Supreme Court Upholds Constitutionality of Section 17(5) of the CGST Act, Denying Input Tax Credit (ITC) on Construction Services Used for Renting Out Commercial Properties

Court’s Decision:

The Supreme Court upheld the validity of Section 17(5)(c) and (d) of the Central Goods and Services Tax (CGST) Act, 2017, ruling that the denial of Input Tax Credit (ITC) on goods and services used in the construction of immovable properties intended for renting or leasing is not unconstitutional. The Court emphasized that the legislative intent behind this provision is to prevent the cascading effect of taxes, which is fundamental to the GST regime.

Facts:

1. The petitioners are engaged in the construction of commercial properties such as shopping malls, which they subsequently lease out for rental income.
2. They sought to claim ITC for the GST paid on goods and services used in constructing these properties.
3. The dispute revolves around Section 17(5) of the CGST Act, which prohibits claiming ITC for construction services used to create immovable property, even if the property is later used for taxable supplies like renting.
4. The petitioners argued that the denial of ITC would result in a cascading tax burden, making their business operations economically unviable.

Issues:

1. Whether the denial of ITC under Section 17(5)(c) and (d) of the CGST Act, 2017, for goods and services used in the construction of immovable property, violates the Constitution.
2. Whether the terms “plant and machinery” and “plant or machinery” used in different parts of the provision lead to ambiguity, requiring judicial interpretation.
3. Whether Section 17(5) violates the fundamental principles of the GST regime by denying credit on business expenses.

Petitioner’s Arguments:

1. Violation of Articles 14 and 19(1)(g): The petitioners contended that the provision is arbitrary, treating those engaged in leasing activities similarly to those who construct properties for sale. This, they argued, contravenes the principle of equality.
2. Cascading Effect of Taxes: They emphasized that denying ITC results in a double taxation burden, as GST is levied on both the construction inputs and the rental income.
3. Interpretation of “Plant or Machinery”: The petitioners argued that the expression “plant or machinery” in Section 17(5)(d) should be read distinctly from “plant and machinery” to include their properties, making them eligible for ITC.
4. Principle of Reading Down: They urged the Court to read down Section 17(5)(d) to allow ITC for properties used to generate taxable supplies such as renting or leasing.

Respondent’s Arguments:

1. Rational Nexus for Classification: The Revenue argued that the classification of immovable properties for the purposes of ITC was based on an intelligible differentia, with a rational nexus to the object of preventing tax evasion and misuse of ITC.
2. Statutory Right, Not Constitutional: ITC is a statutory right, not a constitutional one. The legislature is empowered to restrict ITC to maintain the integrity of the GST system.
3. Avoiding Unintended Benefits: The denial of ITC ensures that businesses do not claim both ITC and depreciation benefits simultaneously, which would be against the GST’s objective.

Analysis of the Law:

1. The Court analyzed the legislative history and intent behind the introduction of Section 17(5) and found that the restrictions were introduced to curb the misuse of ITC and to maintain the tax neutrality of GST.
2. The expression “plant or machinery” in Section 17(5)(d) was interpreted in light of the definition provided in the explanation to the provision. The Court held that the use of “or” instead of “and” was deliberate and cannot be altered to expand the scope of ITC.
3. The principle of “reading down” a statutory provision was discussed, with the Court observing that it should only be applied to cure manifest injustice or constitutional infirmity, neither of which was present in this case.

Precedent Analysis:

1. The Court relied on Eicher Motors Limited v. Union of India, where it was held that the purpose of ITC is to prevent cascading taxes, but the legislature has the authority to limit its application.
2. The Court also referred to the decision in Bharti Airtel Limited v. Union of India, emphasizing that ITC is a statutory concession, not a vested right.

Court’s Reasoning:

1. The Court observed that the denial of ITC under Section 17(5) is consistent with the GST framework’s goal of preventing tax evasion.
2. The Court rejected the argument that Section 17(5) is arbitrary, holding that it treats similarly situated assessees equally and does not violate the principles of equality under Article 14.
3. The provision’s intent is to prevent assessees from benefitting disproportionately by claiming ITC on properties used for rental income, which would lead to revenue loss for the exchequer.

Conclusion:

The Supreme Court upheld the constitutionality of Section 17(5)(c) and (d) of the CGST Act, ruling that the denial of ITC on goods and services used in the construction of immovable properties for leasing is valid. The Court emphasized that the provision aims to prevent the cascading effect of taxes and protect the GST regime’s integrity.

Implications:

The decision clarifies that businesses engaged in leasing or renting commercial properties cannot claim ITC on construction expenses, thereby increasing the cost of business operations in this sector. The ruling may prompt businesses to restructure their operations to minimize the impact of the disallowed ITC. The judgment sets a precedent for interpreting ITC provisions, reaffirming that statutory rights are subject to legislative intent and cannot be read expansively.

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