With the number of notifications and circulars issued in the last 3 months of monsoon it seemed like GST just had a monsoon budget announcement. Right from the day GST was introduced its been common to see majority of changes being announced in GST Council meetings instead of making them a part of the budget announcements.

Background

Section 16 of the Central Goods and Service Tax Act, 2017 (‘CGST Act, 2017’) deals with conditions to be satisfied for availment of Input Tax Credit (‘ITC’). Second Proviso to section 16(2) deals with the provisions for failure on the part of recipient to pay to the supplier the amounts towards the value of supply along with tax payable thereon within a period of one hundred and eighty days from the date of issue of invoice by the supplier.

Further, the third proviso allows the recipient to re-avail the credit of input tax on payment made towards the value of supply of goods or services or both along with tax payable thereon.

The main intention behind the proviso is to curb the menace of fake invoicing where the recipient does not pay the supplier the value of supply along with taxes and avails the credit in his returns. However, since the inception of the GST law, businesses have been struggling to comply with the provisions where the payment is not made within the designated timeline owing to the complications associated with the computation and re-availment of ITC reversed.  

Recently the provisions contained in Rule 37 (which deals with the detailed calculation as required in the proviso to section 16(2)) have been amended by way of notification No. 19/2022 dated 29 September, 2022 and have been brought into effect from 01 October 2022.

One of the important changes made in the article is that the word “proportionate” is missing in the amended rule with regard to reversal of ITC in case of non-payment to the vendor. In this article we seek to analyze the given provisions as well as the issues emanating therefrom.

Discussion on changes made in Rule 37 before amendment

A bare reading of the Rule 37 before 01 October, 2022 gives an understanding that in cases where the payment is not made within the timeline prescribed in section 16, amount of credit availed proportionate to the amount unpaid to the supplier shall be added to the output tax liability of the recipient.

Here, it is imperative to note that there can be various scenarios where the recipient may not make the payment in full including quality issues, settlement w.r.t to value of supply, commercial prudence, ITC amount not reflecting in GSTR 2A/2B etc. In all such scenarios, where only proportionate value of supply remains unpaid, the recipient would not be required to add the entire ITC in the outward liability, but only the proportionate unpaid amount.

However, vide the aforementioned notification, it can be seen that significant changes have been made to Rule 37 by way of amendment. The important changes are briefly discussed below –

Partial Payment Scenario

The word “Proportionate” has been ostensibly removed in the amended Rule 37(1) which raises a question as to whether the entire amount is now required to be reversed in case of failure on the part of the recipient to pay only a certain portion of the value of supply.

Additionally, interpretation of the proviso lies on the basis of words used “if the recipient fails to pay to the supplier”. The meaning of the concept failure to pay has not been defined under the Act or Rules. The meaning of non-payment, as given in the Black’s Law Dictionary, is:

“Failure to deliver money or other valuables, esp. when due in discharge of an obligation.”

Hence, a plain reading of the amended rule suggests that the entire credit is required to be reversed even if only a proportionate amount remains unpaid at the end of 180 days. The words ‘failure to pay’ is required to be interpreted qua the amounts remaining outstanding at the end of the 180 days.

There can be divergent views possible on the said amendment made in Rule 37 as the amended rule is silent about whether the taxpayers are liable to reverse the entire credit, even if only part of the value (and tax) is not paid within 180 days.

One view would be to consider the amended and earlier rule on the same level and not to reverse the entire ITC where part payment is not made. This gets support from Rule 37(2) which states that where the said registered person subsequently makes the payment of the amount towards the value of such supply along with tax payable thereon to the supplier thereof, he shall be entitled to re-avail the input tax credit referred to in sub-rule (1).

Basis the above, it can be very well interpreted that the law allows to re-avail ITC to the extent of the value of supply paid by the supplier to the recipient. Nowhere it has been mentioned that the entire /total amount is required to be paid then only ITC can be re-availed.

Another school of thought would be as the law has specifically removed the word “proportionate”, it should be read strictly and the entire amount of ITC is required to be reversed where part payment is not made.

The second view would fall harshly on the taxpayers as there are varied situation where the taxpayers settle for less amount with their vendors on the basis of negotiation in the value of supply. A detailed clarification would be welcome in this matter from the Council to remove the ambiguity in this area.

Provision in service Tax Regime

Under the erstwhile Finance Act, 1994, reference can be made to similar provision given under Rule 4(7) of Cenvat Credit Rules (CCR), 2004 which stated that   “…in case the payment of the value of input service and the service tax paid or payable as indicated in the invoice, bill or, as the case may be, challan referred to in rule 9 is not made within three months of the date of the invoice, bill or, as the case may be, challan, the manufacturer or the service provider who has taken credit on such input service, shall pay an amount equal to the CENVAT credit availed on such input service except an amount equal to the CENVAT credit of the tax that is paid by the manufacturer or the service provider as recipient of service, and in case the said payment is made, the manufacturer or output service provider, as the case may be, shall be entitled to take the credit of the amount equivalent to the CENVAT credit paid earlier subject to the other provisions of these rules:”

From a reading of the service tax law, it can be understood that even in the service tax regime, it was not very clear whether the entire amount of CENVAT is required to be reversed or only a certain portion which is proportionate to the non-payment of consideration.

However, in several judgements, the courts have favoured the taxpayers and held that Rule 4(7) disallows the proportionate amount of CENVAT credit to the extent the amount remaining unpaid by the recipient to the supplier. (CCE, JAIPUR-II VERSUS M/S HINDUSTAN ZINC LIMITED – 2013 (8) TMI 497 – CESTAT NEW DELHI).

Similarly, in the case of Hindustan Petroleum Corporation Limited (2019-TIOL-1763-CESTAT-HYD), Hon’ble Hyderabad CESTAT held that if payment for invoice is not made within three months, then assessee must refund CENVAT amount thereof. However, if part payment is made, credit can be availed to such extent.

Disclosure in GST Returns

It is to be noted that earlier amount of ITC AS referred to in Rule 37 as proportionate to the value of supply which remains unpaid to the supplier was to be added to the output tax liability of the registered person for the month in which the details were furnished.

However, now the above-mentioned proviso has been removed and further, GSTR 2 and GSTR 3 are no more relevant with effect from 01 October, 2022 and hence the reference is now made to furnish the details in Form GSTR 3B.

Therefore, it can be understood that now the amended Rule 37 provides for the reversal of the credit instead of the addition of the amount to the output tax liability. This is also in sync with the latest Circular issued by the GSTN – Circular No. 170/02/2022-GST dated 06 July, 2022 with respect to change in reporting requirement in GSTR 3B whereby reversal of ITC in case of failure under section 16(2) read with Rule 37 is required to be disclosed as  –

“Registered person will report reversal of ITC, which are not permanent in nature and can be reclaimed in future subject to fulfilment of specific conditions, such as on account of rule 37 of CGST Rules (non-payment of consideration to supplier within 180 days), section 16(2)(b) and section 16(2)(c) of the CGST Act in Table 4 (B) (2). Such ITC may be reclaimed in Table 4(A)(5) on fulfilment of necessary conditions. Further, all such reclaimed ITC shall also be shown in Table 4(D)(1). Table 4 (B) (2) may also be used by registered person for reversal of any ITC availed in Table 4(A) in previous tax periods because of some inadvertent mistake.”

Interest on failure of payment

Rule 37 as in existence prior to the amendment provided that the interest on the amount that will be added to the output tax liability shall be determined u/s 50(1) of the CGST Act, 2017 for the period starting from the date of availing credit on such supplies till the date when the amount added to the output tax liability is actually paid to the supplier.

It may be observed that unlike the old provision, the new provision does not mention the period for which interest is payable, but reference has been given to Section 50 of the Act. Therefore, now as the disclosure has changed from the outward liability to reversal of credit, the interest may not be calculated under section 50(1) as the same is with respect to failure to pay taxes.

Further, sub-section (3) of Section 50 read with Rule 88B(3) deals with undue or excess claim of input tax credit and specifies that the liability to pay interest would arise only if the credit is utilised. It clearly stipulates that interest for wrongly availed and utilised ITC shall be calculated for period starting from date of utilisation of said credit till the date of reversal of such credit. So, in a scenario where there is a balance available in the electronic credit ledger, no interest liability should arise.

Conclusion

Having quoted the above, the proviso to section 16(2) was intended to be an anti-evasion measure and to encounter the menace of fake transactions. The intention of the authorities for incorporation of the section is to avoid cases where the payment has not been made to the supplier also the tax amount is not deposited with the government.

With this intention it would be unfair on the recipient to disallow entire amount of ITC. It is feared that in the absence of clarity on numerous points in the amended rule, some of which are mentioned above, the department may initiate recovery proceedings of the entire ITC even if the significant part of the invoice value has been paid within 180 days.

Whilst the draft rules before GST implementation is similar to the amended Rule 37, and prima facie it appears that the intention is to disallow proportionate credit only in case of non-payment, it is high time that the trade and professional bodies represent before the council for a clarification to be issued in this matter as it is not too far that major litigation on this ground may start soon.

[The authors are Mr. Jigar Doshi, Founding Partner, TMSL and Ms. Priyal Malpani, Assistant Manager, TMSL. The views are personal.]

Mr. Jigar Doshi, Founding Partner, TMSL

Ms. Priyal Malpani, Assistant Manager, TMSL.