Residual Credit Rift: Navigating the ITC Closure Conundrum

[Soham Agrawal and Himansh Soni are second year law students at Hidayatullah National Law University]

Introduction

With the advent of Goods and Services Tax (GST), India’s fragmented tax regime was overhauled to bring in a consolidated tax structure. This move was aimed at curbing the effect of “tax on tax” with Input Tax Credit (ITC) emerging as the forerunner in the pursuit of this objective. ITC is a mechanism that allows a registered taxpayer to offset their output tax liability by claiming credit on goods and services paid heretofore. With time, a grey area has come to the fore, raising an important legal issue: whether a registered taxpayer can claim the unutilized ITC remaining in its electronic credit ledger upon the sole ground of closure of business. The recent judgment of the Sikkim High Court in SICPA India Private Limited and Another v. Union of India and Others has added to the disarray by allowing the petitioner company to claim unutilized ITC upon the closure of its business.

Through this article, the authors aim to analyse the aforementioned grey area in light of the recent judgment by the Sikkim High Court. The article delves into the assessment of this ambiguity in three segments. Firstly, it analyses the statutory framework concerning the refund of ITC in light of business closure. Secondly, it analyses the recent judgment of the Sikkim HC along with the other legal precedents established by various Courts. Lastly, it puts forth the way forward to addressing the existing state of disarray.

Existing Provisions

Currently, the refund of unclaimed ITC upon the closure of business is not envisaged under the current framework of the Central Goods and Services Act, 2017 (CGST Act), the law that primarily deals with indirect taxation in the country. The entitlement to claim a refund of ITC stems from Section 49(6) of the CGST Act, which provides that the refund is to be made following Section 54, which provides for the procedural framework under which refunds are to be granted. Section 54(3) provides that the refund be allowed in two cases - firstly, when zero-rated supplies are made without payment of tax, and secondly, where the credit has accumulated on account of the rate of tax on inputs being higher than the rate of tax on output supplies. It is pertinent to note that there exists a divergence in the judicial position regarding the exhaustible nature of these conditions provided in Section 54(3) for refunds to be allowed. If the said conditions are presumed to be exhaustive, then the only remedy available to a closing business is the reversal of ITC on cancelling the registration of the business, which is provided under Section 29(5).

Analysing the Sikkim High Court Judgment

The Hon’ble Sikkim High Court in its recent pronouncement allowed a company, SICPA India Private Limited to claim its utilized ITC of Rs. 4,37,61,402 on closure of its business, overturning the verdict of the Additional Commissioner of Central Goods and Services Tax, Siliguri. The Hon’ble High Court, placing reliance on the decision in the case of Slovak India Trading Company Private Limited, (Slovak) held that the absence of an express prohibition for claiming a refund of ITC on closure of business constituted a compelling ground to allow the refund despite Section 54(3) providing for only two circumstances wherein the refund could have been made. The Karnataka High Court in Slovak ruled on the erstwhile regime of CENVAT Credit Rules, 2004 (CCR), holding that Rule 5 of the CCR does not provides an express prohibition for refund, and refund in the light of the closure of the factory is justified.

Further, the Court observed that the statute does not provide for retention of tax without authority of law. It is pertinent to note that instead of engaging in the interpretation of the text of the act, the court based its judgment on the Constitutional principle enshrined in Article 265 of the Constitution of India (Constitution). This Article, while prohibiting the imposition or collection of tax without the authority of law, is interpreted in Faridabad Complex Administration. v. Hindustan Milkfood Manufacturers Ltd. to include the retention of tax within its ambit, thus prohibiting the same as well. The case involved a dispute over the imposition of octroi duty on the import of Horlicks powder in bulk containers from Nabha (Punjab) to Faridabad (Haryana), for repacking and subsequent export outside Faridabad, and considered whether such activity qualifies as “consumption, use or sale within the octroi limits” of Faridabad.

This judgment must be assessed in the light of earlier pronouncement of the apex Court in the case of Union of India v. VKC Footsteps (India) (P) Ltd. (VKC Footsteps), wherein the Hon’ble Supreme Court held – “The clear intent of Parliament was to confine the grant of refund to the two categories spelt out in clauses (i) and (ii) of the first proviso[…]The intent of Parliament is evident by the use of a double-negative format by employing the expression “no refund” as well as the expression “in cases other than”. In other words, a refund is contemplated in the situations provided in clauses (i) and (ii) and no other.”

The Sikkim High Court, while allowing the refund of unclaimed ITC, found its judgment on the absence of express prohibition barring refund along with the authority of law to retain tax. However, this ratio departs from the interpretative limitation imposed in the case of VKC Footsteps. Interestingly, the reliance placed on constitutional principles in the instant matter is against the observation made in VKC Footsteps, which explicitly held that the right to refund is not a constitutional right. Moreover, the risk of reconciling this position as one granting relief on residual ground instead of through the formulation of a new ground is evident, as it can open floodgates for refunds based on other grounds which are not expressly prohibited. This approach and interpretation can significantly impact the operation of Section 54(3), as such situations are not explicitly addressed within the scope of the Section.

Way Forward

The silence of the act on the fate of residual ITC in the event of closure of business has given rise to judicial divergence on this issue on account of a lack of authority to retain such tax. In recent times, the position of the Sikkim High Court has also been endorsed by various courts and tribunals, such as the Calcutta High Court in the case of Edelweiss Rural & Corporate Services Limited & Anr., The Hon’ble High Court in the said case directed a reconsideration of the refund sanction order. The issue arose because the refund was credited to the electronic credit ledger of the assessee instead of being transferred to its bank account. The Court noted that the assessee had ceased its operations and, therefore, would be unable to utilize the refund credited to the electronic credit ledger. This serves as a harbinger of judicial ambivalence, displaying the practical consequences emanating from the ruling of the Hon’ble Sikkim High Court. The ruling could lead to disruption in working capital cycles wherein the firms may prioritize ITC refund claims over adjusting the same against output tax liability. Hence, it becomes imperative to devise potential solutions to resolve this equivocation.

Firstly, the Central Board of Indirect Taxes and Customs (CBIC), exercising its power under Section 168 of the CGST Act, must issue a clarificatory direction to help deal with this ambiguity unless a decisive legislative or judicial action is taken. This would align with the broader mandate of the provision, which allows for the issuance of such directions to ensure uniformity in the implementation of the CGST Act.

In furtherance of the preceding resolution, the Union must establish a definitive and clarified position on the refundability of unclaimed ITC under the framework of the act, particularly in light of the constitutional mandate under Article 265 of the Constitution It is pertinent to note that judicial precedents, such as Hero Motocorp Ltd. v. Union of India, have consistently affirmed that the matters related to taxation are construed to be matters of policy which have to be determined by the Union or the State, and the courts cannot interfere unless there is patent arbitrariness in such policies. Hence, where the legislative intent to restrict the refund to two circumstances in Section 54 is evident from the use of a double-negative format by employing expressions of “no refund” and “in cases other than,” it becomes imperative for courts to employ a restrictive interpretation, as it has been a settled position of law that the taxing statutes must be construed strictly as established in the landmark case of A. V. Fernandez, wherein the court held that in construing fiscal statutes and in determining the liability of a subject to tax one must have regard to the strict letter of the law. Further, in Modi Sugar Mills Ltd., it was emphasized that the interpretation of the taxing statute must be confined to what is clearly stated. The interpretation cannot import provisions in the statutes to supply any assumed deficiency and must exclude equitable considerations. Therefore, it becomes imperative for the Union to intervene and clarify its position in the light of diverging judgments.

Global Best Practices: From Influence to Implementation

The Union can take inspiration from its global counterparts, such as the Australian New Tax System (Goods and Services Tax) Act 1999, Section 142.10 of which explicitly codifies the refund of “any” excess GST, subject to the restriction of it not being passed on to another entity. Further, Canada’s Harmonized Sales Tax (HST) regime is designed to ensure that businesses can claim full ITCs for the tax paid on legitimate business expenses. Where the ITCs claimed exceed the GST/HST collected on sales for a reporting period, a net refund is systematically issued to the taxpayer. Hence, the adoption of the systemic model prevalent in Canada, which permits non-conditional refunds of ITCs, would entail that the grant of refund is not contingent upon the restrictive conditions prescribed under Section 54(3) of the CGST Act. Instead, the legitimacy of the refund claim and the fact of it being unutilized would be factors under consideration.

Codification of a similar refund mechanism with a broad entitlement to refunds of the excess tax paid, subject only to essential checks like the prevention of unjust enrichment, would align India's framework with global best practice, serve to uphold the principle of tax neutrality, and remove ambiguities in the framework. Further, businesses in India would benefit from this change as it will lead to the establishment of a refund mechanism, which would prevent the blocking of working capital in the form of unutilized ITCs, which can otherwise contravene the principle of tax neutrality under the GST.

Conclusion

The predicament of the refundability of unclaimed ITC upon closure of business presents an intersection of judicial interpretation, legislative silence, and invocation of constitutional principles. The Hon’ble Sikkim High Court, by way of its verdict in the SICPA, has attempted to address this lacuna. However, while doing so, it has departed from the restrictive interpretation laid down in VKC Footsteps and confined the contours of Section 54(3) of the Act. The resulting divergence has led to ambiguity in the framework and implementation of the act. In this light, it is imperative for the Union to intervene and clarify its stance while implementing reforms that help align this aspect of the GST regime with international practice. Clarity is need of the hour to help prevent the oscillation of courts between equitable relief and statutory restraint.