Input Tax Credit on Construction under GST: Analysis of Supreme Court’s Landmark Judgment

Introduction

The Supreme Court of India’s decision in the case of Chief Commissioner of Central Goods and Services Tax & Ors. vs. Safari Retreats Private Ltd. & Ors. ([2024] 77 TAXLOK.COM 001 (SC)) has addressed significant questions regarding the availability of Input Tax Credit (ITC) for constructions under the Central Goods and Services Tax (CGST) Act, 2017. The judgment analyzed the constitutional validity of Section 17(5)(c) and (d), which blocks ITC on the construction of immovable properties, and clarified the scope of ITC entitlement based on the functionality test. This article provides an in-depth analysis of the judgment, the issues addressed, and the broader implications for businesses engaged in construction activities.

Background of the Case

The case arose from disputes involving Safari Retreats Private Ltd., which constructed a shopping mall for letting out premises. The company incurred substantial expenses on goods and services used in the mall`s construction, resulting in an accumulated ITC of over Rs. 34 crores. Despite this, the authorities denied ITC utilization against the GST payable on rental income, citing the restrictions under Section 17(5)(d) of the CGST Act.

Safari Retreats challenged the constitutional validity of Section 17(5)(c) and (d) before the High Court, arguing that such provisions violated Articles 14 and 19(1)(g) of the Constitution. The High Court ruled in favor of Safari Retreats, holding that the restrictions under Section 17(5)(d) should not apply when immovable properties are used for taxable supplies such as leasing. This decision was challenged by the tax authorities in the Supreme Court.

Key Issues Considered by the Supreme Court

The Supreme Court examined three primary issues:

1. Whether Section 17(5)(d) blocks ITC for constructions intended for taxable supplies, such as renting or leasing.

2. Whether the denial of ITC violates constitutional principles, particularly Articles 14 and 19(1)(g).

3. Whether the functionality test can be used to classify certain constructions as "plant" and thus exempt them from ITC restrictions.

Provisions of the CGST Act Under Scrutiny

Section 17(5)(c): Disallows ITC on works contract services for the construction of immovable property, except when used for further supply of works contract services.

Section 17(5)(d): Blocks ITC on goods or services used for the construction of immovable property "on one’s own account," even if used in the course or furtherance of business, except for plant or machinery.

Explanation to Section 17: Defines "plant and machinery" to include apparatus, equipment, and machinery fixed to the earth by foundation or structural support but excludes buildings, civil structures, and other immovable properties.

Supreme Court’s Observations

The Supreme Court upheld the constitutional validity of Section 17(5)(c) and (d) but provided critical clarifications on their application:

1. Intelligible Differentiation and Rational Nexus: The Court held that the classification created by Section 17(5)(d) between movable and immovable property has an intelligible basis. The objective of avoiding the cascading effect of taxes is consistent with the GST framework. Blocking ITC on immovable property used "on one’s own account" prevents undue fiscal advantages and ensures fair taxation.

2. Functionality Test: The Court emphasized applying the functionality test to determine whether an immovable property qualifies as "plant" under the Act. It held that properties serving as essential tools of trade—like malls, warehouses, or specialized buildings—could be classified as "plant," making ITC available.

3. Tax Neutrality: The Court recognized the importance of tax neutrality and seamless credit flow in the GST regime. It noted that denying ITC on goods and services used in constructing properties for taxable supplies, such as leasing, could lead to cascading taxation, undermining the GST’s core principles.

4. Interpretation of "On One’s Own Account": The phrase "on one’s own account" was interpreted to exclude immovable properties used for generating taxable outputs. ITC denial under Section 17(5)(d) applies primarily to properties constructed for personal use or non-taxable purposes.

Analysis of ITC Availability for Constructions

Constructions Eligible for ITC

1. Commercial Properties Functioning as Plant:

   • Buildings with specialized features essential for business operations (e.g., malls, hotels, and warehouses).

   • Properties that serve as tools of trade rather than mere settings for business.

   • Examples: Shopping malls designed for leasing, hotels with unique features enhancing functionality.

2. Construction for Further Taxable Supply:

   • Works contract services used for further supply of taxable services.

   • Input goods and services used in constructing properties leased or rented for commercial purposes.

3. Properties Qualifying as Plant under the Functionality Test:

   • Structures that are integral to business processes and not simply real estate investments.

   • Decisions cited: CIT vs. Taj Mahal Hotel [1971] 12 TAXLOK.COM (IT) 308 (SC), and Indcon Structurals (P) Ltd. vs. CCE clarified that structures with functional utility could qualify as plant.

Constructions Not Eligible for ITC

1. Personal Use Properties:

   • Office buildings, residential houses, or other immovable properties constructed for personal use.

2. Non-Taxable Output Supplies:

   • Properties used for exempt supplies or non-GST activities.

   • For instance, residential complexes or properties used for non-commercial purposes.

3. Buildings Treated as Real Estate Investments:

   • Properties constructed and sold post-completion certification.

   • Immovable properties not directly used in taxable activities or as plant.

Practical Implications of the Judgment

The Supreme Court’s ruling has significant implications for businesses:

1. Leasing and Renting Businesses:

   • Entities constructing malls, hotels, or warehouses for leasing can claim ITC if the functionality test is satisfied.

   • This reduces tax costs and ensures competitiveness in the leasing industry.

2. Compliance with ITC Conditions:

   • Businesses must maintain clear documentation demonstrating the functional utility of properties as tools of trade.

   • Proper classification of constructions under "plant" is critical for claiming ITC.

3. Avoidance of Cascading Taxes:

   • The judgment aligns GST’s application with its core principles, minimizing cascading effects.

   • Taxpayers can expect a seamless flow of credit for eligible constructions.

4. Tax Planning Opportunities:

   • Businesses can structure construction activities to align with the functionality test and ITC eligibility.

Conclusion

The Supreme Court’s judgment in the Safari Retreats case marks a pivotal development in the interpretation of ITC provisions for construction under GST. By upholding the constitutionality of Section 17(5)(c) and (d) while clarifying the application of the functionality test, the Court has provided a balanced approach that ensures fair taxation without compromising the seamless credit flow envisioned under GST.

Businesses must carefully assess the functional utility of constructions and align their activities with the Court’s principles to maximize ITC benefits. This judgment not only reaffirms the GST’s foundational objectives but also establishes a robust framework for resolving disputes related to ITC on construction activities.