Supreme Court Verdict on Input Tax Credit: Impact on Leasing and Construction

This Article is already published in ICAI GST E-NEWSLETTER (49th Edition)

Introduction

The recent judgement of the Hon’ble Apex Court in the case of Chief Commissioner of Central Goods and Service Tax & Ors.  v. M/s Safari Retreats Private Ltd. & Ors[1]. regarding the much-debated issue on the topic related to Input Tax Credit (ITC) (i.e., Whether the ITC is allowed on the construction of immovable properties for a commercial purpose) and the constitutional validity of section 17(5) (c) & (d) of the CGST Act has generated much attention and debate, particularly among businesses and legal communities. The court in its historic and landmark judgement upheld the constitutional validity of both the clauses.  Also, it allowed the ITC on the construction of immovable property intended for leasing and renting.

This judgement is seen as a positive development in the real estate industries but the broader denial of ITC on the construction of immovable property for other commercial uses like factories etc., continued to raise concern. As these properties are essential for business operation but excluding these from the benefit of ITC will lead to higher cost of construction and a significant impact on the business operation in terms price determination leading to a cascading effect. The judgment while resolving certain ambiguities highlights deeper issues of differential treatment of ITC across different sectors. This critical analysis delves into the crux of the judgement, issued frame and the contentions raised. Further, it deals with the implication of the judgment, how it is aligned with the fundamental principle of the GST and explores the areas in which the reforms are needed for the growth of a healthy business environment.   

Facts of the case

In the instant case, the assessee was constructing a shopping mall for the purpose of the letting out this mall on rent. The construction materials such as cement, iron rods, aluminium, bricks, wire, wood, & electric appliances etc., which are essentially required for the construction of the mall and getting it ready for usable and rentable purposes are being purchased through proper GST invoices and since all the construction material and the service of professional and other skilled worker are taxable under the GST. The assessee accordingly paid the GST. Since the assessee is the registered person under the GST, the assessee wanted to avail the accumulated ITC in order to set off the GST which the assessee is liable to pay on the Rent as received by the assessee as a business activity. But the department didn’t allow this in view of section 17(5)(d) of the CGST Act & OGST. Aggrieved by the decision of the department, the assessee approached the Orisa High Court with the prayer to declare that section 17(5)(d) of the CGST Act & OGST doesn’t apply to the business of construction and subsequent rental of such immovable property as a business activity and to declare that this section is in violation of fundamental right enshrined under the Constitution of India particularly Article 14 & Article 19(1)(g).  The second assessee with Civil no 2949 of 2023 also joined the first assessee on the same prayer. The Hon’ble Orissa High Court in view of the well-settled judgment of the Hon’ble Supreme Court[2] taking broad interpretation held that this particular section doesn’t bar the assess from availing the ITC on the construction of the immovable property intended for the letting out and subsequent GST is paid on rent received by the assessee[3]. The case of second assessee came under the exception of this judgment accordingly the second assessee was not allowed to avail ITC on the construction of a building intended for factory purposes.  Subsequently arrived by the decision of the High Court, the Department preferred an appeal against this order before the Hon’ble Supreme Court and the Hon’ble Supreme Court clubbed all the similar matters pending before the Hon’ble Court in the present Civil appeal and framed the issued for the consideration the Hon’ble Court[4].

Issues raised before the Court.

1. Whether clauses (c) and (d) of Section 17(5) and Section 16(4) of the CGST Act are unconstitutional?
2. Whether the definition of “plant and machinery” in the explanation appended to Section 17 of the CGST Act applies to the expression “plant or machinery” used in clause (d) of sub-section (5) of Section 17?
3. If it is held that the explanation does not apply to “plant or machinery”, what is the meaning of the word “plant”?

Arguments on behalf of the Assessees: –

• That the section 17(c) & Section 17( d) is violative of Art. 14 19(1)(g) & 300A of the constitution.

The assesses in the argument submitted that this section is violative of the Art. 14 on the ground that it fails to satisfy the twin condition test as laid down by the Hon’ble Apex court[5] i.e., intelligible differentia & the reasonable nexus with the object.

The assessee submits that this section fails to satisfy the intelligible differentia on the ground that it has treated unequal as equal i.e., this section has failed to differentiate between a person engaged in the business of the construction of immovable property for the purpose of the 

1. For  Selling
2. to rent/leasing/let out.   

This section treated both purposes on equal footing. So there exist no differentia based on which such classification has been done neither based on immovable characteristics nor the break of the credit chain.

Secondly, the assessee also contended that the basic object of the GST act is to remove the cascading effect of the taxes i.e., tax on the tax but denial of ITC in these cases leads to cascading effects. As the denial of ITC leads to an addon in the price of the price of service i.e., renting /leasing out etc., which in turn results in tax on tax.

• That the phrase “on its own account” should be constructed purposive

 The assessee contented that this phrase should be treated purposive instead of myopic as per the assessee, this phrase should mean construction done for personal use not for services. The assessee content that, given this phrase ITC should only be denied when the construction is for personal use i.e., office factory etc., not when such construction used the supply of the services i.e., renting, leasing/hotel accommodation. In this way, there will be no breakage in the chain of taxable supplies leading to negative cascading effects.  

• That Section 17 (5)(d) can be interpreted to include ITC on the construction of immovable property for further supply.

 In this regard, the assessee contented on the three grounds:

1. That the expression “Plant or Machinery” is different from the expression “Plant and Machinery”. As in the act the definition of “Plant & Machinery” is given and this expression has been used several times in the Act. But the term “Plant or Machinery” has been used only in this section which clearly shows the intention of the legislature to exempt the expression “Plant or Machinery” from blocked credit.
2. The assessee contented that since the expression “Plant or Machinery” is nowhere defined in the act, the Functionality or essentiality test should be applied to decide what constitutes plant i.e., to understand in the neutral sense in the language of trade. As per this interpretation, the term “Plant” includes the building when used for commercial purposes or forming part of business supplies i.e., Hotel, warehouse renting etc.
3. That the service of renting, leasing or letting out concerning immovable property constitutes supply under the act as per clause 2 & clause 5A of schedule II given under the CGST Act.

Contentions from the side of the Department

1. That the provision is not violative of Article 14 on the ground that the classification is on an equal footing and is justified on the ground that both leads to the creation of immovable property which itself is intelligible differentia & it has a reasonable nexus with the objective as there is a break in the tax chain during the supply.
2. The revenue department also contented that denial of ITC is also justified on the ground that ITC is a statutory right, not a fundamental or constitutional right, so if the legislation does not allow such rights, then the court has no power to issue mandamus to grant such right.
3. The revenue department with regards to the interpretation of the expression “Plant and Machinery “and “Plant or machinery” contented that it is common to read the expression “or” as “and vice versa.[6] The department further contented that if “or” is not read as “and” then there will be discrimination between clause (c) & clause (d) as in the earlier clause ITC will not be allowed but in the later clause ITC will be allowed. The department further submitted that both clauses deal with the same subject matter and can’t be treated differently.

RULING OF THE HON’BLE SUPREME COURT

1. Rule of Interpretation of Taxing Statues

The Hon’ble Supreme Court before dwelling into the matter summarised the well-settled rule of the interpretation of taxation statutes:

1. The statutes should be read as it is without any deduction or addition of the word.
2. It is for the legislature to remove the absurdity in the case plain reading of the statutes gives some absurd result.
3. The principle of strict interpretation should be applied.
4. In case, two interpretations are possible, the interpretation favor the taxpayer should be followed by the court.
5. While interpretation, there should not be any equitable consideration or assumption or presumption. The rule of equity should only be followed in the case consideration does not result in injustice.
6. If literal interpretation is not only possible, then the court can modify the language.
7. It is not unjust if the taxpayer is escaping the tax if the word mentioned in the statute does not catch him.
8. If any word is not defined in the statutes, the definition should not be interpreted according to other laws instead it should be interpreted in commercial terms.

• What is the meaning of the term “Plant or Machinery”?

The Hon’ble Court while interpreting the clauses 17(5)(c) & 17(5)(d) of the CGST observed that both of these clauses are different and operate in different domine. The only similarity between these two clauses is that both apply to the construction of immovable property.

The Hon’ble while interpreting the word “Plant and machinery” as given in clause (c) and the word “Plant or Machinery” as given in clause (d) laid down the functionality test to determine whether the building is a plant.

The Hon’ble Court held that if the building is so designed and constructed to as to serve the assessee’ s technical requirement then it is a plant other it will not fall under the definition of plant.

The Court further observed that since renting/ leasing is taxable supplies of the services, then the building in which the premises is situated qualifies for the definition of the plant and the ITC is allowed on the goods and services used in setting up the building.  The court further held that to determine whether a mall or warehouse or any building except a hotel or cinema can be classified as a plant, the case needs to be determined through a functionality test and the nature of the business of the assessee and the role of such building.

• Constitutional validity of Section 17 (5) (c) & (d) and Section 16(4)

The Hon’ble court while determining the constitutional validity of both the clauses held that the contention submitted by the department is valid and both the clauses are not violative of Art. 14 as the twin test is properly satisfied.

The court further held that the ITC is a statuary and no one claimed the ITC unless it is proved by the statutes.

• Validity of Section 16(4) of the act

The court regarding the validity of this section held that only the facts that this section can be drafted in a more articulated or better manner, nowhere attracts the arbitrariness.      

Critical analysis of the judgment

The recent judgment regarding the denial & availment of ITC under Section 17 (5) (C) & (D) under CGST, while clarifying certain key aspects has a significant impact on the businesses dealing in the field of construction of immovable properties for commercial purposes. Despite this judgement upholding the constitutional validity of these provisions, significantly the court allowed the business to avail the ITC on the construction of immovable properties that are for the purposes of lease or rented out such as mall etc. Although this judgement provides major relief to the businesses dealing in this purpose but it raises other critical concerns about the broader application of Section 17(5) (D), especially for the businesses constructing immovable properties for non-leasing activities like manufacturing units etc. The core of this judgement mainly revolved around the interpretation of Section 17(5)(d) and the term “plant or machinery” as the section implies that ITC is only allowed when such construction is “plant or machinery”. The court laid down the concept of “functionality test” and accordingly classified the Renting or leasing building as a Plant. However, the distinction raised a significant question about the treatment of the other commercial properties, such as factory or manufacturing units, where ITC on the construction materials and services continued to be allowed. But from the perspective of the taxpayer, this creates an inconsistency within the GST Framework i.e., ITC on while businesses renting out commercial properties like malls can now claim ITC on the GST paid on construction materials (such as cement taxed at 28%) and services (like work contracts taxed at 18%), the same benefit is denied to manufacturers who construct factories. This differential treatment seems contradictory, especially since factories, like malls, also play a critical role in generating taxable outputs (e.g., goods) and should logically qualify for ITC. This broader denial of ITC is also leading to cascading impacts which is contrary to the GST objective whose purpose is to prevent cascading taxes which means taxes paid on inputs can be offset against taxes collected on outputs.

The judgement highlights the issue of creating business-friendly environment under the GST. While the aim & objective of the GST is to simplify the indirect taxes and reduce the burden of the compliances, the continued disallowance of ITC for certain categories of immovable property is contrary to this main objective of the GST. This ruling although brings positive changes in Real estate but does not go far enough in addressing the financial burden placed on businesses, particularly those in capital capital-intensive sector. In order to promote economic growth and foster a more competitive business environment, it is essential to reconsider the broader application of the section 17(5) and allow the ITC on all immovable property used in furtherance of taxable supplies. 

Conclusion

The judgement allowing ITC on the construction of immovable property for commercial purposes is a positive step which is significant for the growth of the real estate sector and significant development which is in align with the objective of the Goods and Services Tax. However, the broader denial of the ITC on other immovable properties such as factories, warehouse, continues to create financial challenges for businesses and undermines the intended purpose of the GST. To foster a more equitable and competitive tax environment, it is crucial for the policymaker to reconsider the denial of ITC on non-leasing commercial properties and ensure that the GST framework supports the seamless flow of credit across all the sections of the economy.

[1] 2024 INSC 756.

[2] Eicher Motors Limited & Anr. v. Union of India & Ors (1999) 2 SCC 361.

[3] Safari Retreats Private Limited Vs Chief Commissioner of Central Goods & Service tax (Orissa High Court) W.P. (C) No. 20463 of 2018

[4] writ petition (civil) nos. 804 of 2022 & 1030 of 2022, civil appeal no. 2949 of 2023 writ petition (civil) nos. 1036 of 2022 & 90 of 2023 writ petition (civil) no. 846 of 2023 and writ petition (civil) no. 847 of 2023.

[5] Union of India and Ors. v. Nitdip Textile Processors Pvt. Ltd. and Anr.(2012) 1 SCC 226.

[6] Indore Development Authority v. Manoharlal & Ors. (2020) 8 SCC 129.