GST Ambiguities: ITC Reversal of Capital Goods & Corporate Guarantees

Introduction

It’s going to be 7 years of GST implementation on 1^st July 2024. Yet there exists a good number of ambiguity in the various provisions of GST law. Below are a few instances that require clarity yet no notification and advisory has been issued. With such dynamic changes in the implementation of GST law, it is right to say that it has become better over the years. Though these changes look difficult to implement at first with the passage of time businesses and professionals have started to adjust according to the changes only for the betterment of their businesses.

Let’s get started with the ambiguous GST provisions and suggestions on what exactly should be done until some clarification is issued by the authorities.

ITC reversal on Capital Goods sale.

In this case, we are going to discuss ITC reversal on the sale of used capital goods. Before beginning with the issue, one should dive into the background provisions i.e.

What are capital goods under GST?

According to Section 2(19) of the CGST Act, 2017, capital goods are those goods whose value is capitalized in the books of accounts of the person claiming ITC and which are used or intended to be used in the course or furtherance of business.

From the above definition one can conclude that the ITC can be claimed under GST on Capital goods provided these are USED/ INTENDED TO BE USED in the course/ furtherance of business.

Once the taxpayer claims ITC on capital goods, the taxpayer has to reverse the unused ITC or output tax on Sale consideration at the time of selling off the used capital goods.

We’ll now delve into the relevant GST provisions concerning the sale of used capital goods.

Schedule II of the CGST Act, 2017 states the list of the activities/transactions to be treated as supply of goods or supply of services.

Para 4(a) to the Schedule II provides that the

“where goods forming part of the assets of a business are transferred or disposed of by or under the directions of the person carrying on the business so as no longer to form part of those assets, 2 [****]such transfer or disposal is a supply of goods by the person”

The above provision can be divided into three parts for better understanding:

• Goods forming part of business assets;
• Transferred or disposed off and no longer forms part of the business
• By or under the direction of the person carrying the business.

Any transaction falling under any of the above conditions shall be termed as Supply of Goods.

The provision termed Business Goods sold as SUPPLY OF GOODS regardless of :

• Whether Input Tax Credit (ITC) was availed on the purchase of the goods.
• Whether the transaction involves any consideration (payment) or not.
• Whether the goods were purchased before or after the implementation of GST.

This clarifies that the sale of used capital goods constitutes a supply of goods under GST. The next question becomes: how is the value of this supply determined for GST purposes?

Let’s now look at how Section 18(6) of the CGST Act, 2017 applies in this situation. Here’s the exact wording of the provision:

“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”

Decoding the above provision in simpler words we can conclude that-

• In case of SUPPLY OF CAPITAL GOODS
• where ITC was AVAILED by the taxpayer
• Value of supply can be determined as HIGHER of the following:
  • Taxable Value as per Section 15 or
  • ITC Attributable to the Remaining life of the Capital Goods (Total Amount of ITC availed – Percentage points prescribed )

Let’s see how Rule 40(2) determines the percentage point reduction for ITC reversal:

“The amount of credit in the case of supply of capital goods or plant and machinery, for the purposes of sub-section (6) of section 18, shall be calculated by reducing the input tax on the said goods at the rate of five percentage points for every quarter or part thereof from the date of the issue of the invoice for such goods.”

In simpler words:

Reversal of ITC ={ Total ITC Availed on such Capital Goods- (5% per quarter of the year or part thereof for which capital goods have been used in business * Total ITC Availed on such Goods)}

While Rule 40(2) provides a fixed reduction based on the duration of use, another method exists for calculating ITC reversal reproduced as follows:

Rule 44(1)(b)- “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,-

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

Rule 44(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 2[Central tax, State tax, Union territory tax and integrated tax]”

In a nutshell, the above sub-rules of Rule 44 state that ITC is to be reversed on the supply of used capital goods as follows:

Reversal of ITC= Total Amount of ITC availed *Remaining useful life of the asset/ Total life of the asset

Illustration:

Total Useful life of the Capital Good(CG)= 5 years

The remaining useful life of the CG= 1year 8 months

ITC availed on purchase of CG= Rs.72000

Sales consideration= Rs. 115000

Output Tax Liability = Rs. 20700 (115000*18%)

As per Rule 40(2)		As per Rule 44(6)
ITC availed	Rs.72000	ITC availed	Rs.72000
Less ITC availed *5% per quarter of the year or part thereof for which capital goods have been used in business (72000*5%* 14 quarters)	Rs. 50400	Remaining usful life of the CG 1 year 8months 12 days (in months)	21 months
		Total useful life of the CG(5 years) in months	60 months
ITC attributable to remaining useful life	21600	ITC attributable to remaining useful life (72000*21/60)	24000
ITC Reversal -Higher of Rs. 21600 or Rs. 20700	Rs. 21600	ITC Reversal -Higher of Rs. 24000 or Rs. 20700	Rs. 24000

Key Takeaways:

• The contrasting methods for ITC reversal under Rule 40(2) and Rule 44(6) can lead to differences in the taxpayer’s liability.
• This ambiguity can create confusion for businesses when determining the appropriate method for calculating ITC reversal on used capital goods.
• The current ambiguity regarding the preferred method for ITC reversal on used capital goods can be addressed by the authorities issuing clear and distinct guidelines.

Suggestion:

In the absence of clear guidance from the authorities, a prudent approach for businesses selling used capital goods would be to calculate the ITC reversal using both methods prescribed in the CGST Act. The higher of the two calculated ITC reversal amounts should then be compared to the output tax liability to determine the final tax liability.

GST on Corporate Guarantees

Corporate Guarantee a widespread term of the corporate world. It means guarantee by Holding company for another group company or its subsidiary company. In layman’s language when any subsidiary company avails any loan i.e Term Loan or Working Capital Loan from any Financial Institute then Holding Company stands as a guarantor for subsidiary company.

GST applicability on Corporate Guarantees is quite opaque. Now following question arises:

1. Whether Corporate Guarantee is supply?
2. If corporate guarantee is supply, then at what value it will be measured?

To answer the questions above, let’s explore the relevant GST provisions:

Schedule I of Section 7 of the CGST Act, 2017: This schedule specifies transactions treated as a supply even without consideration. Clause 2 states:

“Supply of goods or services or both between related persons or between distinct persons as specified in section 25, when made in the course or furtherance of business”

From above one can conclude that the transactions between related parties/ distinct persons are supply even if made without consideration. Therefore activities like corporate guarantees fall under the definition of supply.

However next question is about its valuation since generally the corporate guarantees are without consideration and no specific valuation method was available until October 2023 vide Notification No. 52/2023- Central Tax dated 26.10.2023, a new sub-rule 2 has been inserted in Rule 28 of the CGST Rules dealing with the determination of the value of supply in case of corporate guarantees. The value of corporate guarantee as a supply should be deemed as 1% of the amount guaranteed or actual consideration whichever is higher.

So one can conclude that corporate guarantees are taxable under GST. However, there are many other similar activities like corporate guarantees fall under the category of supply according to Schedule I. One such example is personal guarantees provided by directors to financial institutions on behalf of the organization. For clarifying such transaction Circular No. 204/16/2023-GST dated 27.10.2023 was issued stating various instances when personal guarantee shall be considered as supply and how it will be valued.

More clarity on such inter-company transactions is requested from the department to provide correct treatment under GST to such cases avoiding legal consequences on the taxpayers in the future.