Input tax credit reversal on write-off

[Shilpi Jain]

It is a known fact that the input tax credit (ITC) which is available under the GST laws is very wide and it covers credit in respect of goods and services that are used for business and to the extent used for making taxable supplies. However, the exception to this is the credit in respect of the goods and/or services or the situations mentioned in section 17(5) of the CGST Act, 2017, which are also known as the blocked credits.

Write-off of goods is one such situation when the credit is blocked i.e. is not available to the taxpayer. The following could be reasons for the write-off of the stock value:

1. Slow or non-moving stocks – due to the market demand certain stocks could be slow moving or non-moving. In some cases, these goods could be used in the future when the need arises.
2. Obsolete stocks – due to technological changes or for any other reason these stocks could be out-dated or no longer usable.
3. Goods destroyed – could be due to natural or other reasons where such goods would be of no use or could be refurbished and used.
4. Any other reason.

This write-off could be either partial or a full write-off. For example, if the value of goods has reduced due to technological advancements or due to the reason of partial destruction (which can be used after certain expenses being incurred to restore it), then there could be only a partial write-off. In other cases, where the goods cannot be used at all or there is a high chance that the demand for those goods will not occur in the future, there could even be a full write-off. The principles of write-off in the books of account are also dependent on the Generally Accepted Accounting Principles (GAAP).

The write-off could be of raw materials or inputs, spares, work-in-progress, finished goods or capital goods/assets. The question that now arises under GST is whether all these kinds of write-offs will entail blocking or reversal of credit. Before answering this let us analyse the position under the CENVAT scheme prior to the introduction of GST.

Position under the CENVAT scheme

Under the CENVAT Credit Rules, 2004, there was a rule 3(5B) which read as below:

If the value of any, -

(i)            input, or

(ii)           capital goods before being put to use,

on which Cenvat credit has been taken is written off fully or where any provision to write off fully has been made in the books of account, then the manufacturer or service provider, as the case may be, shall pay an amount equivalent to the Cenvat credit taken in respect of the said input or capital goods :

Provided that if the said input or capital goods is subsequently used in the manufacture of final products or the provision of taxable services, the manufacturer or output service provider, as the case may be, shall be entitled to take the credit of the amount equivalent to the Cenvat credit paid earlier subject to the other provisions of these rules.

The important aspects to note from the above are

1. Full write off or provision in books: The scenario covered is that of a full write-off of the value or a provision for full write-off created in the books of account. Hence, the write-off of the goods and a provision created in the books for write-off are 2 different aspects. The write-off of the inputs/capital goods (CG) could be in respect of those goods that may not be used in future (due to being obsolete or damaged, etc). The provision created in the books of account could be in respect of the GAAP requirements and there could be a possibility of such goods being used in future.
2. Only inputs and capital goods credit: The reversal is in relation to inputs and capital goods that are written-off. There is no reference of reversal of credit relating to any input services.
3. Reversal effected by way of a payment provision: The reversal of the credit is required to be done by way of payment of an amount equivalent to the CENVAT credit taken in respect of the said input or capital goods. This shows that a specific payment provision is in place to give effect to the reversal of the credit, which was validly availed at the time of receipt of the said goods.
4. Subsequent availing: In case the goods are used subsequently, there is an enabling provision by which the manufacturer can take back the credit that has been reversed due to the write-off.

Position before the said rule was enacted

Prior to the insertion of the above referred rule, the Gujarat High Court in the case of COMMISSIONER OF CENTRAL EXCISE VERSUS INGERSOLL RAND (INDIA) LTD. [2013 (2) TMI 32 - GUJARAT HIGH COURT] held that the reduction of the value of goods for income-tax purpose cannot be equated with writing-off of the physical stock and if under such accounting principles, the assessee is entitled to diminish the value of a certain stock held over a period longer than the specified period, the same has no correlation with the availability of physical stock insofar as the manufacturing activity is concerned. It was thus held that reversal of credit is not required on mere reduction in the value of goods i.e. write off, more so when the goods are still available in the factory in a usable condition.

In the case of FEDERAL MOGUL AUTOMOTIVE PRODUCTS (I) P. LTD. VERSUS COMMR. OF C. EX., JAIPUR [2007 (1) TMI 368 - CESTAT, NEW DELHI]  it was held:

……that inputs that are held in stock by an assessee, even if their value is written of, do not attract requirement for reversal of Modvat credit. In fact, what has happened in the present case is only a revaluation of inputs. Otherwise they are being used for manufacture. Revaluation of assets, in no way, affects Modvat credit taken on them. Increase in the value fetches no additional credit. Similarly, reduction in value, does not diminish the quantum of credit already taken. Quantum of credit available is fixed i.e. equivalent to the specified duties paid.

From the above it can be noted that mere write-off in the value cannot attract credit reversal, since the goods are available for use in the manufacture, unless a specific provision for the reversal of credit is in place in the law as was the position after the insertion of rule 3(5B) ibid.

Provision under GST

Under GST, section 17(5)(h) is the relevant provision which reads as under:

Notwithstanding anything contained in sub-section (1) of section 16 and sub-section (1) of section 18, input tax credit shall not be available in respect of the following, namely:-

(h) goods lost, stolen, destroyed, written off or disposed of by way of gift or free samples;

On contrasting the above provision with what existed under the CENVAT scheme, the following points can be noted:

1. The provision contained in section 17(5) is not a specific credit reversal provision or a payment provision as compared to the CENVAT provision discussed above wherein a specific direction is in place to pay the amount of credit availed on happening of a subsequent event (i.e. write-off) after availing credit on receipt of the ggods. Section 17(5) only states that credit will not be available in respect of goods that are written off. In such a case, whether the said provision must be seen at the time of availing the credit or it has to be seen at all times until the goods are completely used? This question arises on the settled principle that credit eligibility has to be seen at the time of receiving the goods/services as was held in the case of SPENTA INTERNATIONAL LTD. VERSUS COMMISSIONER OF CENTRAL EXCISE, THANE [2007 (8) TMI 25 - CESTAT, MUMBAI] and GRASIM INDUSTRIES LTD. VERSUS COMMISSIONER [2004 (7) TMI 651 - SC ORDER], and any subsequent reversal of credit should have a specific provision requiring such reversal as held in the case of GRASIM INDUSTRIES VERSUS COMMISSIONER OF CENTRAL EXCISE, INDORE [2006 (8) TMI 69 - CESTAT,NEW DELHI] Approved in THE COMMISSIONER OF CENTRAL EXCISE VERSUS M/S. JOY FOAM PVT. LTD., CUSTOMS, EXCISE AND SERVICE TAX APPELLATE TRIBUNAL (CESTAT) [2015 (7) TMI 386 - MADRAS HIGH COURT].
2. The next independent point is, the scenario mentioned in the statute is only a write-off as against provision for write-off in the books. Hence it can be said that mere reduction in the value of the goods which are available for use in future will not be covered u/s 17(5). Similarly partial write-offs will not require reversal of credit as the said goods will be available for future use and it is only a reduction in the value of the goods i.e. as long as they are capable of being used for business and for making taxable supplies credit blocking should not occur.
3. Reversal is required in respect of inputs and capital goods not put to use or would it include reversal of credit in respect of inputs, inputs services, capital goods used in finished goods or work-in-progress written off?

1. If we agree to the fact that 17(5) is a provision that has to be seen at the time of receiving the goods only, then the question of reversal of credit in respect of FG and WIP written off does not arise as the validly availed credit becomes a vested right and its subsequent reversal would require specific reversal provisions whereas section 17(5) is not a credit reversal or a tax payment provision as existed in the CENVAT regime.
2. If we take a conservative view that section 17(5) is a provision that has to be seen until the goods are actually used, then the next question that is to be answered is whether the phrase ‘in respect of’ used in section 17(5) can be said to have such a wide meaning to encompass the credit denial on the inputs, CG and input services that have been used in making the FG or WIP. In this regard, it is to be noted that in general ‘in respect of’ is a phrase of wide connotation as was held in various decisions like UNION OF INDIA VERSUS VIJAY CHAND JAIN [1977 (2) TMI 82 - SUPREME COURT], Canadian Supreme Court in Nowegijick v. The Queen [1983] 1 SCR 29, etc. It has also been considered to have no precise legal meaning by the New Zealand Court of Appeal in - Phonographic Performances (NZ) Ltd. v. Lion Breweries Ltd.- (1980) PSR 383 (1979). (Garner).

However, in the Indian context, in the case of TOLARAM RELUMAL VERSUS STATE OF BOMBAY [1954 (5) TMI 20 - SUPREME COURT] and THE STATE OF MADRAS VERSUS SWASTHIK TOBACCO FACTORY [1965 (12) TMI 90 - SUPREME COURT], it has been held that the meaning of this phrase has to be interpreted considering the context/setting in which it is used and the object of the legislature. In these cases ‘in respect of’ was interpreted to mean ‘on’ i.e. a restrictive word. In the case of Swasthik Tobacco it was held that ‘in respect of the goods’ has to be interpreted in a restricted manner and it cannot cover the inputs that have been used in making the final product.

In the case of GST, the object and reasons statement indicates that GST was enacted to remove the cascading effect of taxes. Hence, it can be said that ‘in respect of’ cannot be construed to have a wide meaning so as to restrict maximum possible credit more so when the object of implementation of GST is to remove the cascading effect of taxes. It should be equated with ‘on’. Hence, on this count also it can be said that the write-off of finished goods would not require reversal of credit relating to the goods and services that have been used for manufacture of the FG or WIP, whereby write-off of value of FG or WIP would not require reversal of any credit.

4. Section 17(5) does not override section 17(1) or section 17(2). This would imply that once the goods are used or intended to be used in making exclusive taxable supplies or commonly used or intended to be used for making taxable and exempt supplies, and the credit has been availed as per rule 42 and 43, then the provisions of section 17(5) will not apply whereby any goods damaged thereafter will not require any reversal of credit. This is drawn from the principle set out in the case of MULTIMETALS LTD. VERSUS ASSISTANT COLLECTOR, CENTRAL EXCISE [1991 (12) TMI 58 - SUPREME COURT] wherein it was held that credit is eligible as it is used in the manufacture. Thereby it can be said that any subsequent reversal will require a specific provision, which in the case of GST does not exist as we have stated that section 17(5) does not override section 17(1) and (2). This also supports the view that once inputs/input services are issued for production i.e. are intended to be used for making taxable supplies then subsequent write-off of the WIP or FG cannot attract reversal of credit.

From the above discussion it can be noted that the provision of credit not being available on the write-off of goods as per section 17(5) ibid, which seems to be a simple provision, does not bear the meaning as simple as it might seem to us as on date. There is a lot of clarity missing since the legislature has chosen not to adopt the settled position under the CENVAT Credit regime. However, our above discussion must be adopted after considering the principle that any interpretation should not lead to redundancy of any provision existing in the legislature i.e. the interpretation adopted should not make the provision of non-availability of credit on write-off, redundant.

For any feedback/queries please write to shilpijain@hiregange.com.

CA Shilpi Jain