Union of India VS VKC Footsteps India Pvt Ltd

Parliament, while enacting the Central Goods and Services Tax Act 2017, included a provision for tax refund in Section 54. Sub-Section (3) provides for the refund of unutilised input tax credit in cases of zero-rated supplies made without payment of tax and credit accumulation due to the rate of tax on inputs being higher than the rate of tax on output supplies. Parliament recognized that ITC might accumulate for various reasons but specifically addressed the situation where credit accumulates because of an inverted duty structure, meaning the tax rate on inputs is higher than on outputs. To address this, a refund provision is included in Section 54(3). The Central Goods and Services Tax Rules 2017 were established under the rule-making authority of Section 164 of the CGST Act. Rule 89(5) includes a formula for refunding ITC in cases of an inverted duty structure and defines “Net ITC” as the input tax credit availed on inputs.

Parliament, while enacting the Central Goods and Services Tax Act 2017, incorporated a provision for tax refunds in Section 54. Sub-Section (3) provides for the refund of unutilized input tax credit in cases of zero-rated supplies made without payment of tax and credit accumulation due to the rate of tax on inputs being higher than the rate of tax on output supplies. Parliament recognized that ITC might accumulate for various reasons but specifically provided for refunds in cases of an inverted duty structure, where the accumulation occurs because the tax rate on inputs is higher than on output supplies. Consequently, Section 54(3) includes this refund provision. The Central Goods and Service Tax Rules 2017, formulated under the rule-making power conferred by Section 164 of the CGST Act, include Rule 89(5), which provides a formula for ITC refunds in cases of an inverted duty structure. This formula uses the term “Net ITC” and defines it as input tax credit availed on inputs. Writ petitions under Article 226 of the Constitution were filed before the High Courts of Gujarat and Madras. Petitioners argued that Section 54(3) allows for ITC refunds due to an inverted duty structure, ITC includes credit of input tax charged on goods and services, and Section 54(3) does not limit refunds only to unutilized ITC from inputs but also from input services if their tax rate is higher than on output supplies. They contended that Rule 89(5) is ultra vires for excluding tax on input services from the refund formula and that if Section 54(3) restricts refunds only to tax on inputs, it would be unconstitutional as it discriminates between inputs and input services.

Parliament, while enacting the Central Goods and Services Tax Act 2017, incorporated a provision for tax refund in Section 54. Sub-Section (3) provides for a refund of unutilized input tax credit (ITC) in cases involving zero-rated supplies made without payment of tax and credit accumulation due to the rate of tax on inputs being higher than the rate of tax on output supplies. Parliament recognized that ITC might accumulate for various reasons but specifically addressed the inverted duty structure, where the rate of tax on inputs is higher than on output supplies. Consequently, a refund provision was included in Section 54(3). The Central Goods and Service Tax Rules 2017 were formulated under the rule-making power of Section 164 of the CGST Act. Rule 89(5) provides a formula for refunding ITC in cases of inverted duty structure, defining “Net ITC” as “input tax credit availed on inputs.”

Writ petitions under Article 226 of the Constitution were filed before the High Courts of Gujarat and Madras. Petitioners argued that Section 54(3) allows for a refund of ITC when accumulated due to an inverted duty structure and that ITC includes credit of input tax on goods and services. They contended that Section 54(3) does not restrict refunds solely to unutilized ITC from a higher tax rate on inputs compared to outputs. The petitioners claimed that Rule 89(5), which excludes tax on input services from the refund formula, is ultra vires and that any restriction in Section 54(3) on refunds only for tax on inputs would be unconstitutional, leading to discrimination between inputs and input services.

The Gujarat High Court, in its judgment on 24 July 2020 in VKC Footsteps India Pvt. Ltd. v. Union of India, held that the explanation in Rule 89(5) denying the refund of unutilized input tax on input services as part of ITC accumulated due to the inverted duty structure is ultra vires to Section 54(3) of the CGST Act, 2017. It directed the Union Government to allow claims for refunds considering unutilized ITC on input services as part of “Net ITC” for calculating refunds under Rule 89(5) in line with Section 54(3).

Contrarily, the Madras High Court, in its judgment on 21 September 2020 in Tvl. Transtonnelstroy Afcons Joint Venture v. Union of India, after noting the Gujarat High Court’s view, concluded that Section 54(3)(ii) does not violate Article 14. It held that the statutory right to a refund, limited to unutilized credit from higher tax rates on input goods compared to outputs while excluding unutilized ITC from input services, constitutes a valid classification and exercise of legislative power.

The Central Goods and Services Tax (CGST) Act 2017, under Section 54, provides a mechanism for refunding unutilized input tax credit (ITC). Sub-Section 54(3) specifically addresses refunds for two scenarios: zero-rated supplies made without tax payment and credit accumulation due to a higher tax rate on inputs compared to output supplies. Parliament recognized that ITC could accumulate for various reasons but specifically provided for refunds in cases of inverted duty structures, where the tax on inputs exceeds the tax on outputs. Rule 89(5) of the CGST Rules 2017, derived from Section 164 of the CGST Act, outlines a formula for calculating ITC refunds in such cases, defining “Net ITC” as the input tax credit on inputs.

Disputes arose when the High Courts of Gujarat and Madras interpreted these provisions differently. Petitioners argued that Section 54(3) allows for ITC refunds from both inputs and input services, claiming Rule 89(5) to be ultra vires for excluding input services. The Gujarat High Court agreed, declaring Rule 89(5) invalid to the extent it excludes input services, thus allowing refunds on unutilized ITC from input services. Conversely, the Madras High Court upheld the rule, stating that the law only intended refunds for ITC on inputs, not services, and this distinction was a valid legislative decision. This divergence in judicial opinions led to further appeals.

Section 54 outlines the refund process, allowing claims within two years of the relevant date. Sub-Section 54(3) specifically permits claims for unutilized ITC at the end of any tax period, barring refunds for fully exempt or nil-rated supplies, except in cases of zero-rated supplies without tax payment or when tax rates on inputs exceed output supplies.

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