The reason behind Reincarnation of Input Tax Credit in GST

Goods and Services Tax (GST) was implemented in our country on 1st July, 2017. The main object for this major tax reform is stated to broad base and replace multiple taxes and remove the cascading effect of multipoint taxes. Further it was to lead to a Common National Market. Tax under the GST is required to be paid at each stage of value addition while allowing the credit of the taxes paid at the earlier stages, therefore, eliminating the cascading effect of Taxes prevailing in the erstwhile indirect taxes regime. Thus, finally reducing the cost of the goods and services benefiting all the stakeholders.

Further, since the credit would be available on all goods and services across India, therefore, there would be no differences in prices of goods and services due to taxes in any corner of India and therefore establishing a common national market. The seamless credit is also expected to make the Goods and Services competitive with the International Market along with the strengthening of the rupee. In the past under service tax and central excise a majority of disputes were in regard to the CENVAT credit. The GST provisions have been an amalgam of CENVAT and credit provisions of local VAT. It is expected that the need for matching and cumbersome procedures set out may not enable SMEs to be able to comply. Hopefully simplification may be resorted to in this regard as we step forward towards the end of one year of GST era.

In this article we will be unveiling the reason why GST was born to replace the erstwhile taxation laws and how it proposes to remove the cascading effect that were present in the erstwhile taxation laws. And how input tax credit is a total game changer in the new taxation law “GST” In GST we have Input Tax Credit system only as GST subsumes almost all forms of Indirect Tax levies. Whereas in Excise law we had Cenvat Credit System. Let us now list out the deficiencies we had in CENVAT Credit Rules which limited the availability of Tax credits on inputs.

What is Cenvat Credit : CENVAT Credit comprises of two words CENVAT and Credit, where CENVAT means Central Excise Duty or Service Tax and also Custom duty (in a few cases). Credit means a subsequent claim of set-off of something paid earlier. Therefore , Cenvat credit means credit of ST/excise and customs(additional duty) paid on purchase of inputs , input services and capital goods. And such credits can be used/utilized/set-off against ST/excise payable on clearance of manufactured products and rendering of services.

A rough understanding gives us an idea that the CENVAT credit scheme was originally designed to avoid cascading effects but it was seen that the Government was diluting this basic philosophy of the rule by introducing many restrictions leading to cascading effect. In the earlier regime of central excise or even for that matter in the State VAT Laws, the terms ‘inputs’, ‘input services’ and ‘capital goods’ are defined with certain negative lists. These negative lists restricts the scope of inputs, input services or capital goods, which in turn restricts the scope of availing input tax credit. This has been done to increase the revenue of the Government. There are some provisions in the erstwhile laws, viz. CENVAT Credit Rules, 2004 and the State VAT laws of different States, which restrict the flow of input tax credit.

Let us list out the these deficiencies one by one

In the negative list, for the purpose of CENVAT Credit Rules we have “capital goods” definition which excludes motor vehicles falling under tariff heading 8702, 8703, 8704, 8711 used in the factory by manufacturers for the purpose of Cenvat Credit. Thus a manufacturer who purchases motor vehicle for transportation of goods within the factory. cannot claim CENVAT Credit on it.

The definition of “inputs” consists of certain exclusions which also restrict the flow of credit like petrol, inputs used for construction or execution of works contract of a building or civil structure except when used for providing such services, motor vehicles, goods which have no direct relationship with the manufacture of the final product, goods primarily used for personal use or consumption of any employee such as food items, goods used in a guest house etc.

The definition of “input service” also consists of exclusions like service provided by way of renting of motor vehicle, service of general insurance business, servicing, repair and maintenance of motor vehicles which is not capital goods with certain exceptions, service portion in the execution of works contract and construction services except when the outward service is construction or works contract service, service provided in relation to outdoor catering, beauty treatment, health services etc. which are used for personal use or consumption of employee.

The CENVAT credit in respect of capital goods received in a factory or in the premises of the provider of output service shall be taken only for an amount not exceeding fifty per cent of the duty paid on such capital goods in the same financial year.

Another restriction of one year from the date of invoice has been imposed for availment of credit of inputs/input services, which very often leads to loss of input tax credit.

Another form of Indirect Tax law which affected the flow of tax credits leading to cascading effects in tax levies was State VAT law.

What is State VAT law : VAT (Value Added Tax) is a form of indirect tax imposed only on goods sold within a particular state, which essentially means that all the intra-state transactions of respective states were governed/administered through State VAT Laws where in levy was made on tangible goods and products sold within the state.

So any purchases made within the state attracted VAT leave and the buyer were allowed to take Input tax credits of the same in their returns. But the VAT system too had some deficiencies that bothered the flow of input tax credits leading to blockages which we call it in taxation terms as cascading effects.

Let us now list the deficiencies which were present in State VAT laws :

Purchases of goods from within the State are only eligible for claiming Input Tax Credit. .

ITC is usually available but in States such as West Bengal, Input tax credit is only available for raw material used for manufacturing; packing materials; capital goods and its spare parts. But Input tax credit is not available for Consumable stores ; goods specified in the negative list ; inter-state purchases.

Many States provide that ITC can be claimed by the purchaser only when the gst payment of tax is made to the Government by the seller, and the same is furnished by the seller in his return.

In case of cross transactions, ex., purchase and sale with the same party, or trade discounts/ incentives received from suppliers, normally payments are made through crossed account payee cheque, net of such adjustments. In such cases, ITC is often dis-allowed to the extent of the amount payable to the suppliers, which is adjusted against say, corresponding sales made to the same party, or discounts/ incentives receivable from the same party.

Since VAT was the subject matter of tax in hands of respective state government, with each state government having different tax rates levied for goods, even some products were exempted specifically in shirt each government had a white paper to fill the tax levies for the goods and also to list the goods which the state government considered to be state specific to exempt from tax and to list the goods which it wanted to be taxed with restrictions on availability of input tax credit.

To sum it up one can tell that all these provisions from erstwhile taxation laws lead to cascading effect, in genuine cases, which is against the very basic philosophy of Value added tax. This very defect in the erstwhile laws is sought to be removed through this new system of taxation in GST. Although some of the legacies continue to find place in the new law, some of these issues have been well been addressed under GST law.