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GST ITC restriction on CSR spend: Why businesses are worried about potential challenges

Mar 21, 2023

As part of FY 2023-24 Budget proposals, the Union Finance Minister has recommended restricting ITC on goods or services used for meeting the CSR obligation. Experts say this may have adverse impact on CSR benefits.

Seamless flow of Input Tax Credit (ITC) is the cornerstone of a robust Value-Added Tax (VAT) architecture. Simply put, say Company A - whether a manufacturer, service provider or trader, who purchases goods or services for business purposes, the VAT charged by its vendors is typically available as a set-off to Company A for adjustment against its output VAT liability. Albeit this principle forms the core of the Goods and Services Tax (GST) law in India, interpretational issues regarding ITC continue to rear their head in diverse rulings and incremental tax disputes over the past years. Amongst these, the ITC eligibility of GST paid on purchases for fulfilling the Corporate Social Responsibility (CSR) obligation of businesses is one such issue. The debate on this is premised on whether such CSR expenditure is for use “in the course or furtherance of business” by taxpayers, or else it will fail the essential test of eligibility to ITC.

Considering the dilemma, taxpayers opted for an advanced ruling route to achieve certainty of the tax position. However, while some rulings held such spending to be ‘in the course or furtherance of business’ as it is a mandatory obligation under the Companies Act, others denied the benefit since CSR activities are excluded from the normal course of business of taxpayers under Companies CSR Policy Rules. The need for certainty of treatment on this issue was further amplified considering the significant CSR expenditure incurred by businesses in the post-pandemic world and the divergent tax position adopted by the industry.

Interestingly, as part of FY 2023-24 Budget proposals, the Union Finance Minister has recommended an amendment in GST laws to restrict ITC on goods or services used for meeting the CSR obligation, referred to in Section 135 of the Companies Act, 2013. It appears that such a proposal is based on the twin rationale that CSR activity is meant for contribution to society and not for the furtherance of business and to align it with direct tax laws where no deduction is allowed for CSR expenses. This proposal has been met with increased concern from businesses as it embodies myriad potential challenges.

Notably, Section 135 of the Companies Act captures mandatory CSR obligations of the specified percentage of average net profits for businesses that exceed the prescribed threshold. Any non-compliance leads to legal consequences and a resultant impact on business. Given that CSR expenditure is mandatorily required to be incurred by companies in the course of business to meet compliance obligations under the company law, it naturally tilts the argument in favour of ITC's allowability of such expenditure. However, it is to be noted that ITC on gifts is specifically restricted in GST laws even if procured in the course of business. This is based on the reasoning that gifts are intended to be voluntary without any element of reciprocity and hence delinked from business purposes. Restriction of ITC on gifts given as part of CSR can however be contested as such activities are undertaken as per mandatory statutory obligations, which negates the concept of gift i.e., a voluntary act sans reciprocity.

Additionally, given that the proposed ITC restriction is solely in respect of mandatory CSR spend under Section 135 of the Companies Act, there is room to argue that any expenditure in excess of the specified mandatory limit should be allowed. Moreover, while it is believed that such restriction on CSR expenditure will be prospective, recovery measures for ITC availed in the past is a looming threat on the horizon. Inputs from the Government officials as per information in the public domain indicate that no coercive action will be taken for the past period, however, this requires express clarification to mitigate any dispute. In the aftermath of the proposed amendment, a detailed Circular, which comprehensively addresses these aspects will help in plugging any related challenge.

Separately, in the wake of increased recognition of inclusive and sustainable growth goals of the Government, significant contribution including welfare and charitable measures from businesses is inevitably expected as part of the larger vision. One hopes that the proposal to deny ITC on CSR spend will be revisited given the litmus test of ITC and the fact that credit restriction will add to the cost of CSR thereby limiting the extent of CSR activities expected to be undertaken by businesses, resulting in an adverse impact on the intended beneficiary of such measures.

[The Economic Times]

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