INPUT TAX CREDIT (ITC) ON DEMO CARS: TO AVAIL OR FOREGO ?

[Dr. Sanjiv Agarwal]

Who are vehicle dealers?

A dealer is a person who is involved in any motor vehicle dealership or supply or distribution, i.e., a business that sells new or pre-owned vehicles at the retail level, based on a dealership contract with an automaker manufacturer (O & M).

Use of Demo Cars

A demonstration vehicle (or demo vehicle) is a new vehicle (car or any other vehicle) that is driven by the dealership's salesmen, managers or executives for the purpose of demonstration, marketing, training etc. Demo vehicles are typically well maintained as they are used to illustrate the vehicles and promote sales at the dealership. In the motor vehicle industry, demonstration vehicle is an indispensable tool for promotion of sales by providing trial run of vehicle to customers. It is a business requirement that motor vehicle dealer has to acquire the demonstration vehicles from principal supplier. These purchases are generally capitalized in the books of account excluding the tax component.

Nature of demo car: a capital good or input for dealer?

As per section 2(19) of the CGST Act, 2017 “capital goods” means goods, the value of which is capitalised in the books of account of the person claiming the input tax credit and which are used or intended to be used in the course or furtherance of business.

As per section 2 (59) of the CGST Act, 2017 “input” means any goods other than capital goods used or intended to be used by a supplier in the course or furtherance of business.

Therefore, a demo vehicle can be either an ‘input’ or a ‘capital good’. Going by the aforesaid definitions, demo vehicle may be considered as a capital asset as it is used for furtherance of business and it is not meant for retail sale to customers. If the demo car is being capitalized in books of accounts, it will be considered as capital asset. If not so, it may be considered as an input.

Input tax credit on demo vehicles

According to section 16(1) of the CGST Act, 2017,  every registered person shall be entitled to take credit of input tax charged on any supply of goods or services or both which are used or intended to be used in the course or furtherance of the business. The capital goods which are used in the course or furtherance of business, may therefore, be entitled for Input Tax Credit (ITC). However, the entitlement for input tax credit is subject to restrictions stipulated in section 17(5) of CGST Act, 2017.

Section 17(5) is an overriding provision as it, starts with ‘notwithstanding’. Accordingly, input tax credit shall not be available in respect of the following:

1. Motor vehicles for transportation of persons having approved seating capacity of not more than thirteen persons (including the driver), except when they are used for making the following taxable supplies, namely:-

(A) further supply of such motor vehicles; or

(B) transportation of passengers; or

(C) imparting training on driving such motor vehicles;

Provided that the input tax credit in respect of such services shall be available-

1. where the motor vehicles, vessels or aircraft referred to in clause (a) or clause (aa) are used for the purposes specified therein;
2. where received by a taxable person engaged-

(I)    in the manufacture of such motor vehicles, vessels or aircraft; or

(II)   in the supply of general insurance services in respect of such motor vehicles, vessels or aircraft insured by him.

2. Goods or services or both used for personal consumption

From the above legal position, it can be inferred that:

1. Section 17(5)(a) carves out an exception to the exclusion in section 17(5) i.e., input tax credit will be available if the motor vehicle is used for making the following taxable supplies:

(A) further supply of such motor vehicles; or

(B) transportation of passengers; or

(C) imparting training on driving such motor vehicles;

This implies that input tax credit will be available if motor vehicle is used for above services. It is pertinent to note that this exception uses the phrase ‘taxable supplies’ which is absent in the present case.

However, in case of (A) above, the exception is ‘further supply of such motor vehicles’. The Department is taking a view that the ‘supply’ is qualified by the word ‘further’ and ‘motor vehicle’ is qualified by the word ‘such’ and therefore, both are relatable to a specific motor vehicle i.e., demo car. The above entry (A) is therefore, subject matter of interpretation and as such, one will have to look for judicial scrutiny.

The other restriction i.e., “goods or services or both used for personal consumption” is also not applicable as the demo cars are used for business are in the course of business. There can not be and there is no question of personal consumption by any stretch of imagination.

Favorable Advance Rulings

There are few advance rulings pronounced by Authority of Advance Rulings (AAR) which have taken the view that input tax credit is available on demo cars considering demo cars as capital assets:

• IN RE: M/S. TOPLINK MOTORCAR PRIVATE LIMITED - 2022 (7) TMI 181 - AUTHORITY FOR ADVANCE RULING, WEST BENGAL; , the applicant who was an authorized dealer of motor vehicle company sought for advance ruling on whether input tax credit would be allowed on purchase of vehicles which would be used for demonstration/test drive purposes. The Authority for Advance Ruling ruled that the provisions of GST laws nowhere specify that input tax credit shall not be available if any outward supply is made at lower price than its procurement value. The demo vehicles after a specified period of time would be supplied at price lower than purchase value of said vehicle. Therefore, the applicant would be eligible to avail input tax credit on purchases of demo vehicles which can be set off against output tax payable under GST.

• IN RE: M/S. A.M. MOTORS - 2018 (10) TMI 514 - AUTHORITY FOR ADVANCE RULINGS, KERALA, the assessee sought for advance ruling on whether input tax credit on the motor car purchased for demonstration purpose of the customer can be availed as credit on capital goods and set off against output tax payable under GST in the case of a motor car dealer. The Authority for Advance Ruling ruled that input tax paid by a vehicle dealer on the purchase of motor car used for demonstration purpose of the customer can be availed as input tax credit on capital goods and set off against output tax payable under GST.

• IN RE: M/S. CHOWGULE INDUSTRIES PRIVATE LIMITED - 2019 (7) TMI 844 - AUTHORITY FOR ADVANCE RULING, GOA, where applicant purchased demo vehicles for promotion of sale by providing trial run to customer against tax invoices from supplier after paying taxes and capitalized purchase of such vehicles in books of account, it was held that capital goods which are used in the course or furtherance of business are entitled for Input Tax Credit, and thus, Input Tax Credit on motor vehicle purchased for demonstration purpose can be availed as Input Tax Credit on capital goods and set off against output tax payable under GST.

Adverse Advance Ruling

In following cases, it has been ruled that input tax credit will not be available:

• IN RE: M/S. KHATWANI SALES AND SERVICES LLP - 2021 (1) TMI 692 - AUTHORITY FOR ADVANCE RULING, MADHYA PRADESH,  the Applicant had purchased the vehicles from the supplier against tax invoices after paying tax and capitalizes the demo vehicles in the books of accounts. The applicant sought the advance ruling on the issue whether Input tax credit on the Demo vehicle purchased can be availed as the same will be capitalized in books.

The Applicant submitted that the firm will not claim depreciation on the tax component of Demo Vehicles which are capitalized in the books of accounts. The AAR found that not charging depreciation on the tax component is as per other relevant provisions of the GST Act, but that can not affect the applicability of provisions of Section 17(5)(a) of GST Act according to which the applicant is not eligible for Input tax credit on Demo Vehicles. It was ruled that the applicant is not eligible for Input Tax Credit on Demo vehicles purchased for furtherance of business in view of barring provisions of clause (a) of sub-section (5) of Section 17 of GST Act, 2017 as they are not covered by any of the exceptions.

• IN RE: M/S. PLATINUM MOTOCORP LLP - 2022 (3) TMI 488 - APPELLATE AUTHORITY FOR ADVANCE RULING, HARYANA, the Appellant was an authorised dealer of Maruti Suzuki India Limited. The appellant purchases ‘Demo Cars’ for demonstration purposes. Each demo car was being used for demonstration for a maximum period of 2 years from the date of purchase after which it can be sold as a second-hand car. The appellant reached out to the Haryana Appellate Authority for the following issues:      

(a) Whether Input Tax Credit (ITC) can be availed on the demo cars          

(b) Whether ITC can be availed on ancillary input services such as insurance and repair and maintenance availed in respect of demo cars.        

It was observed that Section 17(5)(a) of the Central Goods and Services Tax Act, 2017 provides that ITC cannot be allowed on motor vehicles with a seating capacity of up to 13 persons when used for other than the intended purposes. The intended purposes are limited to further supply of such motor vehicles; or transportation of passengers; or imparting training on driving such motor vehicles.             

Further, the demo vehicles are used for the purpose of demonstration to prospective customers for 2 years or so and therefore, afterwards, it loses the character of the new vehicle. These vehicles are then sold akin to second-hand goods. The demo vehicles are not meant for ‘further supply of such motor vehicles’, but are first put to the mentioned uses. The AAAR ruled that if the contentions of the applicant are allowed then in that case all the motor vehicles, irrespective of the nature of the supply will be eligible for ITC across the industries.         

The AAAR thus, held that the appellant has never received the demo cars with the intent to simply ‘further supply/sell’ as such and therefore, ITC on such vehicles cannot be allowed. Further, ITC on repair/insurance/maintenance used in respect of said vehicles cannot be allowed.

• IN RE: M/S. BMW INDIA PVT. LTD. - 2022 (3) TMI 487 - APPELLATE AUTHORITY FOR ADVANCE RULING, HARYANA , it was held that none of the uses to which the BMW vehicles are put to, fits into the uses which find mention in sub-Section 17(5). The vehicles under question are not meant for “further supply of such motor vehicles' i.e further supply as such”, but are first put to the mentioned uses. These are disposed of after prolonged use, which may even not restrict to 12 months as mentioned by the Appellant.

If this argument is allowed, then in all the motor vehicles, irrespective of the nature of Supply will be eligible for ITC across the industries. It will no longer be a restricted clause for Car Dealers, but will be an open-clause for all the trade and industry to avail the ITC on all the Vehicles purchased by them. This has never been the intent of the Parliament in the very first demonstration run demo car loses the character of the new motor vehicle and demo vehicles is sold akin to second hand goods and which is different from new Vehicle and accordingly treated differently under. GST law, so the demo car is not an input.

So it appeared that the BMW Vehicles received by the Appellant under stock transfer have never been received with the intent to simply 'further supply of such motor vehicles/'sell as such'. Input Tax Credit on these vehicles, thus, cannot be allowed. The input credit of the Services of repair/ insurance/ maintenance used in respect of said vehicles with seating capacity up to 13 passengers, cannot be allowed. Demo cars have been considered to be as ‘visitor’s cars’ and ‘personally assigned vehicles’.

Our Comments

1. Receipt of car is on store transfer basis.
2. Demo cars have been considered to be as ‘visitor’s cars’ and ‘personally assigned vehicles’.
3. Such demo cars are then supplied to dealers as old and used vehicles.
4. (Note: We are not sure whether this practice is followed by other O & M’s dealers)
5. Input tax credit has been denied under section 17(5) (g) on the ground of personal use.
6. Also, demo vehicle had been considered as old vehicle as immediately after the first demo run, it losses the character of being ‘new’ and it becomes ‘old’.
7. The said ruling has considered demo car as personal consumption and not for further supply / transportation / training.

The ruling of BMW case is an illustration of narrow interpretation and ignoring the basic legislative intention of input tax credit as well as GST.

Epilogue

Input tax credit should be allowed on demo cars treating them as capital goods and there is no specific restriction on the same if the demo cars have been capitalized, it cannot be considered to be meant for further supply.

It can be further said that eligible taxes paid on purchase of demo cars meant for use in course of furtherance of business and which are capitalized in the books of accounts should normally be allowed to be set off as Input Tax Credit (ITC) under the GST law.