Deductibility of Input Tax in India

Navigating the Labyrinth: An Analysis of Input Tax Deductibility under Indian Indirect Tax Law

Introduction

The deductibility of input tax, commonly known as Input Tax Credit (ITC), is a cornerstone of modern indirect tax systems, including India's Goods and Services Tax (GST) regime. It is the mechanism by which a registered taxable person can reduce the output tax liability on their supplies by the amount of tax already paid on inputs (goods and services) used in the course of furtherance of business. The primary objective of allowing such deduction is to mitigate the cascading effect of taxes (tax on tax), thereby ensuring that the tax burden is effectively borne by the final consumer and that the tax essentially adheres to the consumption principle. This article provides a comprehensive analysis of the principles, conditions, restrictions, and evolving jurisprudence surrounding the deductibility of input tax in India, drawing heavily upon statutory provisions and judicial pronouncements from both the pre-GST and GST eras.

Conceptual Framework of Input Tax Deductibility

The concept of allowing credit for taxes paid on inputs has evolved significantly in India, from the Modified Value Added Tax (MODVAT) scheme to the CENVAT credit scheme under Central Excise and Service Tax, and various State VAT laws, culminating in the comprehensive ITC mechanism under the GST regime.

Pre-GST Regimes: MODVAT, CENVAT, and State VAT

The MODVAT scheme, introduced in 1986, was an early attempt to mitigate the cascading effect of excise duties. The Supreme Court, in Collector Of Central Excise, Pune And Others v. Dai Ichi Karkaria Ltd. And Others (Supreme Court Of India, 1999), affirmed that excise duty paid on raw materials, covered under the MODVAT Scheme, should not form part of the cost when determining the assessable value of intermediate products. This was because the MODVAT credit effectively reduced the real cost of raw materials, highlighting the economic principle that credit mechanisms are intended to reduce the tax burden embedded in costs. The nature of such credits was often debated. In Eicher Motors Ltd. And Another v. Union Of India And Others (Supreme Court Of India, 1999), the Supreme Court held that Rule 57-F(4-A) of the Central Excise Rules, 1944, which mandated the lapsing of unutilized MODVAT credits, could not infringe upon the vested rights of assessees concerning goods manufactured prior to the rule's effective date, where duty had been paid and credits utilized. This suggested that accrued credits could attain the status of a vested right. However, a contrasting view was often expressed, as noted in cases like THE STATE OF KARNATAKA v. TRACTORS AND FARM EQUIPMENT LIMITED (Karnataka High Court, 2025), citing earlier Supreme Court decisions under sales tax laws, which characterized set-off or ITC as a concession or indulgence rather than an absolute legal right.

The GST Paradigm: Towards Seamless Credit

The introduction of GST in 2017 aimed to create a unified national market with a seamless flow of ITC across the supply chain, covering both goods and services. The Central Goods and Services Tax Act, 2017 (CGST Act), along with respective State GST Acts, lays down the framework for ITC. Section 2(62) of the CGST Act defines "input tax" in relation to a registered person as the central tax, State tax, integrated tax, or Union territory tax charged on any supply of goods or services or both made to him, including tax paid on reverse charge basis and IGST on imports. Section 2(63) defines "input tax credit" as the credit of input tax. The fundamental objective is to tax only the value addition at each stage of the supply chain (Union Of India And Others v. Vkc Footsteps India Pvt. Ltd., Supreme Court Of India, 2021).

Eligibility and Conditions for Availing Input Tax Credit under GST

Section 16(1) of the CGST Act establishes the basic entitlement: every registered person shall, subject to such conditions and restrictions as may be prescribed and in the manner specified in Section 49, be entitled to take credit of input tax charged on any supply of goods or services or both to him which are used or intended to be used in the course or furtherance of his business, and the said amount shall be credited to the electronic credit ledger of such person. However, this entitlement is circumscribed by several conditions stipulated in Section 16(2):

  • Possession of a tax invoice or debit note or other prescribed tax-paying documents.
  • Receipt of the goods or services or both. (Explanation to Section 16(2)(b) includes "bill to-ship to" scenarios).
  • The tax charged in respect of such supply has been actually paid to the Government, either in cash or through utilization of ITC admissible in respect of the said supply (Section 16(2)(c)).
  • The registered person has furnished the return under Section 39.

The condition under Section 16(2)(c) has been a subject of considerable debate. As observed in writ petitions before the Kerala High Court (M/S. MALL OF JOY PVT LIMITED, v. UNION OF INDIA, Kerala High Court, 2024; YOHANAN THYPARAMPIL EASOW, v. STATE TAX OFFICER, Kerala High Court, 2024; ULTRAPRIME CEMENTS INDIA PVT. LTD., v. CENTRAL BOARD OF INDIRECT TAXES AND CUSTOMS, Kerala High Court, 2024), petitioners have argued that a recipient dealer who has documentary evidence cannot be held liable for the supplier's failure to deposit tax, contending that denial of ITC in such cases runs against the scheme of GST. Circulars regarding FORM GSTR-2A as evidence for refund claims were also noted, though the primary responsibility remains.

The Burden of Proof and Genuineness of Transactions

The onus of substantiating ITC claims lies heavily on the taxpayer. The Supreme Court, in THE STATE OF KARNATAKA v. M/S. ECOM GILL COFFEE TRADING PRIVATE LIMITED (Supreme Court Of India, 2023), interpreting Section 70 of the Karnataka Value Added Tax Act, 2003 (which is analogous to GST principles on burden of proof), held that mere production of invoices and proof of payment by cheque was insufficient to discharge the burden. The purchasing dealer must provide comprehensive evidence of genuine transactions, including details of the seller, actual movement of goods, and proof of tax payment by the seller. This judgment underscores the stringent verification required for ITC claims, aiming to prevent tax evasion through fictitious transactions.

Timeliness in Claiming ITC: A Contentious Issue

Section 16(4) of the CGST Act imposes a time limit for availing ITC, generally the due date of furnishing the return under Section 39 for the month of September following the end of the financial year to which such invoice or debit note pertains, or furnishing of the relevant annual return, whichever is earlier. The constitutional validity and interpretation of this provision have been challenged. Petitioners in the Kerala High Court cases (M/S. MALL OF JOY PVT LIMITED, v. UNION OF INDIA, Kerala High Court, 2024) argued that Section 16(4) is a procedural provision and should not defeat the substantive right to ITC, especially if returns are filed with late fees and interest. Conversely, the Supreme Court in Union Of India (S) v. Bharti Airtel Ltd. And Others (S) (Supreme Court Of India, 2021), while dealing with rectification of Form GSTR-3B, emphasized adherence to statutory timelines (Section 39(9) of CGST Act and Rule 61(5) of GST Rules), holding that rectifications are permissible only within the month or quarter of error detection. This reinforces the sanctity of statutory deadlines in the GST framework.

Restrictions on Input Tax Credit: Section 17 of the CGST Act

Section 17 of the CGST Act outlines specific circumstances where ITC is restricted or requires apportionment.

Blocked Credits under Section 17(5)

Section 17(5) lists goods and services on which ITC is not available, notwithstanding anything contained in Section 16(1) and Section 18(1). A significant area of litigation has been Section 17(5)(d), which blocks ITC on goods or services received by a taxable person for construction of an immovable property (other than plant and machinery) on his own account, including when such goods or services are used in the course or furtherance of business. In Safari Retreats Private Limited v. Chief Commissioner of Central Goods & Service tax (Orissa High Court, 2019), the petitioner, engaged in constructing shopping malls for letting out, challenged the denial of ITC under Section 17(5)(d). The Orissa High Court read down the provision, holding that if the immovable property is used to make outward taxable supplies (like rental income, which is taxable under GST), then ITC on construction inputs/services should be allowed to avoid breaking the credit chain, which is fundamental to GST. The court indicated that if such an interpretation was not accepted, the provision might be unconstitutional. This highlights judicial efforts to align restrictive provisions with the overall objectives of GST.

Apportionment of Credit: Taxable, Exempt, and Non-Business Use

Section 17(1) mandates that where goods or services are used partly for business and partly for non-business purposes, ITC shall be restricted to so much of the input tax as is attributable to the purposes of his business. Section 17(2) requires that where goods or services are used partly for effecting taxable supplies (including zero-rated supplies) and partly for effecting exempt supplies, ITC shall be restricted to so much of the input tax as is attributable to the said taxable supplies. The principle that ITC is not available on inputs attributable to exempt supplies was also enshrined in pre-GST laws. As held in M.K. Agro Tech (P) Ltd. v. State Of Karnataka (Karnataka High Court, 2014) under the KVAT Act, if no output tax is payable (due to exemption), the question of deducting input tax does not arise. The Supreme Court in M/S MODI NATURALS LTD v. THE COMMISSIONER OF COMMERCIAL TAX UP (Supreme Court Of India, 2023), dealing with the UPVAT Act and Rules (Section 17 and Rule 131), upheld the methodology for apportionment of input tax when a dealer makes both taxable and exempt sales, emphasizing that input tax directly relating to exempt sales is non-deductible.

Judicial Pronouncements Shaping ITC Jurisprudence

The judiciary has played a crucial role in interpreting the provisions related to input tax deductibility, balancing the rights of taxpayers with the objectives of the revenue authorities.

The Nature of Input Tax Credit: Vested Right or Statutory Concession?

The debate regarding whether ITC is a vested right or a mere concession continues under GST. While Eicher Motors (Supreme Court Of India, 1999) under the MODVAT regime recognized that accrued credit could become a vested right, the predominant view, particularly emphasized by revenue authorities and supported by judgments like those cited in THE STATE OF KARNATAKA v. TRACTORS AND FARM EQUIPMENT LIMITED (Karnataka High Court, 2025), is that ITC is a benefit or concession granted by statute and is subject to strict fulfillment of statutory conditions. This perspective implies that the legislature has wide latitude to impose conditions and restrictions on its availment.

Procedural Requirements v. Substantive Entitlement

Courts have often grappled with situations where procedural lapses, sometimes due to technical glitches in the GST Network (GSTN), hinder the availment of ITC. In brand equity treaties limited v. the union of india & ors (Delhi High Court, 2020), the Delhi High Court directed respondents to permit petitioners to file Form TRAN-1 beyond the prescribed period to avail transitional CENVAT credit, acknowledging technical difficulties and the principle that accrued rights should not be defeated by procedural hurdles, especially those attributable to systemic issues. However, as seen in Union Of India (S) v. Bharti Airtel Ltd. And Others (S) (Supreme Court Of India, 2021), the Supreme Court emphasized strict adherence to statutory timelines for return rectification, suggesting a less lenient view on procedural compliance when statutory provisions are explicit.

Challenges to Levy and Double Taxation

The fundamental principles of taxation, such as the avoidance of double taxation and clarity in levy, indirectly impact ITC. In Mohit Minerals Pvt. Ltd. v. Union Of India And Others (Gujarat High Court, 2020), the Gujarat High Court quashed the levy of IGST on the ocean freight component for importers under CIF contracts, holding it resulted in double taxation as IGST was already paid on the total CIF value. The court found the importer was not the "recipient" of the ocean freight service. While not directly an ITC case, it underscores the importance of correct levy and avoidance of double taxation, which are foundational to the integrity of the GST system, including its credit mechanism. If a tax is improperly levied, the question of its credit becomes moot or further complicated.

Refund of Unutilized Input Tax Credit

Section 54(3) of the CGST Act allows for the refund of unutilized ITC in two scenarios: (i) zero-rated supplies made without payment of tax; and (ii) where the credit has accumulated on account of the rate of tax on inputs being higher than the rate of tax on output supplies (inverted duty structure). The interpretation of Rule 89(5) of the CGST Rules, which prescribes the formula for calculating refund in inverted duty structure cases, was contentious. The Gujarat High Court in VKC FOOTSTEPS INDIA PVT. LTD. v. UNION OF INDIA (Gujarat High Court, 2020) had held the rule ultra vires to the extent it excluded input services from the refund formula. However, the Supreme Court in Union Of India And Others v. Vkc Footsteps India Pvt. Ltd. (Supreme Court Of India, 2021), overturning the Gujarat HC decision and upholding the Madras HC view, validated Rule 89(5). The Apex Court reasoned that Section 54(3) itself provides for restrictions and that the rule, by confining refunds to ITC availed on "inputs" (i.e., goods) in an inverted duty structure scenario, was a matter of legislative policy and not ultra vires. This decision clarified that "input tax credit" in the context of proviso (ii) to Section 54(3) could be read down to mean credit on input goods only, distinguishing it from the broader definition of input tax.

Transitional Credits: Bridging Past and Present Regimes

The transition from pre-GST regimes to GST involved carrying forward eligible CENVAT credit and VAT credits. Section 140 of the CGST Act and associated rules, like Rule 117 for filing Form TRAN-1, governed this process. The time limit prescribed under Rule 117 became a major source of litigation. As seen in brand equity treaties limited (Delhi High Court, 2020), courts, in several instances, permitted filing of TRAN-1 beyond the deadline, especially due to technical glitches, recognizing the nature of such credit as an accrued or vested right for many taxpayers.

Consequences of Non-Deductibility and Alternative Treatments

When input tax is not deductible under the GST law (e.g., due to restrictions under Section 17(5) or non-fulfillment of conditions under Section 16), it becomes a cost for the business. In certain specific circumstances, such non-credited tax might be claimed as a business expenditure under the Income Tax Act, 1961. For instance, the Income Tax Appellate Tribunal in M/S. Castron Technologies Ltd., Kolkata v. D.C.I.T. (ITAT Kolkata, 2023) allowed a VAT loss (unutilized input tax credit on consignment sales where credit was not available under Jharkhand VAT) as a business loss. Similarly, in Chandrashekahar Ashok Joshi,, Nashik v. Deputy Commissioner of Income-tax (ITAT Pune, 2022), VAT liability arising from denial of input VAT credit by state authorities, when discharged, was allowed as business expenditure under Section 37(1) read with Section 43B of the Income Tax Act. However, it's important to distinguish this from penalties or interest on late payment of income tax itself, which, as held in Commissioner Of Income Tax v. Ashoka Mills Ltd. (Gujarat High Court, 1995), is generally not deductible, unlike interest on late payment of indirect taxes which may be considered a business expense. The distinction between a "tax" and a "fee/charge" can also be relevant, as discussed in M/S TAMILNADU STATE MARKETING CORPORATION LIMITED, CHENNAI v. ACIT (ITAT Chennai, 2022), where it was argued that certain levies were fees and not taxes, impacting their deductibility under specific income tax provisions; this distinction could also arise in determining if a levy qualifies as "input tax" for ITC purposes under GST.

Conclusion

The deductibility of input tax is a critical element of India's indirect tax framework, designed to ensure tax neutrality and prevent cascading. While the GST regime aims for a seamless flow of credit, its availment is governed by a complex web of statutory provisions, conditions, and restrictions. The judiciary has been instrumental in interpreting these provisions, often balancing the legislative intent of preventing revenue leakage with the taxpayer's entitlement to credit. Key areas of contention include the stringency of conditions under Section 16(2) (particularly supplier compliance), the scope of blocked credits under Section 17(5), time limits for availing ITC under Section 16(4), and the precise mechanics of refund for unutilized credit. The jurisprudence continues to evolve, with courts striving to harmonize the procedural framework with the substantive right to credit, which is fundamental to the economic rationale of GST. As the GST system matures, further clarity and simplification, coupled with robust anti-evasion measures, will be essential to realize the full potential of a truly seamless input tax credit mechanism in India.