Rationale To Deny ITC To Service Provider Who Is Not Liable To Pay Tax On Output Services Is Obvious: Delhi High Court

The Delhi High Court has held that the rationale to deny input tax credit (ITC) to service providers who are not liable to pay tax on output services is obvious.

The bench of Justice Vibhu Bakhru and Justice Amit Mahajan has held that the service providers rendering services on which tax is payable on a reverse charge basis would constitute a class of their own, and a challenge to the same founded on Article 14 of the Constitution of India would necessarily fail. It is well settled that Article 14 of the Constitution of India does not prohibit reasonable classification, which has a rational nexus to its object. Denying input tax credit to service tax providers, who are not liable to pay tax on output services, is founded on a rational basis, which has a clear nexus with the classification.

The petitioner/assessee is in the business of providing services as a recovery agent to a non-banking financial company (NBFC). It is, essentially, aggrieved on account of service tax and GST in respect of the said services being payable on a reverse charge basis. Consequently, the liability to pay the service tax under the Finance Act, and after 01.07.2017, the liability to pay GST, on such specified services, rests on the recipient of services.

Pursuant to the Scheme of Service Tax under the Finance Act as well as GST under the CGST Act and the IGST Act, where the tax is payable on a reverse charge basis by the recipient of services, the service provider is not entitled to claim any benefit of the taxes paid on input services.

The rationale is that since there is no liability for output tax on the service provider, it would not be entitled to claim any set-off or credit for the tax paid on inputs. Thus, the petitioner is not entitled to claim any credit for the service tax or GST paid on inputs, as it is not liable to pay any service tax or GST on the services of a recovery agent rendered by it. The petitioner seeks to challenge the scheme of taxation as discriminatory.

The petitioner claimed that it continued to file its periodical service tax returns in the prescribed form (Form ST-3) in terms of Section 70 of the Finance Act and discharged its liability to pay service tax as applicable. The petitioner states that it also availed Cenvat Credit in respect of the input services under the Cenvat Credit Rules, 2004.

By virtue of the notification dated June 20, 2012, issued under Section 68(2) of the Finance Act, service tax on certain services was entirely payable by the recipient of the services, and in respect of some services, part of the service tax was apportioned in the specified ratio between the service provider and the recipient of the service.

Illustratively, the services provided by an insurance agent to any person carrying on the insurance business would be chargeable to service tax entirely in the hands of the person receiving the services—the service recipient carrying on the insurance business. However, in the case of services by way of the supply of manpower for any purpose, 25% of the service tax chargeable was payable by the service provider, and 75% of the service tax chargeable on such services would be payable by the service recipient.

The petitioner contended that the denial of input tax credit to the petitioner and similarly situated service providers is discriminatory and plainly arbitrary. According to the petitioner, the same is contrary to the scheme of the CGST Act and the fundamental structure on which the GST law is premised. The petitioner claimed that there is no rationale for providing the charge of tax on a reverse charge basis on certain supplies, thus excluding the service providers from the benefit of availing input tax credit on the services used for providing the taxable service.

The department contended that the petitioner could raise no grievance regarding the manner in which it had structured its business. In terms of the agreement between the petitioner and M/s Hero Fincorp Limited, the petitioner was required to provide the services and not outsource them. If the petitioner had complied with this obligation, he would have had no grievance. The Parliament has the necessary legislative competence to enact a scheme of taxation involving the levy and collection of tax on a reverse charge basis.

The court held that the legislative scheme for denying input tax credit in respect of services on which service tax or GST is payable on a reverse charge basis is arbitrary and falls foul of Article 14 of the Constitution of India. First of all, the right to utilize input tax credit is a statutory right; such credit is available only if the statute permits it and to the extent that it does. A service provider providing services that are subject to payment of tax on a reverse charge basis is not liable for payment of service tax or GST in respect of the services that it renders. Thus, a service provider is not assessed a tax on the output services. By its very definition, the tax on such services is payable by the service recipient.

Counsel For Petitioner: Bharat Raichandani

Counsel For Respondent: Vivek Goyal

Case Title: Pace Setters Business Solutions Pvt. Ltd. Versus Union Of India And Ors.

Citation: 2024 LiveLaw (Del) 447

Case No.: W.P.(C) 7742/2019

Click Here To Read The Order