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  • Ayush Katyayana

Disallowance of Input Tax Credit on CSR Expenditure: An Unnecessary Dampener for Companies

[Ayush is a student at National Law University Delhi.]


Input tax credit (ITC) is essentially a mechanism whereby at the time of paying tax on output supplies, the tax paid on purchasing inputs can be offset against the said amount payable on outward supply. Corporate social responsibility (CSR), meanwhile, is a statutory obligation mandated on certain companies vide Section 135 of the Companies Act 2013, such that companies meeting the stated thresholds are required to spend at least 2% of their average net profits over the last three financial years towards pursuing their CSR Policy.


On 1 February 2023, the Union Budget for 2023-2024 proposed an amendment (Amendment) to the goods and services tax (GST) framework to the effect that ITC would be ineligible for the goods and services used in relation to mandatory CSR activities. Thereafter, the Finance Act 2023 was notified and Section 130(b) of this law proposed the insertion of clause (fa) to Section 17(5) of the Central Goods and Services Tax (CGST) Act 2017, by virtue of which CSR expenditure has been classified among the blocked credits on which ITC is not available. Accordingly, ITC is now no longer available on expenditures towards goods and services used/intended to be used for CSR activities.


This article critiques and analyzes the said prohibition of ITC on CSR expenditure in light of the legal justifications in favour of the same. It would accordingly forward suggestions and solutions to remedy the status quo produced by the Amendment.

 

CSR Expenses are in the Course and Furtherance of Business of a Company


The primary grounds urged in support of the ineligibility of CSR expenditure for ITC are that firstly, such expenditure is not “in the course or furtherance of business”; and secondly, that expenditure towards inward services procured for CSR activities is in the nature of expenditure towards goods disposed of by way of a gift or free samples, because under CSR a company provides output/output services without consideration or free of cost, and there is hence no taxable supply here on which ITC can be charged.


Regarding the first contention, any expense, in order to be eligible for availing of ITC under GST, should be incurred in the “course or furtherance of his business” as per Section 16(1) of the CGST Act, and should not be a blocked credit under Section 17(5). It is argued that CSR expenditure, being mandated under the Companies Act 2013, forms a core part of a company’s business process and should be treated as incurred in the course of and the furtherance of the business, as held in M/s Dwarikesh Sugar Industries Limited and  In Re: M/S. Bambino Pasta Food Industries Private Limited. As rightly held by the CESTAT, Mumbai in Essel Propack Limited v. Commissioner of CGST, Bhiwandi, CSR activities are essential for a company to carry out its business in an economically, socially, and environmentally sustainable manner, and undertaking these enhances the reputation, image, and goodwill of the company in the corporate world and among the public at large. It can thus safely be said that CSR activities do play an integral role in furthering the business of a company. A classic example of this would be the awarding of the IPL title sponsorship rights to TATA back in 2022, wherein TATA’s well-respected reputation arising from its social and philanthropic activities undoubtedly had a role to play in it being awarded the title rights, thus replacing Vivo, a Chinese company, at a time when India was grappling with tenuous ties with China.


Therefore, albeit not directly in terms of expenditure on CSR yielding profits/monetary gains that can be directly linked and attributed to such expenditure, in the larger scheme of things for a company, CSR activities do certainly contribute to the furtherance of its business in various indirect ways. Hence, a purposive interpretation of the said requirement ought to have been imported while deciding on the allowability of CSR expenditure for ITC, as was argued by the appellants (and allowed by the CESTAT Mumbai) in Essel Propack.

 

CSR Expenditure is Not Towards Non-Taxable Supply / in the Nature of a Gift


Coming now to the second contention in favour of prohibiting ITC on CSR expenditure that such expenditure is by way of a gift or free samples or does not result in an outward taxable supply (which is a pre-requisite for claiming ITC as per Section 17(2) of the CGST Act), it is argued by the author that:


Firstly, Gifts, free samples, and expenditures on them are voluntary, which is starkly opposed to expenditure on CSR activities, which are mandatory vide the Companies Act 2013 and hence cannot be categorised as a gift. Secondly, while CSR initiatives are free of cost for their beneficiaries, the cost of CSR activities and tax paid thereon forms part of the cost of final products produced by a business, as held in Commissioner of CEX, Bangalore v. Millipore India Private Limited. Hence, consideration is certainly paid for CSR activities, just that it is derived from customers/buyers of the final products/services of a company rather than direct beneficiaries of CSR activity. Such a situation of a party other than the recipient/beneficiary of services paying the consideration for the same is permitted under the GST regime as per Indian Institute of Corporate Affairs, In re.


Given that the very rationale and intent behind the introduction of ITC was to avoid the cascading effect of taxes along the supply chain, it is patently unclear why the same is to be denied on CSR expenditure, which like other expenses undertaken by a company is borne in the furtherance and course of business and also attracts consideration down the supply chain as part of the value of finished goods/services offered by a company.


Another anomaly thrown up by the disallowance of ITC on CSR expenses is the resultant conflict between the Companies Act 2013 on one hand and CGST Act on the other. Post the Amendment, it is not clear whether the part of the payable tax that a company was previously eligible to get back by way of ITC would be included in the mandated expenditure of 2% of average net profits that a company is required to undertake as per Section 135(5) of the Companies Act 2013, or whether this would be over and above this 2%. If it is the former, it effectively leads to diminished actual spending on CSR thereby undermining the spirit and objective of CSR under the Companies Act 2013, and if it is the latter, it essentially amounts to nothing but an added burden for companies in meeting their statutory obligations by effectively subjecting them to the cascading effect of taxes, which is what the ITC framework was envisaged to avoid in the first place.

 

Suggesting a Way Out: A Constitutional Challenge to the Validity of the 2023 Amendment


The Amendment can be challenged on the touchstone of Article 14 of the Constitution on grounds of creating an unintelligible classification with respect to CSR expenditure in two ways, firstly, the denial of ITC on CSR expenditure unfairly discriminates against expenditure on CSR activities relative to other such transactions that are in the course and furtherance of business, which continue to be eligible for ITC and are not credit-blocked by the statute; and secondly, it is to be noted that companies can undertake CSR activities in two ways - by directly providing goods and services to beneficiaries as is typically the case, or by making donations and contributions to charitable trusts and organisations. Now, if a charitable donation or activity in relation to a trust or charitable institution under Section 12AA of the Income Tax Act 1961 is philanthropic in nature leads to no commercial gains and is not an advertisement, then it is exempt from GST altogether. There thus exists no reasonable justification for GST exemption on such philanthropic expenditure and donations, when expenditure towards activities under CSR, which is very similar in nature, purpose, and underlying policy to such exempted charitable donations, are subject to GST without the availability of ITC.


Further, the Amendment to Section 17(5) of the CGST Act can also be constitutionally challenged on the anvil of Article 21. The importance of CSR activities, which have an environmental, social, and philanthropic dimension and the duty of companies and businesses to undertake these, have been recognised by the Supreme Court in a series of judgements like Indian Council for Enviro-Legal Action v. Union of India, Indian Social Action Forum v. Union of India, and Lafarge Umiam Mining Private Limited v. Union of India, as serving as a stimulus for the auxiliary arm of the government to enforce Fundamental Rights under the Constitution, and most notably the expanse of rights under Article 21 in addition to Directive Principles of State Policy.


Hence, the denial of ITC on CSR expenditure is likely to have the effect of discouraging companies from undertaking CSR activities beyond the 2% threshold mandated under the Companies Act 2013, hence limiting and restricting the realisation of Article 21 rights through CSR initiatives. This is especially important given that during the COVID-19 pandemic, despite incurring huge losses, companies proactively undertook CSR expenditures in various forms such as manufacturing masks, PPE kits, etc., which is illustrated by the fact that the expenditure on CSR activities in the COVID-19 period had increased even as the number of companies participating in CSR activities reduced since more than 50% of the companies spent more on CSR than what was prescribed and mandated under the Companies Act 2013. It is therefore doubtful if, going forward, companies would still be willing to take such initiative in times of need, considering CSR expenditure beyond the mandated quantum now stands disincentivised owing to the denial of ITC on the same.

 

Conclusion


The foregoing analysis concludes with the finding that the disallowance of ITC on CSR expenditure brought about via the Finance Act 2023 and the Amendment has been a step in the wrong direction since it not only lacks a sound legal basis but also goes against the very rationale and policy objective of promoting CSR activities under the Companies Act as well as avoiding the cascading effect of taxes via ITC under the CGST Act. Hence, given the unlikelihood of a legislative intervention to reverse the Amendment, the author has put forth the solution of challenging the very constitutional validity of the Amendment on the anvil of Articles 14 and 21 of the Constitution to obtain a rollback of the same.

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