Delhi Court rules against ITC denial to NBFCs’ recovery agents.

[Shrey Bhatnagar]

Delhi Court rules against ITC denial to NBFCs’ recovery agents.

PACE SETTERS BUSINESS SOLUTIONS PVT. LTD. VERSUS UNION OF INDIA AND ORS. [2024 (4) TMI 289 - DELHI HIGH COURT]

The Goods and Services Tax (GST) primarily places the tax liability on the supplier of goods and services. This is commonly known as the Forward Charge Mechanism. However, in some cases, the recipient, rather than the supplier, can be made liable for the tax. This is referred to as the Reverse Charge Mechanism (RCM).

Recently, the Delhi High Court was presented with a challenge concerning certain service tax and GST notifications, as well as Section 17(3) of the Central Goods and Services Tax (CGST) Act. This section denies Input Tax Credit (ITC) to recovery agents when tax is payable under the RCM.

PETITIONER'S ARGUMENT

The petitioner, a recovery agent providing services to a Non-Banking Financial Company (NBFC), argued that the contested service tax and GST notifications, specifically Notification No. 30/2012-ST (dated 20.06.2012) issued under Section 68(2) of the Finance Act, stipulate that service tax on certain services would be entirely payable by the service recipient. Notification No. 10/2014-ST (dated 11.07.2014) amended the previous notification to include services provided by a recovery agent to a banking company, financial institution, or Non-Banking Financial Company (NBFC), making the entire service tax payable by the service recipient. Furthermore, Notification No. 10/2017-Integrated Tax (Rate) (dated 28.06.2017), issued under the Integrated Goods and Services Tax (IGST) Act, classified services supplied by a recovery agent to a banking company, financial institution, or NBFC as services chargeable to IGST under the RCM.

In addition, Section 17(3) of the CGST Act considers the supply of recovery agent services as exempted supplies when the tax is payable under the RCM, thereby denying the service provider the Input Tax Credit. The petitioners claimed these provisions to be ultra vires the respective Acts.

The petitioners also contended that this scheme results in double taxation, as the service is taxed both at the input stage and in the hands of the service recipient. The petitioner’s grievances stem from the fact that under the Finance Act, 1994 and the GST regime, the liability to pay service tax and GST on specified services rests on the recipient of services. This is due to the reverse charge mechanism, where the recipient of the service (in this case, the NBFC) is responsible for paying the GST to the government, not the service provider (the recovery agent)

They argued that denying ITC to recovery agent service providers, where the service recipient (NBFC) is liable for tax under the RCM, is discriminatory and arbitrary since it prevents the service provider from claiming any benefit of the taxes paid on input services. This is because there is no liability for output tax on the service provider, so it would not be entitled to claim any set-off or credit for the tax paid on inputs. They further argued that the classification for the reverse charge basis lacks intelligible differentia, thereby violating Article 14 of the Constitution, which guarantees equality before the law.

REASONS AND CONCLUSION

The court established that both the Finance Act and the GST Acts (CGST and IGST) authorise the imposition of taxes on a reverse charge basis. It emphasised that Section 68(2) of the Finance Act encompasses a non-obstante clause, which signifies that it supersedes the provisions of Section 68(1). This clause empowers the Central Government to designate taxable services for payment on a reverse charge basis, irrespective of the standard rule that every service provider is responsible for paying the tax.

Further, the impugned Notifications were issued by the Central Government in the exercise of its legislative powers delegated under Section 68(2) of the Finance Act. This reinforces the legality of such notifications.

Similarly, The CGST Act and the IGST Act provide The term ‘Reverse Charge’ is defined under Sub-section (98) of Section 2 of the CGST Act, which provides clarity on the reverse charge mechanism within the context of the CGST Act. The Central Government is granted the authority to specify categories of supply of goods or services or both, on which tax shall be paid on a reverse charge basis, by Sub-section (3) of Section 9 of the CGST Act and Sub-section (3) of Section 5 of the IGST Act, implying that the government can designate certain transactions where the recipient, instead of the supplier, is liable for paying the tax.

Therefore, it can be concluded that impugned Notifications were issued under appropriate authority.

From the court’s perspective, the other challenges were addressed by invoking several relevant legal principles and case laws.

The court refers to the case of INCOME-TAX OFFICER, SHILLONG, AND ANOTHER VERSUS N. TAKIN ROY RYMBAI - 1976 (2) TMI 2 - SUPREME COURT, where it was held that taxation laws, while subject to the equality clause of Article 14, allow the state a wide discretion in classification for taxation purposes. The classification, as long as it does not violate the fundamental principles of equality, is not vulnerable to challenge.

In KHANDIGE SHAM BHAT VERSUS AGRICULTURAL INCOME-TAX OFFICER - 1962 (8) TMI 67 - SUPREME COURT, the court observed that the legislature enjoys a larger discretion in fiscal matters in classification, provided it adheres to the fundamental principles of equality.

The court also cites TTWYFORD TEA CO., LTD. VERSUS STATE OF KERALA - 1970 (1) TMI 80 - SUPREME COURT  emphasizes the wide latitude in classification for taxation purposes. It states that a state is allowed to pick and choose districts, objects, persons, methods, and rates for taxation if done reasonably.

In the context of the petitioner’s challenge, the court argues that the government’s selection of certain services for taxation under the reverse charge mechanism does not amount to hostile discrimination. It emphasises that taxation is a sovereign power, and the Parliament has wide discretion in choosing the persons or objects for taxation. The court concludes that challenging the selection of certain services for taxation or the use of different taxation mechanisms based on Article 14 is not tenable.

The denial of input tax credit for services subject to tax under the reverse charge mechanism is justified and not arbitrary. The court explains that since the service provider is not liable to pay tax on the output services, there is no liability against which the input tax credit can be set off.  

The court further states that service providers subject to tax under the reverse charge mechanism constitute a distinct class. The denial of input tax credit to them is based on a rational classification, which has a clear nexus with the objective of the taxation scheme.

The court cites the case of GUJARAT AMBUJA CEMENTS LTD. Versus UNION OF INDIA - 2005 (3) TMI 492 - Supreme Court to support its argument. In this case, the Supreme Court rejected a challenge to certain provisions of the Finance Act, where the discrimination alleged was due to differences in the method of tax collection. The court held that if the legislature deems a specific method of tax collection rational for certain classes of taxpayers, it does not violate Article 14 of the Constitution.

Finally, the court emphasises that it is beyond the judicial purview to determine the most appropriate method of tax collection for a particular class of taxpayers. This decision falls within the domain of legislative wisdom and policy-making. Therefore, the court concludes that the notifications in question were issued under proper authority and did not violate the right to equality guaranteed under Article 14 of the Constitution.

IMPACT  

The ruling states that Goods and Services Tax (GST) is applicable to services provided by recovery agents for Non-Banking Financial Companies (NBFCs). This tax is applied under the Reverse Charge Mechanism (RCM), which means the recipient of the service (the NBFCs) is responsible for paying the GST to the government, not the service provider (the recovery agent). The ruling also supports the denial of ITC to recovery agents. ITC is a mechanism where businesses can reduce their tax liability by claiming credit for taxes paid on inputs (goods and services used in the course of business). In this case, recovery agents cannot claim ITC, increasing their operational expenses.

The increase in operational expenses for recovery agents could affect the financial dynamics within the sector. It could lead to higher costs for NBFCs if recovery agents increase their fees to compensate for the higher expenses. Recovery agents cannot charge GST when they bill their clients (Banks, NBFCs, or Financial Institutions) because this is covered under the Reverse Charge Provisions. As a result, the outward supply of services by the Recovery Agent becomes an exempt supply, meaning it’s not taxable under GST.