22 March 2019

Breaking the credit chain – An avenue to boost revenue?

By Brijesh Kothary

The Goods and Services Tax Council, in its 34th meeting held on 19-3-2019 recommended certain measures to streamline implementation of lower effective rates of GST for real estate sector. In its previous meeting, the GST Council recommended that from 1-4-2019, the effective tax rate of tax for affordable housing properties would be 1% and that 5% would be applicable on residential properties outside the affordable segment.

While the home-buyers may be pleased with an apparently lower rate of GST, the reality may be different considering the conditions put forth for availing the reduced tax rate. The conditions recommended by the GST Council for applicability of new effective tax rates are that:
  • Input tax credit (ITC) shall not be available, and
  • 80% of inputs and input services shall be purchased from registered persons. On shortfall of purchases from 80%, tax shall be paid by the builder @ 18% on reverse charge (RCM) basis. However, tax on cement purchased from unregistered person shall be paid @ 28% under RCM, and on capital goods under RCM at applicable rates.
The above conditions would bar suppliers from taking ITC on goods and services procured by them. When the inputs and input services do not suffer tax when procured from unregistered persons, the builder would be obliged to pay such tax under RCM effectively recouping the ITC involved in such cases. It appears that the government is targeting to make up for the revenue shortfall on account of reduction in the rate of tax on outward supplies by collecting non-creditable tax from the recipient, thereby breaking the chain of ITC.

Precedent on restricting ITC

A decision to restrict availment of ITC was taken by the GST Council in the 23rd GST Council meeting with regard to the supplies made by restaurants chargeable to GST @ 5% without the benefit of ITC. The principal reason for this decision seems to be that the benefit of ITC was not being passed on by restaurateurs to the consumers. The concerns raised by the Finance Minister on this aspect, leading to the recommendation of reducing the rate of tax by restricting the benefit of ITC, is extracted from the Minutes of the GST Council Meeting, hereunder:

“65.23. The Hon'ble Chairperson stated that the organized chains of restaurants were factoring the input tax credit and transferring its benefits to the consumers, but standalone restaurants had not transferred the benefits of input tax credit to the consumers. The anxiety and keenness shown by these restaurants to permit input tax credit was a method of profiteering by them without benefiting the consumers. He added that sectors like automobile had passed on the benefit of input tax credit but restaurants despite having an advantage of 7-8% input tax credit, had not reduced the prices and this sector had brought bad name to GST.

Considering industry’s reluctance to reduce prices, the GST Council appears to have gone by a popular saying in Hindi ‘जब घी सीधी उंगली से निकले तो ऊँगली टेढ़ी करनी पड़ती है’”, which implies ‘we will either find a way, or make one!’ While the GST Council has taken a decisive stand of regulating the price of supplies made by restaurateurs and caterers by reducing the rate of tax, the industry is still struggling to find their way out for the period where they have availed ITC.

Role of NAA

The Government had taken a proactive step by incorporating anti-profiteering measure in GST law to ensure that any reduction in rate of tax on any supply of goods or services or the benefit of ITC is passed on to the recipient by way of commensurate reduction in prices. However, lack of lucidity regarding the methodology and procedure for passing on the benefits to the recipient by way of commensurate reduction in prices, seems to have diluted the concept of anti-profiteering. In fact, some of the members in real estate and restaurant business are even held guilty of profiteering by the National Anti-Profiteering Authority. Some of the companies seem to have chosen to approach the courts seeking judicial approval to the stand taken by them to withhold price reductions.


It may be pertinent to note that the concept of restricting ITC is not new to the tax statutes in India. Several States had imposed restrictions on ITC in cases of inter-State stock transfers and inter-State sale of goods to unregistered dealers under the Value Added Tax regime. The Supreme Court in the case of TVS Motor Company Ltd. v. State of Tamil Nadu [2018-VIL-29-SC] held that the scheme of ITC is a concession and not a vested right, and that it was open to the legislature to impose such restrictions.

International perspective

The concept of breaking the chain of input tax credit is also prevalent in the tax laws of other countries. The Australian GST law has a unique concept called ‘Input Taxed Supplies’, where the supplier can neither charge GST, nor can he recover any of the GST incurred in relation to that supply, as credit. This concept is different from GST-free supply (i.e., exempt supply). It may not be appropriate to say that no GST is payable on input taxed supplies, as the hidden element of GST at input stage is added to the cost of supplies made. Some of the categories of input taxed supplies under Australian GST law are financial supplies, residential premises, precious metals, canteens, etc.

In UAE, Profit Margin Scheme is applicable on second hand goods, wherein the second-hand goods dealer pays VAT on the difference between sale price and the purchase price, without availing the benefit of input tax. The concept of margin scheme is also available in Indian GST law. The European Union VAT Rules are simplified in some EU countries by providing Flat-Rate Scheme, wherein the tax is calculated by multiplying the VAT flat rate on the VAT inclusive turnover, without allowing input VAT. This concept is similar to the composition scheme in Indian GST law.

Impact of recent amendments

Some of the recent changes (effective from 1-4-2019) in GST regime by way of introduction of composition scheme for suppliers of service (or mixed suppliers) as per Notification No. 2/2019-Central Tax (Rate) dated 7-3-2019 and increase in turnover limit for existing composition scheme by Notification No. 14/2019-Central Tax dated 7-3-2019, can be regarded as moves to enhance the ease of doing business, and in the process breaking the chain of ITC. Similarly, Notification No. 10/2019-Central Tax, dated 7-3-2019 granting higher exemption threshold limit for supplier of goods is aimed at reducing the compliance burden of small taxpayers at the cost of loss of ITC for registered persons.

The overall impact of the above schemes is that the cost of supply to an ultimate consumer would be less than it would be under the normal taxation system and more to a registered person due to hidden GST component in the cost of supply which is not available as credit.

Parting remarks

Eliminating cascading effect of taxes and allowing seamless flow of ITC were the primary reasons for us to migrate to GST regime. Breaking the chain of ITC would take us back to the erstwhile regime. Blocking or restricting ITC at various stages of supply chain may help the Government meet its revenue targets as every supplier would end up foregoing ITC and pay tax on the sale price rather than on the value added by him. This practice should therefore be implemented selectively in exceptional cases and not as a general rule.

The supplier is the best judge to determine the price of his products and services. The principles of fiscal neutrality, proportionality and the protection of legitimate expectations must be interpreted in favour of the supplier to assess their eligibility to avail ITC, particularly when all the conditions prescribed under law are complied with. If the departmental statistics or data analytics reveal that the ITC is not being efficiently utilised in a particular sector, then the option must be given to the industry to choose between paying lower rate of tax without the benefit of ITC or a higher rate of tax with the benefit of ITC.

[The author is a Principal Associate, Lakshmikumaran & Sridharan, Bangalore]

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