Madras High Court Ruling On GST Credit Will Impact Pharma, Textile Sectors

In August, the Gujarat High Court allowed a footwear company to claim refund of unused goods and services tax credit. But last week, infrastructure, textiles, food and refining businesses were denied similar relief by the Madras High Court.

Until the Supreme Court rules on the matter, contrary rulings by the high courts will create confusion. Businesses in Tamil Nadu will face cash-flow challenges and structural inefficiencies, legal experts said. This adverse impact may extend to taxpayers in other states as well since the department is likely to rely on the Madras High Court ruling.

Inverted Duty Structure

At the heart of it lies a 2018 amendment to the Central GST law on inverted duty structure.

This arises when businesses pay a higher tax on inputs than on the output, resulting in accumulation of unused tax credits. While the law initially allowed refund on input goods and input services, the 2018 amendment excluded services from the scope of refunds.

Companies argued before the Madras High Court that the Central GST Act never contemplated a source-based difference for refund of tax credits. And this differentiation was brought in by the government by way of rules. The act intended businesses to claim refunds on the entire accumulated credit—on account of both goods and services—without any further limitation, they said.

The GST department said a source-based limitation for using tax credit is a “legitimate exercise”. And that such classification exists under GST as well as earlier indirect tax laws.

Limitation On Refunds Valid, Says Madras High Court

A two-member bench of Chief Justice A P Sahi and Justice S Ramamoorthy dismissed the companies' arguments saying exclusion of input services is a valid exercise under the legislative powers of the government. It held:

• The Gujarat High Court failed to consider the scope of a proviso to section 54 of the CGST law. This section limits the entitlement of refund only in the manner specified by the government through the CGST Rules. [To reiterate, it's these rules that excluded services from the scope of ‘input' against which businesses can claim credit.]
• The refund related provisions qualify and curtail both—the class of businesses as well as the source of tax credit against which a refund can be availed.

The ruling will adversely impact businesses which have substantial accumulated credits arising from input services.

Services attract a GST rate of 18% under the existing tax structure. Companies which rely on services for manufacturing their final product incur costs on intrinsic and common services like contract labour, internet, and phones, etc. However, most goods sold to the ultimate consumer carry a rate of 5% or 12%.

The expectation of taxpayers was that the accumulated credit, as result of excess tax paid on input services, would be available to them as refunds. But now taxpayers have been denied this refund by the Madras High Court.

The ruling will impact cash-flow, permeate structural inefficiency and diminish comparative advantage for different sectors of the economy, Ajinkya Gunjan Mishra, partner at L&L Partners, told BloombergQuint.

The GST authorities may rely on this judgment for denying relief to companies claiming tax credit refund.

The issue will now certainly reach the apex court but the wait to get a decision could be excruciatingly long, Jigar Doshi, partner at TMSL LLP, said. In the interim, except for Gujarat and Tamil Nadu, the rest of country would have two decisions to follow with opposite conclusions, which may lead to a perplexing situation, he said.

Affected industries such as e-commerce, fertilisers, steel utensils, railway wagons and many others may have to put such refunds in abeyance, Doshi added.