GST Input Tax Credit On Construction Costs Can Be Claimed If Building Construction Was Necessary For Renting Out Service : Supreme Court

The Supreme Court on Thursday (October 3) held that if construction of a building is essential for supplying services such as renting out, it could fall into the "plant" exception to section 17(5)(d) of CGST Act which provides that Input Tax Credit cannot be claimed for construction material (other than plant or machinery) for immovable property construction.

“If the construction of a building was essential for carrying out activity of supplying services such as renting or giving on lease or other transactions in respect of the buildings or part thereof which are covered by clauses 2 and 5 of the Schedule 2 of the CGST Act, the building could be held as a plant. Functionality test will have to be applied to decide whether building is a plant”, the Court held.

A bench of Justice Abhay Oka and Justice Sanjay Karol held that the functionality test will have to be applied to the facts of each case to decide whether a building is a plant. 

The Court further held that it is not necessary to read down Section 17(5)(d) of the CGST Act so that it does not apply to cases where immovable property is constructed for the purpose of letting out on rent.

The bench held that the challenge to Section 17(5)(d) of the Central Goods and Services Tax (CGST) Act 2017 was rejected. The Court remitted the matter to the High Court to determine on facts if the case fell within the "plant" exemption for availing input tax credit as per Section 17(5)(d). 

Conclusions of the SC judgment :

a. The challenge to the constitutional validity of clauses (c) and (d) of Section 17(5) and Section 16(4) of the CGST Act is not established;

b. The expression “plant or machinery” used in Section 17(5)(d) cannot be given the same meaning as the expression “plant and machinery” defined by the explanation to Section 17;

c. The question whether a mall, warehouse or any building other than a hotel or a cinema theatre can be classified as a plant within the meaning of the expression “plant or machinery” used in Section 17(5)(d) is a factual question which has to be determined keeping in mind the business of the registered person and the role that building plays in the said business. If the construction of a building was essential for carrying out the activity of supplying services, such as renting or giving on lease or other transactions in respect of the building or a part thereof, which are covered by clauses (2) and (5) of Schedule II of the CGST Act, the building could be held to be a plant. Then, it is taken out of the exception carved out by clause (d) of Section 17(5) to sub-section (1) of Section 16. Functionality test will have to be applied to decide whether a building is a plant. Therefore, by using the functionality test, in each case, on facts, in the light of what we have held earlier, it will have to be decided whether the construction of an immovable property is a “plant” for the purposes of clause (d) of Section 17(5).

The Orissa High Court, in its judgment delivered in 2019, had said that Input Tax Credit (ITC) for construction materials cannot be denied under Section 17(5)(d) of the Central Goods and Services Tax (CGST) Act, 2017 to builders engaged in constructing property for letting it out on rent.

Section 17(5)(d) of the CGST Act specifies that ITC is not available on goods and services used in the construction of immovable property (other than plant and machinery) on one's own account, including when such goods or services are used for business purposes.

Background

The petitioners, M/s. Safari Retreats Pvt. Ltd. and another, constructed a shopping mall in Bhubaneswar for the purpose of letting it out to tenants. To construct the mall, the petitioners incurred expenses in purchasing goods and services such as cement, steel, lifts, air-conditioning systems, and architectural services. They paid GST on these purchases under the CGST and OGST Acts.

The petitioners intended to claim ITC of Rs. 34,40,18,028 for the GST paid on these purchases to offset the GST liability arising from the rental income they earned by letting out the mall. However, the petitioners were denied this ITC by the tax authorities, citing Section 17(5)(d) of the CGST and OGST Acts, which restricts ITC for goods and services used in the construction of immovable property on the taxpayer's own account.

The primary issue before the court was whether the petitioners were entitled to claim ITC on the GST paid for goods and services used in the construction of a shopping mall, which was intended to be let out on rent, under the provisions of Section 17(5)(d) of the CGST Act and its Odisha equivalent.

The Orissa HC noted that the CGST Act aims to eliminate the cascading effect of various indirect taxes by allowing input tax credit on inputs, services, and capital goods. It is based on the VAT concept, enabling taxpayers to offset input taxes against output taxes, thereby reducing multistage levies. Section 16 of the CGST and OGST Acts allows registered persons to claim input tax credit on goods or services used or intended to be used in the course or furtherance of their business, subject to conditions and as specified under Section 49. The credited amount is recorded in the person's electronic credit ledger to avoid the cascading effect of taxes.

The HC observed that the denial of ITC in this case would lead to double taxation. The HC noted that the GST was paid on both the inputs used for the construction of the mall and the rental income derived from the mall. Since the construction was not for sale but for letting out, there was no break in the tax chain.

The HC said that the purpose of the GST regime was to avoid the cascading effect of taxes by allowing ITC. It held that denying ITC in cases where the immovable property is constructed for the purpose of letting out, and not for sale, would be against the basic rationale of the GST system.

The HC held that Section 17(5)(d) should be interpreted in a way that aligns with the purpose of the GST laws. The provision, in its plain reading, was meant to apply to cases where the immovable property was constructed for sale, and not for letting out, as GST is not applicable to sale after completion certificate. The HC observed that applying the provision to cases where the property is let out would lead to inequitable results and was contrary to the spirit of the law.

The HC said that denying ITC to the petitioners violated their fundamental right under Article 14 of the Constitution. It said that treating different types of building – those sold and those let out as the same is contrary to the basic principles regarding classification of subject matter for the levy of tax. The classification treats assessees like the petitioner differently from others with similar continuous business and unbroken tax chains, granting input tax credit to some while denying it to the petitioner, the HC said.

The HC read down Section 17(5)(d) of the CGST and OGST Acts and stated that it does not apply to cases where immovable property is constructed for the purpose of letting out on rent. The HC said that the petitioners were entitled to claim ITC for the GST paid on goods and services used in the construction of the shopping mall, which was let out on rent.

The HC also noted that the denial of ITC would render properties constructed for letting out uncompetitive compared to older properties, which would adversely affect the business of such developers.

Case no. – C.A. No. 2948/2023

Case Title – Chief Commissioner of Central Goods and Service Tax and Ors v. M/S Safari Retreats Private Limited and Ors. 

Citation : 2024 LiveLaw (SC) 774

Click here to read the judgment