GST Audit Case Study 13 - Availment of ITC on Sales Promotion Expenses which the goods or services blocked under Section 17 (5)

Input tax credit of goods or services covered under the provisions of section 17(5) of the Central Goods and Services Tax Act, 2017 is not permissible to take.

Aims and objectives of GST Audit

Audit in GST should intend to evaluate the credibility of self-assessed tax liability of a taxpayer based on the twin test of accuracy of their declarations and the accounts maintained by the taxpayer. Thus, Audit in GST should have the following objectives:

• Measurement of compliance levels with reference to compliance strategy of the tax administration.
• Detection of non-compliance and revenue realization
• Prevention of non-compliance in the future.
• Discovering areas of non-compliance to prevent taxpayers from continuing with such deviations from expected compliance behaviour that results in erroneous declaration of self-assessed liability.
• Providing inputs for corrections in/amendments to the legal framework which are being exploited by taxpayers to avoid paying taxes.
• Encouraging voluntary compliance.
• Any other goals deemed worth pursuing by the GST administration.

GST Audit Para

Section 17 (5) stipulates as follows :

Notwithstanding anything contained in sub-section (1) of section 16 and sub-section (1) of section 18, input tax credit shall not be available in respect of the following, namely:-

(a) ..........

--

(ab) services of general insurance, servicing, repair and maintenance in so far as they relate to motor vehicles, vessels or aircraft referred to in clause (a) or clause (aa):

(b)        The following supply of goods or services or both-

(i)         Food and beverages, outdoor catering, beauty treatment, health services, Cosmetic and plastic surgery, leasing, renting or hiring of motor vehicles, vessels or aircraft referred to in clause (a) or clause (aa) except when used for the purposes specified therein, life insurance and health insurance.

The sub-clauses of Section 17(5) of the CGST Act, 2017 proposes for restriction of ITC on tax paid on certain inward supply of goods or services that are referred to as blocked credits. The supplies covered under blocked credits includes goods lost, stolen, destroyed, written off or disposed of by way of gifts or free samples (clause h).

On verification of the ITC register submitted by the taxpayer, it is seen that, they had availed ITC on certain invoices with remark as ‘sales promotion expenses’. On enquiry it was submitted by the taxpayer that, the said invoices are related to purchase of certain items which are intended for supply as gift or free samples to their clients. Since the ITC involved in the said invoices are hit by the vice of restriction under provisions of Section 17(5), they are liable to reverse the ITC so availed. Accordingly, the taxpayer is liable to reverse an amount of ₹.XXXXX/-as detailed below:

In view of the above legal position, The above credit of input tax is inadmissible as the same is blocked under Section 17 (5) credits amounting to Rs. xxxx/- of IGST, Rs.xxxx/- each of CGST and SGST are liable to be reversed along with interest under Section 50(3). Penalty as applicable is also liable to be paid.

Author’s Note 

Input tax credit of goods or services covered under the provisions of section 17(5) of the Central Goods and Services Tax Act, 2017 is not permissible to take.

GST is paid on such goods or services as listed out under section 17(5), however, the buyer/ purchaser cannot claim the input tax credit on the same. Hence, as the input tax credit is not available, the same is termed as ‘Blocked Input Tax Credit’.

Firstly, it is important to note that provisions of section 17(5) of the Central Goods and Services Tax Act, 2017 overrides both the following sections -

1. Section 16(1) which states that the registered person will be entitled to take credit of input tax used/ intended to be used in the course or furtherance of business; and 

2. Section 18(1) which deals with the availability of input tax credit in special circumstances.

Accordingly, overriding both section 16(1) and section 18(1), provisions of section 17(5) simply state that input tax credit shall not be available in respect of listed goods or services or both. The list of said ‘blocked input tax credit’ is detailed below.

List of ‘Blocked Input Tax Credit’ along with exceptions - 

The following table provides the list of ‘Blocked Input Tax Credit’ as covered under provisions of section 17(5) of the Central Goods and Services Tax Act, 2017 along with the exceptions to the same.

How to report Section 17(5) of the CGST Act in GSTR 3B

The ineligible ITC claimed but needs to be reversed by the recipient or buyer shall be reported while filing GSTR 3B for the month or the quarter as per Section 17(5) of the CGST Act. These values of ineligible ITC under Section 17(5) must be reversed in Table 4(B) instead of Table 4(D) of GSTR 3B from July 2022.

Advance Ruling on Claiming of ITC which is blocked under Section 17(5) 

Advance Ruling Order No. 15/2023, A.R.Com/04/2023, Dated 02^nd  September, 2023 of Telangana

ORDER UNDER SECTION 98(4) OF THE CENTRAL GOODS AND SERVICES TAX ACT, 2017 AND UNDER SECTION 98(4) OF THE TEALANGANA GOODS AND SERVICES TAX ACT, 2017.]

BRIEF FACTS OF THE CASE:

The applicant M/s. Geekay Wires Limited is engaged in the business of manufacturer of Steel Nails and other steel products in its manufacturing unit situated at Shankarampet-R, Village, Shankarampet- R Mandal-Medak, Medak, Telangana. The raw materials for manufacturing Steel Nails are Steel Wire rod. The applicant purchases steel wire rods and draw it to required sizes and then in Nail making machine make Steel nails of different sizes. The other major inputs for manufacturing Nails are Polypropylene, Copper wire, Paper tape and packing material like cartons, pallets etc...The applicant purchases these raw materials from the other registered taxable persons within the State and also from outside the State of Telangana and avail GST input tax credit on all the materials purchased as stated above. Output tax on Nails supplied in the course of business is regularly paid as per the provisions of the GST Act. During the manufacturing process steel scrap is also generated which the applicant sells in the market and GST liability is paid / set off on the same against the GST input.

Manufacturing process:

Steel wire rod is drawn in wire drawing machine for required sizes and then in Nail making machine Steel nails of different sizes are manufactured. Once steel Nails are manufactured, they are further collated through collating machines by using the collation material like Polypropylene, Copper wire, Paper tape. Once Nails are collated they are packed in Cartons and then all these cartons are palletized on wooden pallets for sales purpose as a Finished goods.

It is submitted by the applicant that on 17th Dec '2022 fire broke out in the applicant's factory premises and major quantities of Finished goods as stated above are destroyed and now these finished goods can be sold only as a steel scrap in the market.

The applicant submitted that he has already claimed the input tax credit on all the raw materials and other inputs for manufacturing of Steel Nails in the month in which they are procured from the registered taxable persons under the GST Act as per Section 16 of the CGST Act

The applicant submitted that according to Section 17 (5) (h) of the CGST Act, input tax credit shall not be available in respect of the goods lost, stolen, destroyed, written off or disposed of way by of gift or free samples. In the applicant's case, the goods purchased from the GST registered taxable persons are not destroyed but they are used in the manufacturing of finished goods and the finished goods are destroyed in the fire accident and these burnt finished goods can be sold only as scrap in the market and output tax liability will be paid on such supply of scrap under the GST Act.

STATEMENT containing the applicant's interpretation of law and/or facts, as the case may be in respect of the aforesaid question (i.e. applicant's view point and submissions on Issues on which the advance ruling is sought):

1. That according to Section 16 (1) of the CGT Act, every registered person shall, subject to such conditions and restrictions as may be prescribed and in the manner specified in Section 49, be entitled to take credit of input tax charged on any supply of goods or services or both to him which are used or intended to be used in the course or furtherance of business and the said amount shall be credited to the electronic credit ledger of such person.

2. That as per the above provision under the CGST Act, a registered person is entitled to take input tax credit on the goods used or intended to be used in the course of business. In the case of the applicant, the goods/service received from registered taxable persons are already used in the manufacturing process and new commercial commodity is emerged than the different inputs used in such manufacturing activity. These inputs and input services are not destroyed in the fire accident as already by the time of fire accident they are used in the manufacturing of finished goods and lost their identity. The relevant expenditure is then business expenditure.

3. That according to Section 17 (5) (h) of the CGST Act, input tax credit shall not be available in respect of the goods lost, stolen, destroyed, written off or disposed of way by of gift or free samples. It is submitted that the goods destroyed in the applicant's case is finished goods and these finished goods are not procured from any registered taxable person under the Act and therefore the question of availing Input tax credit/restriction of such availed input tax credit in respect of the finished goods does not arise.

4. That as per Section 2(62) of the CGST Act, 'input tax' in relation to a registered person, means the GST charged on any supply of goods or services or both made to him. It is submitted that the applicant availed ITC on inputs and input services which are already used in the manufacturing process.

5. That the words used in Section 17 (5) (h) with regard to non-availability of input tax credit is in respect of. It is therefore important to understand the ambit of the phrase 'in respect of and whether the same would extend to raw material which are already consumed in the final product.

6. That to understand the scope of the phrase 'in respect of, reference is made to State of Madras Vs. Swastik Tobacco Factory AIR 1966 SC 1000 wherein the Court was examining the phrase in respect of used while granting deduction of excise duty paid in respect of goods sold. While the Revenue argued that 'in respect of here is synonymous with 'on' and narrows down the scope of the phrase to only those goods 'on' which excise duty was paid, the assessee argued that the phrase was wide enough to cover even cases where excise duty paid on raw materials can be attributed to the finished goods. The Court rejected the argument of the assessee and held that 'in respect of in the context can only mean goods 'on' which excise duty was paid and not on raw materials which are attributable to the final product.

7. That even though the above case was not pertaining to destruction of finished goods, a similar interpretation can be adopted for the purpose of 'in respect of used in Section 17(5)(h) of the CGST Act Accordingly, ITC can be disallowed only 'on' those input goods which are lost, stolen, destroyed, etc.

8. That in light of the above analysis, it emerges that there has to be a matching of the identity of goods on which credit is take and on which credit is denied under Section 17(5)(h). Thus, while applying the said Section, the "identity test" of the goods needs to be considered i.e. ITC can be denied only on those specific goods on which credit is taken. Once the goods on which credit is taken are consumed in the final product and lose their identity, then, ITC reversal cannot be demanded.

9. That accordingly, it can be said that the ITC restriction does not extend itself to inputs contained in the finished goods after being put to use.

10. That a similar interpretation was taken by the Maharashtra Authority for Advance Ruling in General Manager Ordnance Factory Bhandara, 2019 (26) G.S.T.L. 423 (A.A.R. GST), where it was held that "where inputs are used, they cease to -- exist and they being destroyed, lost or stolen will not arise. Therefore, once the inputs are used in manufacture of final products, which are then sent for testing purposes, then in such a case the said inputs cannot be considered to have been destroyed."

11. That when inputs are properly/fully utilized in the manufacturing of finished goods, the same cease to exist and thus, credit availed on said inputs is not required to be reversed in the event of destruction of finished goods in fire.

12. That when the finished goods are destroyed in fire accident and the destroyed finished goods are sold as scrap also input tax credit is available for the reasons mentioned above. It is also submitted that in this case, on the supply of scrap output tax liability is liable to be paid at the applicable rates under the GST Act.

5. QUESTIONS RAISED:

The applicant seeks clarification with regard to eligibility of input tax credit on the raw materials purchased for manufacture of finished goods i.e. whether already claimed ITC is required to reversed or not in the following circumstances.-

i) When the raw materials purchased are already used in the manufacture of finished goods and the finished goods are destroyed in the fire accident completely

ii) When the raw materials procured are lost in the fire accident before use in manufacture of finished goods.

iii) When the destroyed finished goods can be sold as steel scrap in the open market and output tax liability on such supply of scrap is paid.

DISCUSSION & FINDINGS:

It is a general rule of interpretation of a statute that it must be read as a whole in its context. The Hon'ble Supreme Court of India in the case of Uninor India Vs Elephintstone spinning and weaving company limited (2001) 4 SCC 139 (Constitution bench) has adopted the statement from a catena of earlier case law that when the question arises as to the meaning of a certain provision in a statute, it is not only legitimate but proper to read the provision in its context. The context here means, the statute as a whole, the previous state of the law, other statutes in pari materia, the general scope of the statute and the mischief that it was intended to remedy. The Hon'ble Supreme Court in an earlier case of Philips India Limited Vs Labour Court (1985) 3 SCC 103 held that it is a rule now firmly established that the intension of the legislature must be found by reading the statute as a whole. This rule referred to as "elementary rule" was followed in many national and international cases. It is spoken of construction 'ex visceribus actus' i.e., every part of the statute must be construed within the four corners of the Act.

In this context the legislative intent for allowing input tax credit under Section 16 has to be gathered from the conditions under which restrictions to claim the same arise under Section 17 of the CGST Act, 2017.

Section 17(2) of the CSGT Act, 2017 concludes with the clause "The amount of credit shall be restricted to so much of input tax as is attributable to the taxable supplies including zero rated supplies". Therefore the input tax credit on the purchases made in the context of Section 17(2) has to be restricted to the taxable supplies only. This Section is further buttressed by Section 18(4) where in the condition of debiting or paying back the input tax already claimed is clearly enumerated. The sub section is abstracted hereunder.

"(4) Where any registered person who has availed of input tax credit opts to pay tax under section 10 or, where the goods or services or both supplied by him become wholly exempt, he shall pay an amount, by way of debit in the electronic credit ledger or electronic cash ledger, equivalent to the credit of input tax in respect of inputs held in stock and inputs contained in semi-finished or finished goods held in stock and on capital goods, reduced by such percentage points as may be prescribed, on the day immediately preceding the date of exercising of such option or, as the case may be, the date of such exemption:

PROVIDED that after payment of such amount, the balance of input tax credit, if any, lying in his electronic credit ledger shall lapse."

It is seen from the above statute that once the output becomes non-taxable for any reason the input tax already utilized pertaining to the corresponding inputs has to be reversed or paid back. Under this statute this reversal will apply to the portion of input tax relatable to,-

i. Inputs held in stock.

ii. Inputs contained in semi finished or finished goods in stock.

iii. Capital goods.

Further under Section 17(5)(h) clearly mentions that input tax shall not be availed in respect of "goods lost, stolen, destroyed, written off or disposed of by way of gift or free samples".

The above statutory provision of the Act has to be interpreted in the context of other statutory provisions i.e., 17(2) and 18(4) and the meaning has to be discerned by applying the principle discussed above i.e., 'ex visceribus actus'. The scheme of the Act becomes clear from the combined reading of three provisions that input tax credit is available to a taxable person only when such taxable person makes taxable supplies. When the taxable supplies are not made input tax credit is not available under Section 17(2) and 17(5)(h). If the input tax credit is already utilized such credit needs to be paid back as given under Section 18(4).

Therefore the input tax credit to the extent of manufactured goods destroyed or inputs destroyed is not available to the applicant and the same needs to be paid back either through the credit available in the credit ledger or by cash.

Scrap sold by the applicant is nothing but a destroyed goods therefore in the context of above discussion sale of scrap i.e., sale of destroyed goods are not eligible for input tax credit.

In view of the foregoing, we rule as follows:

The applicant seeks clarification with regard to eligibility of input tax credit on the raw materials purchased for manufacture of finished goods i.e. whether already claimed ITC is required to reversed or not in the following circumstances:

ITC on gifts under GST

It is well known that there are no free lunches in this world, esp. in business. At the same time, there are several schemes available in the market which promise assured gifts to customers. Such gifts for example could be free cars to purchasers of flats, or giving gold coins for purchases done above certain value by customers.

The term 'gift' has not been defined in the GST law. When a term is not defined under GST, we may refer to the definitions under other laws. The Gift Tax Act has defined the word 'gift 'to mean transfer by one person to another of any existing moveable or immoveable property voluntarily and without consideration in money or money's worth.

The Supreme Court cited the definition of 'gift' from Corpus Juris Secundum, Volume 38 in Sonia Bhatia v. State of UP [1981] 2 SCC 585 as follows: A 'gift' is commonly defined as a voluntary transfer of property by one to another, without any consideration or compensation therefore. A 'gift' is a gratuity and an act of generosity and does not require a consideration, but there can be none; if there is a consideration for the transaction, it is not a gift.

It can be concluded from above that gift is gratuitous and does not require consideration. Conversely if consideration is attached to any transaction, it cannot be called as gift. Love and affection maybe non-legal consideration in respect of a gift, but there cannot be monetary consideration for a gift. Further gift cannot arise under a contractual obligation.

Restriction on availment of credit on gifts

Section 16 of GST Act gives conditions for availment of credit on goods/services used in course of business. Section 17(5) of the CGST Act sets out the blocked credit list. In section 17(5)(h), ITC shall not be available in respect of goods lost, stolen, destroyed, written off or disposed of by way of gift or free samples.

Section 17(5) itself starts with a non obstante clause, which means even if Section 16 allows the credit, as conditions for taking of credit are satisfied, but Section 17(5) shall block the credit in respect of certain cases. Moreover, Section 17 (5) is a specific provision. It is an established principle that specific provision prevail over general provisions. This doctrine has always been upheld. The cases on the subject would be found in the Third Edition of Maxwell which is 'generalia specialibus non derogant' - i.e. 'general provisions would not abrogate special provisions.'

If there is dispute between Section 16 and Section 17(5), then Section 17(5) over rides Section 16. In other words, if something qualifies for ITC under section 16 but is blocked from ITC under section 17(5) then ITC would not be available.

ITC on goods given away or disposed as 'gifts' should not be available when no tax is being paid on their disposal, even though such gifts are given in course of business of supply of taxable goods/services.

The intention which is behind the restriction given in Section 17(5)(h) seems to be that it tries to restrict people from giving benefits- in kind or in lieu of cash/ goods nomenclated as so called 'gifts'to avoid levy of GST. When gold coins/other items are given as free supplies without consideration in course of business, then it maybe covered as 'gifts' and ITC restricted on same.

In a different scenario, a business man may give branded diaries/calendar at New Year time, given for publicity, target based schemes where items such as fridge/TV etc are given as incentives under promotional schemes for distributors/retailers. Whether such goods which are given can be said to be gifts or goods given which are related to business?

When such items are not given unless customer satisfies certain criteria laid under scheme, then it may be said to be given in course of business. Such goods given to customers, may not satisfy conditions to treat as gift when-giving away such items to customer is not a voluntary act noras a gift distributed to customer.

When the goods nomenclated as 'gifts' are given as measure of sales promotion or are given for reaching certain sales/turnover targets, then it maybe said to be given 'in course of business 'and may not actually be 'gifts' but given under contractual obligations. The input tax credit may be availed on such goods given away for marketing/promotion to dealers by the supplier. However the supplier who avails credit on such goods given as sales promotion measure, has to have document to establish why it is not gift, to ensure the credit on such goods is not denied at future date.

An additional aspect which may have to be seen is if the said goods are given as consideration[non-monetary] in exchange for the sales promotion/marketing services supplied by the customer such as a distributor to the manufacturer. Further if the goods are given as barter against such supply of promotion services by customer, then the manufacturer has to raise tax invoice charging GST on the goods given away and may avail corresponding credit as well.

Under GST law, the intention is to restrict the credit in scenario where there is no outward supply. When the item is merely called as 'gift' but there is extra commercial consideration for same, then it is treated as supply of goods for a consideration, taxable to GST. Once it is taxable supply, corresponding credit maybe availed.

Further Schedule I of GST Act, deals with activities to be treated as supply even when done without consideration. Supply of goods/services between distinct/related persons is deemed as supply even when done without consideration. In light of this entry, supply of goods is in course or furtherance of business, between related persons/branches located in different states is treated as supply, even when done without consideration.

Employee is related person of employer-company. However there is exemption for gifts not exceeding Rs 50000 pa given by employer to employee. When gifts given exceeds Rs. 50000 per employee per year, it is taxable to GST.

Relevant aspects on promotion schemes- Circular No. 92/11/2019-GST

Free samples and gifts

Where the activity of distribution of gifts falls within the scope of supply on account of the provisions contained in Schedule I of the said Act, the supplier would be eligible to avail of the ITC.

Buy one get one free offer:

1. Sometimes, companies announce 'Buy One, Get One free' offers. For example, buy one soap and get one soap 'free'.

It may appear that one item is being supplied 'free of cost' without any consideration. In fact, it is not an individual supply of free goods but a case of two or more individual supplies where a single price is being charged for the entire supply. It can be treated as supplying two goods for the price of one.

2. Taxability of such supply will be dependent upon as to whether the supply is a composite supply or a mixed supply and the rate of tax shall be determined accordingly.

It is also clarified that ITC shall be available to the supplier for the inputs, input services and capital goods used in relation to supply of goods or services or both as part of such offers.

Paper writer note: Example-for mixed supply, when fridge is given as 'free' when AC is purchased, where single price is charged, taxed at highest applicable rate of tax

Recent Advance ruling on gifts

In Biostadt India Ltd (Dated: December 20, 2018) 2019-TIOL-59-AAR-GST

Facts: The gold coins distributed to the customers at the end of the scheme for achieving stipulated lifting or payment criteria.

Issue: Whether credit is available on gold coins given to customers when they satisfy certain conditions?

Held: ITC not admissible on procurement of Gold coins. ITC not available on gifts' when no GST is being paid on their disposal, section 17(5) of the CGST Act, 2017 blocks such credits: AAR

Note:

Advance ruling is applicable to assessee who has sought it and to his set of facts It has limited persuasive value for others, unless it is in line with provisions of GST law.

In light of specific restriction on credit on gifts, the companies may take call to go for discount instead of promotional items as a business decision, to be done based on customer preferences.

Author's Suggestion

Input tax credit of goods or services covered under the provisions of section 17(5) is inadmissible as the same is blocked under Section 17 (5) and is hence it is advised don’t take ITC on it. Taxpayer will be liable to reverse claimed ineligible ITC before issuance of notice by the department in GSTR-3B as soon as detected claim of ineligible ITC along with Interest at the rate of 18%  per annum starting from the date of filing of GSTR-3B with wrong ITC till the date of its reversal. If not utilized the claimed ITC then no interest is required.