Last week, we discussed in Part-I of this article, the availability of input tax credit (‘ITC’) to traders with respect to unsold stock as on the appointed date, where they are in possession of invoice/prescribed documents evidencing payment of duty.

In this Part, we have discussed the provisions related to the availability of ITC to traders on a notional basis, where invoice/documents evidencing payment of duty are not available with them.

Relevant transition provisions in this regard are Proviso to Section 140(3) (‘relevant Proviso’) of the Central Goods & Service Tax Act, 2017 (‘the CGST Act’) and Sub-rule 3 of Rule 1 of the draft Transitional Provisions Rules (‘the draft Rules’).

As per the aforementioned provisions, a person can claim ITC on unsold stock on a notional basis (in respect of which there are no documents available evidencing payment of duty), in the following manner:

1. Eligibility: Following criteria should be fulfilled by a person to become eligible for notional ITC on unsold stock-
   • He should be registered under GST;
   • He should not be a ‘manufacturer’ or ‘supplier or services’; and
   • He should not be registered under the ‘existing law’
2. Amount of eligible ITC: ITC will be allowed to the extent of 40% of the Central tax (which is defined to mean ‘CGST levied under the CGST Act’) applicable on supply of such goods after the appointed date
3. Conditions: ITC on unsold stock shall be available subject to fulfilment of following key conditions:

• ITC on unsold stock will be allowed only after supply of such goods under GST and after payment of applicable Central tax;
• Benefit of such ITC should be passed on to the customer by way of reduced prices; and
• Goods should not be wholly exempt from Excise duty or were not nil rated; and
• This option will be available only for 6 months from the appointed day subject to furnishing of prescribed information, availability of document for procurement of goods, separate storage of such goods etc.

Although, on a prima facie reading of the above provisions, it appears that any trader should be eligible to avail ITC on unsold stock computed at the rate of 40% of the CGST paid on supply of such goods, but there are following practical challenges and interpretation issues in availing this benefit:

1. Eligibility of traders registered under the Central Sales Tax Act, 1956 (‘the CST Act’) to claim notional ITC –

The relevant Proviso (if read on a standalone basis) states that all GST registered persons (other than manufacturer or service provider) should be eligible to claim ITC on unsold stock on notional basis. Accordingly, all ‘traders’ should get covered here.

On a reading of the relevant Proviso, only as an exception to the main provision i.e. Section 140(3) of the CGST Act, only the following specified persons (inter-alia others) would be able to claim ITC on unsold stock:

• who were not liable to be registered under the existing law, or
• first stage dealers or
• second stage dealers or
• registered importers or
• depots of manufacturers

Further, the draft Rules also provide that the person should not be registered under the ‘existing law’, for notional ITC benefit.

Therefore, on a combined reading of the relevant Proviso, related sub-section and the draft Rules, it is apparent that in order to be eligible for claiming ITC on unsold stock on notional basis, trader should not be registered under the ‘existing law’.

As discussed in detail in Part-I of the Article, under Section 2(48) of the CGST Act, ‘existing law’ has been inter-alia defined to mean the law relating to levy and collection of duty or tax on goods or services or both passed before the commencement of CGST Act by the Parliament. On a bare reading of the above definition, it is apparent that any law passed by the Parliament for levy of tax on goods or services, irrespective of its scope, would get covered in the meaning of ‘existing law’.

Accordingly, even the CST Act passed by the Parliament for the levy of tax on inter-state sale of goods would get covered under the ambit of the phrase ‘existing law’.

Thus, basis such interpretation, any trader who is registered under the CST Act, would not be eligible for notional ITC.

Unlike what has been discussed in the Part I of the article, even taking additional Excise registration as importer/ first stage dealer/ second stage dealer would not be of any help in the instant case because the mechanism provided in the draft Rules to avail notional ITC is only for persons ‘not registered under existing law’. Thus, the benefit of notional credit could be denied by the tax authorities in case of a CST registered person.

2. Challenge in computation of notional ITC of 40%

The draft Rules provide that notional ITC on unsold stock shall be computed at the rate of 40% of the Central tax applicable on supply of such goods after appointed date. Also, there is a condition that benefit of ITC should be passed on to the customer by way of reduced prices

Issue arises because computation of notional ITC is dependent on the output tax paid on supply of goods under the CGST Act, which in turn depends on the benefit to be passed on the customer on account of ITC entitlement.

For better understanding, let’s take an example of a wholesale dealer of chairs who has an unsold stock worth INR 1,12,500 including Excise duty component, as on the appointed day and he sells these chairs at a price of INR 2,00,000.

In that case, CGST liability (assuming at the rate of 9%) would come to INR 18,000. Accordingly, notional ITC (at the rate of 40%) would be INR 7,200.

Because of the condition of passing of the benefit of this INR 7,200 to the customer (by way of reduction in price), the dealer will be required to reduce the chair prices from INR 2,00,000 to INR 1,92,800. But again, this will result in reduction in output CGST liability, which in turn will change the notional ITC calculation.

Accordingly, due to this circular reference (i.e. mutual interdependence), computation of notional ITC amount is a never ending mathematical equation. Due to this issue, proper computation mechanism in the Rules at the time of their enactment is desirable.

3. Eligibility of notional ITC on unsold stock in case of subsequent inter-state sale

The draft Rules provide that notional ITC on unsold stock shall be computed at the rate of 40% of the Central tax applicable on supply of such goods after appointed date. Section 2(21) of the CGST Act defines ‘Central Tax’ to mean CGST levied under Section 9 of the CGST Act. Also, Section 2(2) of the Integrated Goods and Services Tax Act, 2017 (‘the IGST Act’) provides ‘Central tax’ to mean taxes levied and collected under the CGST Act.

In case trader makes an inter-state sale of goods from the unsold stock lying with him as on the appointed date, IGST shall be applicable on such supply. However, the draft Rules do not provide any mechanism for computing notional ITC on the basis of IGST.

Section 20 of the IGST Act provides for application of certain provision of the CGST Act to the IGST Act including transitional provisions. Therefore, on a purposive construction, the notional ITC of 40% should also be computed on IGST in case of an inter-state sale.

Since IGST would have both Centre and State tax components, 40% of IGST would always be higher in comparison to 40% of CGST which would make it beneficial for trader to sell the goods inter-state instead of locally.

Since the above may not be in line with the intention of the Government, necessary clarification should be issued with respect to the mechanism of calculation of notional ITC in case of an inter-state sale.

4. Eligibility of notional ITC in lieu of Countervailing Duty (CVD)

Section 140(3) of the CGST Act allows credits of eligible duties (which inter-alia includes Central Excise or CVD) in relation to unsold stock.

However, the draft Rules provide mechanism for notional ITC on unsold stock in respect of which person is not in possession of any document evidencing payment of Central Excise Duty only.

Since a proviso is generally not read independently of the Section under which it is incorporated, the relevant Proviso should specifically allow notional ITC in lieu of CVD i.e. benefit of notional ITC should also be available to importer-traders in case they are not in possession of prescribed documents evidencing payment of duty.

Thus, the final Rules that are enacted should provide a mechanism for availing notional ITC where person is not in possession of any document evidencing payment of other eligible duties including CVD.

Conclusion: The provision to allow notional ITC on unsold stock to traders as their supply under GST would be subject to tax, is definitely a welcome move. However, necessary clarifications on account of above discussed challenges are desirable in order to effectively implement the provisions and for meeting the objectives of allowing notional ITC on unsold stock.