In a significant development for businesses undergoing mergers and amalgamations across state lines, the Bombay High Court has delivered a landmark ruling, urging the GST Council and the GST Network (GSTN) to establish a formal mechanism for the seamless transfer of unutilised Input Tax Credit (ITC) between companies in different states. This decision, in the case of Mumbai-based Umicore Autocat, addresses a critical pain point for businesses and highlights the need for the GST framework to evolve with the complexities of modern corporate restructuring.

The News: A Call for Mechanism and Practical Relief

The recent ruling by a division bench of Justices Nivedita R. Mehta and Bharati H. Dangre has brought much-needed attention to a glaring gap in the current GST system. The Bombay High Court specifically requested the GST Council and GSTN to “provide for a mechanism to deal with such contingencies, when the ITC is sought to be transferred from one State to another or from one State to any Union Territory by updating its network to deal with such a situation”.

Beyond this forward-looking recommendation, the court also provided immediate relief to the petitioner, Umicore Autocat. It permitted the transfer of unutilised Integrated Goods & Services Tax (IGST) and Central Goods & Services Tax (CGST) amounts from the electronic credit ledger of the transferor company (in Goa) to the petitioner company (in Maharashtra) via a “physical mode for the time being”. This interim solution, while practical, underscores the urgent need for an automated, digital mechanism to handle such transfers efficiently.

The core of the issue, as challenged by the petitioner, was the tax administration’s restriction on transferring unutilised ITC when a merger or amalgamation involves companies in distinct states. The company argued that neither the GST Act nor the GST Rules explicitly prohibit such a transfer. However, the Tax Department’s counsel countered by stating that the current GSTN system simply lacks a mechanism for cross-state ITC transfers, justifying their refusal to permit the transfer from Goa to Maharashtra.

The History of the Case: Umicore Autocat’s Challenge

The case originated from a merger/amalgamation where Umicore Autocat, located in Mumbai, was the transferee company, and the transferor company was situated in Goa. Post-merger, Umicore Autocat sought to transfer the unutilised ITC accumulated by the Goan entity to its electronic credit ledger in Maharashtra. However, this transfer was blocked by the tax authorities due to the inter-state nature of the transaction.

The petitioner’s contention was straightforward: while mergers and amalgamations are common corporate exercises, the existing GST framework, particularly its technological backbone (GSTN), did not facilitate the logical and necessary transfer of ITC across state boundaries. They argued that the spirit of the GST law, which aims for a seamless flow of credit, was being undermined by a procedural or technological bottleneck. The tax department, while acknowledging the lack of mechanism, maintained that without such a facility, they were justified in disallowing the transfer. This created a deadlock, necessitating judicial intervention.

Technical Aspects: Understanding ITC and GST in Mergers

To fully grasp the implications of this ruling, it’s essential to understand the technical aspects of Input Tax Credit (ITC) and how GST generally applies to corporate restructuring like mergers.

Input Tax Credit (ITC):

In the GST regime, ITC is the backbone of the value-added tax system. It allows businesses to claim credit for the GST paid on inputs (goods or services) used in the course or furtherance of their business. This prevents the cascading effect of taxes (tax on tax), as businesses only pay tax on the value addition at each stage of the supply chain. The unutilised ITC accumulates in an electronic credit ledger maintained for each registered taxpayer on the GSTN portal. This credit can then be used to offset future output tax liabilities.

GST and Mergers/Amalgamations:

Corporate mergers, demergers, and amalgamations are common business strategies for growth, consolidation, or streamlining operations. Under Section 18(3) of the CGST Act, 2017, the law specifically addresses the transfer of ITC in such “special situations”. This sub-section is designed to ensure that the accumulated ITC of a merging or de-merging entity is transferred to the resultant entity, preventing the loss of legitimate credits simply due to a change in legal structure. The challenge, however, arises when these entities are registered in different states, as GST is a destination-based consumption tax and states have their own GST administrations.

The Inter-State Challenge:

The GSTN portal, the technological backbone of GST, is designed primarily for transactions within a single state or inter-state transactions that result in a defined ITC flow (e.g., IGST). However, it currently lacks a built-in mechanism to facilitate a direct, automated transfer of accumulated ITC from the electronic credit ledger of a company in one state to a company in another state, especially in scenarios like mergers where the GST registrations are distinct but legally merged. This procedural gap was at the heart of the Umicore Autocat case.

Details of the Court Case: Key Observations and Rationale

After careful consideration of arguments from both sides, the Bombay High Court made several crucial observations and laid down its rationale for the ruling.

Entitlement to ITC Transfer: The bench unequivocally stated that Umicore Autocat, having amalgamated with the transferor company and undertaken all its liabilities, was “entitled to take benefit of ‘sub-section (3) of Section 18 of the CGST Act, 2017’”. This sub-section specifically allows for the transfer of ITC in special situations like mergers, thus affirming the petitioner’s legal right to the credit.

Revenue Neutrality for CGST and IGST: A significant part of the court’s reasoning revolved around the revenue implications for the Central and State governments. The court noted that CGST and IGST are ultimately claimed by the Central Government. Therefore, if the unutilised CGST and IGST credits were utilised in Maharashtra instead of Goa, the Central Government would “have nothing to lose”. This effectively meant that the transfer of these components of ITC was revenue-neutral from the Central Government’s perspective.

State Specificity of SGST: The court, however, took a different view regarding State Goods & Services Tax (SGST). It highlighted that SGST is collected and consumed by the respective State. Permitting the utilisation of SGST from Goa in Maharashtra would directly “result in financial loss to the State of Goa”. This distinction is crucial, as GST operates on a dual model (Centre and State each levy and collect their own taxes).

Petitioner’s Relinquishment of SGST: Recognizing this challenge, Umicore Autocat proactively stated its willingness to “relinquish its claim for unutilised SGST”. This concession likely played a significant role in the court’s decision to permit the transfer of CGST and IGST.

GSTN Portal’s Limitation Not a Bar to Statutory Entitlement: Importantly, the bench firmly stated that the fact that the “GSTN portal does not allow such transfer” cannot be a ground to deny a legitimate benefit to the petitioner, especially when they are “so entitled in the wake of the statutory scheme”. This observation puts the onus squarely on the GST Council and GSTN to update their systems to align with legal entitlements.

What It Means for Businesses: Navigating Mergers and ITC

This Bombay High Court ruling carries substantial implications for businesses, particularly those engaged in cross-state mergers and acquisitions:

Recognition of a Systemic Flaw: The ruling explicitly acknowledges a significant lacuna in the current GST system – the inability to seamlessly transfer ITC across states during corporate restructuring. This is a victory for businesses that have long faced procedural hurdles in such scenarios.

Urgency for GSTN and GST Council: The court’s direct request to the GST Council and GSTN to develop a mechanism is a strong judicial nudge for necessary technological and policy updates. Businesses can now hope for a more streamlined process in the future.

Interim Relief and Practical Approach: The permission for “physical mode” transfer of CGST and IGST provides immediate, albeit temporary, relief to companies like Umicore Autocat. This demonstrates the judiciary’s willingness to find practical solutions when the digital infrastructure falls short.

Clarity on SGST Limitations: The ruling also provides clarity regarding SGST. It confirms that due to the state-specific nature of SGST, its cross-state transfer without specific state-level adjustments or agreements is likely to be problematic and could lead to revenue loss for the originating state. Businesses must be prepared to relinquish SGST claims or explore alternative mechanisms for such credits during inter-state mergers.

Reduced Legal Uncertainty (for CGST/IGST): For CGST and IGST, the ruling reduces the legal uncertainty surrounding their transferability in cross-state mergers. Businesses can now rely on this precedent to argue for the transfer of these credit components.

Advocacy for Policy Change: The judgment empowers industry associations and businesses to further advocate for policy changes and system upgrades. It provides a legal basis to push for a comprehensive solution that aligns the GST framework with the realities of corporate M&A.

Potential for Future Automation: The request to GSTN to update its network suggests a future where such transfers could become automated and instantaneous, significantly reducing compliance burden and working capital blockages for businesses post-merger.

In conclusion, the Bombay High Court’s ruling is a progressive step towards making the GST regime more accommodating to complex business transactions. While the immediate relief is significant, the most impactful aspect is the judicial push for systemic change, promising a more integrated and efficient GST framework for inter-state corporate mergers in the near future. Businesses should closely monitor developments from the GST Council and GSTN as they work towards implementing a mechanism for these crucial ITC transfers.