Apportionment and Blocked Credits

The availability of Input Tax Credit (ITC) on goods or services procured for Corporate Social Responsibility (CSR) activities has been a contentious issue.
Initially, there were conflicting Advance Rulings (AARs) on this matter, with some allowing ITC and others disallowing it, often invoking Section 17(5)(h) (goods disposed of by way of gift or free samples) or arguing that CSR expenses are not in the course or furtherance of business.
However, the Finance Bill 2023 proposed an amendment to Section 17(5) of the CGST Act, specifically disallowing ITC on goods or services or both received by a taxable person which are used or intended to be used for fulfilling obligations under Corporate Social Responsibility (CSR) as referred to in Section 135 of the Companies Act, 2013.
This amendment aims to clarify that ITC will generally not be available for CSR expenses. The rationale provided by the Finance Ministry is that CSR expenditure is not for the furtherance of business in the same way as other business expenses, and similar disallowances exist under the Income Tax Act.
While a detailed clarificatory circular from CBIC was anticipated post-enactment of the Finance Bill 2023, the legislative amendment itself makes the position clear: ITC is blocked for goods and services used to meet mandatory CSR obligations. It was also clarified that companies would not be pursued for ITC claimed on CSR expenses prior to the effective date of this amendment.

Section 17(5)(b) of the CGST Act, 2017, generally blocks ITC on the following:

1. Food and beverages, outdoor catering, beauty treatment, health services, cosmetic and plastic surgery.
2. Membership of a club, health and fitness centre.
3. Rent-a-cab services, life insurance, and health insurance.
   Exceptions: ITC is available for these services in two main scenarios:

• Further Supply: When an inward supply of such goods or services or both is used by a registered person for making an outward taxable supply of the same category of goods or services or both or as an element of a taxable composite or mixed supply. For example, a restaurant providing outdoor catering services can claim ITC on outdoor catering services purchased from another vendor.
• Mandatory by Law: Where the provision of such services is obligatory for an employer to an employee under any law for the time being in force. For example, if a company is legally required to provide health insurance to its employees, it can claim ITC on that insurance.

As per Section 17(1) of the CGST Act, 2017, ITC is not available to the extent goods or services are used for non-business purposes. This means that the amount of credit shall be restricted to so much of the input tax as is attributable to the purposes of the business. Rule 42 (for inputs and input services) and Rule 43 (for capital goods) of the CGST Rules, 2017, provide the mechanism for reversal of ITC in such cases. The amount of ITC attributable to non-business use is considered a blocked credit and must be reversed. For inputs and input services, the ITC attributable exclusively to non-business purposes ('T1') is identified and reversed. This ensures that ITC is only claimed for the portion of goods or services actually used in the course or furtherance of business.

Section 17(5)(c) of the CGST Act, 2017, blocks ITC on works contract services when supplied for construction of an immovable property (other than plant and machinery), except where it is an input service for further supply of works contract service. This means if a works contractor receives works contract services from a sub-contractor for a project which the main contractor is also undertaking as a works contract, then ITC is available to the main contractor.
Furthermore, Section 17(5)(d) blocks ITC on 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, including when such goods or services or both are used in the course or furtherance of business.
The term "construction" includes re-construction, renovation, additions or alterations or repairs, to the extent of capitalization, to the said immovable property. "Plant and machinery" means apparatus, equipment, and machinery fixed to earth by foundation or structural support that are used for making outward supply of goods or services or both and includes such foundation and structural supports but excludes land, building or any other civil structures, telecommunication towers, and pipelines laid outside the factory premises.

Rule 42 applies when inputs or input services are used partly for business and partly for other purposes, or partly for taxable supplies and partly for exempt supplies. The ITC attributable to exempt supplies and non-business use must be reversed. The reversal for exempt supplies is calculated proportionally based on the ratio of exempt turnover to total turnover during the tax period.

Rule 42 of the CGST Rules, 2017, prescribes the manner for determining and reversing input tax credit (ITC) on inputs and input services used partly for business and partly for other purposes, or partly for taxable supplies (including zero-rated) and partly for exempt supplies.
The methodology involves several steps:

1. Total ITC (T): Identify the total input tax paid on inputs and input services in a tax period.
2. ITC exclusively for non-business/exempt supplies (T1, T2):
   • T1: ITC on inputs/input services used exclusively for non-business purposes.
   • T2: ITC on inputs/input services used exclusively for effecting exempt supplies.
     These amounts are not credited to the electronic credit ledger.
3. Blocked Credits (T3): ITC on inputs/input services on which credit is not available under Section 17(5) of the CGST Act. This amount is also not credited.
4. ITC exclusively for taxable supplies (T4): ITC on inputs/input services used exclusively for effecting taxable supplies (including zero-rated supplies). This amount is fully credited.
5. Common Credit (C2): The remaining ITC, which is common to both taxable and exempt supplies and non-business purposes, is calculated as C2 = C1 - T4, where C1 = T - (T1 + T2 + T3).
6. Reversal related to exempt supplies (D1): D1 = (E ÷ F) × C2, where 'E' is the aggregate value of exempt supplies and 'F' is the total turnover of the registered person during the tax period.
7. Reversal related to non-business use (D2): A deemed 5% of the common credit (C2) is attributed to non-business use, i.e., D2 = 5% of C2.
8. Monthly Reversal: The amounts D1 and D2 are reversed and added to the output tax liability for the month.
9. Annual Adjustment: Rule 42 mandates a final annual computation after the end of the financial year. If excess ITC was reversed, it can be reclaimed; if short reversal occurred, additional reversal must be made along with interest. This annual true-up is a common area of departmental objection.
   Rule 43 deals with apportionment of ITC on capital goods, spreading the credit over a useful life of 60 months.

Section 17(5)(a) of the CGST Act, 2017, generally blocks Input Tax Credit (ITC) on motor vehicles for transportation of persons having an approved seating capacity of not more than thirteen persons (including the driver).
However, there are crucial exceptions where ITC is allowed:

1. Further Supply: When such motor vehicles are used for making further taxable supplies of similar motor vehicles (e.g., a car dealer purchasing cars for resale).
2. Transportation of Passengers: When used for transportation of passengers (e.g., a taxi service or a bus operator).
3. Imparting Training: When used for imparting training on driving such motor vehicles (e.g., a driving school).
   Similar provisions apply to vessels and aircraft under Section 17(5)(aa), with exceptions for further supply, passenger transport, imparting training, and transportation of goods.
   Furthermore, ITC on services of general insurance, servicing, repair, and maintenance in so far as they relate to such motor vehicles, vessels, or aircraft is also blocked, unless the underlying conveyance itself qualifies for ITC or is received by a taxable person engaged in the manufacture of such conveyances or in the supply of general insurance services in respect of such conveyances.
   Practical Scenario: A company purchases a sedan (seating capacity 5) for its CEO's personal use. ITC will be blocked. However, if the same company purchases a fleet of sedans to operate as a taxi service, ITC will be allowed. Similarly, a car manufacturer can claim ITC on components used to build cars, even if those cars have a seating capacity of less than 13.

When inputs or input services are used partly for effecting taxable supplies (including zero-rated supplies) and partly for effecting exempt supplies, the common ITC must be apportioned as per Rule 42 (for inputs and input services) and Rule 43 (for capital goods) of the CGST Rules, 2017. The total ITC on inputs and input services for a tax period is denoted as 'T'. From this, ITC attributable exclusively to non-business purposes ('T1') and exclusively to exempt supplies ('T2') are identified and reversed. ITC on inputs and input services on which credit is not available under Section 17(5) is denoted as 'T3'. The remaining credit, 'C1' (T - (T1+T2+T3)), is then considered. ITC attributable exclusively to taxable supplies is denoted as 'T4'. The common credit (C2) is then calculated. The amount of common credit attributable to exempt supplies ('D1') is calculated as (E/F) * C2, where 'E' is the aggregate value of exempt supplies and 'F' is the total turnover in the State/UT during the tax period. This amount (D1) is reversed. The remaining common credit (C3 = C2 - D1) is available for use. This reversal is done on a monthly basis and is subject to annual finalization and adjustment.

When a company initially avails Input Tax Credit (ITC) on inputs, input services, or capital goods, and subsequently, some of its supplies become exempt, a proportionate reversal of ITC is mandated under Rule 42 (for inputs and input services) and Rule 43 (for capital goods) of the CGST Rules, 2017.

For Inputs and Input Services (Rule 42):

• The reversal is done on a provisional basis monthly and then finalized annually.
• The common credit (C2) is identified after excluding ITC used exclusively for non-business purposes (T1), exempt supplies (T2), and blocked credits (T3), and ITC used exclusively for taxable supplies (T4).
• The amount of ITC to be reversed attributable to exempt supplies (D1) is calculated as D1 = (E ÷ F) × C2.
  • 'E' represents the aggregate value of exempt supplies made during the tax period.
  • 'F' represents the total turnover of the registered person during the tax period.
• An additional amount (D2) representing 5% of C2 is also reversed for non-business use.
• Timeline: The provisional reversal is done monthly. The final calculation for the entire financial year must be completed before the due date for furnishing the return for the month of September following the end of the financial year to which such credit relates. Any shortfall in reversal leads to interest liability, while any excess can be reclaimed.

For Capital Goods (Rule 43):

• When capital goods on which full ITC was initially availed are subsequently used for exempt supplies, the ITC attributable to the remaining useful life needs to be reversed.
• The useful life of capital goods is considered as five years (60 months) from the date of invoice.
• The ITC attributable to exempt supplies (Te) for each tax period is calculated as Te = (E ÷ F) × Tm, where Tm is the common ITC on capital goods for that month. The total ITC (A) on capital goods is credited to the electronic credit ledger, and then a monthly reversal is computed.
• Timeline: This reversal is done every month for the remaining useful life of the capital goods. An annual true-up is also required under Rule 43(2) similar to Rule 42(2).

Sections 17(5)(c) and 17(5)(d) of the CGST Act, 2017, deal with blocked credits related to immovable property.

• Section 17(5)(c) - Works Contract Services: ITC is blocked on works contract services when supplied for the construction of an immovable property (other than plant and machinery).
  • Exception: ITC is available if the works contract service is an input service for further supply of works contract service. For example, a main contractor can avail ITC on works contract services received from a sub-contractor if the main contractor is further supplying works contract services.
• Section 17(5)(d) - Goods or Services for Construction: ITC is blocked on goods or services or both received by a taxable person for construction of an immovable property (other than plant or machinery) on his own account, even if used in the course or furtherance of business. This clause applies when a business constructs property for its own use (e.g., an office building or factory shed).
• Key Distinction:
  • Section 17(5)(c) applies to the recipient of works contract services.
  • Section 17(5)(d) applies to a taxable person constructing immovable property on their own account using various goods and services.
• Common Exception (Plant and Machinery): Both clauses explicitly exclude "plant and machinery" from the blocked credit provisions. This means ITC is available for works contract services or goods/services used for the construction of plant and machinery. The term "construction" includes re-construction, renovation, additions or alterations or repairs, to the extent of capitalisation, to the said immovable property.

Under Section 17(5) of the CGST Act, ITC on motor vehicles for transportation of persons having an approved seating capacity of not more than 13 persons (including the driver) is blocked, EXCEPT when they are used for further supply of such vehicles, transportation of passengers, or imparting training on driving.

Blocked credits (where ITC is not available) include: Motor vehicles for transport of persons (capacity <= 13) except for specified uses; food and beverages, outdoor catering, beauty treatment; membership of a club/health/fitness centre; travel benefits to employees; goods/services for construction of immovable property on own account; goods lost, stolen, destroyed, or given as free samples.

The availability of ITC on CSR expenses has been a subject of litigation. However, recent amendments explicitly state that ITC shall not be available in respect of goods or services or both received by a taxable person, which are used or intended to be used for activities relating to his obligations under Corporate Social Responsibility referred to in section 135 of the Companies Act, 2013.

Section 17(5)(a) of the CGST Act, 2017, generally blocks ITC on motor vehicles for transportation of persons having a seating capacity of not more than thirteen persons (including the driver), and aircraft and vessels. However, ITC is available in the following three specific cases:

1. When such motor vehicles, vessels, or aircraft are used for making further supply of such vehicles or conveyances (i.e., for resale).
2. When they are used for transportation of passengers.
3. When they are used for imparting training on driving, flying, or navigating such vehicles or conveyances.
   For example, a car dealer can claim ITC on cars purchased for resale, and a taxi service provider can claim ITC on cars used for transporting passengers. ITC is also fully available for vehicles meant for transporting goods.

The definition of 'exempt supply' under Section 2(47) of the CGST Act, 2017, includes nil-rated supplies, wholly exempt supplies, and non-taxable supplies. For the purpose of ITC apportionment under Rule 42, the value of exempt supplies ('E') in the formula (E/F)*C2 has specific inclusions and exclusions. While all supplies falling under Section 2(47) are generally included, Explanation 1 to Rule 42 clarifies that the value of 'exempt supply' shall not include the value of activities or transactions specified in Schedule III of the CGST Act, except those specified in paragraph 5 of the said Schedule. This is crucial because the sale of land and building is an activity specified in Schedule III (neither a supply of goods nor services). Therefore, the value of sale of land and building is generally excluded from the 'E' (value of exempt supplies) for the purpose of common credit reversal under Rule 42, preventing disproportionate ITC reversal. However, transactions in securities are deemed exempt supplies for the limited purpose of ITC reversal under Rule 42, even though they are outside the scope of GST. The value of services by way of extending deposits, loans, or advances where the consideration is interest or discount is also typically part of exempt supply for Rule 42 calculations.