Supreme Court Upholds Punjab and Haryana High Court Ruling: “Vested ITC Rights Cannot Be Arbitrarily Reduced”; Strikes Down Retrospective Restriction on Input Tax Credit Before April 1, 2014

Court’s Decision

The Supreme Court dismissed the appeals filed by the State of Punjab, upholding the Punjab and Haryana High Court’s ruling that Rule 21(8) of the Punjab Value Added Tax Rules, 2005 (Punjab VAT Rules), which restricted input tax credit (ITC) for goods in stock, lacked legal validity before April 1, 2014.

The Court held that the State did not have the statutory power to retrospectively reduce ITC before April 1, 2014, when the enabling provision in the Punjab Value Added Tax Act, 2005 (Punjab VAT Act) came into force. It emphasized that ITC is a vested right and cannot be arbitrarily reduced through delegated legislation without statutory backing.

The ruling safeguards businesses from retrospective taxation changes, ensuring that ITC earned under previous tax rates remains valid unless explicitly revoked through statutory amendments.

Facts of the Case

1. Introduction of Rule 21(8) and ITC Restriction:
   • On January 25, 2014, the Punjab government issued a notification introducing Rule 21(8) in the Punjab VAT Rules.
   • The rule stated that when tax rates on goods in stock are reduced, the ITC on those goods would also be restricted to the new lower tax rate.
   • This meant that businesses that had paid VAT at a higher rate before February 1, 2014, would not receive full ITC at the previous rate. Instead, ITC would be capped at the new lower rate of tax applicable from February 1, 2014.
2. High Court Challenge by Traders & Manufacturers:
   • Trishala Alloys Pvt. Ltd. and other businesses challenged Rule 21(8) before the Punjab and Haryana High Court.
   • They argued that the Punjab VAT Act did not authorize the government to reduce ITC for stock-in-trade retrospectively.
   • They pointed out that the parent statute (Punjab VAT Act) was amended only later on April 1, 2014, which meant there was no legal authority for enforcing Rule 21(8) before that date.
   • The High Court agreed with this argument and declared Rule 21(8) invalid before April 1, 2014.
3. State’s Appeal to the Supreme Court:
   • The Punjab government appealed to the Supreme Court, arguing that Rule 21(8) was within its rule-making power and ITC should be adjusted to match the reduced tax rates.
   • The Supreme Court dismissed the appeal, holding that the rule was invalid before April 1, 2014, because the statutory amendment enabling such a restriction came into force only on that date.

Key Issues Before the Court

1. Did the Punjab government have the legal authority to enforce Rule 21(8) before April 1, 2014, restricting ITC on goods in stock?
2. Can a rule be introduced under delegated legislation (Punjab VAT Rules) before the parent Act (Punjab VAT Act) provides the necessary authority?
3. Does restricting ITC on pre-existing stock violate vested rights of taxpayers who had already paid VAT at a higher rate before the tax reduction?
4. Does Rule 21(8) violate the principle that tax laws should not operate retrospectively unless explicitly stated?

Petitioner’s (State of Punjab) Arguments

1. Rule 21(8) Was Lawfully Introduced Under Section 70 of the Punjab VAT Act:
   • The Punjab government argued that Section 70 of the Punjab VAT Act empowered it to make rules with prospective or retrospective effect.
   • Since taxes had been reduced from February 1, 2014, the government was within its rights to align ITC with the new tax rates.
2. ITC is a Benefit, Not an Absolute Right:
   • The State contended that ITC is not a fundamental right of taxpayers but a mechanism to avoid tax cascading.
   • Since VAT is charged at the time of sale, the State had the power to modify ITC entitlements based on the new tax regime.
3. Rule 21(8) Was Not Retrospective:
   • The government claimed that the rule did not take away past ITC but merely adjusted future ITC calculations for goods sold after February 1, 2014.
   • The rule only affected sales occurring after February 1, 2014, and therefore did not violate vested rights.

Respondent’s (Manufacturers & Traders) Arguments

1. No Statutory Authority for Rule 21(8) Before April 1, 2014:
   • The traders and manufacturers argued that on January 25, 2014, when Rule 21(8) was issued, there was no provision in the Punjab VAT Act allowing such a restriction on ITC.
   • The enabling amendment to Section 13(1) of the Punjab VAT Act came into force only on April 1, 2014, meaning that Rule 21(8) was invalid before this date.
2. ITC is a Vested Right, Not a Government Concession:
   • Businesses had already paid VAT at a higher rate before February 1, 2014, and had earned ITC accordingly.
   • Reducing ITC later due to a rule that had no statutory backing violated their vested rights and legal certainty.
3. Retrospective ITC Reduction is Unconstitutional:
   • The respondents argued that tax laws cannot be changed retrospectively unless explicitly provided in the parent Act.
   • Rule 21(8) effectively imposed retrospective taxation by reducing ITC on purchases made before its enactment.

Analysis of the Law

1. Section 13 of the Punjab VAT Act (Pre- & Post-Amendment):
   • Before April 1, 2014: ITC was available for goods “for sale” or “for use in manufacture”.
   • After April 1, 2014: ITC was restricted only to goods that “are sold” or “are used in manufacture”, limiting its availability.
   • The Court ruled that since this restriction was not in force before April 1, 2014, the State could not enforce Rule 21(8) before this date.
2. Rule-Making Power Under Section 70 of the Punjab VAT Act:
   • Section 70 allows rules to be made prospectively or retrospectively, but only if there is statutory authority in the parent Act.
   • Before April 1, 2014, no such authority existed in the Punjab VAT Act, making Rule 21(8) legally unenforceable.

Precedent Analysis

The Supreme Court relied on several previous judgments to support its ruling:

1. Eicher Motors Ltd. v. Union of India (1999) 2 SCC 361:
   • Held that ITC is a right accruing at the time of purchase, and reducing it retrospectively is invalid.
2. Jayam & Co. v. Assistant Commissioner (2016) 15 SCC 125:
   • A tax provision lowering ITC rates cannot have retrospective effect unless explicitly stated in the statute.
3. Sedco Forex International Drill Inc. v. CIT (2005) 12 SCC 717:
   • Tax laws should be applied prospectively unless expressly mentioned otherwise.

Court’s Reasoning & Conclusion

• Rule 21(8) could not be applied before April 1, 2014, as the Punjab VAT Act did not permit such a restriction before this date.
• Reducing ITC retrospectively violated vested rights of taxpayers.
• The High Court’s ruling was upheld, and the appeals were dismissed.

Implications

1. Businesses Cannot Be Subjected to Retrospective Taxation Without Clear Legal Authority.
2. State Governments Must Ensure Rule-Making Powers Are Exercised Within the Limits of the Parent Act.
3. Future ITC Restrictions Must Be Explicitly Provided in the Parent Act Before Implementation.

This judgment reinforces taxpayer rights against retrospective taxation and arbitrary ITC reductions.

Also Read – Bombay High Court Dismisses Writ Petition Against Reassessment, Emphasizes Alternate Remedy—”Taxpayers Must Exhaust Appellate Remedies Before Invoking Writ Jurisdiction”