The Supreme Court of India recently made an important ruling regarding how businesses can claim Input Tax Credit (ITC) for expenses related to constructing properties like shopping malls and office buildings. This decision could change how businesses approach tax compliance, especially those involved in leasing or renting out such properties.

The Main Issue

Section 17(5) of the Central Goods and Services Tax (CGST) Act limits the ability to claim ITC on goods and services used for constructing immovable properties, with some exceptions. This law aims to prevent misuse of tax credits for personal construction. However, the question arose: can businesses that build properties for commercial use—like renting them out—claim ITC on construction costs?

The Case of Safari Retreats

In the case of Safari Retreats Pvt. Ltd., the company built a shopping mall and wanted to claim ITC on the construction expenses. However, tax authorities rejected their claim, stating it was against Section 17(5)(d), which prevents ITC for properties built "on one’s own account." The Supreme Court has now sent the case back to the Orissa High Court, asking them to consider whether the mall can be classified as a “plant” based on a new principle called the functionality test.

Understanding the Functionality Test

The functionality test looks at how essential a property is for a business's operations. If a property, like a shopping mall, is crucial for generating taxable income, it may qualify as a “plant” and thus be eligible for ITC. This broadens the definition of what can qualify for tax credits.

Implications for Businesses

1. Potential ITC on Construction Costs: Companies constructing commercial properties could now claim ITC if they can show the property is vital for their business.

2. Supports Seamless Credit: The ruling aligns with the GST's goal of allowing easy credit flow and reducing tax burdens.

3. Focus on Business Purpose: Businesses need to assess how their properties contribute to taxable activities to take advantage of this ruling.

4. Reevaluate Tax Positions: Companies in real estate, hospitality, or retail should review their tax strategies to see if they can claim ITC on construction costs.

A Call for Policy Review

While the ruling clarifies ITC eligibility, the Supreme Court also noted that changes in tax policy should come from the GST Council. This judgment encourages the Council to reevaluate Section 17(5) to make the tax framework more business-friendly.

Next Steps for Businesses

• Assess Property Roles: Evaluate how properties fit into your business model.

• Review Section 17(5): Understand the restrictions and see if your property qualifies as a “plant.”

• Follow Case Developments: Stay updated on the Orissa High Court’s decision regarding the Safari Retreats case.

• Document Claims: Keep detailed records to justify ITC claims based on the property’s role in your business.

Conclusion

The Supreme Court’s interpretation of Section 17(5) brings clarity and could lead to fairer tax treatment for businesses. By introducing the functionality test, the ruling suggests that properties used for generating taxable income should not be viewed as mere passive assets. This could result in significant tax savings for eligible businesses.