available in the credit ledger, then businesses must reverse the same at the time of closure of their business. However, this reversal does not necessarily imply that such a balance would lapse.

Similarly, in a case where a registered person opts to pay tax under the Composition Scheme or where supplies become wholly exempt, the law mandates that such a business must reverse ITC on inputs or goods held in stock, and capital goods held on the day preceding the date of exercising such option. Additionally, any balance ITC in the credit ledger shall lapse, entailing that the taxpayer shall inherently lose the right to retain such credit as per law, unlike Section 29(5).

The aforesaid provisions clearly indicate the legislative intent to adopt a restrictive approach for granting refunds of unutilised ITC in specified circumstances. In all other circumstances, including closure of business, any accumulated credit which would be rendered ineligible to avail, must duly be reversed. There exists no general entitlement to a refund of such accumulated credit under the provisions of Section 49(6) read with Section 54 of the CGST Act.

While Indian legislation lays down a very limited outlook, the tax laws of various other countries have a different comprehension. Division 35 of The New Tax System (Goods and Services Tax) Act 1999 in Australia provides that the Commissioner is obligated under the law to grant a refund of the utilised ITC after off-setting amounts of GST for a given reporting period. Similarly, the taxpayers in UK under the Value Added Tax Act, 1994, in Canada under the Excise Tax Act, 1985 and in New Zealand under the Goods and Services Tax Act, 1985 (NZ) can claim a refund from their revenue agencies for excess input tax paid by them after off-setting their output tax liability for each reporting period.

Thus, the position of law in other countries is that for every reporting period, if there is any excess input tax paid by a taxpayer while off setting their output payments, the revenue agencies refund the said amount to the taxpayer. The refund mechanism adopted by their countries aids in ensuring that businesses maintain sufficient cash flow, thereby facilitating a smooth operation. Further, this refund mechanism is also available to the taxpayers at the time of closure of business, wherein the taxpayer would be eligible to avail refund of their unutilised ITC.

In contrast to the International position, the Indian legislation allows for a refund of ITC only in certain specified circumstances, such as in cases of zero-rated supply or inverted duty structure.

The single judge Bench of the High Court of Sikkim in the case of SICPA India Private Limited Vs Union of India ruled in favour of the petitioner, allowing the refund of unutilised ITC on closure of business. The said ruling placed reliance solely on the ruling of the High Court of Karnataka and held that there is no express prohibition in Section 49(6) read with Section 54 of the CGST Act for claiming a refund of ITC on closure of a business unit. Despite the fact that Section 54(3) of the CGST Act provides for two circumstances as aforementioned for refund under the GST laws, the statute does not provide for retention of tax without the authority of law. Accordingly, the petitioners are entitled to the refund of their unutilized ITC claimed upon discontinuance of their business.

However, subsequently, the Revenue filed an appeal before the Division Bench challenging the said decision in the case of Union of India vs. SICPA India Private Limited, on the grounds that the decision of the Supreme Court (“SC”) in Union of India vs. VKC Footsteps (India) (P) Ltd. is not considered by the single judge Bench while allowing the refund of unutilised ITC on closure of business.

The Division Bench of the Sikkim High Court reversed the previous single Bench’s decision, relying heavily on the Supreme Court's decision in VKC Footsteps (Supra), which established that ITC refunds are purely statutory rights, and not constitutional entitlements. Section 54(3) of the CGST Act is restrictive to the two specific circumstances, and refunds of amounts in the electronic credit ledger cannot be granted in situations apart from the said situations. Thus, allowing the refund of unutilised ITC on closure of business would amount to judicial rewriting of the statute. Since closure of business does not fall within the categories stipulated under the statute, the refund of ITC in respect of the same cannot be legally granted. The court further observed that businesses discontinuing their operations must reverse accumulated ITC under Section 29(5) of the CGST Act instead of claiming refund.

Although the question of refund of unutilised ITC upon closure of business under GST has been judicially settled by the decision of the Division Bench of the Sikkim High Court, it is only fair that a registered person ought to have been entitled to a refund of unutilised ITC on closure of their business. At the very least, India can propose to amend the legislation to allow the refund of unutilised ITC at the time of closure of business.

In the event of sale, merger, transfer, etc. of a business, the statute allows for unutilized ITC of such business to be transferred to the other entity in terms of Section 18(3) of the CGST Act. However, in event of closure of business, the denial of refund of unutilised ITC would lead to unjust enrichment by the state. It is only reasonable to allow the refund of unutilised ITC on the closure of a business, subject to some checks and balances, to ensure that such provisions are not misused, and that the refund is granted only in legitimate cases.

About the authors: Shradha Rajgiri is a Principal Associate and Sneha Suresh is an Associate at Shivadass & Shivadass (Law Chambers).

Rishab J, Associate Partner, provided his inputs.

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