[Yash More and Hitoishi Sarkar are II year students at Gujarat National Law University]
In 2017, the Indian Parliament introduced the concept of Goods and Services Tax (“GST“). Designed to be a single, comprehensive, destination-based taxation system, it aimed to overhaul the existing indirect tax framework and unify the country in terms of how taxes are collected. An uninterrupted and seamless chain of input tax credit is the core feature of GST.
In this post, the authors delineate the concept of input tax credit (“ITC”) and argue that the criterion to avail ITC under section 16(2)(c) of the CGST Act is unfair and arbitrarily punishes innocent buyers for the negligence and wrongdoings of a seller. The authors conclude that the provision does not stand the test of law and logic.
Concept of Input Tax Credit under the GST Regime
Input Tax Credit is a mechanism to avoid cascading of taxes. The cascading of taxes means a ‘tax on tax.’ The basic principle is that at every stage, from production to sale, the tax should be levied only on the “value added” in a stage and not on the entire sale price. The value-added is the difference between the sale price and cost price. It is pertinent to note here that the concept of ITC is not a novel creation of the GST Regime and similar input credit was available in the VAT regime.
In an indirect taxation framework, a seller is assumed to be an “agent” of the government who collects tax on supply of goods/services and deposits it with the government. ITC allows a trader to use the tax paid on a purchase to reduce his tax liability when he makes a sale. In other words, businesses can reduce their tax liability on a sale by claiming credit to the extent of GST paid on purchases.
For example, when a retailer buys a good from the wholesaler, he pays GST on it at the applicable rate. If the cost price is Rs 800 and the GST rate is 10%, he will pay Rs 80 as GST to the wholesaler. Now, let us assume that the retailer sells the goods to the final consumer at the price of Rs 1000. He collects Rs 100 as GST from his customer which he has to deposit with the government. The ITC system allows the retailer to use Rs 80 paid on purchase (input credit) to reduce the total tax that it will have to pay to the government on the sale and deposit only the difference (100-80) = Rs 20.
Unreasonable Burden on Buyer under section 16 of CGST Act
Section 16 of the CGST Act, inter alia,lists the essential conditions to avail ITC by a buyer of goods. These include possession of the tax invoice, actual supply of goods/services and filing proper returns. However, one essential to avail ITC that is unfair, arbitrary and unjust, to a genuine and innocent buyer is laid under section 16(2)(c). It states that no buyer shall be entitled to the credit of any input tax in respect of any supply of goods/services unless “the tax charged in respect of supply has been actually paid to the government by the supplier.”
This implies in case the seller fails to deposit the GST collected, the buyer cannot avail ITC. Consequently, the buyer has to bear the loss of ITC, which he is lawfully entitled to and against which he has dutifully paid his share of taxes. Thus, the law imposes an unreasonable onus on the buyer to ensure that the seller has deposited the GST charged by him in the invoice. Moreover, what adds to the predicament of an innocent buyer, is that under the present GST mechanism, he has no means to verify whether his supplier has deposited the GST collected from him. Further, the buyer is also made to pay interest on the reversal of input under section 50.
Validity of Section 16(2)(c) of CGST Act
In a host of decisions, various High Courts across the country have opined that input is an inalienable right of an innocent buyer. For example, in Gheru Lal Bal Chand v. State of Haryana, the constitutionality of section 8 of the Haryana VAT Act, 2003 was challenged before the Punjab & Haryana High Court. The provision imposed a similar liability on the buyer if the seller failed to deposit the tax collected in the treasury. The Court read down section 8 and held that no liability could be fastened on a buyer on account of non-payment of tax by the seller in the treasury unless a case of fraud is made out by the Revenue, or unless collusion/connivance between the seller and buyer is established.
In Sri Vinayaga Agencies v. The Assistant Commissioner, a writ petition was filed challenging an order of the tax department which reversed the input claimed by a purchasing dealer on account of non-payment by supplier pursuant to the law laid down in section 19 of the Tamil Nadu VAT Act, 2006. The Madras High Court held that law could not empower tax authorities to revoke the input tax credit availed on a plea that the selling dealer has not deposited the tax. It can revoke input credit only if it relates to the incorrect, incomplete or improper claim of such credit by a dealer. Based on this decision, the Madras High Court allowed a similar writ in Indroyal Furniture Company v. The Assistant Commissioner. Even though the Court did not find an opportunity to rule on the validity of such law, it did in effect read down the provision.
The issue was examined in depth by the Delhi High Court in Arise India Limited v. Commissioner of Tax. Section 9 of the Delhi VAT Act, 2004 which sought to deny input tax credit in such circumstances, was under challenge. The Court held that such clauses require the buyer to do an “impossible” task, i.e., to anticipate the seller who will not deposit tax collected with the government and therefore avoid transacting with such selling dealers. The Court read down section 9 to not include a buyer who has bona fide entered into purchase transactions with validly registered dealers who have issued tax invoices against the transaction.
The Delhi High Court explained that such provision, if not read down, is violative of Article 14 of the Constitution for being inherently arbitrary. The only case when such provision applies is if the tax authorities comes across some material to show that the purchasing dealer and the selling dealer acted in collusion in detriment to the exchequer. However, in the event that the selling dealer has failed to deposit the tax collected, the remedy for the authorities is to proceed against the defaulting selling dealer to recover such tax and not deny the purchasing dealer his input. The Supreme Court dismissed the Revenue’s petition seeking special leave to appeal against this decision.
The Bombay High Court in Mahalakshmi Cotton Ginning v. The State of Maharashtra, appears to have struck a discordant note, when it upheld a similar provision in the Maharashtra VAT Act, 2002. It reasoned that a plea of hardship on account of buyers could not result in the invalidation of a statutory provision in a fiscal enactment, which is otherwise lawful. Further, the purpose of an input is to obviate the cascading effect of taxes; and this must be balanced with the need to secure tax compliance and ensure zero loss of legitimate revenue to the government. This balance is drawn by ensuring that while input is available against tax paid on purchase of goods, the set-off is based on the actual deposit of tax into the government treasury.
However, as explained in Arise India, the Maharashtra VAT Act lacked provision to take care of a situation where the seller and the buyer acted in collusion with a view to defraud the authorities. In fact, the operative part of the order of the Bombay High Court indicates that the Bombay High Court ordered authorities to prosecute selling defaulters. The relevant Revenue department also undertook to upload on its website the details of the defaulting dealers and once there was a final recovery of the tax from the seller, refund would be granted to the buyer. In summary, even though the Court did not explicitly read down the provision, in effect, it did uphold the buyer’s right to input credit.
Misery of Small Traders and MSMEs
It is understood that the intention of the law is to check tax avoidance by businesses, and the fact that it is not feasible for the revenue to detect and contain the problem systematically. However, the cascading consequences of doing this in practice and the issues it creates has been undermined by the legislature.
The restriction increases the working capital requirements of the business houses for no fault of theirs. MSMEs typically suffer unevenness of cash flow. Even a week’s delay in payment throws their routine out of gear. A promising auction or offer for materials which would give them higher profitability, will force them to readjust their cash cycles for a few weeks to take advantage of it.
A dealer can no longer assume that the transaction is over when he pays tax and will have to wait for at least 10-15 days to confirm whether he is eligible to receive the input credit for the tax he paid. During this time, buyers may withhold the payment to the supplier, refuse to pay the tax portion, demand bank guarantees to cover the possible risks, etc., leading to multi-step transactions and an increase in both working capital needs as well as the cost of doing business.
It is evident that section 16(2)(c) does not stand the test of law and must be read down, even if not rendered unconstitutional.In the past, it was not feasible for the authorities to systematically mitigate the risk of fraud. However, GST Law gives extraordinary traceability for recovery of tax along with harsh penalties and prosecutions. The system of invoice matching eliminates false bills and wrong claims. A PAN-Bank Account linkage will make it impossible for fake companies to commit fraud and remain undetected. Thus, the liability of a buyer must cease once he pays his share of taxes. If there is a mismatch in the claim of input, the buyers must only be required to prove their bona fides. Thereafter, the burden must be shifted on the defaulting seller.
– Yash More & Hitoishi Sarkar