[By Ishtmeet Kaur]
The author is a student of Rajiv Gandhi National University of Law, Patiala.
Introduction
Since the introduction of GST in 2017, Input Tax credit (ITC) has consistently remained at the centre of litigation and policy debates. Although ITC was envisioned as a mechanism to avoid the cascading effect of taxes and provide relief to the taxpayers, however in practise, it has produced the exact opposite outcomes. In the past few years, a plethora of cases have come forward where ITC has been denied by the department to bona-fide purchasers either due to the default of the supplier or because of retrospective cancellation of supplier’s registration. In this context, the recent judgment of Sikkim High Court in the case of SICPA India (P.) Ltd. v. Union of India provides a ray of hope to the taxpayers who are facing uncertainties surrounding ITC entitlement. In this landmark ruling, a single-judge bench of the High Court has allowed the assessee to claim refund on unutilized ITC on the closure of business after the same was denied by the adjudicating and appellate authorities under the GST regime. While the judgment is progressive and aligns with the interests of the taxpayers, however the rationale given by the court appears legally inadequate and therefore deserves scrutiny.
This article intends to critically examine the judgment of the court, contending that despite being tax-payer friendly it may not withstand appellate scrutiny due to the absence of a robust legal foundation. At the same time, through this piece the author advocates that the core idea underlying the judgment, which is the recognition of refund of ITC on business closure should be legislatively codified, subject to certain safeguards to ensure that such refunds are only granted in genuine cases.
A Closer Look at the HC’s ruling
In the present case, the petitioner upon shutting down its manufacturing unit in Sikkim, sought a refund of the unutilized balance of Input Tax Credit lying in its Electronic Credit Ledger (ECL). However, the same was denied by the Assistant Commissioner on the ground that exists no statutory provision which allows the refund of ITC on the closure of business.
On an analysis of the provisions governing refunds, Section 49(6) of the Central Goods and Service Tax (CGST) Act, 2017 permits the refund of ITC but in accordance with the conditions laid down in Section 54. Specifically, Section 54(3) of CGST Act, 2017 clearly lays down two conditions in which the refund of unutilized Input Tax Credit can be claimed, i.e., (i) in case of zero-rated supplies and (ii) inverted-duty structure (rate of tax on inputs being higher than the rate of tax on outputs). Therefore, there is no express provision in the CGST Act which allows the assessee to claim ITC refund in situations like cancellation of registration or closure of business.
Despite the absence of a legal provision providing for refund of ITC on business closure, the court allowed the refund by relying on Karnataka High Court’s judgment in Union of India v. Slovak India Trading Company Private Limited in the erstwhile regime. The rationale adopted by the Court was that there is no express prohibition either in Section 49 or 54 which does not allow such refunds. While the intention of the court may have been to prevent undue burden on taxpayers, however the judgment appears to be overstepping the judicial boundaries especially in absence of a statutory basis or even robust reasoning by the court.
Fault Lines in the Judgment
- Flawed Interpretation of Section 54(3)
The High Court in its judgment has held that Section 54(3) does not expressly prohibit the refund of unutilized Input Tax Credit on closure of business. However, this reasoning of the court appears to be erroneous. The language of the first proviso to Section 54(3) has been framed by the Parliament in the following terms: “Provided that no refund of unutilised input tax credit shall be allowed in cases other than”. The critical expressions used here: “no refund shall be allowed” and “in cases other than”, clearly indicate that the legislature intends to allow refund only in these two situations as provided. Hence, the construction of the proviso is prohibitory and exhaustive in nature.
This interpretation has also been affirmed by the apex court in the case of Union of India & Ors. V. VKC Footsteps India Pvt. Ltd. where the court has clearly held that “A refund can be allowed only in the eventualities envisaged in clauses (i) and (ii). The expression “in cases other than” is a clear indicator that clauses (i) and (ii) are restrictive and not conditions of eligibility.” It remains uncertain as to how the High Court’s judgment would withstand judicial scrutiny when its interpretation of Section 54(3) clearly diverges from the one already laid down by the apex court.
- A case of Judicial Overreach
Taxation statutes are required to be strictly interpreted. The rationale behind this is that the fiscal policy of the government is often shaped by various economic and administrative considerations which may not necessarily align with the broader principles of equity usually applied by the courts. In such a context, courts through their judgments must remain confined to the text of law and should not dictate fiscal policy making by the government.
By disregarding the rule of literal interpretation, the High Court appears to have overstepped these boundaries, particularly when the intention of the Parliament was unambiguously expressed in the language of the proviso to Section 54(3). Introduction of an additional ground by the Court on which refund of ITC can be claimed serves as judicial encroachment on the powers of the legislature. This view also finds support in the decision of Supreme Court in the case of C.I.T. v. Calcutta Knitwears, where strict interpretation of a taxing statute was emphasized. “Common sense approach, equity, logic, ethics and morality have no role to play. Nothing is to be read in, nothing is to be implied; one can only look fairly at the language used and nothing more and nothing less.”
- Misplaced Reliance on Pre-GST precedents
The Sikkim High Court while delivering the judgment heavily relied on precedents from erstwhile regime, especially the decision in Slovak India Trading Co., where the Karnataka High Court held that under Rule 5 of CENVAT Credit Rules (CCR), 2004, there is no express prohibition on claiming refund on closure of business. While the judgment of the Karnataka High court itself appears to be flawed on the same reasoning of judicial overreach, however a close comparison between Rule 5 of CCR, 2004 and Section 54(3) of CGST Act, 2017, reveals a significant difference in statutory language. Rule 5 of CCR provides that, “A manufacturer who clears a final product or an intermediate product for export without payment of duty under bond or letter of undertaking, or a service provider who provides an output service which is exported without payment of service tax, shall be allowed refund of CENVAT credit…”. On a plain reading, Rule 5 of CENVAT Credit Rules does not appear to be restrictive in nature unlike Section 54 of the CGST Act where the Parliament has used a double negative format while drafting the provision. It does not expressly prohibit refund on grounds other than the ones which are expressly mentioned. Therefore, the High Court’s reliance on a precedent from the erstwhile regime may not be legally tenable in light of substantive changes in legislative language.
Comparative Analysis of ITC refund Mechanisms in GST jurisdictions
In order to gain a comprehensive understanding of the existing practices related to the refund of unutilized ITC on business closure, a comparative analysis of international GST regimes is crucial. This article examines the practices of ITC refund followed in Canada, New Zealand and Australia, which have GST frameworks comparable to India’s. Although it is true that there exists no specific provision with regards to refund of ITC on business closure in these jurisdictions, however, a key distinction lies in the rigid refund framework and fragmented credit system in India compared to other countries. The Indian legal framework adopts a narrow approach, permitting ITC refunds only in limited and specified circumstances. In contrast, jurisdictions like Canada, Australia, etc do not exhaustively list any situation in which refund may be granted. Instead, any unutilized or excess ITC left is refunded at the end of each filing or reporting period.
For instance, Section 225(1) of Canada’s Excise Tax Act, 1985 defines “net tax” as the difference between the output tax liability and the available ITC. Section 228(3) of the Act further provides that if this net tax is a negative amount for a reporting period, the registrant is entitled to a refund of the excess amount. This ensures that the unutilized balance is refunded to the taxpayer without any special conditions. Australia’s New Tax System (Goods and Services Tax) Act 1999, under Section 35-5 also mandates a refund if the “assessed net amount” (difference between GST payable and total ITC) is less than zero. A negative net amount basically indicates excess or unutilized ITC of taxpayer. Similarly, Section 45 of New Zealand’s Goods and Services Tax Act, 1985 also provides for the refund of any excess amount after adjusting for tax liability.
In all three jurisdictions, any unutilized credit is routinely adjusted and refunded throughout the life of business. Accordingly, by the time the business ceases to exist, most or all of the eligible ITC would already have been recovered through regular filings. Therefore, even upon closure, any remaining eligible ITCs could be claimed because the “net tax” calculation applies up to the final reporting period. However, there are no such refund mechanisms in India which allows the assessee to claim the refund of unutilized ITC after every filing period.
Another critical observation emerging from the GST regimes of Canada, New Zealand and Australia is the presence of a unified ITC structure, where “all ITC” can be adjusted against the output tax liability and there is no such distinction between central (CGST), State (SGST) and inter-state (IGST) components, which also prevents ITC from being stranded in the taxpayers’ ledgers. In contrast, India’s GST framework provides specific rules for the set-off of ITC, for example, SGST credit cannot be used to discharge CGST liability, and this results in accumulation of unutilized credit. Even though provisions have been made for claiming refund in case of inverted duty structure (where the tax rate on inputs exceeds that on outputs), it is still common for ITC to remain unutilized due to the rigid rules governing credit set-offs between CGST, SGST, and IGST. For instance, businesses engaged primarily in inter-State transactions are generally left with substantial SGST credit which they may find unable to utilize effectively. Moreover, there does not exist any provision which allows for general refunds for such unutilized ITC, leading to a significant issue for businesses. Given this systematic limitation and the unique GST mechanism of India, it is imperative to introduce an explicit provision allowing for refunds of unutilized ITC on business closure, aligning with global practises.
Way Forward: Should the refund of ITC be allowed on business closure?
Given the unambiguous language of Section 54(3) of the CGST Act, 2017 and the binding precedent laid down by the Supreme Court in VKC Footsteps India Pvt. Ltd., it is likely that the Sikkim High Court’s ruling will be challenged by the department in appeal to the division bench or the Supreme Court. Furthermore, the apex court has already held that refund is neither a constitutional guarantee nor a statutory entitlement, and is available only within the parameters prescribed by the legislature. In such a backdrop, it may not be advisable for judiciary to undertake any further interpretation of Section 54(3) to allow refunds on additional grounds, especially in light of the principles of minimal judicial intervention in taxing statutes. However, at the same time, it is imperative to recognize that refusal to grant refund of unutilized ITC on closure of business violates the foundational objectives of GST, that are, eliminating the cascading effect of taxes and ensuring that ultimate burden is borne by customers. Furthermore, once the operations of the business cease, there is no possibility of any further supplies, implying that there would be no output tax liability. In the absence of such a liability, the ITC will remain unutilized, thereby leading to unjust enrichment of the State.
In Eicher Motors Ltd. vs. Union of India, the apex court unequivocally held that right to claim input tax credit (ITC) accrues to the assessee at the time when tax is paid on inputs. This right continues until the benefit of credit is fully utilized or until the relevant goods exist. Therefore, if there accrues a right to avail ITC on payment of tax, there should also exist a corresponding right to claim refund of any such unutilized ITC.
Therefore, what is required at present is a legislative amendment to the CGST Act to expressly include closure of business as a ground for refund of unutilized ITC. Such a step would be consistent with the broader objectives of GST law and the principle of fairness. However, certain safeguards should be adopted by the department so that only genuine refund claims are entertained. Firstly, the refund should be allowed only if there are no dues pending under the GST regime. Secondly, the Input Tax Credit in question must not be under any dispute or subject to ongoing investigation. Thirdly, a clear audit trail should exist to establish the legitimacy of the credit which has been claimed such as tax invoices, GST returns, etc. This will ensure that only legitimate claims of refunds are allowed by the department.
Conclusion
In conclusion, although the judgment of Sikkim HC is a step in the right direction in terms of protecting taxpayers’ interests, however its deviation from a binding precedent and rules of interpretation, raises concerns about its legal veracity. The judgment suffers from various limitations including a flawed reading of Section 54(3), judicial overreach in interpreting taxation statutes, conflict with binding Supreme Court precedent, and misplaced reliance on decisions from the erstwhile regime. Instead, the initiative of allowing refunds of unutilized ITC on business closure should come from the legislature. This would not only bring legal clarity but also reinforce the confidence of businesses in the tax system.