This legal opinion examines the eligibility of Input Tax Credit (ITC) on construction-related goods and services, specifically focusing on air conditioners as a case study. The analysis is conducted in the light of Section 17(5)(d) of the CGST Act, 2017, and incorporates the amendments made to the section from 01st October 2023.
The examination of air conditioners will take into account various possible scenarios, such as their use in commercial buildings, factories, and residential premises, to determine their eligibility for ITC based on the end-use, functionality, and taxable supply tests.
Additionally, this opinion includes relevant judicial precedents and interpretations that inform the understanding of ITC eligibility for construction-related goods under the current GST framework.
2. Statutory Framework: Section 17(5)(d) of the CGST Act
2.1 Pre-Amendment Position (before 01.10.2023)
Prior to October 1, 2023, under Section 17(5) of the CGST Act, ITC was disallowed on goods and services received for the construction of immovable property (other than plant and machinery) intended for self-use or own account.
The relevant provision stated:
"Input tax credit shall not be available in respect of goods or services or both received by a taxable person for construction of an immovable property (other than plant and machinery) on his own account, even when used in the course or furtherance of business."
This created ambiguity in relation to the eligibility of ITC for construction materials, such as cement, bricks, steel, and air conditioners.
2.2 Post-Amendment Position (from 01.10.2023)
With the amendment to Section 17(5)(d) effective from October 1, 2023, ITC is now available for construction of immovable property when it is undertaken for the purpose of making taxable outward supplies. The amended provision reads:
Proviso: ITC is allowed for construction of immovable property when the property is constructed for making taxable supplies such as leasing or renting, provided the construction is part of a business activity.
This amendment allows businesses that intend to lease or rent out property to claim ITC on goods and services used in the construction of such property, as long as the end-use is for taxable activities.
3. Judicial Interpretation and Key Cases
3.1 Safari Retreats Pvt. Ltd. v. Chief Commissioner of CGST (2023)
In the Safari Retreats case, the issue was whether ITC could be claimed on construction materials for a commercial building that was eventually leased out. The Supreme Court ruled that:
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The construction of the building was primarily for own account (for the company’s leasing business), and the property was not being directly used for taxable outward supply at the time of construction.
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The Court disallowed ITC on materials used for constructing the immovable property as it was for self-use and did not qualify under the definition of taxable supply.
Rationale: The "own account" test was a key factor in denying ITC. Even though the final use of the property was for leasing (a taxable supply), the building was constructed for internal use initially, which did not qualify for ITC.
3.2 Larsen & Toubro Ltd. v. State of Karnataka (2013)
In this case, the Supreme Court allowed ITC on works contract materials used in construction, recognizing that the construction was part of a taxable business activity.
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L&T constructed a property as part of a works contract to sell or lease, and ITC was allowed on materials like cement and steel, as the project was intended for commercial purposes, which qualified as taxable supply.
Rationale: This case demonstrated that construction for business purposes (such as for sale or lease) could allow ITC on goods like cement and steel used in construction, as they were tied to taxable supplies.
3.3 KEI Industries Ltd. (2022, AAR Gujarat)
In the KEI Industries case, the company sought ITC on various construction materials, including air conditioners and transformers used for setting up a factory.
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The AAR Gujarat ruled that:
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Air Conditioners were part of the immovable property and were used for comfort purposes, and therefore, ITC was denied.
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Transformers, however, were plant and machinery essential for the operation of the factory, and ITC was allowed.
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Rationale: The functionality test was crucial here. Air conditioners were considered as part of the building’s comfort infrastructure, making them ineligible for ITC. In contrast, transformers were considered essential machinery that enabled business operations, making them eligible for ITC.
4. Analysis of ITC Eligibility on Air Conditioners in Different Scenarios
4.1 Scenario 1: Air Conditioners in Commercial Buildings (Leasing)
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Use: Air conditioners are installed in a commercial building intended for leasing to tenants, with the rental income being subject to GST.
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Analysis: Air conditioners in this case would be used in the course of making taxable outward supplies (rental income subject to GST). Therefore, ITC would be eligible under the amended provisions of Section 17(5)(d).
Test Application:
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End-use: The property (including air conditioners) is used for taxable supply (rental income).
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Functionality: The air conditioners are used for comfort but do not impede the functioning of the business (the property is rented out for tenants’ use).
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Taxable supply: The renting of commercial property is subject to GST.
Conclusion: Eligible for ITC.
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4.2 Scenario 2: Air Conditioners in Residential Property (For Personal Use)
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Use: Air conditioners are installed in a residential property for personal comfort.
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Analysis: In this case, the air conditioners are part of an immovable property used for personal use. As per the GST law, ITC on goods used for personal purposes is not allowed.
Test Application:
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End-use: The air conditioners are used for personal purposes, which is not a taxable supply.
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Functionality: Air conditioners are part of the immovable property, intended for comfort rather than business operations.
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Taxable supply: The use is non-taxable (no business activity).
Conclusion: Ineligible for ITC.
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4.3 Scenario 3: Air Conditioners in Factory (Used for Production)
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Use: Air conditioners are installed in a factory to maintain optimal working conditions for machinery or employees involved in the production process.
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Analysis: In this case, the air conditioners are essential for the operation of the business, enabling the functioning of machinery and ensuring that employees work efficiently. Since the air conditioners are used in the course of business, ITC may be eligible.
Test Application:
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End-use: The air conditioners are used in the business process to support production.
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Functionality: The air conditioners support the functioning of the factory and are not merely part of the building’s comfort infrastructure.
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Taxable supply: If the factory’s products are sold or the output is used for taxable supplies, the air conditioners qualify as essential business equipment.
Conclusion: Eligible for ITC as they are used for business operations.
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5. Tests for ITC Eligibility: Recap
5.1 End-Use Test
This test examines the purpose for which the goods (e.g., air conditioners) are used. If the goods are used for taxable business purposes (such as leasing or production), ITC is eligible. If they are used for personal purposes or in a non-taxable manner, ITC is denied.
5.2 Functionality Test
The functionality test looks at whether the goods form part of the plant and machinery or are essential for the operation of the business. Goods such as air conditioners that serve as comfort items (not part of the production process) may be ineligible for ITC unless used directly in business operations.
5.3 Taxable Supply Test
This test assesses whether the goods contribute to a taxable supply. If the goods are used to produce or facilitate taxable output (such as rent or goods sold), ITC is eligible. If they are part of a non-taxable activity, ITC is denied.
6. Conclusion
6.1 Pre-01.10.2023 Position: Under the old law, ITC was generally not allowed for construction materials used in immovable property, especially when the property was constructed for self-use.
6.2 Post-01.10.2023 Amendment: The amended Section 17(5)(d) now allows ITC on construction-related goods used for buildings that are intended for taxable supply (e.g., leasing or renting). The end-use, functionality, and taxable supply tests should be applied rigorously to determine ITC eligibility.
6.3 Air Conditioners: ITC on air conditioners is eligible when they are used in the course of taxable supplies (e.g., commercial leasing or factory production). However, ITC is denied when used for personal comfort or in non-taxable residential premises.
