Union Of India vs Vkc Footsteps India Pvt. Ltd. on 13 September, 2021

1. Outcome
The Supreme Court allowed the appeals filed by the Union of India, setting aside the judgment of the Gujarat High Court (which had permitted refund of Input Tax Credit on input services in inverted duty structure cases). Conversely, the Court dismissed the appeals filed by the assessees against the Madras High Court judgment, thereby affirming the Madras High Court's view that such refunds are not permissible. The Court urged the GST Council to reconsider the formula prescribed in Rule 89(5) of the CGST Rules to address certain inequities.

2. Core Issue
The core issue was the interpretation of Section 54(3) of the Central Goods and Services Tax Act, 2017 (CGST Act) and the validity of Rule 89(5) of the Central Goods and Services Tax Rules, 2017 (CGST Rules). Specifically:
* Whether refund of unutilised Input Tax Credit (ITC) accumulated due to an inverted duty structure includes ITC on 'input services' in addition to 'input goods'.
* Whether Rule 89(5) of the CGST Rules, which restricts the definition of "Net ITC" for such refunds to "input goods" only, is ultra vires Section 54(3) of the CGST Act or violates Articles 14/19 of the Constitution.
* The validity and workability of the formula prescribed in Rule 89(5).

3. Key Facts
* Assessees were engaged in manufacturing or providing services where the output GST rate (e.g., 5%) was lower than the GST rate on input goods and input services (e.g., 12% or 18%), leading to an accumulation of unutilised ITC.
* Originally, Rule 89(5) of the CGST Rules (effective from 1 July 2017) allowed refund of ITC on both input goods and input services for inverted duty structures.
* Subsequently, Rule 89(5) was amended (retrospectively effective from 1 July 2017) to redefine "Net ITC" to mean ITC availed on "inputs" only, effectively excluding input services from the refund calculation.
* The Gujarat High Court held that the amended Rule 89(5), by denying refund of ITC on input services, was ultra vires Section 54(3) of the CGST Act.
* The Madras High Court took a contrary view, holding that Section 54(3)(ii) does not infringe Article 14 and that restricting the refund to input goods was a valid classification and exercise of legislative power.
* The Supreme Court heard appeals against both High Court judgments to resolve this divergence.

4. Arguments

• Revenue (Union of India):

  • Goods and services are distinct at both constitutional (Articles 366(12), 366(26A)) and statutory (CGST Act Sections 2(59) 'input' for goods, 2(60) 'input service' for services) levels.
  • Section 54(3) permits a claim for refund of "any unutilised ITC," but its first proviso acts as a restriction, stating "no refund... shall be allowed in cases other than" the two specified situations.
  • Proviso (ii) to Section 54(3) specifically refers to "rate of tax on inputs," which by definition (Section 2(59)) means goods other than capital goods. This intentional omission excludes input services.
  • Explanation-I to Section 54 defines "refund" explicitly for zero-rated supplies to include ITC on "inputs or input services," but for inverted duty structures, it refers back to Section 54(3), reinforcing the distinction.
  • Refund is a statutory right, not a fundamental right, and can be regulated by legislative conditions and limitations. Tax legislation enjoys wide latitude in classification; goods and services are not the same class.
  • The doctrine of reading down cannot be used to expand the scope of a statutory provision for refund.
  • Rule 89(5) is a valid exercise of delegated legislation under Section 164 to bifurcate ITC as it becomes a homogenous pool in the electronic ledger after availing credit.
  • Economic legislation is empirical and allows for crudities; imperfections in the formula do not render it unconstitutional.

• Taxpayer (Assessees):

  • GST aims for tax neutrality and elimination of cascading effects. Denying refund on input services defeats this fundamental objective, as businesses are merely pass-through entities.
  • The main part of Section 54(3) allows refund of "any unutilised ITC," which, based on definitions in Sections 2(62) and 2(63), includes both input goods and input services.
  • The first proviso to Section 54(3) merely sets conditions of eligibility (cases), not restrictions on the quantum of refund. Once the inverted duty structure condition (based on input goods) is met, the entire unutilised ITC (including input services) should be refunded.
  • The term "inputs" in proviso (ii) should be interpreted contextually to include both input goods and input services, in line with the harmonized GST structure envisioned by Article 279A(6) and the overall treatment of goods and services in the CGST Act.
  • Rule 89(5) is ultra vires Section 54(3) because it curtails the scope of refund beyond the principal statute by excluding input services from "Net ITC."
  • The formula in Rule 89(5) is inherently flawed and discriminatory (violating Article 14) because it deducts the entire output tax from only the ITC on input goods, implicitly assuming no utilisation of input service ITC. This leads to anomalies and less refund.
  • The retrospective amendment to Rule 89(5) takes away vested or accrued rights.
  • The doctrine of reading down or severability should be applied to strike down "on inputs" in the definition of "Net ITC" in Rule 89(5) to make it consistent with Section 54(3) and the Constitution.

5. Court’s Reasoning

• Interpretation of Section 54(3): The Court held that the main part of Section 54(3) allows a "claim" for "any unutilised ITC", but the first proviso is a clear and explicit "restriction" on what "shall be allowed". The phrase "no refund... shall be allowed in cases other than" implies that refunds are only permitted in the two specified categories.

  • Crucially, the Court noted the legislative distinction: Clause (i) of the first proviso (zero-rated supplies/exports) explicitly covers ITC on "inputs or input services." In stark contrast, Clause (ii) (domestic inverted duty structure) specifically refers to "rate of tax on inputs."
  • "Input" is defined in Section 2(59) of the CGST Act as "any goods other than capital goods." The Court found no reason to interpret the plural "inputs" differently, holding that expanding it to include input services would do violence to the statutory language.
  • Explanation-I to Section 54 further solidifies this distinction, defining refund for exports comprehensively (including input goods and services) but for domestic inverted duty cases, referring specifically to "as provided under sub-section(3)", thereby upholding the restriction to input goods.
  • The Court emphasized that it cannot re-write legislative boundaries based on an ideal GST framework or economic doctrines. Fiscal policy choices are within the legislative domain.

• Constitutional Validity (Article 14): The Court rejected the argument that denying refund on input services violates Article 14.

  • It reiterated that tax laws enjoy wide legislative latitude in classification, and discriminatory treatment is not per se invalid if based on a rational differentiation.
  • Goods and services, and input goods and input services, are distinct species in the constitutional and statutory scheme, allowing for differentiated treatment.
  • There is no constitutional right to refund; it is a matter of statutory prescription. Parliament has the authority to define the circumstances for refund.
  • The Court cannot substitute its wisdom for legislative choices, which involve complex policy balances.

• Validity of Rule 89(5):

  • The Court upheld the validity of Rule 89(5), stating that the power to make rules under Section 164 is broad and not confined to sections explicitly using the term "prescribed."
  • Rule 89(5) defining "Net ITC" as "input tax credit availed on inputs" is not ultra vires Section 54(3), as it is consistent with the Court's interpretation that Section 54(3)(ii) restricts refunds in inverted duty structures to ITC on input goods only. To strike down "on inputs" would impermissibly expand the statutory ambit of refund.
  • The Court acknowledged "anomalies" and "inequities" in the formula (e.g., deducting total output tax from only the input goods component of ITC), but held that an anomaly per se does not invalidate a fiscal rule framed under delegated legislation.
  • The Court emphasized that it would not re-craft the formula, as this would be judicial encroachment into legislative/executive policy, citing the principle from RK Garg v. Union of India.
  • However, recognizing the pointed out anomalies, the Court strongly urged the GST Council to reconsider the formula and take a policy decision.

6. Statutory References

• Constitution of India: Articles 14, 19(1)(g), 19(6), 246, 246A, 254, 265, 269A, 279A(4), 279A(6), 366(12), 366(12A), 366(26A), 366(29A).
• Central Goods and Services Tax Act, 2017 (CGST Act): Sections 2(52), 2(59), 2(60), 2(62), 2(63), 2(67), 2(82), 2(83), 2(87), 2(102), 2(106), 2(112), 2(119), 9, 16, 16(1), 16(2), 16(3)(a), 17, 17(1), 17(2), 17(5), 18(3), 22(3), 23(1)(b), 31(2), 37, 39, 41, 46, 49, 49(1), 49(3), 49(4), 49(5), 49(6), 54, 54(1), 54(3), 54(3)(i), 54(3)(ii), 54(6), 54(8), 54(10), Explanation 1 to Section 54, 164, 164(1), 164(3), 171.
• Central Goods and Services Tax Rules, 2017 (CGST Rules): Rules 3, 42, 42(1), 43, 86, 86(3), 89(3), 89(4), 89(5), 89(5) Explanation (a).
• Integrated Goods and Services Tax Act, 2017 (IGST Act): Sections 5(3), 5(4), 16(3).
• Gujarat Value Added Tax Act: Section 11.
• Gujarat Value Added Tax Rules 2006: Rule 15(6).
• Maharashtra Value Added Tax Act 2002: Section 51.
• Maharashtra Value Added Tax Rules 2005: Rule 60.
• Finance Act 1994: Sections 65(12), 65(105)(zm).
• Income Tax Act 1961: Sections 10-A, 17(2), 28, 80-HHC(3), 80-HHE.

7. Precedents Cited
1. VKC Footsteps India Pvt. Ltd. v. Union of India, R/ Special Civil Application No 2792 of 2019 (Gujarat High Court)
2. Tvl. Transtonnelstroy Afcons Joint Venture v. Union of India, Writ Petition Nos 8596, 8597, 8602, 8603, 8605 and 8608 of 2019 (Madras High Court)
3. Mafatlal Industries Limited v. Union of India, (1997) 5 SCC 536
4. All India Federation of Tax Practitioners v. Union of India, (2007) 7 SCC 527
5. Association of Leasing and Financial Service Companies v. Union of India, (2011) 2 SCC 352
6. Hiralal Rattanlal v. State of UP, (1973) 1 SCC 216
7. CIT v. Bipinchandra Maganlal & Co. Ltd., Bombay, AIR 1961 SC 1040
8. State of Rajasthan v. Leela Jain, AIR 1965 SC 1296
9. Bihar Cooperative Development Cane Marketing Union Ltd. v. Bank of Bihar, AIR 1967 SC 389
10. S Sundaram Pillai v. V R Pattabiraman, (1958) 1 SCC 591 (Note: commonly cited as (1985) 1 SCC 591)
11. Assistant Commissioner of Urban Land Tax v. Buckingham and Carnatic Co. Ltd., (1969) 2 SCC 55
12. Federation of Hotel & Restaurant Association of India v. Union of India, (1989) 3 SCC 634
13. Union of India v. NITDIP Textile Processors Private Limited, (2012) 1 SCC 226
14. Assistant Commissioner of Commercial Tax (Asst.) v. Dharmendra Trading Company, (1988) 3 SCC 570
15. Elel Hotels and Investments Limited and Others v. Union of India, (1989) 3 SCC 698
16. Spences Hotel Pvt Ltd. v. State of West Bengal, (1991) 2 SCC 154
17. State of Jammu & Kashmir v. Triloki Nath Khosa, (1974) 1 SCC 19
18. Re The Special Courts Bill, 1978, (1979) 1 SCC 380
19. Kerala State Electricity Board v. Indian Alluvium Co. Ltd., (1976) 1 SCC 466
20. Bharat Hari Singhania v. Commissioner of Wealth Tax (Central), (1994) Supp 3 SCC 46
21. Commissioner of Income Tax, Coimbatore v. Lakshmi Machine Works, (2007) 11 SCC 126
22. Commissioner of Income Tax v. HCL Technologies Limited, (2018) 16 SCC 709
23. Arun Kumar and Others v. Union of India, (2007) 1 SCC 732
24. RK Garg v. Union of India, (1981) 4 SCC 675
25. Morey v. Doud, 351 US 457 (1957)
26. Secretary of Agriculture v. Central Roig Refining Company, 94 L Ed 381 (1950)