Examining Applicability of Input Tax Credit on Corporate Social Responsibility in 2023

Introduction

Corporate Social Responsibility (CSR) in India is a voluntary measure undertaken by companies to engage in activities that benefit society. Companies are required to spend 2% of their average profits on CSR activities and publish an annual report. Goods and Services Tax (GST) a unified indirect tax regime was introduced in India in 2017. GST is applicable on both goods and services and is collected at the State and Central level. The objective of GST is to eliminate cascading taxes, broaden the tax base and simplify the taxation system in India.

Input Tax Credit (ITC) is a mechanism for businesses to recoup taxes paid on inputs used in the production process. This system is beneficial for businesses as it encourages the efficient use of resources. In the context of CSR, ITC can be used to offset the cost of CSR activities if they are designated as expenses in a company’s accounting system. This means that companies can reduce their tax liabilities by investing in CSR activities, thus encouraging them to engage in socially responsible practices.

Interplay of CSR and GST

The Companies Act, 2013

It mandates every company with:

(a) “net worth of INR 500 crores or more, or

(b) turnover of INR 1000 crores or more, or

(c) net profit of INR 5 crores or more”,¹

to spend in every financial year at least 2% of their average net profit made during the preceding three financial years towards meeting its CSR obligations. CSR activities undertaken by companies aim to balance the companies’ economic and commercial interests with their social and environmental impact, to achieve more holistic and inclusive growth.

Pre-GST

ITC was available for services used in CSR activities. To be eligible for this credit, the service must have been used exclusively to fulfil CSR obligations as stipulated by the Companies Act, 2013. In addition, the service must be provided to an entity that is not related to the company and the company should bear the liability of payment. Input tax credits are only allowed up to the amount which is spent on CSR activity, and not exceed the total service tax paid on the services used for CSR activities.

In Bambino Pasta Food Industries (P) Ltd., In re², the Authority for Advance Ruling (AAR) held that input tax credits can be taken on services used exclusively for CSR activities. The Court held that input tax credits are available only up to the amount spent on CSR activities and not beyond that.

In 2018, the Customs, Excise and Service Tax Appellate Tribunal (CESTAT)³, Mumbai had held that CSR expenses were obligatory for the private sector to undertake. The concept of CSR goes beyond charity and has a direct bearing on the activities of companies since it augments their credit rating and standing in the corporate world. Accordingly, the CESTAT, Mumbai had set aside the denial of ITC on CSR expenditure by the Tax Department.

However, in a judgment⁴ passed in 2022, CESTAT, New Delhi upheld the denial of ITC on CSR expenses holding that input services are those which are used for providing output services, but CSR obligations arise only after providing the output services. Accordingly, the Tribunal held that CSR expenses cannot be treated as input services for providing output services but are a consequence of such companies providing output services.

Position under GST

This issue of ITC entitlement on CSR activities remained contentious even under the Goods and Services Tax regime. Under GST, a registered person is entitled to ITC on the inward supply of goods or services which are used or intended to be used in the course or furtherance of his business.

Thus, the companies argued that since CSR activities are a mandatory business expense, non-compliance with CSR obligations can result in business disruption as well as impact brand value. Therefore, CSR expenses ought to be considered as “used or intended to be used in the course or furtherance of business” and consequently, ITC should be made available.

In fact, various stakeholders filed applications before the Authority for Advance Ruling in different States in this respect, only to result in divergent rulings once again. While certain Authorities allowed ITC on CSR expenses, others categorically denied the same.

Judicial precedents

In Pristine Industries Ltd., In re⁵, which has used ITC to offset the cost of its solar energy investments in India. The AAR held that, the grant of ITC to offset the cost of solar power projects, allowing enterprises to reduce their tax liabilities. The AAR further held that, the solar power plants are required to be fastened on the rooftop of buildings resulting in to fall under the category of “permanently fastened to anything attached to the earth” hence, can be considered as “plant and machinery” eligible for ITC.

A more recent example is major telecom enterprises such as Bharti Airtel, Vodafone are approaching the Government to seek either refunds on their input credit or receive soft loans which would aid their liquidity issues. Reliance Jio has refund ITC pending of Rs 18,000 crores, while Bharti Airtel and Vodafone Idea have pending of Rs 10,000 crores and Rs 7000 crores, respectively.⁶

In 2023, a Division Bench of the Delhi High Court upheld that “mere suspicion without concrete evidence or proof, the application for refund of ITC cannot be denied”.⁷

In Indian Institute of Corporate Affairs, In re⁸, the company was granted input tax credits (ITC) for goods and services tax (GST) paid for the purchase of gifts given to its workers. The authorities argued that such items were not eligible for ITC under the GST regime.

However, after examining the details provided by the company, the authorities found that the gifts were related to the company’s business activities and allowed the company to claim input tax credits for them. This case is still relevant today because it serves as a reminder that input tax credits are available for goods and services used for business purposes, even if such items do not immediately appear to be eligible for ITC. This case also shows that businesses should always provide sufficient evidence and detailed explanations of how the goods and services purchased are related to their business activities in order to minimise disputes when claiming ITC.

Amendment under the Finance Bill, 2023

To bring an end to this controversy under GST, the Bill proposed to restrict ITC on goods or services or both received by a taxable person i.e. proposed amendment to Section 158-A⁹ of the Central Goods and Services Tax (CGST) Act, 2017, which are used or intended to be used for activities relating to its obligations under CSR.

This amendment is analogous to the corresponding provisions under the Income Tax Act, 1961¹⁰ under which CSR expenses cannot be claimed as tax deductible expenditure while computing income chargeable under “profits and gains of business or profession”.

The consequence of this amendment is that companies will now have to bear higher tax costs on CSR expenses, which may also impact allocation of funds by companies for CSR purposes. However, given the prospective nature of this amendment, it can be contended that there was no restriction on availing ITC on CSR expenses for the period from 1-7-2017 (date of implementation of GST regime) till the date of enforcement of this amendment.

Analysis

The changes to the ITC provisions are expected to help businesses better practice their GST obligations by providing more clarity and certainty in the taxation system. By allowing businesses to take full advantage of their eligible ITCs, they can better set off their GST liabilities against their purchases. This will help them save money on taxes and help reduce the cost of doing business. Additionally, the improved compliance rate will lead to higher levels of economic efficiency and boost government revenue. Finally, businesses will be able to focus more on the supply-side rather than the tax aspect of their activities, further boosting economic efficiency.

The proposed amendments to the ITC provisions of the Finance Bill, 2023¹¹ will allow businesses to avail ITC on a self-assessed basis i.e. Section 41¹² of the CGST which sets out the provisions for payment of tax by any person who is liable to pay tax. The section specifies the consequences of failing to pay tax, as well as provisions for collection of unpaid amounts.

This means that businesses can now calculate their own tax liability on their purchases and offset them against their GST liabilities. Furthermore, businesses will no longer need to wait for a Goods and Services Tax Network (GSTN)¹³ refund on their ITC claims, and instead, will receive the ITC immediately upon filing of their returns.

Finally, businesses will be able to claim ITC after a period of three months from the date of the invoice, compared to the current six-month period.

Additionally, the improved compliance rate due to these changes is likely to result in higher levels of economic efficiency and also increase government revenue. The introduction of the e-invoicing system i.e. Section 122¹⁴ of the CGST and other new rules are expected to further streamline the process of claiming ITC and make it easier for businesses to comply with their GST obligations.

Conclusion

The proposed amendments under the Finance Bill, 2023 include changes to the input tax credit provisions that allow businesses to offset their GST liabilities by taking advantage of the input tax credits. These changes are expected to bring more clarity and certainty in the taxation system, which will result in a better compliance rate.

In addition, businesses will be able to focus more on the supply-side rather than the tax aspect of their activities, leading to an improvement in economic efficiency. Finally, by allowing businesses to take full advantage of their ITCs, the cost of doing business is likely to drop for many companies. These changes will also help reduce the cost of doing business for many companies as they can take full advantage of their eligible input tax credits. The move is indicative of Government’s continued focus on stringent compliance monitoring and inter-departmental data sharing.