SC lays down ‘functionality’, ‘essentially’ test to claim ITC

• The Supreme Court declared that real estate companies can claim Input Tax Credits (ITC) under the Goods and Services Tax (GST) regime, on costs of construction for commercial structures intended for renting or leasing purposes.

Highlights:

• The Supreme Court of India, in a significant judgment delivered on Thursday, has ruled that real estate companies are eligible to claim Input Tax Credits (ITC) under the Goods and Services Tax (GST) regime on the costs incurred for constructing commercial buildings intended for renting or leasing purposes.
• This ruling offers a much-needed relief for the real estate industry by reducing investment costs.

Key Takeaways from the Ruling:

• Eligibility for ITC on Commercial Properties: The Court, led by Justice A.S. Oka, held that if a building qualifies as a "plant" under the GST law, Input Tax Credit can be availed against services such as renting or leasing.
• The decision was based on the premise that renting or leasing immovable property is classified as a supply of service under the Central Goods and Services Tax (CGST) Act, making it subject to taxation.
• Conditions for Availing ITC: ITC can be claimed only if the property serves business purposes and is classified as a plant or machinery as per the provisions of Section 17(5)(d) of the CGST Act. However, if the construction of the building is for the owner's use, ITC cannot be claimed, as this breaks the ITC chain.
• Definition of ‘Plant’: The ruling emphasized that whether a structure, such as a mall, warehouse, or any commercial building (excluding hotels or cinemas), qualifies as a "plant" depends on its functionality in business operations.
• This must be assessed through a functionality test that examines the role the building plays in the overall business activities.
• Functionality and Essentiality Tests: Abhishek A. Rastogi, who represented multiple petitioners, explained that the functionality and essentiality tests are critical in determining ITC eligibility. If a building is essential for conducting business activities, ITC may be allowed. However, if these tests are not met, the credit would be denied.
• Section 17(5) Read Down: The Court’s interpretation effectively read down the restrictive provisions of Section 17(5)(c) and (d) of the GST Act.
• These sections previously barred ITC claims on immovable properties, but the ruling clarifies that businesses can claim ITC as long as their business nature and the credits claimed satisfy the functional criteria.

Implications for the Real Estate Sector

• This judgment is expected to significantly reduce the cost burden on developers of commercial properties by allowing them to offset tax paid on construction materials and services.
• The decision is particularly relevant for companies that lease out malls, office spaces, warehouses, and other commercial structures, as they can now avail of the tax credits associated with their construction expenses.

Prelims Takeaways:

• Input Tax Credits (ITC)
• Central Goods and Services Tax Act