Interest Income not an Exempt Supply for ITC Reversal w.e.f. 01.07.2017

Background

1. In business entities engaged in manufacturing and service sector, many a times surplus money left is invested for the time in interest bearing investments. From the said investment activities, interest income is earned. In GST, it is called 'supply of service by way of extending deposits, loans

or advances against consideration in form of interest' ("Interest Supply"). Interest Supply is exempted from GST chargeability.¹

In GST law, if your output supply is taxable then you will be eligible to take benefit of input tax credit. However, if your output is exempted then you shall not be allowed to take the benefit of input tax credit. There can also be cases where an input is attributable to both taxable output supply as well as exempt output supply. In such cases, amount of input tax credit shall be restricted to so much input tax credit as is attributable to taxable output supplies. To deal with such cases, method for quantification of the amount of input tax credit attributable to exempt supply and taxable supply, is prescribed in Rule 42 and Rule 43 of the Central Goods and Services Tax Rules, 2017 ("CGST Rules")

From the above principle, input tax credit which is in relation to Interest Supply, being an exempt supply, should also not be eligible. However, one will appreciate that the assessee is not engaged into the business of Interest Supply and it is just an investment of surplus money which will be withdrawn when there is a requirement in the business. With this intent, an amendment has been made to the CGST rules by the Central Goods and Services Tax (Amendment) Rules, 2018 [Notification No. 03/2018 – CT dated 23.01.2018] ("Notification dated 23.01.2018"). Through the said amendment, Explanation to Rule 43 was substituted with the new Explanation. In the new Explanation to Rule 43, Government clarified that value of Interest Supply shall be excluded from the aggregate value of exempt supply for the purpose of Rule 42 and Rule 43 of the CGST Rules. As the Explanation to Rule 43 is in the form of clarification, whether a view can be taken that the clarification being exclusion of value of Interest Supply from the value of exempt supplies for the purpose of reversal of input tax credit, shall be effective retrospectively from 1st July, 2017, i.e., the date when Rule 42 and Rule 43 of the CGST Rules came into force.

Applicable Legal Provisions and Judicial Analysis

2. As discussed above, methodology to determine the input tax credit attributable to taxable supplies and exempt supplies has been specified in Rule 42 and Rule 43 of the CGST Rules. VideCentral Goods and Services Tax (Twelfth Amendment) Rules, 2017 [Notification No. 55/2017 dated 15.11.2017], Explanation was inserted in Rule 43 ("Old Explanation") to provide for exclusion of value of certain supply of service from the aggregate value of exempt supplies. The said explanation reads as under

Explanation –

For the purposes of rule 42 and this rule, it is hereby clarified that the aggregate value of exempt supplies shall exclude the value of supply of services specified in the notification of the Government of India in the Ministry of Finance, Department of Revenue No. 42/2017-Integrated Tax (Rate), dated the 27th October, 2017 published in the Gazette of India, Extraordinary, Part II, Section 3, Sub-section (i), vide number GSR 1338(E) dated the 27th October, 2017

Vide Notification dated 23.01.2018, new Explanation substituted Old Explanation. New Explanation to Rule 43 ("New Explanation") reads as under:

Explanation: -

For the purposes of rule 42 and this rule, it is hereby clarified that the aggregate value of exempt supplies shall exclude: -

(a)		the value of supply of services specified in the notification of the Government of India in the Ministry of Finance, Department of Revenue No. 42/2017-Integrated Tax (Rate), dated the 27th October, 2017 published in the Gazette of India, Extraordinary, Part II, Section 3, Sub-section (i), vide number GSR 1338(E) dated the 27th October, 2017;
(b)		the value of services by way of accepting deposits, extending loans or advances insofar as the consideration is represented by way of interest or discount, except in case of a banking company or a financial institution including a non-banking financial company, engaged in supplying services by way of accepting deposits, extending loans or advances; and
(c)		the value of supply of services by way of transportation of goods by a vessel from the customs station of clearance in India to a place outside India.

From the above, it is evident that vide Old Explanation and New Explanation, Government has issued three clarifications, being exclusion of value of certain supplies from the aggregate value of exempt supplies for the purpose of Rule 42 and Rule 43 of the CGST Rules. One such clarification is exclusion of value of Interest Supply from the aggregate value of exempt supplies ("Relevant Clarification").

Now, for examining whether the Relevant Clarification can be said to be effective from 01.07.2017, one should understand the intent of government behind providing the Relevant Clarification. The said clarification was provided after discussion of GST Council in its 25th meeting dated 18.01.2018. After perusal of the agenda for 25th GST Council Meeting-Volume 2 (Page 18), we can observe that CII & FICCI were proposing that the value of Interest Supply should be excluded from the aggregate value of exempt supplies for the purpose of Rule 42 and Rule 43 of the CGST Rules. CII and FICCI also gave justifications for the said proposal and Fitment Committee was in agreement with the said proposal. Relevant extract of the agenda for 25th GST Council Meeting is reproduced below for ready reference:

S. No.	Represented by	Proposal	Justification	Comments of Fitment Committee
12	CII, FICCI	The input tax reversal by way of Section 17(2) of the CGST Act should be amended to exclude the value of supply by way of extending deposits, loans or advances as was under Service Tax.	Explanation I(e) to Rule 6 under CENVAT Credit Rules, 2004 provided that value of exempt services for the purpose of reversal of Cenvat credit shall be exclusive of value of the service by way of extending deposits, loans or advances insofar as consideration is represented by way of interest. This provision did not apply to a banking company and a financial institute including a non-banking financial company, engaged in providing services by way of extending deposits, loans or advances.	Position in Service tax-Services by way of extending deposits, loans or advances against consideration in the form of interest was in the Negative List. Under the CENVAT Credit Rules, 2004 (CCR), services in the Negative List were treated at par with exempted services for the purpose of reversal of input tax credits [Rule 2(e) of CCR refers]. Therefore, CENVAT credit of common inputs and input services used in exempted or negative list services was required to be reversed proportionately. However, as a business-friendly measure, it had been provided in the CENVAT Credit Rules, 2004 [Explanation-I(e) to Rule 6], that value for the purpose of reversal of common input tax credit shall not include the value of service by way of extending deposits, loans or advances against consideration in the form of interest. This provision, which was incorporated in the CENVAT Credit Rules in June, 2012, was meant for assessees in manufacturing and service sector who invested surplus cash available with them for earning interest but did not engage in advancing deposits, loans, advances etc. as their main or regular economic activity. Position in GST- In GST an identical exemption for services by way of extending deposits, loans or advances, insofar as the consideration is represented by way of interest or discount (other than interest involved in credit card services) exists in notification No. 12/2017-CT(R) S. No. 27. However, there is no provision for excluding the interest income earned by an assessee by investing surplus cash available with him. This may result in reversal of ITC disproportionate to the inputs and input services consumed by him in the activity of investing or lending such surplus on interest. In exercise of powers under section 17(3) of the CGST Act, it may be provided in CGST rules that value of exempt supply under sub-section (2) of section 17, in case of any person other than banking company and a financial institution including a non-banking financial company engaged in providing services by way of extending deposits, loans or advances, shall not include the value of the service by way of extending deposits, loans or advances, insofar as consideration is represented by way of interest or discount. This will restore the position as existed in service tax as on 30.06.2017. Fitment Decision Approved.

From the above, it can easily be inferred that the reason for providing the Relevant Clarification is to restore the position as existed in service tax regime till 30.06.2017. In the service tax regime, Rule 6 of the Cenvat Credit Rules, 2004 ("CCR") dealt with reversal of input tax credit as attributable to exempt services. Further, Interest Supply was covered under the scope of negative list in the service tax regime, i.e., not chargeable to service tax and for the purpose of reversal of input tax credit, services covered under the scope of negative list were treated at par with exempt services. However, on account of Explanation I to Rule 6 of CCR, value of exempt services for the purpose of reversal excluded the value of Interest Supply. As per the comments of Fitment Committee as reproduced above, said provision of CCR as a business friendly measure, was meant for assessees in manufacturing and service sector who invested surplus cash available with them for earning interest but did not engage in advancing deposits, loans, advances, etc., as their main or regular economic activity.

After understanding the above intent of excluding the value of Interest Supply from the value of exempt supplies for the purpose of reversal of input tax credit in service tax regime, the said provision should also be continued in the GST regime. However, there was no such corresponding provision in the GST regime. Therefore, to restore the positing in GST regime, necessary amendment took place in Rule 43 of the CGST Rules.

From the aforesaid analysis, one can reasonably infer that the nature of the Relevant Clarification is curative in nature. It has been held in various judicial precedents Allied Motors (P.) Ltd. v. CIT [1997] 91 Taxman 205/224 ITR 677 (SC); CIT v. Alom Extrusions Ltd. [2009] 185 Taxman 416/319 ITR 306 (SC); CIT v. Calcutta Export Co. [2018] 93 taxmann.com 51/255 Taxman 293/404 ITR 654 (SC) that amendments to the legislation which are curative in nature should be treated as retrospective in effect and should be applicable for earlier years also. Therefore, one can reasonably take a view that Relevant Clarification being curative in nature shall be considered to be effective from the period from which cure was required in the law, i.e., date from which Rule 42 and Rule 43 are effective.

Furthermore, from the above reading, it is evident that through the Relevant Clarification, benefit to the assessee has been conferred by the legislature by way of not including the value of Interest Supply in the value of exempt supplies for the purpose of reversal of input tax credit. Accordingly, if value of exempt supply is less, reversal of input tax credit shall also be proportionately less. Hence, the benefit is in the form of increase in the quantum of eligible input tax credit. Since the Relevant Clarification is for the benefit of the assessee, it should be applied retrospectively CIT v. Vatika Township (P.) Ltd. [2014] 49 taxmann.com 249/227 Taxman 121/367 ITR 466 (SC).

The aforesaid view can also be substantiated by one more reasoning. As per the provisions of Rule 42 and Rule 43 of the CGST Rules, input tax credit in relation to exempt supply is required to be determined every month as per the method prescribed therein. After the end of financial year, amount of input tax credit in relation to exempt supply shall be determined finally for the financial year as per the method prescribed therein. Accordingly, it can be inferred that month-wise calculation of input tax credit in relation to exempt supply is on provisional basis which shall be finalized at the end of financial year. Any difference in the final calculation and provisional calculation shall be adjusted in the month not later than the month of September following the end of financial year.

In the issue under consideration, the reversal made in the month of July, 2017 to December, 2017 was on provisional basis. During such time, Interest Supply was considered as an exempt supply for the purpose of reversal of credit. While making the final calculation for the period starting from July 2017 to March 2018, the Relevant Clarification has been made part of the law book. Therefore, while finalizing the provisional calculation of reversal of input tax credit in relation to exempt supply for the period starting from July 2017 to March, 2018, value of Interest Supply shall be excluded from the value of exempt supply, in turn, making Relevant Clarification effective from 01.07.2017 and any excess reversal on account to inclusion of value of Interest Supply in the value of exempt supply shall be made good.

Conclusion

3. From the above one can take a view that Interest Supply shall not be included in the value of exempt supply for the purpose of reversal of input tax credit with retrospective effect from 01.07.2017. Therefore, while making the final calculation of input tax credit for the FY 2017-18, one can consider the aforesaid view and any excess reversal of input tax credit on account of treating Interest Supply as exempt supply can be made good. However, last date of making the said adjustment shall be due date for furnishing of return for the September month following the end of financial year and due date of GSTR 3B of September, 2018 is 20.10.2018.