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THE INSIGHT

Refund in case of Inverted Duty Structure
By K V Srinivasamurthy, Sr. Consultant – Indirect Taxes, PKF Sridhar & Santhanam LLP, CA, Chennai
Oct 14, 2020

SECTION 54(3) of the CGST Act, 2017 read with Section 89(5) of the CGST Rules deals with refund of any unutilised input tax credit at the end of any tax period in accordance with the following provision.

Provided that no refund of unutilised input tax credit shall be allowed in cases other than––

(i) zero rated supplies made without payment of tax.

(ii) where the credit has accumulated on account of rate of tax on inputs being higher than the rate of tax on output supplies (other than nil rated or fully exempt supplies), except supplies of goods or services or both as may be notified by the Government on the recommendations of the Council:

Provided further that no refund of unutilised input tax credit shall be allowed in cases where the goods exported out of India are subjected to export duty:

Provided also that no refund of input tax credit shall be allowed, if the supplier of goods or services or both avails of drawback in respect of central tax and claims refund of the integrated tax paid on such supplies.

This article is limited to the analysis of refund with regard to Proviso (ii) of Section 54(3), which reads as below:

•  where the credit has accumulated on account of rate of tax on inputs being higher than the rate of tax on output supplies (other than nil rated or fully exempt supplies), except supplies of goods or services or both as may be notified by the Government on the recommendations of the Council:

Rule 89(5) of the CGST Rules, 2017 provides the method for obtaining the refund under Rule 54(3)(ii).

At the time of entry into force of the CGST Act on 01.07.2017, Rule 89(5) read as follows:

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

•  Maximum Refund Amount= {(Turnover of inverted rated supply of goods) x Net ITC ÷ Adjusted Total Turnover} – tax payable on such inverted rated supply of goods

Here it was clarified that the term Net ITC included both input tax credit availed on inputs and input services during the relevant period.

Subsequently Su b-rule (5) of rule 89 was later amended vide notification no. 21/2018 - Central Tax dated 18.04.2018.

So, the definition of Net ITC as per amended Subrule (5) of rule 89 allows for refund of ITC accumulated on account of inputs only. The earlier provision, prevailing prior to this amendment allowing refund of ITC accumulated on account of input services, was deleted

Taxpayers challenged the above amendment to Rule 89(5) of the CGST Rules, 2017 as ultra vires  of Section 54(3) of the CGST Act for prescribing restriction which does not derive its powers from parent statute.

There were two challenges before the High Court of Gujarat and High Court of Madras.

VKC Footsteps India Pvt. Ltd. vs. Union of India - High Court of Gujarat [TOG-572-HC-GUJ-GST-2020]

TVL Transtonnelstroy Afcons Joint Venture vs. Union of India High Court of Madras

In the case of VKC Footsteps, the Gujarat High Court ruled in their favour which is reproduced below.

Explanation (a) to Rule 89(5) which denies the refund of "unutilised input tax" paid on "input services" as part of "input tax credit" accumulated on account of inverted duty structure is ultra vires the provision of Section 54(3) of the CGST Act , 2017.

Explanation (a) to the Rule 89(5) is read down to the extent that Explanation (a) which defines "Net Input Tax Credit" means "input tax credit" only. In fact, the Net ITC should mean "input tax credit" availed on "inputs" and "input services" as defined under the Act".

However, the Madras High Court in a contrary decision has ruled in favour of the Revenue.

The Madras Court observed as follows:

According to the Madras High Court that the proviso to Section 54(3) of the CGST Act and, more significantly, its import and implications do not appear to have been taken into consideration in VKC Footsteps.

As is evident in H.E.H. Nizam, the Supreme Court held that a proviso performs the function of qualifying the substantive clause. In S. Sundaram Pillai v. V.R. Pattabiraman, (1985) 1 SCC 591 (Sundaram Pillai), the Supreme Court delineated the multiple roles that a proviso could play and held that a proviso could even acquire the tenor and colour of a substantive enactment. Reliance was also placed on Kedarnath Jute Manufacturing Co. v. CTO, AIR 1966 SC 12 to contend that a proviso may perform the function of exempting, excluding or qualifying the enacting clause.

Further the High Court of Madras observed that sub-clause (ii) would have merely stated "where the rate of tax on inputs being higher than the rate of tax on output supplies" and the words "credit has accumulated on account of" would not have been introduced if the intention was not to identify the source from which – i.e. input goods and the rate of tax thereon – unutilised input tax credit should accumulate for entitlement to refund, if the intention was to provide a refund of the entire unutilised input tax credit.

It was concluded that, when rule 89(5), as it stands today, is analysed in the context of Section 54(3)(ii), it is clear that Net ITC has been re-defined in the amended Rule 89(5) so as to provide for a refund only on unutilised input tax credit that accumulates on account of input goods. Thus, the amended Rule 89(5) as amended, is intra vires Section 54(3) of the CGST Act.

Interpretation of the Word "Proviso"

The normal function of a proviso is to except something out of the enactment or to qualify something enacted therein which but for the proviso would be within the purview of the enactment.

A proviso is not to be construed as an enacting provision enabling something to be done which is not to be found in the statute itself. The correct way to understand a proviso would be to read it in the context of the main provision and not in isolation Lord Goddard in Bretherton vs. United Kingdom Totalisator Co. Ltd. [(1945) 2 All.E.R.

The fallacy is that i t treats it as if it were an independent enacting clause instead of being dependent on the main enactment - Ex p. Partington [(1844) 6 Q.B. 649].,

It is a qualification of the preceding enactment which is expressed in terms too general to be quite accurate – Lord Watson in West Derby Union v. Metropolitan Life Assurance Co. (1897 AC 647) (HL). The golden rule is to read the whole section, inclusive of the proviso, in such manner that they mutually throw light on each other and result in a harmonious construction. If the principal provision is clear, then a proviso cannot expand or limit it - Dwarka Prasad v. Dwarka Das Saraf 1975 (8) TMI 121 - SUPREME COURT

"IF THE LANGUAGE OF THE ENACTING PART OF THE STATUTE DOES NOT CONTAIN THE PROVISIONS WHICH ARE SAID TO OCCUR IN IT YOU CANNOT DERIVE THESE PROVISIONS BY IMPLICATION FROM A PROVISO." LORD WATSON IN WEST DERBY UNION V. METROPOLITAN LIFE ASSURANCE CO. (1897 AC 647) (HL)

IF IN A DEED AN EARLIER CLAUSE IS FOLLOWED BY A LATER CLAUSE WHICH DESTROYS ALTOGETHER THE OBLIGATION CREATED BY THE EARLIER CLAUSE, THE LATTER CLAUSE IS TO BE REJECTED AS REPUGNANT, AND THE EARLIER CLAUSE PREVAILS - PER LORD WRENBURY IN FORBES V. GIT [1922] 1 A.C. 256)

Normally, a proviso does not travel beyond the provision to which it is a proviso - Lord Watson in West Derby Union v. Metropolitan Life Assurance Co.

A proviso to a section cannot be used to import into the enacting part something which is not there, but where the enacting part is susceptible to several possible meanings it may be controlled by the proviso (See Jennings v. Kelly [1940] A.C. 206).

The ordinary and proper function of a proviso coming after a general enactment is to limit that general enactment in certain instances" (per Lord Esher in Re Barker, 25 Q.B.D. 285).

Courts must avoid the danger of a priori determination of the meaning of a provision based on their own pre-conceived notions of ideological structure or scheme into which the provision to be interpreted is somewhat fitted - Dr. R. Venkatchalam and Ors. etc. v. Dy. Transport Commissioner and Ors. etc. (AIR 1977 SC 842),

Proviso as Independent legislative provision:

In exceptional circumstances a proviso may not really be a proviso in the accepted sense but may be a substantive(Independent legislative) provision itself.

In the case of COMMISSIONER OF COMMERCIAL TAXES vs R S Jhaver - 1968 AIR 59, it was held as below:

Section 41(2) of the Madras General Sales Tax of 1959 contained as below:

All accounts, registers, records and other documents maintained by a dealer in the course of his business. the goods in his possession and his offices, shops, godown, vessels or vehicles shall be open to inspection at all reasonable times by such officer Provided that no residential accommodation (not being a place of business-cum-residence) shall be entered into and searched by such officer except on the authority of a search warrant issued by a Magistrate having jurisdiction over the area, and all searches under this sub-section shall, so far as may be, be made in accordance with the provisions  of the Code  of Criminal Procedure.

From the above it could be observed that the there is no provision in the main part of the sub-section for searching purely residential premises. It is only the proviso which provides for a search. This is led to the High Court to hold that the proviso was otiose.

But the Apex Court observed that generally a provision is an exception to the main part of the section, it is recognised that in exceptional cases, as in the present case, the provision may be a substantive provision itself. As such proviso to Clause (2) of Section 41 was to be treated as an independent legislation . This is because when the proviso provides for a search it is providing something independent of the main part of the sub-section.

Section 54(3)(ii), which provides that a registered person may claim refund of any unutilised input tax credit at the end of any tax period provided that no refund of unutilised input tax credit shall be allowed in cases other than

(ii) where the credit has accumulated on account of rate of tax on inputs being higher than the rate of tax on output supplies

Thus Section 54(3) provides that there shall be refund of "Unutilized input tax credit". Thus, the quantum of ITC to be refunded includes both input tax credit of goods and services.

Further if the proviso (ii) is considered to provide for the quantum of ITC to be refunded, i.e., whether input tax of goods or services or both, then proviso would be contrary to the provisions of the main enactment. In such a situation the proviso (ii) altogether destroys the earlier provision made in the main enactment under Section 54(3) and as such the proviso is to be rejected as repugnant and the main enactment would prevail. This is because the aim of provisions of sub-section 54(3) and proviso(ii) would appear to be the same.

The point to be noted is that the proviso (ii) does not appear to provide for something which is missing in the main part of the sub-section 54(3).

Hence in order to save the "proviso" it would be appropriate to read it as carving out an exception to Section 54(3) by specifying the eligibility condition for the Taxpayer to apply for refund of unutilised input tax credit.

Thus, by going by the above, it could be viewed that the proviso to Section 54(3) specifies the situations where refund shall be permissible. The proviso sets out the eligibility condition. In other words the proviso does not curtail the entitlement to refund of the entire unutilised input tax credit and merely sets out the eligibility conditions for claiming such refund.

Further the use of the sentence "on account of "make the eligibility condition more specific, in the sense that the taxpayer shall be entitled to refund, only when rate of tax on inputs being higher than the rate of tax on output supplies. This is irrespective the fact whether the word "INPUT" as mentioned is either goods or services or both.

Thus, the humble view is that the benefit shall flow from the main section 54(3) and not from the "Proviso (ii)". The main section clearly permits refund of input tax credit which includes both input tax of goods and services – Sec.2(62).

When the principle provision is clear, a proviso cannot limit or expand it as rightly pointed out in Dwarka Prasad v. Dwarka Das Saraf 1975 (8) TMI 121 - SUPREME COURT.

As per explanation to Rule 89(5), "Net ITC" means ITC availed on inputs, whereas Section 2(62) defines input tax as tax charged on any supply of goods or services or both. Further as per 2(63) ITC means credit of input tax. Thus, the meaning in Rule 89(5) is contrary to meaning assigned to the same in the Act.

The Madras High Court judgement appears to be a set-back to the taxpayers. In light of these contradictory decisions, the taxpayers have to wait until it is settled by the Apex Court.

[The author is Senior Consultant – Indirect Taxes, PKF Sridhar & Santhanam LLP, Chartered Accountants, Chennai and the views expressed are strictly personal.]