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THE INSIGHT

Inventory Write-off – Post-GST & Pre-GST
By K V Srinivasamurthy, Senior Consultant – Indirect Taxes, PKF Sridhar & Santhanam LLP, CA, Chennai
Aug 05, 2020

RECENTLY I came across a situation, wherein Write off of capital goods, the value of which was merely written down from the books of account as per accounting standards with neither loss of control nor removal of goods from the factory was considered as 'Supply'.

Analysis:

Before going to the issue, it would be pertinent to look into the following -

I. Section 17(5)h) of the CGST Act, 2017 - goods lost, stolen, destroyed, written off or disposed of by way of gift or free samples - Input tax credit shall not be available.

II. Section 18(6) of CGST Act, 2017 - In case of "supply" of capital goods or plant and machinery, on which input tax credit has been taken, the registered person shall pay an amount equal to the input tax credit taken on the said capital goods or plant and machinery reduced by such percentage points as may be prescribed or the tax on the transaction value of such capital goods or plant and machinery determined under section 15, whichever is higher.

III. Rule 44 (6) of CGST Rules, 2017 - The amount of input tax credit for the purposes of sub-section (6) of section 18 relating to capital goods shall be determined in the same manner as specified in clause (b) of sub rule (1) and the amount shall be determined separately for input tax credit of central tax, State tax, Union territory tax and integrated tax:

IV. Rule 44(1)(b) of CGST Rules, 2017 - for capital goods held in stock, the input tax credit involved in the remaining useful life in months shall be computed on pro-rata basis, taking the useful life as five years.

•  Illustration: Capital goods have been in use for 4 years, 6 month and 15 days. The useful remaining life in months = 5 months ignoring a part of the month. Input tax credit taken on such capital goods = C. Input tax credit attributable to remaining useful life = C multiplied by 5/60

V. Rule 3 (5B) of Cenvat Credit Rules, 2004 - If the value of any,

(i) input, or

(ii) capital goods before being put to use,

on which CENVAT credit has been taken is written off fully or where any provision to write off fully has been made in the books of account, then the manufacturer or service provider, as the case may be, shall pay an amount equivalent to the CENVAT credit taken in respect of the said input or capital goods:

VI. Supply – Section 7(1) of CGST Act, 2017 –

For the purposes of this Act, the expression "supply" includes–

a. all forms of supply of goods or services or both such as sale, transfer, barter, exchange, licence, rental, lease, or disposal made or agreed to be made for a  consideration by a person in the course or furtherance of business;

b. import of services for a consideration whether or not in the course or furtherance of business;

c. the activities specified in Schedule I, made or agreed to be made without a consideration; and

d. the activities to be treated as supply of goods or supply of services as referred to in Schedule II.

VII. Schedule I-ACTIVITIES TO BE TREATED AS SUPPLY EVEN IF MADE WITHOUT CONSIDERATION ;

1. Permanent transfer or disposal of business assets where input tax credit has been availed on such assets.

VIII. SCHEDULE II - Transfer of business assets;

(a) where goods forming part of the assets of a business are transferred or disposed of by or under the directions of the person carrying on the business so as no longer to form part of those assets, whether or not for a consideration, such transfer or disposal is a supply of goods by the person

IX. Definition of the words Disposal & Transfer;

•  Disposal means distribution, transferring to new hands, extinguishment of control over, forfeit or pass over control to another.

•  Collins Dictionary - Disposal is the act of getting rid of something that is no longer wanted or needed

•  Cambridge English Dictionary - the  act  of getting  rid  of something,  especially  by  throwing  it away

•  Transfer means to pass over, convey, relinquishment of a right, abandonment of claim, alienate, each or any of the above acts, lawfully.

Post-GST Write Off -

a) It is necessary to understand the term "Write-off" to determine whether the same amounts to supply. Since the value is removed from the books, there may exist an assumption that it could amount to "Permanent disposal/disposal made without consideration" as provided under Schedule I(1) & Schedule II 4(a) of CGST Act and thus could attract the provisions of Section 18(6) of CGST Act.

b) An inventory write-off is the process of removing from the  general ledger  any inventory that has no value. An inventory write-off is an accounting term for the formal recognition of a portion of a company's inventory that no longer has value.

c) Write-offs typically happen when inventory becomes obsolete, spoils, becomes damaged.

d) obsolete input/capital goods written off in financial account but are lying in factory.

e) Merely because the same were written off in the books of account and the value shown as nil, by itself, cannot be considered to amounting to removal of the inputs from the factory premise.

1. Based on the above understanding of the term 'Write-off', it can be construed that the same cannot be in line with definition of either the word 'Transfer or Disposal". Hence, the word 'Write-off' is neither transfer nor disposal.

2. Further, the word does not fall in line with Section 7(1)(a) of CGST Act, 2017 to treat the same as amounting to supply. It would be pertinent to note that Section 17(5)(h) has the wordings 'Written-off or disposed', which means both the terms are different. Thus, the term 'Write-off' is not a supply and would not be subject to the provisions of Section 18(6) of CGST as cited supra. Hence, the input tax credit shall be reversed on the total value of assets written off and shall not be liable to GST as outward supply. F or capital goods held in stock, the input tax credit involved in the remaining useful life in months shall be computed on the pro-rata basis, taking the useful life as five years.

3. The above provisions are applicable only in the event of purchase and availment of ITC of inputs & capital goods during the GST regime.

Write off Inputs or Capital goods on which Cenvat Credit was availed during Pre-GST period but are written-off during GST regime:

1. According to Rule 3(5B) of Cenvat Credit Rules, If the value of any,

(i) input, or

(ii) capital goods before being put to use,

on which CENVAT credit has been taken is written off fully or where any provision to write off fully has been made in the books of account, then the manufacturer or service provider, as the case may be, shall pay an amount equivalent to the CENVAT credit taken in respect of the said input or capital goods.

Case Laws:

UNITECH MACHINES LTD Vs. COMMR. OF C. EX. & S.T., MEERUT-I - 2015 (329) E.L.T. 860 (Tri. - Del.) – Held - Credit under Rule 3(5)(b) of Cenvat Credit Rules, 2004 reversible if input or capital goods have been written off before use - Impugned goods, having been written off after use thereof, impugned provisions not applicable - Credit not required to be reversed.

2. Here it would be pertinent to note that the Cenvat credit shall not be reversed if the capital goods are put into use.

3. Further in this case, no credit is taken as input tax credit in accordance with Section 16 or 18 of CGST Act, 2017. Hence, the provisions of 17(5)(h) shall not get attracted in such a situation.

4. Hence, one may come to a conclusion that no ITC needs to be reversed in case of write-off of Pre-GST inputs or capital goods as the earlier Act stands repealed.

5. But one needs to take into consideration that Cenvat credit was transferred as transitional credit from the earlier regime to the present GST Regime.

6. Here it would be pertinent to draw attention to para 8 & 10.1 of Circular No. 37/11/2018-GST dated 15th March 2018, wherein it has been clarified as below:

•  It is clarified that as the transitional credit pertains to duties and taxes paid under the existing laws viz., under Central Excise Act, 1944 and Chapter V of the Finance Act, 1994, the same cannot be said to have been availed during the relevant period and thus, cannot be treated as part of 'Net ITC' (Para 8)

•  Furthermore, it should be ensured that no refund of the amount of CENVAT credit is granted in case the said amount has been transitioned under GST. (Para 10.1)

7. From the above, it could be assumed that the transitional credit still retains the character of Cenvat Credit. In other words, it continues to be a Cenvat Credit only and not input tax credit under GST.

8. Further as per Section 174(2) of Repeal and saving of CGST Act, 2017, the repeal shall not affect the following:

•  Section 174(2)(c) - affect any right, privilege, obligation, or liability acquired, accrued, or incurred under the amended Act or repealed Acts or orders under such repealed or amended Acts:

9. As per Crawford's Statutory Construction, saving clause is used to exempt something from immediate interference or destruction. Saving clause helps in easy transitioning of the law from its old to new format/ form and, is generally used in the repealing statue to prevent it from affecting rights accrued and liabilities incurred or accrued, penalties incurred, duties imposed, or proceedings started under the statute sought to be repealed. If new statute that repeals an old one contains no saving clause, Section 6 of General Clauses Act, 1897 steps in which plays the role of a protector of rights and liabilities under repealed act.

10. Where an Act is repealed, then unless a different intention appears, the repeal shall not affect any right or liability acquired or incurred under the repealed enactment - THIRUMALAI CHEMICALS LTD Vs. UNION OF INDIA - 2011 (268) E.L.T. 296 (S.C.)

11. Based on the wordings as it appears in 174(2)(c), i.e., "affect obligation or liability acquired, accrued, or incurred under the amended Act or repealed Acts or orders under such repealed" one may argue that the liabilities accrued during the old regime, which is carried forward, shall be saved and liability occurring subsequently during the GST regime would have no impact.

12. The other view is that liabilities occurring at any point of time would have an impact.

13. As such any conclusion not to reverse the Cenvat Credit (Transitional Credit) may be subject to objections being raised by the Revenue and may lead to litigation. They may argue that the transition of credit was allowed subject to the compliance of the erstwhile Cenvat Credit Rules.

14. Also, the obligation would accompany the transition credit and would get activated when the event occurs. Hence, it could be argued that with the subsuming and repealing of the old Act would not take away the rights & obligations which existed in the earlier Act by the saving clause as provided under Section 174(2)(C) of the CGST Act.

15. It is time the Government comes out with an appropriate clarification to such a situation as to write-off of Pre-GST inventory, to avoid future dispute. This will go long way to ensure ease of tax compliance by the trade for its smooth functioning.

[The views expressed are strictly personal.]