Reversal Of Input Tax Credit In Schedule-I Transactions (Without Consideration): Interplay Between Section 16(2) And Rule 37

The second proviso to Section 16(2) states that if recipient fails to pay the supplier, the amount due for the value of supply along with the tax paid thereon within 180 days, an amount equal to the ITC availed by the recipient will be added to their output tax liability, along with interest. However, the first proviso to Rule 37^[1] states that the requirement to make actual payment to the supplier within 180 days to the extent of value is deemed to be paid.

A careful look at the said provisions points towards an inconsistency i.e., Second proviso to Section 16(2) mandates the payment of both the value of supply and tax whereas the first proviso to Rule 37 creates a deeming fiction only to the extent of value of supplies and not the tax. Due to this inconsistency, it appears that even in absence of consideration (value of supply), recipient may be liable to pay the tax portion to the supplier in order to avail the ITC.

The minutes of the 5th and the 29th GST Council meeting indicates that Section 16(2) was inserted to inter alia ensure the genuineness of purchase accounted by recipient and to ensure timely payment to suppliers especially those in the MSME sector. Therefore, keeping in mind the intent of the Government, applicability of Second proviso to Section 16(2) in Schedule-I transactions (where recipients have no contractual obligation to remit payment to suppliers) appears to be against the intention of law makers. Though, the provider is statutorily liable to pay the tax to the exchequer, the burden of tax is to be ultimately borne by the service recipient, however, it is a settled principle that the parties to contract can fix responsibility for the payment of indirect tax^[2].

It could be inferred that in Schedule-I transactions, where the consideration from the recipient is absent and discharging the burden of taxes is agreed upon by the supplier, then such transactions may not warrant application of Second proviso to Section 16(2).

It is also essential to note that the second proviso to Section 16(2) mandates reversal of ITC in the event of failure of payment to the supplier. Failure has been interpreted^[3] to mean, “not doing something that one is expected to do”. Thus, in Schedule-I transactions, wherein there is no obligation to pay consideration, the applicability of the said second proviso becomes questionable. Such questionable applicability can also be observed in cases where the contractual obligation for payment to supplier itself is beyond 180 days or where the contract monies are retained till the completion of contract or in cases of post supply discounts which are not allowed as deduction in terms of Section 15 of the CGST Act.

However, it is a trite law that a taxing statute must be strictly construed, which leads to a conservative point of view on this inconsistency that the first proviso to Rule 37 applies solely to the value of supply and not to the applicable taxes, needs to be read down.

In our view, the interplay between second proviso to Section 16(2)(d) and first proviso to Rule 37 has an industry wide and significant impact on related party transaction covered under Schedule-I. Therefore, before adopting any practice, it is imperative that the industries through appropriate channels, represent and seek clarity from the Board.

Authors: Brijesh Kothary (Partner) Chitrartha Gupta (Senior Associate) and Akshay Purohit (Associate) At Lakshmikumaran & Sridharan. Views are personal. 

1. Reversal of input tax credit in the case of non-payment of consideration ↑

2. Rashtriya Ispat Nigam Limited vs. M/s Dewan Chand Ram Saran reported in 2012 (5) SCC 306 ↑

3. Kavungal Kooppakkattu Zeenath vs. Mundakkattu Sulfiker Ali – 2008 (3) TMI 776 – Kerala High Court ↑