The Goods and Services Tax ( GST ) regime in India aims to streamline indirect taxation and eliminate tax cascading by allowing Input Tax Credit ( ITC ) on goods and services used by businesses in the course of their functioning. However, the provisions governing ITC lays down requisite conditions and restrictions based on which they may be availed by taxpayers. A recurring issue is whether ITC should be reversed for goods lost during the manufacturing process. This article provides an overview of this issue, its relevance under GST law, and the legal principles established through judicial interpretations.
Under Section 16 of the CGST Act, 2017, ITC can be claimed on inputs, provided they are used in the course of, or in the furtherance of business. ITC may be available on raw materials, components, and consumables that are transformed or consumed in manufacturing processes.
Manufacturing inherently involves some degree of consumption, wastage, or loss of materials. Inputs may be fully utilized, partially consumed, or left as scrap during the production process. While GST laws permit ITC on inputs that contribute to the production of taxable supplies, questions arise when portions of these inputs are lost during the manufacturing process.
Section 17(5)(h) of the CGST Act disallows ITC on goods that are lost, stolen, destroyed, written off, or disposed of as gifts or free samples. However, the term “lost” remains undefined in the CGST Act, 2017. The lack of definition of the term within the body of the Act leads to much ambiguity, leading to differing interpretations, especially with regards to materials consumed or wasted during manufacturing.
The primary question is whether inherent manufacturing losses—such as materials consumed in production or transformed into scrap—fall within the scope of “goods lost.”
Manufacturing losses can be primarily categorized as Inherent Losses and External Losses. Inherent losses refer to natural and unavoidable consumption or transformation of inputs during production, such as evaporation or melting. External losses are caused by external factors such as theft or accidental destruction that may arise at any time during the manufacturing process. ITC restrictions under Section 17(5)(h) generally apply to external losses. Inherent losses, being an integral part of production, do not amount to “goods lost” as envisioned by the law.
Courts have consistently held that inherent manufacturing losses are not equivalent to “goods lost.” For instance, rulings have emphasized that materials consumed during production retain their identity as inputs contributing to the final product.
The implications of ITC reversal on manufacturing losses are significant, especially for industries with high inherent wastage. It is ideal for businesses to maintain clear records of input usage, wastage, and scrap generation while ensuring compliance with GST laws
Businesses can also secure themselves by leveraging judicial precedents to defend their claims, while challenging unjustified demands for ITC reversal.
Maintaining best practices and ensuring compliance are essential for businesses to safeguard their ITC claims under GST. Accurate documentation of input consumption and manufacturing processes is critical, as it provides a clear record to justify ITC claims.
Additionally, proper scrap management is crucial; businesses must ensure GST compliance on the sale of scrap to demonstrate that all materials, including by-products and waste, are accounted for in the tax process. Finally, legal preparedness plays a vital role in mitigating disputes. Familiarity with relevant case laws and proactive consultation with legal advisors can help businesses effectively navigate potential challenges and uphold their tax positions.
When facing a demand notice from revenue authorities regarding the reversal of ITC on goods lost during manufacturing, businesses should respond methodically and ensure their reply is comprehensive and well-supported. Start by thoroughly analyzing the notice, identifying the specific allegations, and gathering all relevant documentation, such as input records, manufacturing process details, and evidence of GST compliance on scrap sales.
The reply should adequately cite applicable provisions of the CGST Act, judicial precedents, and established legal principles, emphasizing that inherent manufacturing losses are not “goods lost” under Section 17(5)(h). Businesses should also request a personal hearing to present their case effectively and, if needed, seek legal assistance to strengthen their representation and ensure procedural compliance.
Click the Blue Box below to Access a PDF file containing Draft Reply for Non-reversal of ITC on Goods Lost in Manufacturing Process.
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