GST: Bar on input tax credit for immovable property: Extent & exceptions

Successive governments in India have addressed themselves to the problem of distortions in the indirect tax structure caused by the cascading effect of tax on tax. The Goods and Services Tax (GST) introduced in 2017 is the culmination of these attempts: however some faultlines remain, which continue to distort the ideal of a tax on value-addition alone. Here I shall look at one major problem, namely, the manner in which the bar on input tax credit for immovable property is formulated and interpreted. The sequence of the discussion will be as follows:

• A glance at the history of input tax credit
• What is immovable property?
• The exception made for plant and machinery
• Reading down the phrase "on his own account"

A glance at the history of input tax credit. In the early days of excise duty, the duty was levied on manufacturers of raw materials. This kept the tax base small for ease of administration. The Indirect Tax Enquiry Committee 1977 (LK Jha Committee) commented on this as follows (underlining added):

However, as the tax base expanded to cover more items and moved down the supply chain, the taxes on raw material and again on intermediate and final products led to a cumulative levy which was actually a far higher rate of tax on the consumer than was intended. The Association of Indian Automobile Manufacturers carried out a study, on which the report of the LK Jha Committee published the following figures.

It is seen from the numbers above that the cumulative levy (last column in the table) was substantially higher than the nominal levy (total of statutory levies), being more than double in some cases. A similar situation prevailed with the finished automobile as sold to the consumer:

This state of affairs was sought to be remedied by fixes like "chapter X procedure", which allowed duty-free supply to an OEM under certain procedures and conditions; proforma credit, which gave a set-off of duty payable against duty paid on raw material or components of the same or specified tariff headings; MODVAT, which expanded the coverage of input tax credit and removed the requirement of one-to-one nexus with the finished product; CENVAT, which linked up service tax also; and finally GST, which linked up state VAT and extended credits across state boundaries as well as provided for cross-credits with central levies. GST is the most advanced form of VAT that India has seen thus far.

A VAT aims to tax only value-addition at every stage of the supply chain by eliminating input tax from the taxable value of the supply made. VAT systems everywhere do this by reducing tax paid on inputs from tax payable on outward supply. The method may vary: in India, the government portal electronically maintains an account of credits of input tax for each taxpayer, which can be accessed and adjusted by him for paying tax on outward supply. As the purpose of input tax credits is to reduce input tax from the value that is presented for taxation of the final supply, a final supply on which no tax is levied is necessarily excluded from the chain of VAT. In other words, input tax is not allowed as a credit if the inputs are meant for use in exempted or non-taxable supplies. Input tax relief operates only for an intermediate transaction in the supply chain: at the end of it, somebody has to actually bear the burden of an indirect tax.

Immovable property. Sale of immovable property is not within the scope of GST, which applies only to goods and services. For this reason, input tax credits are blocked for such sales, and the input taxes are allowed to become part of the price. However, some forms of supply of immovable property are taxed. (See item 5 in Schedule II to the Central Goods & Services Tax Act 2017.) Leasing or renting out of immovable property attracts GST. Similarly, if immovable property is constructed for another person, this is a service and attracts GST. Even if part payment is received from the buyer before completion of the construction, it is deemed that the construction was for him and the construction is taxed as a service.

Though different kinds of transactions in immovable property are differently treated for the purpose of levy of GST, section17(5) of the CGST Act uniformly bars input tax credit if the inputs are for construction of immovable property. The bar is contained in clauses (c) and (d) of section 17(5) of the CGST Act.

Thus, under section 17(5) of the CGST Act, clauses (c) and (d) disallow input tax credit on the following:

The above clauses are both about construction of immovable property excepting plant and machinery. In the first case, it is about works contract service received for construction of immovable property. (The expression used in the clause is "works contract service when supplied", rather than when received: however this looks like a drafting error and a literal interpretation would make it unworkable. The AAR in the case of Sital Kumar Poddar in 15/WBAAR/2020-21 observed that "supplied" means both inward and outward.) GST on works contract service is allowed as input tax credit only if it is an input for further supply of works contract service. For example, a developer has a project to build flats and sell them upon completion. A company X has been contracted to construct the residential complex for the developer and subcontracts parts of the work to other contractors. The GST paid by these sub-contractors on works contracts service provided by them is allowed to X as input tax credit. However, the developer who has given the contract to X and receives the service of construction of the complex is not permitted to take the credit of GST paid on this. The GST paid by X on works contract service and charged to the developer becomes part of the price of the flat and is borne by the consumer.

The first clause was about a person who receives works contract service for purposes other than outward supply of works contract service. The second case [clause (d)] is about a person who constructs property "on his own account". This could be by a mode other than works contract: maybe, for example, he buys the material himself and outsources the other activities. In the case covered by the second clause, no input tax credit of any goods or services is allowed for construction of immovable property by a taxable person on his own account (even when the inputs are used in business). Thus, a company constructing an office building is not allowed to take credit of the input goods and services used for construction, even though they come within the broad rubric of goods and services "used in the course of or for the furtherance of his business" which are allowed for input tax credit in terms of section 16.

The term "immovable property" is not defined in the CGST Act. However, section 3(26) of the General Clauses Act defines immovable property as land, benefits to arise out of land, and things attached to the earth, or permanently fastened to anything attached to the earth. For clarity on the meaning of "attached to the earth" we need to refer to section 3 of the Transfer of Property Act, in terms of which -

There are several precedents in the old central excise law on what can be considered as attached to the earth. Prior to GST, central excise duty was levied on "goods", which are by definition movable; so, immovable property could not attract excise duty. When heavy machinery was fabricated or assembled on a foundation to which it was attached, there was often a dispute on whether this was "goods" so as to be taxed, or immovable property, which was not liable to excise duty. The Supreme Court discussed the foregoing case law and analysed the issue in detail in the case of Solid and Correct Engineering Works. In this case the appellant had assembled Hot Mix Plant at a road construction site. This was a large machinery system consisting of sub-assemblies like Feeder, Conveyor, mixing drums, asphalt tank, fuel tank, and drier, each of which was separately imbedded in a concrete foundation 1.5 feet deep. The capacity of the drier alone was 40 MT, which gives an idea of the size of the machinery. The appellant argued that this was attached to the foundation, being immovable once imbedded, and could not be goods so as to attract excise duty. However, the Supreme Court applied the test in clause (c) of the definition of "attached to the earth", namely, was the machinery attached to the foundation for the permanent beneficial enjoyment of the foundation. The Court observed that it was nobody's case that the object of attachment to the foundation was to enjoy the foundation; further, that there was no permanence in the attachment, as the machinery could be removed from the foundation without damage to the machinery itself. In terms of this, the Court upheld the stand of Revenue that assembly of the machine was excisable as a manufacture of goods.

In the course of the discussion in Solid and Correct Engineering Works, the Supreme Court discussed the approach of British and Indian courts to the issue in past decades. British courts have used the expression "annexation to the freehold" to determine the nature of the attachment of disputed thing to the earth. The extent and object of annexation are the tests. If the annexation to the freehold is of such a nature that the thing cannot be removed without destruction, then it is a permanent annexation. Object of annexation refers to the intention of the taxable person. Was permanent attachment the intention? One can look at agreements and attendant circumstances to discern this. Also, the mode of attachment itself can indicate whether the intention is to attach the thing permanently: if it cannot be removed without destruction, it is clear that the object was permanent annexation to the property. The Supreme Court noted that Indian courts have reasoned similarly.

In terms of the above discussion, a thing is considered to be immovable property if it is wall or buildings or similar property that is imbedded in the earth, or if it is attached to the wall or building or similar property (like foundation) for the permanent beneficial enjoyment of the said wall or building or other such property.

The required intention of "permanent beneficial enjoyment" of the immovable property to which the disputed item is attached has not been given sufficient attention in advance rulings that disallow input tax credit on pre-engineered structures attached by anchor bolts to a foundation. (The title picture shows one such in process of erection.) Such structures are typically used for putting up warehouses, sheds at work sites, and other structures that may need to be dismantled and shifted to another location. In the case of Tewari Warehousing, the Authority for Advance Rulings emphasised that the warehouse had an RCC floor and insisted that the whole structure was erected for beneficial enjoyment of the floor. Also, as these structures are precision-engineered and meant for delivery of services, there is a need to examine whether they can be excluded from the bar by categorising them as 'plant and machinery'.

Construction of plant and machinery, whether by works contract mode or otherwise, constitutes an exception to the bar on input tax credit for construction of immovable property. 'Plant and machinery' is defined for this purpose.

Plant and Machinery. An Explanation to section 17 of the CGST Act defines 'plant and machinery' as follows:

Plant and machinery, thus defined, are excluded from the bar on input tax credit that otherwise operates for construction of immovable property. The exclusion in turn had exceptions: thus, telecommunication towers, pipelines laid outside the factory premises, and immovable property in the nature of land, building or any other civil structures remain covered by the bar by virtue of the exclusions from the exception.

An item is 'plant and machinery' if it has all the following characteristics:

As a building is not apparatus, equipment or machinery, it cannot be 'plant and machinery' even if used to make the output supply. For example, a shopping mall is not part of the plant and machinery of the owner even though he leases out premises to the businesses that operate there and also provides them services like security, landscaping and parking. On the other hand, a piece of apparatus, equipment or machinery cannot be 'plant and machinery' if it lacks direct nexus with the output supply: the electric cabling system in a factory has no direct nexus with the output supply and it therefore barred from input tax credit because it is used for construction of the building and hit by the bar for immovable property.

At this point we must note the history of the term 'plant' in income-tax law. The law, in section 43 of the Income-tax Act, provided for a different rate of depreciation for buildings and for plant and machinery. However, a series of case law held that a building from which the business was carried on, like mill, hotel, cinema, resort, was to be treated as 'plant'. This lacuna was plugged by amending section 43(3) to exclude building, furniture and fittings from the definition of 'plant'. In service tax law, these old cases had been relied upon to claim input tax credit for construction of buildings that may be called 'plant'. The Orissa High Court was probably persuaded by this background to issue judgment dated 17.4.2019 in W.P. (C) No. 20463 of 2018, allowing input tax credit on inputs and services for construction of a resort that was used for provision of taxable services. This case of Safari Retreats Private Limited, reported as 2019 (25) GSTL 341, is now before the Supreme Court. A perusal of the judgment shows that while the matter was well argued, the court's own discussion and conclusions, contained in paragraphs 19 and 20, are somewhat cursory.

While the bar on input tax credit towards construction of immovable property is likely to remain, because immovable property, per se, is not taxed in GST, it is possible to separate out the transactions involving immovable property which are in the GST chain. Below I discuss a means of reading the extant law to this end.

"On his own account" Schedule II of the CGST Act specifies two kinds of transaction in immovable property that are taxed in GST. These are listed in item 5 of Schedule II:

These are cases where the immovable property is itself the output supply, but the nature of the transaction is different from outright sale of a ready property. As the transaction partakes of the nature of service, it is taxed under GST law. However, these two cases, namely renting and construction for sale to an identified person, are treated differently for the purpose of input tax credit. Input tax relief is available for construction for sale; but it is not available if a building is constructed for renting out, like a shopping mall or a warehouse, even if the documentation shows the purpose of construction.

A property may also be constructed for provision of other taxable services through the medium of the property. For example, a hotel, a resort, a cinema hall, an auditorium, a sports stadium, are all immovable property through which taxable services are delivered. These properties are part of the GST chain: however, there is a blockage of input tax credit by virtue of the bar in section 17(5) of the CGST Act. This prompts us to scrutinise the legislature's use of the expression "on his own account" to describe the kind of construction that is barred from input tax credit. In the context of the scheme of GST, perhaps the legislature means to exclude such construction as is for the use of the taxpaying entity and has no direct nexus with the taxable supply provided. This would be in keeping with the nexus test stipulated by the Supreme Court in Maruti Suzuki (Civil Appeal Nos. 5554-5555 of 2009, decided on 17-8-2009).

It is indisputable that there are two categories of immovable property that a business entity may construct. One would be office buildings, staff quarters, and the like, which do not have a nexus with the output supply. The other would be the kind of property that is central to the output supply, like a hotel, resort, cinema, stadium, shopping mall, public warehouse. These were, in some earlier income-tax rulings, sought to be covered as "plant" to differentiate them from other kinds of buildings. These are constructed by the entity for the use of the client or customer. It can be argued that, in the context of GST law, these are not constructed by the entity "on its own account". Accordingly, they should not be hit by the bar in section 17(5)(d) of the CGST Act, and should be eligible for input tax relief. As huge amounts are involved, perhaps the government will then want to consider rules and procedures for deferring part of the credit (as was done for capital goods in the CENVAT rules).

In sum, if the law is not amended to carve out a category of immovable property that is used for delivery of the outward supply and therefore eligible for input tax relief, it is hoped that the courts will read down the expression "on his own account" to achieve this.