Supreme Court allows ITC benefit on commercial property construction & leasing

In a move that could foster greater investment in the commercial real estate sector, the Supreme Court on Thursday (October 3) provided relief to the industry by allowing the benefits of input tax credits (ITC) on construction costs for commercial buildings intended for leasing.

This ruling is expected to alleviate the financial burden of rents on tenants of commercial spaces.

Real estate players such as DLF, Max Estates, and Bharti Realty, among others, are likely to benefit, as buildings can now be classified as plant and machinery.

This benefit extends beyond commercial real estate, as rentals for commercial properties paid by various industries will also be eligible for ITC.

The ruling indicates that the benefit of ITC will be available retrospectively.

However, the industry is now seeking clarity from the government on whether similar relief should be extended to other sectors, including ports, airports, factories, warehousing, and data centers.

Background of the case

Safari Retreats filed a writ petition in the Odisha High Court, claiming eligibility for input tax credits on works contract services and other goods and services used in the construction of immovable property, excluding plant and machinery.

The Odisha High Court interpreted Section 17(5)(a) to allow for the availability of ITC.

Following this, the revenue department at the center filed a Special Leave Petition (SLP) in the Supreme Court, asserting that GST rules do not permit claiming ITC on immovable property.

Several petitioners subsequently approached the Supreme Court to challenge the constitutional validity of the provisions, as the Odisha High Court had not addressed this aspect.

In 2023, the Supreme Court concluded the matter but reserved its orders. Justice Abhay S. Oka and Justice Sanjay Karol pronounced the decision today.

The Supreme Court’s ruling addressed three key questions. First, it examined whether the term “plant and machinery” in the explanation to Section 17(5) of the GST Act differs from “plant or machinery” referenced in Section 17(5)(d). Second, if these terms are indeed different, what should be understood by the term “plant”?

Third, the Court assessed the constitutional validity of the provisions in Sections 17(5)(c) and (d).

In a clear and detailed judgment, the Court ruled that the phrase “plant and machinery” in the explanation to Section 17(5) is distinct from the phrase “plant or machinery” in Section 17(5)(d). Consequently, the Court stated that it is essential to establish guiding principles to define what constitutes “plant.” While upholding the constitutional validity of Sections 17(5)(c) and (d), the Court emphasized that eligibility for ITC must be determined on a case-by-case basis.

According to the judgment, several factors must be considered when determining eligibility, including the nature of the taxpayer’s business, the role of the building or structure in delivering output services, and the functionality test—assessing whether the building contributes to the operational capabilities of the business. The Court clarified that these factors will help determine whether a building qualifies as a “plant” and, consequently, whether ITC should be allowed under Clauses (c) or (d).

Importantly, the Court upheld the taxpayer’s submissions regarding Clause (d). Experts believe that lower adjudicating authorities will now decide ITC eligibility based on the specific facts and circumstances of each case.

This nuanced, fact-based approach is expected to guide future determinations on the subject.

To summarise, ITC was previously unavailable for the construction of commercial properties meant for leasing, as these were classified as immovable property.

Therefore, tenants could not claim ITC on the rents paid. Until now, leasing income attracted 18% GST without ITC.

Industry reaction

“The eligibility of input tax credit (ITC) will be determined based on the functionality and essentiality tests,” explained Abhishek A. Rastogi, founder of Rastogi Chambers, who represented multiple petitioners in the Supreme Court case.

“The essentiality test requires that the procurement of goods or services be directly essential to the business’s operations, while the functionality test assesses whether the inputs are functionally integral to the performance or output of the business. Therefore, unless it can be demonstrated that the claimed credits do not meet these criteria, the denial of credit would not be justified under the law,” he said.

Rastogi emphasised that the judgment significantly narrows the circumstances under which ITC can be denied.

He noted that the Court’s approach provides greater clarity and fairness to businesses by ensuring that credit is denied only when the inputs are not integral to the functioning or operations of the business.

This ruling is expected to have a impact on how ITC claims are handled, especially concerning construction and immovable property, where the interpretation of what constitutes a “plant” or an essential business input has been contentious.

Rastogi concluded that this decision provides much-needed guidance for future cases and will likely serve as a key reference point for lower courts and adjudicating authorities in interpreting Section 17(5).

“The Supreme Court has upheld the Orissa High Court’s judgment in Safari Retreat, allowing the availment of input tax credit for construction-related expenses when the immovable property is used for business purposes or for the construction of plant or machinery,” Onkar Sharma, Partner, Khaitan & Co cheered.

This judgment is expected to have a major impact on the real estate and manufacturing sectors, depending on the factual scenario in each case, he emphasised.

Saurabh Agarwal, a Tax Partner at EY, noted that while the Revenue Department’s appeal was allowed, the Court’s acknowledgment that malls could, in certain situations, be classified as Plant and Machinery indicates a more adaptable interpretation of the law.

This ruling presents new opportunities for businesses, particularly in the real estate and commercial leasing sectors, to assess their eligibility for ITC on construction-related expenses.

Although the constitutional challenge was dismissed, the Court’s acceptance of the taxpayer’s arguments under Section 17(5)(d) is seen as a positive development. This outcome could reduce the financial burden on developers and encourage increased investment in commercial real estate.

Agarwal emphasised the need for the real estate industry to carefully analyze the implications of this ruling concerning ITC eligibility for outward supplies related to rental income.

He suggested that, in light of the Supreme Court’s decision, the GST Council should provide clarifications that would enable real estate players to claim ITC on rental income.

Moreover, the ruling is expected to lower rental costs, as ITC would no longer represent a financial strain for the industry. It is essential to note that the ruling applies retrospectively from the inception of the GST; however, the deadline for claiming ITC for the period up to 2022-23 has already passed.

Nonetheless, industry participants can still claim ITC for FY 2023-24 until November 30.

Source: CNBC TV18