Introduction

Capital goods comprise of an important part of the business assets of any person. Since a huge amount of Input tax credit is involved in such goods, stringent provisions have been kept in Central Goods and Service Tax Act, 2017 and rules framed thereunder to ensure that such goods are used in the business of the person claiming Input tax credit on the same. In case the said capital goods are supplied to any other person, tax is payable on the same. However, the provisions prescribing the manner of computation of tax payable on the supply of such capital goods are ambiguous and contradictory. This piece of articulation dives into the whereabouts of this anomaly.

What are Capital Goods?

Central Goods and Service Tax Act, 2017 and rules framed thereunder prescribe special provisions for capital goods. But before discussing those provisions, it is important to know which goods qualify as “Capital goods” covered in the net of those special provisions.

As per section 2(19) of the Central Goods and Service Tax Act, 2017:

“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 analysis of the above definition makes it clear that to fall in the definition of capital goods, the following conditions are to be satisfied:

1. There should be “goods”;
2. The value of such goods is capitalized in the books of the person claiming credit;
3. The said goods are used or intended to be used in the course or furtherance of business.

The term goods is defined in section 2(52) of the Central Goods and Service Tax Act, 2017 which states that:

“goods” means every kind of movable property other than money and securities but includes actionable claim, growing crops, grass and things attached to or forming part of the land which are agreed to be severed before supply or under a contract of supply.

In view of this definition, land and building, even though capitalized, does not fall in the definition of capital goods as it is not “goods” per se. Therefore, not everything that is capitalized in the books of accounts of a person will qualify as capital goods under Goods and service tax law. Every asset of a business must be scanned under the provisions of section 2(19) to ensure whether it is capital goods or not.

Admissibility of Input Tax Credit on Capital Goods under GST Law

Under the erstwhile Central Excise Act, 1944, credit in respect of capital goods was allowed to an amount not exceeding 50% of the duty paid and the balance was allowed in any financial year subsequent to the year of purchase. But Central Goods and service tax Act 2017 allows the 100% input tax credit at the time of purchase subject to the following terms and conditions:

• The general conditions prescribed in section 16 of the Central Goods and Service Tax Act 2017 should be satisfied.
• Capital goods should not be used exclusively for exempt supply.
• 100% input tax credit is allowed on capital goods that are used exclusively for the taxable supply.
• However, if capital goods are used commonly for both taxable and exempt supply; then 100% credit is admissible subject to the condition that the proportionate amount of credit attributable to exempt supply shall be reversed in the manner prescribed under rule 43 of Central Goods and service tax rules, 2017. This reversal must be done in every tax period for the period of five years from the date of purchase.

In the nutshell, if the capital goods are used exclusively for taxable supply or for making both taxable and exempt supply, the input tax credit is allowed. Once a credit is taken on any capital goods and the same is supplied to any other person whether or not, for a consideration, it is treated as supply and tax is payable on the same under the provisions of section 18(6) of Central Goods and Service Tax Act, 2017.

“Provisions of section 18(6) are attracted only if the input tax credit was availed on any capital goods.”

Section 18(6) of Central Goods and Service Tax Act, 2017

When a person supplies capital goods or plant and machinery on which input tax credit has been availed, it is treated as supply and tax is payable on the same. This tax is to be paid in the manner prescribed under sub-section 6 of section 18 of the Central Goods and service tax. This sub-section reads as follows:

“(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.”

Thus, if capital goods or plant and machinery on which credit was availed are supplied, tax payable is computed by considering the higher of the following two figures:

1. Input tax credit taken on said capital goods / plant & machinery reduced by prescribed percentage; or
2. Tax on the transaction value of such capital goods / plant & machinery.

Thus, two figures are to be computed; the first one is the input tax credit taken on such capital goods which shall be reduced by a prescribed percentage. The manner of computing the reduced input tax credit is prescribed in the Central Goods and Service Tax Rules, 2017. Central Goods and service tax rules prescribe the manner of computing reduced input tax credit referred in section 18(6) in two rules – rule 40(2) and rule 44 of Central Goods and Service Tax Rules, 2017. Interestingly, both rules prescribe two different manners of computing the reduced input tax credit, thereby creating ambiguity.

Rule 40 of Central Goods and Service Tax Rules, 2017

Rule 40 prescribes the manner of claiming credit in special circumstances. Sub-rule 2 of this rule reads as follows:

“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.”

The language of sub-rule 2 of rule 40 makes it clear that:

• It has been framed to provide the manner of calculating the reduced input tax credit under section 18(6).
• In this rule, reduced input tax credit is computed by reducing five percentage points for every quarter or part thereof.
• The reduced input tax credit shall be computed on a quarterly basis right from the date of issue of the invoice of such goods.

The rule is simple and unambiguous. However, there is one more rule framed section 18(6) which provides a different manner of computation under the same situation.

Rule 44 of Central Goods and Service Tax Rules, 2017

Rule 44 provides for the manner of reversal of credit under special circumstances. Sub-rule 6 of this rule reads as follows:

“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.

Provided that where the amount so determined is more than the tax determined on the transaction value of the capital goods, the amount determined shall form part of the output tax liability and the same shall be furnished in FORM GSTR-1”

The analysis of sub-rule 6 makes it clear that the manner of computing reduced input tax credit for the purpose of section 18(6) shall be the same as provided in clause (b) of sub-rule 1 of rule 44. This clause reads as follows:

“(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.

Illustration:
Capital goods have been in use for 4 years, 6 months and 15 days.
The useful remaining life in months = 5 months ignoring a part of the month.
The Input tax credit is taken on such capital goods = C.
Input tax credit attributable to remaining useful life = C multiplied by 5/60.”

The analysis of rule 44(6) read with rule 44(1)(b) of Central Goods and Service Tax Rules, 2017 makes it clear that, in case of a supply of capital goods, the reduced input tax credit will be computed on pro-rata basis by taking useful life of such capital goods as five years. As per the illustration given in clause (b) above, computation is to be done by taking the useful life of capital goods in months.

Rule 40(2) v/s Rule 44(6) – Detailed Comparison & Practical Case Illustration

Both the rules clearly give reference to section 18(6) of the Central Goods and Service Tax Act, 2017 and are clearly worded. There is no scope for any ambiguity so far as the language of the individual rule is concerned. However, rule 40(2) provides the manner of reducing input tax credit on a quarterly basis. On the other hand, rule 44(6) provides the manner of computing reduced input tax credit on a monthly basis taking useful life as 5 years or 60 months. In some cases, the computations made in both rules will give different results. Let us understand it with the help of an illustration.

Let us compute the amount of tax payable in terms of section 18(6) of the Central Goods and Service Tax Act, 2017 read with rule 40(2) as well as rule 44(6) of Central Goods and Service Tax Rules, 2017:

Computation 1: Section 18(6) read with Rule 40(2) (Quarterly Basis)

In terms of rule 40(2), the reduced input tax credit is to be computed on a quarterly basis. It will be calculated by reducing the amount of input tax credit attributable to quarters in which capital goods were used from the total input tax credit availed. Capital goods were purchased on 01.03.2021 and sold on 24.10.2022. It means it has been used for total of 8 quarters – starting from January to March, 2021 quarter until October to December, 2022 quarter. Thus, we will reduce the Input tax credit attributable to 8 quarters from total credit availed in order to arrive at the figure of the reduced input tax credit.

Particulars	Amount (₹)
(a) Reduced input tax credit computed on quarterly basis:     Total input tax credit: ₹ 1,80,000     Less: ITC attributable to 8 quarters/part of quarters in which capital goods was used [1,80,000 * 5% * 8 quarters = ₹ 72,000]	1,08,000
(b) Tax on transaction value [5,50,000 * 18%]	99,000
Tax payable under Rule 40(2) (being higher of above two figures)	₹ 1,08,000

Computation 2: Section 18(6) read with Rule 44(6) (Monthly Pro-rata Basis)

In case of rule 44(6), amount of input tax credit to be reversed is to be calculated on monthly basis taking into consideration the remaining useful life of capital goods. Capital goods was purchased on 01.03.2021 and sold on 24.10.2022. It means it has already been used for 20 months, so its remaining useful life is 40 months (out of 60 months).

Particulars	Amount (₹)
(a) Input tax credit attributable to remaining useful life of capital goods [1,80,000 * 40/60]	1,20,000
(b) Tax on transaction value [5,50,000 * 18%]	99,000
Tax payable under Rule 44(6) (being higher of above two figures)	₹ 1,20,000

Thus, the amount of reduced input tax credit calculated under rule 40(2) comes ₹ 1,08,000 and in case of rule 44(6), it comes ₹ 1,20,000. This example is sufficient to show the huge impact of anomaly created by these two rules (a variance of ₹ 12,000 on a single transaction).

While Parting

Provisions of section 18(6) are attracted only if the input tax credit was availed on any capital goods. So, in case of capital goods, on which either credit is not allowed or on which no credit was availed, will not be covered by this section. For example, if any person sells used motor vehicle the credit of which is restricted under section 17(5) of the Act; its sale will not be covered in section 18(6). Tax on such motor vehicle will be paid on basis of transaction value computed under section 15.

However, in all the other cases where credit was availed and such capital goods are supplied, section 18(6) will be attracted. It is worthwhile to mention here that selling used capital goods is a common phenomenon in businesses. There are number of capital goods that require huge investments which makes it non-affordable for small businesses. There are couple of other factors also which makes the trading of used capital goods a common practice; thereby attracting the provisions of section 18(6) of Central Goods and Service Tax Act, 2017. Once this section is hit, the anomaly gets automatically triggered.

Though above anomaly exists, one may take a reasonable interpretation of applying Rule 44 for the purpose of section 18(6) instead of Rule 40. This is so because title of Rule 44 is worded as “Manner of reversal of credit under special circumstances” whereas title of Rule 40 is worded as “Manner of claiming credit in special circumstances”. At the time of supply of capital goods, the supplier is going to pay the tax (reverse the credit) and not claim the credit. However, one may have to litigate if the department’s intent is different.

Therefore, suitable amendment for the welfare of trade can be explored in this direction.

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Author may be reached at: preeti.parihar@gmail.com and eboard@icai.in