• Lex Specialis

The Working Of Input Tax Credit

- Shubham Ranjan*


Introduction


Input Tax Credit is one of the key features of Good and Services Tax more commonly known as GST. This feature was put in place to avoid cascading of taxes. In simple English, cascading means putting a tax over another tax. To kick things off, I will explain the situation of taxation when Value Added Tax(VAT) was in place before GST was introduced in India. I will be using an example to explain the scenario. Ram (owner of an umbrella company) wants to manufacture an umbrella as the rainy season is approaching. For this Ram will require plastic, thin metal rods and cloth. All these materials that Ram will procure are chargeable to central excise duty. After the manufacturing of the umbrella is completed, the complete umbrella will also be chargeable to central excise duty. Assume the price of the materials to make the umbrella is Rs. 100, then @10% of central excise duty, Rs. 10 will be paid. Now lets assume the cost of umbrella will be Rs.200, then @10% of central excise duty, Rs 20 will be paid. So now Ram will price the final umbrella at Rs. 230 (200+10+20). Now when Ram sells this umbrella to a shop, he is required to levy VAT on this particular sale. Under the old system of VAT, Ram will not be able to use the credit of central excise duty on the umbrella for the payment of the Value Added Tax because of the simple fact that there is no linkage between the taxes being levied by the central government and the state government. Thus, Ram is required to pay VAT on the entire price of the umbrella (Rs.230), this example clearly shows the cascading of tax as Ram is not only paying VAT on the umbrella (Rs.200) but also paying VAT on the already added tax on the umbrella (Rs.230). 


Pre-GST Vs. Post-GST


Now as GST has been introduced this cascading of taxes will no more take place as most of the indirect taxes applied by the central and state government will be combined together under a single tax. The way Input Tax Credit works is that the tax should be applied only on the “value added” in a certain stage and not on the price of the entire product. Now to explain what “value added” means, simply put it is the difference between the cost price of a product and the sale price of a product. As GST is an indirect tax that is levied in India, a seller of any kind of goods is considered to be an agent of the government who has the task of collecting tax from the buyers and then handing it over to the government.  I will give an example to explain how this works in industries across India. Aryan (owner of umbrella shop) buys umbrellas from Ram(manufacturer of umbrellas). If he has bought umbrellas worth Rs. 1000 and the GST rate is 10%, then he will be paying Rs. 100 as GST to Ram. Now moving forward, Aryan will sell these umbrellas for Rs. 1500 to his customer. That customer will pay Rs. 150 as GST to Aryan @10% which he would have to then hand to the government. Now with the Input Tax Credit system in place, this allows Aryan to use Rs.100 which he paid on purchase to Ram to reduce the total amount of tax that he would have to pay. So now since Aryan has paid Rs. 100 to Ram and collected Rs.150 from his customer as GST, he will only have to deposit the difference between the two to the government (150-100=50). This concept is not completely new and was also prevalent in the pre-GST era, but under the GST era the scope of Input Tax Credit has been widened. In the Pre-GST era, it was not permissible to claim ITC for Luxury Tax, Central Sales Tax and Entry Tax. Also before GST was introduced in 2017, the concept of cross credit of taxes was not allowed (Eg- Value Added Tax against service tax/excise). Since GST was introduced, since all these taxes will be combined into one tax, there will be no restriction as such when it comes to Input Tax Credit. 


Section 16 Of Central Goods And Services Tax Act, 2017


Now coming to another very crucial aspect of Input Tax Credit, Section 16 of the Central Goods And Services Tax Act,2017. Under this section, there are several conditions that are mentioned that have to be fulfilled for the buyer to avail Input Tax Credit. There are certain basic conditions that need to be fulfilled such as tax invoice, filing of returns and the actual supply of goods or services. These conditions are absolutely justified from the side of the government as with these conditions they will be able to regulate the whole credit system. There was one condition that I found absolutely arbitrary and one that was unjust and unfair, this condition is mentioned in Section 16(2)(c ) of the Central Good and Services Tax Act, 2017. This section in simple terms states that no buyer of goods will be entitled to the credit of the input tax unless and until the tax that has been charged with respect to that particular transaction of goods or services has been paid by the supplier/seller. I will explain this section by using an example. Arjun(seller/supplier of umbrellas) for some reason fails to deposit the GST that he has collected from Ram (umbrella shop owner) when Ram purchased 100 umbrellas for his shop. With Section 16(2)(c ) in place, Ram will not be able to avail the ITC until Arjun deposits the GST he received from Ram when he purchased 100 umbrellas. I feel this is an extremely unreasonable law made by the Government. This law is making the buyer bear the loss for no mistake of his. This particular section puts the onus on the buyer to make sure that the seller that he has purchased goods from has deposited the amount he got as GST with the government. Another fault I feel in this Act is that there is no way for the buyer to find out whether the seller has deposited the GST with the authorities or not. 


Case Law Regarding Input Tax Credit


A lot of parties across India have also found the above mentioned section to be unjust thus there has been a lot of litigation regarding this section. In 2017, there was a case brought forward in the Delhi High Court named Arise India Limited Vs. Commissioner Of Tax. This case circled around Section 9 of the Delhi VAT Act which was introduced in 2004.  This section speaks about Tax Credit rules that apply in Delhi and lists down multiple conditions that have to be fulfilled for an individual to be able to claim tax credit. The Delhi High Court in this case held that a clause where the buyer has to make sure that the seller has deposited the GST is an “impossible” task. It was further mentioned in the judgment that how is the buyer supposed to be able to anticipate as to which seller will deposit GST or not. The Delhi High Court further held that Section 9 of the Delhi Vat Act, 2004 should not include a buyer who has entered into a transaction with no mala fide intention. These transactions should also take place with registered dealers who have issued tax invoices whenever required. The High Court also backed this by stating that such clauses are violative of Article 14 of The Indian Constitution for the simple reason that these laws are extremely arbitrary.


Conclusion


Overall, I am of the opinion that the concept of Input Tax Credit is an extremely smart move by our Government. The biggest benefit of ITC is that it stops the cascading of taxes and allows seamless transactions for both buyers and sellers. The laws regarding ITC still require slight modification but I feel the laws that are currently in place are quite adequate. The only issue with the current laws is the above mentioned sections which surely need to be modified or have to be taken down. I feel in the years to come that will also be fixed. The Indian legal system is constantly evolving and I am sure the legal system will reach unprecedented heights in the years to come. 


- Shubham Ranjan* is a student at Jindal Global Law School. n

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