Companies are required to incur many expenses for creation of new assets in terms of immovable property as well as Plant and Machinery to sustain and augment their businesses. GST law was brought in with a promise of seamless credit across all business expenses be it capital or revenue in nature. However, Section 17 of the CGST and SGST Act (Hereinafter referred to as the Act) prescribes certain restrictions on claiming of credits. There are lot of misconceptions about legalities surrounding credits on expenses relating to Immovable properties and Plant and Machinery which require clarification, this article deals specifically with 2 questions:
Eligibility of Credit on expenses related to construction of Immovable properties like offices, buildings, furniture, etc.
Eligibility of Credit on Plant and Machinery
Genesis of the Confusion
Section 17(5)(c) and (d) of the Act restricts certain credits, these provisions read as under:
17 (5) Notwithstanding anything contained in sub-section (1) of section 16 and subsection (1) of section 18, input tax credit shall not be available in respect of the following, namely: —
(c) works contract services when supplied for construction of an immovable property (other than plant and machinery) except where it is an input service for further supply of works contract service;
(d) goods or services or both received by a taxable person for construction of an immovable property (other than plant or machinery) on his own account including when such goods or services or both are used in the course or furtherance of business.
Explanation––For the purposes of clauses (c) and (d), the expression “construction” includes re-construction, renovation, additions or alterations or repairs, to the extent of capitalisation, to the said immovable property;
Explanation.––For the purposes of this Chapter and Chapter VI, the expression “plant and machinery” means apparatus, equipment, and machinery fixed to earth by foundation or structural support that are used for making outward supply of goods or services or both and includes such foundation and structural supports but excludes —
(i) land, building or any other civil structures;
(ii) telecommunication towers; and
(iii) pipelines laid outside the factory premises.
Above provisions restrict credit of Construction related expenses in certain scenarios and not all cases. In other words, credit of GST paid on expenses relating to construction of immovable property be it works contract or otherwise is not completely restricted, only in certain cases would the credit be disallowed.
Principles necessary to be established before deciding whether credit of expenses relating to construction is available:
Whether the expense is in the nature of a Works Contract
Term “Works Contract” is defined under section 2 (119) of the Act as under:
“works contract” means a contract for building, construction, fabrication, completion, erection, installation, fitting out, improvement, modification, repair, maintenance, renovation, alteration or commissioning of any immovable property wherein transfer of property in goods (whether as goods or in some other form) is involved in the execution of such contract;
Any of the activities listed above like construction, maintenance, etc of any immovable property shall be classified as a works contract.
In other words, if the same are done in respect of any movable property then the same shall not be a works contract for the purposes of GST. First step would be to establish the factum that the transaction concerned can be classified as a works contract or not.
It is pertinent to note that a service where property in goods is involved in the execution of such contract cannot be in relation to a Plant & Machinery which is not in the nature of Immovable Property as the definition of Works Contract restricts its applicability to Immovable Properties only.
- Whether the expense is in the nature of Construction
Term “Construction” is defined vide explanation to section 17 (c) and (d) so as the include
- alterations or
Traditionally the term ‘Construction’ is associated with civil works relating to a building but under GST especially for section 17 construction shall mean a lot more than mere construction. If the expense can be categorised in any of the above words, then the same would be in the nature of the word “Construction”.
Second step would be to establish whether the expense concerned can fall into the definition of Construction or not.
- Nature of the expense - ‘Capital’ or ‘Revenue’.
Classification of an expense between Capital and Revenue runs on a very thin line of interpretation and final decision rests on exact facts of a transaction. GST Law does not define the terms capital expenditure and revenue expenditure; hence one will have to depend on their natural meaning as well as decided cases
Capital expenditure represents expenditure on fixed assets. Capital expenditure can be an outlay of resources on the investment of long-term income generating capability of the company. Investment in fixed assets will lead to an increase or improvement in the investing company's revenue generating capacity. Capital expenditure can also be in the form of significant acquisitions or purchases of more expensive items of equipment that will last longer than a financial year and give enduring benefit to the company.
All capital expenditures are recorded in the balance sheet. It will be depreciated or amortised annually to ensure that an expense is charged to the profit and loss account to reflect the capital expenditure's usage by the company.
Revenue expenditure are expenses incurred in the day to day running of a company. In most cases revenue expenditure involves the procurement of services and goods that will be used and consumed within one year. It does not improve or increase the life or quality of the underlying asset but only leads to the maintenance or continuation thereof.
Revenue expenses are recorded in the profit & loss account under various expense heads.
Certain cases decided by Supreme Court give us tests to decide whether an expense is Capital or Revenue in nature.