Supreme Court Lays Down ‘Functionality’ and ‘Essentiality’ Test for Claiming Input Tax Credit (ITC)

Supreme Court Lays Down ‘Functionality’ and ‘Essentiality’ Test for Claiming Input Tax Credit (ITC)

Sub: Eco

Sec: Fiscal policy

• Supreme Court Judgment on ITC for Real Estate Companies:
  • Real estate companies can claim Input Tax Credit (ITC) under the Goods and Services Tax (GST) regime for costs incurred on construction of commercial structures intended for renting or leasing purposes.
  • The judgment is a positive development for the real estate sector, providing them the benefit of ITC for commercial properties.
• Conditions for ITC Eligibility:
  • A building qualifies for ITC if it is deemed to be a plant and is used for the supply of services such as renting or leasing.
  • ITC can be availed only if the other terms and conditions under the CGST Act and Rules are fulfilled.
• Key Clarification by the Court:
  • The court emphasized that ITC would not be available if the construction of the building is for the recipient’s own use. This means that if the property is built for personal use, the ITC chain breaks, and the credits cannot be claimed.
  • The decision on whether a building qualifies as a plant under Section 17(5)(d) of the Central Goods and Services Tax Act, 2017 is a factual question.
• Functionality and Essentiality Test:
  • The court introduced a functionality test to determine if a building can be classified as a plant.
  • The role of the building in the business operations is critical—if the building is functionally integral to the business’s performance or output, ITC may be available.
  • For instance, buildings such as malls, warehouses, or any structure besides hotels or cinemas may qualify as plants, but this depends on their use in the registered person’s business.
• Reasoning for the Judgment:
  • Renting or leasing of immovable property is considered a supply of service under the CGST Act. Therefore, if the premises qualify as a plant, the ITC on goods and services used for setting up the property can be allowed.

This judgment provides clarity on the conditions and tests that need to be met for claiming ITC on construction costs in the real estate sector, ensuring better compliance with the CGST framework.

What is Input Tax Credit (ITC)?

• Definition:
  • Input Tax Credit (ITC) refers to the tax already paid by a person at the time of purchasing goods or services, which can be used as a deduction from the tax payable on sales. It helps to avoid the cascading effect of taxes, i.e., “tax on tax”.
• Mechanism to Avoid Cascading:
  • ITC is designed to eliminate double taxation on the same product or service at different stages. It ensures that the tax is only levied on the value addition at each stage of production or service.
• Application in GST:
  • Under Goods and Services Tax (GST), ITC is available for the CGST, SGST/UTGST, or IGST charged on the supply of goods or services made to a registered person.
  • IGST on imports and tax paid under the reverse charge mechanism are also included in the ITC framework.
• Utilization of ITC:
  • When a registered dealer buys goods or services, they pay taxes at the time of purchase.
  • On selling goods or services, they collect taxes. The taxes paid during purchases are adjusted against the output tax (tax on sales).
  • The balance tax liability is calculated as tax on sales minus tax on purchase, and the remaining amount must be paid to the government.
  • This process of adjusting input tax against output tax is called the utilization of input tax credit.
• Refund Mechanism:
  • If the tax paid on inputs is higher than the tax on the output, the excess tax can be claimed as a refund.
• Exceptions:
  • Businesses under the composition scheme cannot avail of ITC.
  • ITC cannot be claimed for goods or services used for personal purposes or for exempted goods.