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“You can’t tax business. Business doesn’t pay taxes. It collects taxes.” 

A Discussion on recent VAT Provisions regarding Input Tax Credit 

What Ronald Reagan said on that evening in his office at Wilshire Boulevard Road, California as Governor of the State of California, US in an interview to the ‘Reason’ magazine in July, 1975 still holds good even in present days especially in Indirect Taxation. But sometimes, we come across some legal framework in indirect taxation that travels beyond the principle of collecting the taxes through business to the extent of collecting of taxes from business.

This write-up is regarding denial of and restriction on Input Tax Credit available under the Punjab Value Added Tax Act, 2005 by introduction of Sub-Rule 7 and Sub-Rule 8 to Rule 21 of the Punjab Value Added Tax Rules, 2005 defying the basic principles of removal of cascading effect, imposing tax on tax, reducing the already available credit to the business and thereby .......taxing the business.

As we know, VAT is a multi point tax which is applicable on sale of goods at different stages of sale. Each sale attracts tax that when paid at the earlier stage is claimed as credit by the subsequent purchasers or user of the inputs. VAT aims to obviate the cascading effects of taxation at each stage with a motive to reduce costs. This input tax credit is afforded to the manufacturers and the traders both and it reduces their tax liability. Unlike in general Sales Tax, there is no ‘tax’ on ‘tax’ component in vat regime. And this way, Business doesn’t pay tax, it collects tax.

Contrary to the above basic VAT principles, Rule 21(7) and Rule 21(8) of the Punjab VAT Rules, 2005 (Rules) have been introduced vide Notifications No.S.O.8/PA.8/2005/S.6/2014 and S.O.9/PA.8/2005/S.8/2014, Notification No. No.GSR5/P.A.8/2005 /S.70/Amd(53)2014 both dated 25th January, 2014 and Public Notices on the same date under the Punjab Value Added Tax Act, 2005 (the Act).

Rule 21(7) to PVAT Rules, 2005 has been added to restrict Input Tax Credit on Goods in lying in Stock to the reduced rate of VAT.

Rule 21(8) to PVAT Rules, 2005 has been added to restrict Input Tax Credit on Iron and Steel Goods (wheels, tyres, axles and wheel sets) up to two stages, i.e. up to First Stage Taxable Person and Second Stage Taxable Person only.

Let us have a look on the financial impact and practical implications of these amendments.

Implication of Introduction of Rule 21(7):

Rule 21(7) affects each type of commodity, rate of vat whereon is reduced on a particular date. It debars the dealer of its genuine credit of already paid tax as input vat. It will cause financial loss to the dealer because he will not be able to fully avail credit of already paid VAT as ITC and already paid VAT shall become his expenditure.

In addition to the above amendment, rates of VAT on some particular commodities have been reduced. Reduction of VAT on these commodities coupled with introduction of Rule 21(7) adversely affects the dealers in these commodities. These goods are iron and steel goods (except few items) and non-Cenvat iron and steel scrap. Rate of VAT on these goods have been reduced from 4.95% to 2.50% and 1.10% respectively. Immediate effect of the reduction in rates of vat on these items is that, input tax credit otherwise available to the dealer at 4.95% shall now be available up to 2.20% and 1.10% only.

For example, Input Tax Credit of Rs. 24750/- available @ 4.95 on the stock in hand of Rs. 5,00,000 shall after reduction in rate of output vat to 2.20%, be curtailed to Rs. 11,000/-, creating financial loss to him to the tune of 13,750/-. It is to be noted that though the dealer has paid Rs. 24750/- as tax credit available to him for future sale by him, the already vested right of tax credit for Rs. 13750/- shall be taken away by Rule 21(7).

Since the introduction of Rule 21(7), VAT is reduced only on Iron and Steel goods and till now the adverse commercial impact is felt by dealers in Iron and Steel goods only. This Sub-rule shall also adversely affect the dealers in each type of goods if rate of vat in respect of goods dealt in by him is reduced subsequently.

Implication of Introduction of Rule 21(8):

Insertion of Rule 21(8) affects only the dealers in specified category of goods being Iron and Steel goods mentioned in Section 14 of CST Act, 1956 (except wheels, tyres, axles, wheel sets) in a way that purchasers buying from dealers otherwise than from the First Stage Taxable Person or Second Stage Taxable Person shall not be eligible for input tax credit.

Here "First stage taxable person" shall mean a taxable person who purchases goods directly from the manufacturer registered under the Punjab Value Added Tax Act, 2005 or an importer of goods from outside the State of Punjab and "second stage taxable person" shall mean a taxable person who purchases goods from the first stage taxable person.

Thus the first manufacturer / the importer in the state or the first buyer from the manufacturer or the importer and the second buyer shall only be eligible to transfer the input tax credit. Any purchases from subsequent dealer in goods shall not grant the right of ITC to the buyer. It will adversely affect the business of  all subsequent dealers in trade of Iron and Steel Goods as the buyer in B 2 B economy will  insist on buying from first stage and second stage dealers only and not from subsequent dealers so as to avail ITC.

Summarizing the practical implications of the above amendments, we may conclude that;

1. Iron and Steel Traders subsequent to second stage dealers shall not be eligible to transfer input tax credit

2. Whenever any rate of vat is reduced on any commodity, the already available input tax credit shall be reduced to the reduced rate of output rate of vat.

Punjab State being a major consumer of iron and steel which is primarily consumed / dealt with and traded by small operators needs free and unrestricted flow of transactions and economy of the State would suffer and shall lead to higher input costs if the ITC is not allowed beyond 2 stages or if input tax credit is restricted to the extent of reduced rate of VAT. It affects the business competitiveness of the small traders.

Before proceeding further, let us have a cursory look on legal framework for Input Tax Credit under Value Added Tax under PVAT Act, 2005.

Present Legal Framework of ITC

Scheme of ITC as per PVAT is enshrined through law of PVAT. Section 13 of the Punjab Value Added Tax Act, 2005 (for short the ‘Act’) provides that a taxable person shall be entitled to the input tax credit, in such manner and subject to such conditions, as prescribed, in respect of input tax on taxable goods, including capital goods, purchased by him from a taxable person within the State during the tax period. It further provides that such goods should be for sale within the state of for interstate sale or for export and for purposes specified therein.

The taxable person becomes entitled to Input Tax Credit immediately on purchase of goods provided the conditions laid down in Section 13 are fulfilled.

Section 2(p) of PVAT Act, 2005 defines Input Tax Credit to mean “ITC available to a taxable person under this Act.”

The right of ITC is conferred under the Act subject to few restrictions given in Section 13 of the Act, like non-admissibility of ITC on SIN goods like Petrol, Diesel, restricted availability of ITC on Furnace oil, Transformer Oil, Mineral Turpentine Oil, Water Methanol Mixture, Naptha and Lubricants, non-availability of ITC on office equipments etc.

After having a look on the practical /economic impact of the new rules and   present legal framework for ITC, we will now discuss how even Fundamental Rights of the Dealers are vitally affected by these amendments making the amendment ultra vires the Constitution of India as well ultra vires the VAT Act, and how far these amendments to the Rules are discriminatory, arbitrary and against the scheme of Value Added Tax.

Rules are Ultra-vires the Act

As per the scheme of law for VAT credit, the right of Input Tax Credit is conferred by the Act. It cannot be curtailed or snatched by the executive orders or the rules. The ITC once granted u/s 13 of PVAT Act, 2005 cannot be restricted by executive orders. Thus the Rules as above defeat the legislative intent of granting credit of tax.

Section 13 talks of admissibility of ITC subject to all restrictions are laid down in the section 13 only. Meaning thereby whatever restrictions for admissibility of ITC are, have been provided for in Section 13 itself. What has been conferred by the Act cannot be taken back by the rules.

It is a settled principle of law that ‘Rules, being subordinate legislation must yield to Section’. Hon’ble High Court of Guwahati has in the case of CIT vs Hardware Exchange [(1991) 190 ITR 61] categorically held that rules must give effect to the section, otherwise, it would mean to putting the cart before the horse.

When a Taxable Person receives the legitimate right to claim ITC under the Act, the Rules cannot snatch away this legitimate right of ITC by either fixing the stages up to which the ITC shall be available or by curtailing the vested right of the dealer to the extent of future rate of VAT. Thus the provisions are ultra-vires the Act as the rights vested by statue is being taken away by the rules.

Rules are even ultra vires the Constitution of India

Constitutional validity of these provisions is also questionable. As per Article 265, no tax can be imposed without authority of law. Denial of ITC too amounts of imposition of tax and that in present case is beyond the powers conferred by PVAT Act, 2005 and thus is beyond the authority of law.

Further, Article 14 of the Constitution of India confers equality to every person before law, whereas as we have discussed above, vide the above provisions, equality before law to Iron and Steel traders and subsequent dealers is being denied.

These provisions also violate Article 19(1) (g) of the Constitution of India that confers freedom to every person to carry business in an unrestrictive manner because subsequent stage dealers have been restricted in free business as they cannot transfer the ITC further that restricts their trade.

Basic principle of taxation under Value Added Tax System is being defied

The very principle of taxation under value added tax system is being defied by these amendments. Restricting the admissibility of VAT to only 2 artificially created stages of inputs/outputs is against the spirit of the VAT Scheme as a whole and is bound to introduce cascading effect of taxes leading to enhanced inputs and costs. Resultantly, all stages of transactions after Second Stage iron and steel and goods of iron and steel except the specified few will continue to be liable to tax at each stage / subsequent stage but no ITC would be admissible against the tax paid after Second stage transactions. It will create tax on tax, which is not envisaged under VAT.

It is to be noted that carrying of CENVAT Credit up to two stages under Central Excise cannot be equated with the provision of VAT. Cenvat Credit can be transferred up to two stages only but Excise Duty, unlike VAT,  is imposed only once at the time of clearance of goods.

Similarly whatever tax is once paid on purchase of goods should be available as Input Tax Credit, and it is against the very basic principle of value added tax if rate of output vat is reduced in future, the input tax credit is also restricted.

The rules are against the principle of Promissory Estoppel

The Government is also bound by its promise. Input Tax Credit has been conferred by the Government through operation the provisions of the Act. With reference Rule 21(7) regarding reduced ITC on goods on which rate of VAT is reduced in future, we find in the light of very clear judgements of honourable Supreme Court in similar matters that depriving the right to already accrued right to the dealer shall defy the important principle of Promissiory Estopple.

The amendments are arbitrary and discriminatory

The provisions as introduced are arbitrary in nature so far as restriction of Input Tax credit is up to two stages and also so  far as these affect a particular class of commodity. The number of stages specified for eligibility of transfer of tax credit has been arbitrarily fixed.  ITC credit up to two stages has also arbitrarily fixed.

Secondly, restriction of ITC only for a person dealing in particular class of commodities i.e. Iron and Steel is also arbitrary.

The provisions are also discriminatory because only one category of goods has been taken out for such illegal treatment. On the same grounds, the provisions are discriminatory to Subsequent Dealers viz a viz First Stage and Second Stage Dealers as the later ones get fairer treatment as far as ITC is concerned.

Thus the new rules are ultra vires the Act, Ultra Vires the Constitution, against the principle of VAT and general law, arbitrary and discriminatory.

Before I conclude, I take you back to the introductory paragraph of this discussion wherein we discussed about charging tax on tax and thereby taxing the business itself. Denial of Input Tax Credit from stages subsequent to second stage taxable person amounts to inclusion of tax paid on purchases in the cost of goods to the subsequent dealers. Similarly denial of ITC to the extent of subsequent reduction in VAT rates also amounts to taxing the taxes by inclusion of tax to cost of goods. These new rules amount to tax the business itself rather than collecting taxes from the business.

CA. Rajeev K. Sharma


Published by

CA. Rajeev K. Sharma
(VAT and Service Tax)
Category VAT   Report

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