Input Tax Credit under GST

On 14th June 2016, the Finance Ministry released a draft of the Model GST Bill. (This time, the draft is official, unlike the last time!)

Since the whole idea behind GST is to have a seamless tax credit chain, it would be appropriate to look at that clause before anything else. Uh Oh! This is problematic. 

Here's section 16(11), have a quick read of clause (c):

"(11) Notwithstanding anything contained in this section, but subject to the provisions of section 28, no registered taxable person shall be entitled to the credit of any input tax in respect of any supply of goods and/or services to him unless

(a) he is in possession of a tax invoice, debit note, supplementary invoice or such other taxpaying document as may be prescribed, issued by a supplier registered under this Act or the IGST Act;

(b) he has received the goods and/or services;

(c) the tax charged in respect of such supply has been actually paid to the credit of the appropriate Government, either in cash or through utilization of input tax credit admissible in respect of the said supply; and..."

(emphasis supplied)

Basically, you cannot take input tax credit unless the seller (or service provider) has paid the tax. This will disrupt payment cycles across businesses, forcing buyers (and service recipients) to re-plan their business behavior afresh. Here's why:

The responsibility of tax payment by seller (or service provider) has been cast on the buyer (or service recipient, as the case may be). But how can the buyer ensure when the seller deposits tax?

Remember MODVAT era? Rule 57A(6) of the Central Excise Rules, 1944 then required buyer to exercise 'reasonable care' that tax was actually paid by seller. In the case of CCE v. Kay Kay Industries, the Supreme Court ruled that 'reasonable care' did not imply that assessee should go and confirm from the department that tax has been paid. 

Now note that the proposed law does not talk of 'reasonable care' but just creates a blanket condition that tax should have been actually paid. The burden of ensuring tax collection has simply been shifted from revenue authorities to the buyer (or service recipient). Yet, there is really no framework for a buyer to find out whether the seller is paying tax or not. Hence the questions:

1. Since tax credit is conditional on actual tax payment by the supplier, should buyers try and withhold payment of the tax component in the invoice till they have proof that tax has been actually paid to the department? If so, this will disrupt payment cycles and business behavior in a big way. 

2. If the buyer asks the supplier to prove that tax on the invoice has been actually paid, how exactly should the supplier do so? The supplier would typically be collecting tax from several parties, and paying aggregate tax in one go. Further, this payment would involve adjusting tax credits as well as cash payment. The supplier cannot establish payment of tax on a particular invoice without possibly sharing a lot of confidential business data, unless GSTN provides a framework which assures the buyer that tax on a particular invoice has been paid.  

3. Tax collected in a month is typically payable in the next month. Till now, tax credit was being taken at the time of receipt of goods (subject to certain conditions). Should the buyer wait till due date of payment of tax before taking credit? That will delay credit-taking by a month. Surely, that cannot be the idea behind the provision!

Clause (c) of section 16(11) thus single-handedly frustates the whole idea of creating a seamless tax credit chain. It needs to go, the sooner the better.