I. Brief background of the issues involved in the case
Safari Retreats (Company) is engaged in the construction of a shopping mall for the purpose of letting out premises in the malls to different tenants. Vast quantities of material, inputs and services are required for the construction of the malls in the form of cement, sand, steel, aluminum, wires, etc., and consultancy services, architectural services, legal and other professional services. These goods and services used in the construction of the mall are taxable under the CGST Act. It had accumulated input credit (ITC) of GST amounting to more than Rs. 34 crores on these input goods and services used in the construction of the shopping mall. At the same time, letting out of units in the shopping mall attracts GST based on the rent received by the company. Therefore, the company was desirous of availing and utilizing the ITC accumulated against the rental income received by it upon letting out the mall premises.
The company was advised by the department concerned to deposit GST on rent without deducting ITC because of the exception carved out by Section 17(5)(d).
Company filed a writ petition in Orissa High Court seeking judgement on following 2 aspects:
a. Section 17(5)(d) of the CGST Act and the corresponding provisions of the Orissa Goods and Services Act, 2017 do not apply to the construction of immovable property intended for letting out on rent.
b. Section 17(5)(d) is violative of Articles 14 and 19 (1)(g) of the Constitution of India
Orissa High Court vide its order dated 17.04.2019 held that Section 17(5)(d) was required to be read down as the very purpose of ITC is to benefit the assessee. The High Court held that if the assessee is required to pay GST on the rental income from the mall, it is entitled to ITC on the GST paid on the construction of the mall. It was held that the narrow interpretation given by the Department to Section 17(5)(d) would frustrate the very object of the Act.
Against this judgement, department approached the Supreme Court.
II. Legal abstract on which this entire issue revolves:
17 (5) Notwithstanding anything contained in sub-section (1) of section 16 and sub-section (1) of section 18, input tax credit shall not be available in respect of the following, namely: —
(c) works contract services when supplied for construction of an immovable property (other than plant and machinery) except where it is an input service for further supply of works contract service;
(d) goods or services or both received by a taxable person for construction of an immovable property (other than plant or machinery) on his own account including when such goods or services or both are used in the course or furtherance of business
Explanation.—For the purposes of clauses (c) and (d), the expression “construction” includes re-construction, renovation, additions or alterations or repairs, to the extent of capitalisation, to the said immovable property;
Explanation. For the purposes of this Chapter and Chapter VI, the expression “plant and machinery” means apparatus, equipment, and machinery fixed to earth by foundation or structural support that are used for making outward supply of goods or services or both and includes such foundation and structural supports but excludes—
(i) land, building or any other civil structures;
(ii) telecommunication towers; and
(iii) pipelines laid outside the factory premises.
III. Relief sought from and answered by this judgement:
1. 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 section 17(5)?
2. If it is held that the explanation does not apply to “plant or machinery”, what is the meaning of the word “plant”?
3. Whether Time limit for availing ITC imposed by Section 16(4) is constitutionally valid or not?
4. Whether Section 17(5) (c) and (d) are constitutionally valid or not?
IV. Important issues on which the entire judgement is based on:
a. AND vs OR argument:
Petitioners submitted that section 17(5)(d) uses the term “Plant OR Machinery” whereas everywhere else in the GST law including section 17(5)(c) and explanation below section 17(6) uses the term “Plant AND Machinery” and therefore, ITC on goods and services purchased for construction of a building or civil structure which is going to be used for supplying taxable services must be eligible as the said building or civil structure is classified as a Plant.
Government submitted that it was a drafting mistake of the legislature, “OR” should be read as “AND” in sub-clause (d).
Supreme Court disagreed with this argument and said that had it been a mistake, the error would have been cured by the legislatures long before because the judgement of Orissa High court came in 2019. It further stated that Model GST law published in 2016 had a similar clause wherein phrase “Plant AND Machinery” was used but when the GST Act was enacted, word AND was replaced with OR, hence the change was intentional and cannot be brushed aside by claiming it to be a mistake.
It was argued by the petitioners that the phrase ‘on his own account’ should be read down and given a purposive construction to mean only ‘for personal use’ and should not include immovable property being used for supply of taxable goods and services.
Supreme Court in para 32 discussed this issue at length, wherein following clarity emerges:
a. As understood, clause (d) seeks to deny ITC goods or services or both consumed to construct an immovable property on his own account.
b. There are 2 exceptions carved out in clause (d) to the above denial of ITC on construction of immovable property, if a taxpayer meets anyone of these exceptions, ITC would be allowed, these exceptions are:
- The first exception is where goods or services or both are received by a taxable person to construct an immovable property consisting of a “plant or machinery”.
- The second exception is where goods and services or both consumed for the construction of an immovable property made not on his own account.
- Construction of immovable property can be is said to be on a taxable person’s “own account” if the property is used for his personal or private use and not if it used for taxable business purposes.
- However, construction cannot said to be on a taxable person’s “own account” if it is intended to be sold or given on lease or license.
c. Perhaps this is one of the most important paragraph of the judgement whereby clause d is broken down to mean that, construction related ITC is available if
- the immovable property is either a plant OR
- it is used for conducting taxable business.
Though this important finding is not used in the judgement portion, but nonetheless it is a finding / opinion of the court. Hope it is soon taken up as an obiter dictum in any other judgement on similar issue and we get to see it being used to pronounce a judgement to bring closure to this crucial issue.
c. Sub clause (c) and (d) of section 17(5) are distinct
Government argued that if distinct meaning is assigned to the two clauses it would result in unequal treatment of works contract services for the construction of immovable properties under clause (c) and goods and services for the construction of immovable properties under clause (d).
Supreme Court disagreed with this argument and said that both the clauses are different in their purport and application, only similarity being that both carve out exceptions to section 16(1) and that both apply to construction of immovable property, other than that both the clauses are distinct in nature.
Department argued that as soon as the building is constructed by consuming goods and services, the said property becomes immovable and therefore the credit chain breaks.
Supreme Court disagreed with this argument on the count that this argument is true only upto sale of immovable property and not so for lease or tenancy of the said immovable property and GST is leviable on the supply of the same on lease.
Explanation to section 17 defines the term “Plant AND Machinery” wherein Land, building and civil structure are specifically excluded. Hence, Supreme Court denied giving any further interpretation to clause (c) of section 17(5) as Parliament has the right to exclude specific category of goods or services and ITC is a creation of legislature and not a birthright. However, term “Plant OR machinery” is not defined in law hence Supreme court denied considering OR as AND.
The expression “plant or machinery” has a different connotation. It can be either a plant or machinery. Section 17(5)(d) deals with the construction of immovable property. The very fact that the expression “immovable property other than “plants or machinery” is used shows that there could be a plant that is an immovable property. As the word ‘plant’ has not been defined under the GST Law, its ordinary meaning in commercial terms will have to be attached to it.
After considering various Supreme Court judgements the court stated that one will have to apply ‘Functionality or essentiality test’ to decide what a plant is. This Court held that if it is found on facts that a building has been so planned and constructed as to serve an assessee’ s special technical requirements, it will qualify to be treated as a plant.
Supreme Court relied on the 3 judge bench judgment in case of Karnataka Power Corporation which overruled 2 judge bench order in case of Anand Theatres.
h. Constitutional Validity of section 17(5)(c) and (d).
Court after going through all the arguments and judgements, concluded that these clauses are not discriminatory at all by stretch of imagination and the court cannot impose its views on the legislature, therefore the said clauses are constitutionally valid.
Court stated that it has not been shown to them as to how the provision is arbitrary and discriminatory and therefore the said provision is constitutionally valid.
V. Critical issues that are debate worthy and can be argued in similar case.
a. As discussed above, para 32 lays down an opinion that ITC of construction related expenses is available if the immovable property is used for business purposes.
b. Judgement says that section 17(5)(c) uses the term “Plant AND Machinery” and therefore immovable property cannot be considered as a Plant and by this logic ITC of works contract services shall not be available. However, clause (d) uses the term “Goods or services or Both”. It is settled that Work contract is a Service and therefore one can say that ITC of works contract service can become eligible if the resultant immovable property is used for business or if the property clears the functionality test and is therefore a Plant.
VI. What does this judgement mean for Safari Retreats and other taxpayers.
a. Section 17(5)(c) and (d) are different and cannot be used in tandem. Both have different application.
b. Immovable property CAN be considered as a Plant under Section 17(5)(d) in certain situations which means that anyone building a mall and procuring goods and services separately under separate contracts will be eligible to avail ITC on those procurements.
c. Anyone wanting to claim such ITC on construction of immovable property will have to clear the Functionality or essentiality test. In other words, if the immovable property is constructed to serve an assessee’s special technical requirements, it will qualify to be treated as a plant and it shall be eligible to avail ITC of goods and services procured separately.
d. In effect Supreme Court has remanded the case of Safari Retreats back to Orissa High Court and stated that the high court will have to check whether the mall being constructed by Safari fulfills the functionality test as all malls are different.
e. Para 56 of the judgement makes a remark that Hotels and Cinema Theatres on fact cannot be considered as a plant because of the Anand Theaters SC judgement. Therefore it seems Hotels and Theatre owners will not be able to rely on this judgement to fight their cases as they cannot avail any ITC on construction related expenses even under section 17(5)(d) because as ruled in the case of Anand Theatres by the Supreme Court 2 judge bench, they do not qualify to be a ‘Plant’. However they can argue on the basis of para 32 observations (discussed above) that the hotel or theatre is constructed for a taxable business and hence it need not fulfill the condition of it being a plant.
f. GST law prescribes a Time limit for availing ITC in section 16(4), as per which one can avail ITC of a financial year only upto 30th November of subsequent financial year. For example, time limit for availing ITC of an expenditure of FY 2023-24 is 30.11.2024. This time limit is written in stone now, if one misses this time limit, that ITC is gone forever.
g. Section 17(5)(c) and (d) are constitutionally valid provisions.
VI. Conclusion
This judgement in my view was one of the most awaited judgements under GST law as it dealt with a very important aspect of ITC architecture. We all know that GST was introduced with a promise of seamless flow of credit. Cascading effect of taxes was a cornerstone of the sellers of GST. We were made to believe that all the vices of erstwhile indirect tax laws will not be repeated in GST, however, the law makers could not resist from bringing those very vices through the back door by blocking legitimate ITC under the garb of legislative freedom, it was a toolkit used in the past, why has it been carried forward to the promised land is beyond me.
I most humbly believe that creating a divide between clause (c) and (d) of section 17(5) by considering them distinct is a big stretch, a person employing a works contract service provider who supplies goods and services for single consideration will be at a huge disadvantage from a person who procures goods and services separately. I can foresee that overnight works contract service providers will be converted into Labour service providers. Such arbitrariness could have been avoided.
We will now have to wait for the judgement of Orissa High court to see whether the Mall in question fulfills the functionality test or not, till then mall owners cannot have a sound sleep.
The only positive outcome of this judgement is that Person constructing a factory which is specifically being constructed to serve an assessee’s special technical requirements which fulfills the functionality or essentiality test will be eligible to avail ITC on procurement of goods and services separately.
Moot Question, what if the Council chooses to retrospectively amend section 17(5)(d) and replace the word “OR” with “AND” and define the phrase “on his own account”, we all know that it has used that route in the past in case of clubs & member associations by introducing section 7(aa). If that happens, this judgement will be a big waste of national energy.
On the question of time limit under section 16(4), I still believe that, if the taxpayer can prove absolute handicap with evidence that he could not have availed the ITC within the prescribed time-period, court will grant him relief, but the doors are well shut on the constitutional validity argument. Hope a larger bench revisit this very important piece of legislation.
Formulated by:
CA Nitesh Jain
Managing Partner
N J Jain & Associates
Chartered Accountants