ITC on construction of building used for further letting out

This is to apprise you about a recent judgement of Orissa High Court in the case of Safari Retreats Private Limited v. UOI, 2019-VIL-223-ORI. The High Court was dealing with the issue of availability of ITC on construction of building used for further letting out.

In this case, the petitioner undertook construction of shopping malls for the purpose of letting out the same. The petitioner intended to claim Input Tax Credit (‘ITC’) on various goods and services used for the construction of such malls.

The tax authorities proposed to deny ITC on the ground that Section 17(5)(d) of the Central Goods and Services Tax Act, 2017 (‘CGST Act’) bars ITC on goods and services received by a recipient used for the construction of immovable property on his own account. The authorities contended that the expression ‘on his own account’ will encompass the case of the petitioner where immovable property will be rented. In other words, ITC shall be available only in cases where immovable property is being sold prior to issuance of completion certificate.

The High Court rejected the contention of the tax authorities and held that the property cannot be said to be used by the petitioner ‘on his own account’ where it lets out the same to various tenants for their use. The Court drew parallel between the sale of immovable property (before issuance of completion certificate) with the rental of immovable property and observed that GST is paid on outward supply in both the cases. While reading down the provision, the Court held that disallowance of ITC in this case would frustrate the purpose of GST which is to remove the cascading effect and allow seamless flow of credit throughout the value chain.

Basis the above, the Court allowed ITC on goods and services used for construction where the petitioner was renting out such immovable property.

NITYA Comments:

This judgment, although favourable to taxpayer, did not discussed the scope of Section 17(5)(d) of the CGST Act in detail and has merely concluded that letting out of property does not fall under the expression ‘on his own account’. The Court seems to have applied the ‘usage test’ to interpret this expression i.e. whether the constructed property will be used by the taxpayer or will be sold / let out.

In our view, the aforesaid judgment has not interpreted Section 17(5)(d) in right legal perspective. Section 17(5)(d) uses the expression ‘on his own account’ along with the activity of construction of immovable property. Hence, in our view, the same should exclude only such cases where the taxpayer is undertaking construction done for some other person (i.e. where construction service is being provided). In case of a rented property, the landlord gets the construction done for itself and hence, the landlord gets construction done ‘on his own account’. Consequently, the landlord should not get ITC on goods and services used for the construction of property to be let out.

Given the above ruling in place, the taxpayers getting immovable properties constructed (like malls, factories or commercial spaces) and renting out the same, can choose to avail ITC on goods and services used for such construction. If the High Court judgment is correct, this rationale will equally apply to hotels, guest houses etc. providing accommodation services that are akin to rental. While it will be a matter of time before the issue goes to the other High Courts and is finally settled by the Supreme Court, taxpayers who do not avail ITC now, will not be able to avail the same post last date of taking the same. In the light of above, taxpayers may decide to avail ITC before the due date and keep the same unutilized till the issue attains finality.

It is important to note for taxpayers that due date for availing credit for FY 2017-18 is the last date of filing annual return (due date of same is June 30, 2019). This is because the alternate date suggested by law is the last date of filing of return for March 2019 under Section 39 of the CGST Act. The ‘return’ under Section 39 is GSTR-3 and GSTR-3B is neither a return under Section 39 nor a substitution of GSTR-3. Hence, date of filing of annual return shall only be relevant for reckoning last date. Please also refer to our detailed update dated May 15, 2019 on the issue.

It is important to note that even after this ruling, the taxpayers will not be able to avail ITC on works contract service (which is specifically barred under Section 17(5)(c) of the CGST Act).

Another point emerging basis this decision is that there is a tax arbitrage between getting the factory / office constructed for self-use (where no ITC is available) and getting the same on rent (where ITC on goods and services used for construction will be available to the landlord and ITC on rent will be available to the taxpayer). This creates a tax planning opportunity for the taxpayers for availing ITC.

Lastly, it is also important to ponder the validity of the restriction under Section 17(5)(d) of the CGST Act which the High Court refrained from deciding in this case. It is well settled that the legislature has unlimited power to allow or deny credit while levying taxes. At the same juncture, the denial of ITC should not be violative of the principles enshrined in Article 14 or Article 19 of the Constitution of India. De-horse this judgment, CGST Act allows ITC to a person providing construction service but not to a person providing renting of immovable property service. Similarly, ITC is being allowed on renting of immovable property service but not on construction of property on own account. This dichotomy lacks the intelligible differentia and thus, is violative of Article 14 of the Constitution. Further, the existence of building is essential for any business to operate and restricting ITC on the same would inflict excessive burden on the business. Hence, vires of such restriction can be challenged under Article 19 of the Constitution.

Recently, a batch of writ petitions have also been filed by various hotels, malls and real estate companies in Delhi High Court on the admissibility of ITC in similar cases. It will be important to watch the outcome of this as well as similar litigations in times to come.