Abdulla Pettiwala

Taxes – Overview:

In simple terms, the fee one pays for the utilisation of the common services in a country is referred to as ‘tax’. The Public Services rendered by the Government is by the expenditure of the revenue from such taxes.

The Constitution of India establishes a federal structure to the Indian government, declaring it to be a “Union of States”. Part XI of the Indian constitution specifies the distribution of legislative, administrative and executive powers between the Central government and the States of India. The legislative powers are categorised under a Union List, a State List and a Concurrent List, representing, respectively, the powers conferred upon the Union government, those conferred upon the State governments and powers shared among them. Certain taxes are governed by the Union List and some by the State List.

Taxes, broadly, are of two types Direct Taxes and Indirect Taxes.

Direct tax is a tax linked to the earnings of a person (an individual(s) or a legal entity). The incidence of tax is borne by the person who earns the income as also paid by such person. The burden of tax is direct since it is reduced / collected from the income earned/received. The tax is generally computed for a given period (a year) during which income is earned. In India Income Tax Act 1961 governs the Direct Taxes and is under the Union List.

Indirect tax is a tax on consumption/acquiring of tangible products and / or services. The incidence of the tax is borne by the purchaser/consumer and is to be paid into the government treasury by the seller/vendor. The burden of tax is indirect since the same is included and collected along with the price of the product / service at the time of purchase itself. The tax is computed as a percentage of the sale price and is on supply of each product. The tax may be levied at the final consumption point or at each stage of supply leading to the final product. The tax is generally paid into the government treasury for a given month or quarter.

Before the enactment of the Goods and Service Tax Law (GST Law) in 2017 we had a plethora of tax laws under the Union List and State List; viz. Service Tax Law (governed by the Finance Act 1994), (Central) Excise Act, 1944, (State) VAT Laws 2002, Local Levies, Octroi Law 1935. All these laws were consolidated by the 101st Constitutional Amendment, under the GST Law 2017 which now governs the Indirect Taxes.

Customs Duty continues to be payable at the time of import of goods into India or export of goods from India. It is an indirect tax levied at the time of entry of goods into the country or taking goods outside the country and is governed by the Customs Act 1962. 

Whilst generally all movable goods and services other than securities and money is within the ambit of GST Law (now). There are certain events which are taxed at the final point of consumption which are governed by Stamp duty (for property transfer), Securities Transaction Tax (on purchase and sale of securities).

GST:

GST Law introduced effective Jul-2017 has consolidated the levy of tax on goods and services with a broad structure of differential rates for goods which are classified basis them being for necessities, lifestyle goods, luxury goods and sin goods with a median rate for services.

The federal structure of the Union of India was maintained with a uniform, multi-layered rate of tax on goods and uni-layer rate of tax on services, to be levied for State GST and Central GST, though collected on a common invoice and paid by the supplier under two difference accounts into the government treasury.

To avoid the cascading effect of taxes, which was one of the objective for introduction of GST, the tax cost at each stage of supply was set-off by the credit at the subsequent stage until the consumption stage, this is enshrined as Input Tax Credit (ITC) – a rebirth of CENVAT, which itself was born out of MODVAT.

ITC mechanism is essentially an arrangement of ‘set-off of the tax-cost’ at each stage of value-creation /value-addition through a ‘credit’ earned at the subsequent stages, right up to the final consumption stage. This concept / mechanism was integrated into the new GST Act, which came along with its own baggage of woes in the form of Inverted Duty Structure.

It is important to note that the concept of ‘Input Tax Credit’ is at the level of aggregation of multiple inputs to one output in respect of supply of goods or services.

Inverted Duty Structure:

A situation of ‘Inverted Duty Structure’ arises where tax on output is lower than the tax on collective set of inputs. This concept was effectively passed onto the GST Laws from the erstwhile Excise Laws.

The input tax accumulation due to higher rate of tax on inputs (goods and services) than that of the output (goods) was acknowledged by the law makers. This recognition lead to creation of a mechanism for refund under the GST Laws [Sec 54(3) of CGST Act read with Rue 89(5) CGST Rules]. This scheme was in sync with the Inverted Duty Structure under the erstwhile Excise laws.

The mechanism of refund due to Inverted Duty Structure excluded the service sector. Such exclusion was correct in so much as where the inputs and the output were in the nature of services alone, since the rate of GST on services is uni-layered.  However, where the output in nature of services has inputs of goods which are at a higher rate, then the said exclusion needs to be rectified.

The exclusion of the services sector from the ‘benefit’ of this refund under Sec 54(3) of CGST Act read with Rule 89(5) of CGST Rules lead to an amendment in the extant Rule to include the output of services too within the ambit of the refund under inverted duty structure. [Noti 21/2018 CGST dated 18-Apr-18].

Considering that the input tax accumulation on inputs (services) for output (services) would not arise since the GST rate on services is uni-rate, the amendment correctly provided for exclusion to that extant.

What the notification endeavoured to achieve lead to another strange and perhaps unintended outcome, leading to restriction of the refund on input (services) for cases where there is an inverted duty structure for output (goods). This has resulted into a situation of impasse, where the rightful refunds are withheld in cases of inverted duty structure for output of goods.

To appreciate the point discussed, lets us examine a simplistic scenario where the inputs and output are totally taxable (a theoretical business scenario) for us to understand the position of refund of inverted duty structure prior and post Noti 21/2018 (supra).

As can be seen, the refund on account of inverted duty structure for a business having output(goods) has reduced from 340 to 70 post Apr-18 while the business having output(services) has increased by 240.

The law provides for the refund under inverted duty structure for a more realistic business scenarios in Section 54(3)(ii) read with Rule 89(5) of the CGST Act and Rules.

Prior to Noti 21/2018

In case of refund on account of inverted duty structure, refund of input tax credit shall be granted as per the following formula –

Maximum Refund Amt = [(Turnover of inverted rate supply of goods and services) * Net ITC / Adjusted Total Turnover]

  Less Tax payable on such inverted rated supply of goods and services

Explanation – For the purpose of this sub-rule, the expressions “Net ITC” and “Adjusted Total Turnover” shall have the same meaning as assigned to them in sun-rule(4).

The definition of “Net ITC” under sub-rule(4)

  • “Net ITC” shall means input tax credit availed on inputs and input services during the relevant period other than the input tax credit for which the refund is claimed under sub-rule(4A) and (4B) or both.

Post Noti 21/2018

In case of refund on account of inverted duty structure, refund of input tax credit shall be granted as per the following formula –

Maximum Refund Amt = [(Turnover of inverted rate supply of goods and services) * Net ITC / Adjusted Total Turnover]

  Less Tax payable on such inverted rated supply of goods and services

Explanation – For the purpose of this sub-rule, the expressions –

  • Net ITC shall mean input tax credit available on inputs during the relevant period other than the input tax credit availed for which the refund is claimed under sub-rule (4A) or (4B) or both; and
  • “Adjusted Total Turnover” and “relevant period” shall have the same meaning as assigned to them in sub-rule(4).

To summarise the change, the Notification (wef 18-Apr-18) has

  • included services in the turnover of inverted rate supply and
  • excluded from the Net ITC the input tax credit on services.

The loss of refund on account of suppliers of goods could have been avoided with a different definition of Net ITC for goods and services to overcome the single rate for services.

Judiciary will take a view in due course, where the writs are pending before the High Courts of different States seeking relief on account of this blip.

Solution:

Solution to this un-intended situation is perhaps more legislative in nature rather than judicial, when we keep the intent of the legislature in mind. 

Accordingly, a simpler solution would be for legislature to separate the refund law for ‘output of services’ and ‘output of goods’, with distinct calculation approaches, namely:

  • Refund in respect of goods: Continue to include the ITC on input goods as well as input services.
  • Refund in respect of services: Consider ITC on Input-goods only.