Transactions relating to Capital Goods under Goods and Services Tax

The treatment of transactions relating to 'capital goods' have always been a matter of discussion and deliberation, be it under the earlier laws such as Excise and Value Added Taxes or the current law i.e. Goods and Services Tax Law (hereinafter referred to as GST). In this write-up we shall analyze the following aspects relating to capital goods under GST-

1. Meaning
2. Inward supplies
3. Outward supplies
4. Supply of old motor vehicles

1. Meaning of the term 'capital goods'

In order to analyze various transactions relating to 'capital goods' it’s important to first understand the meaning of the term 'capital goods'. The term is defined in sub-clause 19 of Sec 2 of the Central Goods and Services Tax Act, 2017 (hereinafter referred to as CGST Act) as below-

19) '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;

The above definition highlights for the following important aspects-

a. 'Goods' only: Firstly, only 'goods' can be classified as capital goods. In other words, in no case can an 'input service' be classified as capital goods even if it satisfies the rest of the conditions.

b. Capitalisation: Secondly the value of those goods must be capitalized in the books of account.

c. Business Use: Finally, the goods must be used or intended to be used in the course or furtherance of business.

Note: Although the terms 'fixed assets' and 'capital goods' are many a times used interchangeably in the ordinary course, it is important to understand that 'capital goods' is only a subset of fixed asset, i.e. all capital goods would qualify as fixed assets but all fixed assets may not qualify as capital goods. For example 'works contract' which may be capitalized as leasehold improvement in the books of accounts, would not qualify as capital goods though it is a fixed asset.  

2. Inward supply of 'capital goods'

Inward supply is directly related to Input tax credits and accordingly in this section of the write up we shall discuss about the eligibility of input tax credit on inward supply of capital goods.

The taxpayer under GST is allowed to take credit of input tax charged on any supply to him of goods or services or both subject to various condition as provided in the law. The law does not make any distinction between manners of claiming input tax credit on account of inputs or capital goods, as credit in both categories is available as soon as the conditions specified in Sec 16(2) are satisfied.

Although in most situations the input tax credit relating to capital goods is allowed in full, under certain circumstances either the credit is not available at all or a proportion of credit has to be reversed in a specific manner and within a specified period. Some of those situations are listed here under-

1. Specified capital goods on which input tax credit is blocked u/s 17(5)

Section 17(5) prohibits input tax credit on certain goods and services and some of the entries therein have a bearing on capital goods, those entries are-

i) motor vehicles and other conveyances [17(5)(a)]

ii) goods or services or both received by a taxable person for construction of an immovable property (other than plant or machinery) on his own account including when such goods or services or both are used in the course or furtherance of business [17(5)(d)]

iii) goods or services or both used for personal consumption. [17(5)(g)]

iv) goods lost, stolen, destroyed, written off or disposed of by way of gift or free samples [17(5)(h)]

In other words if a capital good is in the nature of motor vehicle or is used for construction of an immovable property or for personal consumption or it is lost, stolen, destroyed, written off or disposed of by way of gift or free sample then the credit of the same would not be allowed.

2. Use of capital goods exclusively for exempt supplies

In case where a capital good is used exclusively for exempt supplies then input tax credit of the same is not available in terms of Sec 17 of the CGST Act read with Rule 43 of the CGST Rules.

3. Use of capital goods for both taxable and exempt supplies

In cases where a capital good is used for both 'taxable and exempt supplies' or for both 'business and non-business purposes' then the credit would be allowed in proportion as provided in Sec 17(1) and Sec 17(2) read with Rule 43 of the CGST Rules.

3. Outward supply of 'capital goods'

It is the most important issue amongst all the issues discussed in this article. This issue is broadly divided in two parts:

• When the supply of capital goods is made to related party; and

• When the supply of capital goods is made to unrelated party.

A Supply Of Capital Goods When Supplier And Recipient Are Not Related

In an ordinary business transaction under GST the tax is payable at the transaction value if the conditions as provided in Sec 15 are satisfied, which are that ‘price is the sole consideration’ and ‘supplier and the recipient of the supply are not related’. The same also applies for supply of capital goods but Sec 18(6) has provided that in case the taxpayer is supplying a capital good on which input tax credit has been taken then the amount payable on the supply would not be dependent merely on the 'transaction value' but would also depend upon the 'input tax credit attributable to remaining useful life'. The concept of input tax credit attributable to the unexpired useful life and the provision of Sec 18(6) are as follows -

Sec 18 Availability of credit in certain circumstances

(6) In case of supply of capital goods or plant and machinery, on which input tax credit has been taken, the registered person shall pay an amount equal to the input tax credit taken on the said capital goods or plant and machinery reduced by such percentage points as may be prescribed or the tax on the transaction value of such capital goods or plant and machinery determined under section 15, whichever is higher:

Provided that where refractory bricks, moulds and dies, jigs and fixtures are supplied as scrap, the taxable person may pay tax on the transaction value of such goods determined under section 15.

RULE 44. Manner of reversal of credit under special circumstances 

(6) The amount of input tax credit for the purposes of sub-section (6) of section 18  relating to capital goods shall be determined in the same manner as specified in clause (b) of sub-rule (1) and the amount shall be determined separately for input tax credit of central tax, State tax, Union territory tax and integrated tax.

(1) The amount of input tax credit relating to inputs held in stock, inputs contained in semi-finished and finished goods held in stock, and capital goods held in stock shall, for the purposes of sub-section (4) of section 18 or sub-section (5) of section 29, be determined in the following manner, namely,-

(a) for inputs held in stock and inputs contained in semi-finished and finished goods held in stock…..;

(b) for capital goods held in stock, the input tax credit involved in the remaining useful life in months shall be computed on pro-rata basis, taking the useful life as five years.

Illustration:

Capital goods have been in use for 4 years, 6 month and 15 days.

The useful remaining life in months= 5 months ignoring a part of the month

Input tax credit taken on such capital goods= C

Input tax credit attributable to remaining useful life= C multiplied by 5/60

The concept of ITC attributable to remaining useful life better is discussed with the help of an example which is discussed hereunder-

Facts: A taxpayer purchased a 'capital good' worth Rs 30,000/- Taxable Value and GST @ 18% amounting to Rs 5,400/-. This good was purchased on 1st May, 2018 and later supplied on 15th Sep, 2018. What is the credit amount attributable to remaining useful life?

Explanation:

• Initial Credit: As per provisions of Sec 16 the taxpayer would have already taken credit of Rs 5400/- in his return for the month of May, 2018.

• Useful Life: As per provisions of Rule 44(6) read with Rule 44(1) the deemed useful life of the capital goods is 60 months. Accordingly, monthly credit would amount to Rs 90/- per month (Total Credit i.e. Rs 5400 / Total Months i.e. 60).

• Deemed Holding Period: As per the said provisions, month or part of the month shall be taken as a full month. Accordingly, the assets which were held between the dates 1st May, 2018 to 15th Sep, 2018, would be considered as having been used for 5 months i.e. May, Jun, July Aug and Sep, 2018.

• Remaining Useful Life: The remaining useful life of the assets as per the provision is 55 months i.e. total life of 60 months as reduced by the period for which it was used i.e. 5 months.

• Balance Credit: Basis above, the credit attributable to the unexpired useful life would amount to Rs 90 X 55 month i.e. Rs 4950/-.

Further as per the provisions of Sec 18(6) Read with Rule 44 a taxpayer would be required to pay an amount equal to the higher of –

1. Tax on transaction value; or

2. Input tax credit attributable to remaining useful life of the asset

To understand it better, lets assume that in the above example the capital good was supplied further for Rs 5,000/- and GST was @18% amounting to Rs 900/-. In that case what would be the amount payable by the taxpayer?

Ans. As per provision of Sec 18(6) the taxpayer would be required to pay higher of-

• Tax on transaction value or

• Input tax credit attributable to remaining useful life

The tax on transaction value in the instant case is Rs 900/- while the ITC attributable to remaining useful life is Rs 4,950/- as calculated above. Therefore the taxpayer would be required to pay Rs 4,950/- on the outward supply of that capital good.

Note- Here the important point to note is that even if a capital good is permanently transferred or disposed off without any consideration it would still be a supply in terms of Sec 7 read with Schedule I and the impact of Sec 18(6) shall be taken into consideration. The relevant entry of schedule 1 is reproduced hereunder-

SCHEDULE I [Section 7]

ACTIVITIES TO BE TREATED AS SUPPLY EVEN IF MADE WITHOUT CONSIDERATION

1. Permanent transfer or disposal of business assets where input tax credit has been availed on such assets.

B Supply of Capital Goods When Supplier And Recipient Are Related

As discussed in Para 3A above generally tax is payable at the transaction value except in the situations where Input tax credit on capital goods is taken. But in case of supply between related persons as per the provisions of Sec 15, the value of supply has to be determined based on the valuation rules i.e. the transaction value will not be accepted as such. The extract of the relevant valuation rule is provided hereunder-

RULE 28. Value of supply of goods or services or both between distinct or related persons, other than through an agent.-  

The value of the supply of goods or services or both between distinct persons as specified in sub-section (4) and (5) of section 25 or where the supplier and recipient are related, other than where the supply is made through an agent, shall-

(a) be the open market value of such supply;
(b) if the open market value is not available, be the value of supply of goods or services of like kind and quality;
(c) if the value is not determinable under clause (a) or (b), be the value as determined by the application of rule 30 or rule 31, in that order: 

Provided that where the goods are intended for further supply as such by the recipient, the value shall, at the option of the supplier, be an amount equivalent to ninety percent of the price charged for the supply of goods of like kind and quality by the recipient to his customer not being a related person:

Provided further that where the recipient is eligible for full input tax credit, the value declared in the invoice shall be deemed to be the open market value of the goods or services.

The above rule provides for multiple option that a taxpayer can use to arrive at the value of supply. Here it is important to note that the above valuation rules would be applicable in all cases irrespective of the fact that credit is taken on capital goods or not. The requirement of Sec 18(6) is additional to that as provided in Rule 28 in case of related party supplies.

To illustrate, the second proviso of Rule 28 provides that if the recipient is a related party and is eligible for full input tax credit then the value declared in the invoice shall be deemed to be the open market value i.e. it will become taxable value. Here due care must be taken of the impact of Sec 18(6) and accordingly in order to avoid litigation the valuation must be done considering the ITC attributable to remaining useful life. In addition to the above, due care must also be taken when the taxpayer enters into certain transactions with his employees who are deemed to be related person under GST vide Schedule I.

The above can be summarized to conclude that in case of supply of capital goods to related party the tax is to be paid as follows-

a. Where ITC on capital goods is not taken- Tax on value computed through Rule 28

b. Where ITC on capital goods is not taken- Higher of

i) Tax on value computed through Rule 28 or
ii) Input tax credit of attributable to remaining useful life

4. Supply of motor vehicles

Supply of motor vehicles has been under huge deliberation since the inception of GST. Though there was little to no confusion on the taxability in case of supply of motor vehicles after use but its logical validity was under huge criticism as the credit in respect of motor vehicles is blocked but when the vehicle was supplied after use, tax was payable again and the tax rates were as high as 28% plus cess. The issue has been taken up by the government and the taxability of the same is streamlined as follows-

Note:- The tax rates of Electrically operated vehicles, including two and three wheeled electric motor vehicles and Fuel Cell Motor Vehicles was 12%.

5. Summary

6. Concluding remarks

The GST law is still in its nascent stages and expecting it to have built-in solutions to all the practical issues that arise in day to day business activities would be unrealistic. There are various issues relating to capital goods that still need consideration such as:

i) What would be the impact of Sec 18(6) and Rule 42 and Rule 43 when a capital goods is converted into stock in trade or vice versa?

ii) What would be the impact of Sec 17(5)(h) on capital goods which are lost, stolen or destroyed after using them for some time?

Although as professionals we can arrive at and device the best suitable solution based on our understanding of the law, whether it would be accepted by the departmental officers is a matter of concern.

DISCLAIMER

The contents of this document are solely for informational purpose. It does not constitute professional advice or a formal recommendation. The presentation is made with utmost professional caution but in no manner guarantees the content for use by any person. It is suggested to go through original statute/notification/circular / pronouncements before relying on the matter given.  The presentation is meant for general guidance and no responsibility for loss arising to any person acting or refraining from acting as a result of any material contained in this presentation will be accepted by us. Professional advice recommended being sought before any action or refrainment.

The author can also be reached at tarun@tsarora.com