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The Functional Test for Input Tax Credit: A Multifaceted Legal Landscape
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Namaste!

Today, I would like to address the concept of the functional test, which has emerged as a pivotal topic in relation to input tax credit (ITC) claims under the GST Act, particularly following the Supreme Court's ruling in M/s Safari Retreats Private Limited. During discussions with various business owners and tax professionals, I noticed a common belief that if a building is utilized for rental purposes, ITC on the construction cost may be claimed.  

While this notion holds some merit, it is not entirely accurate. A detailed reading of the Supreme Court's judgment clarifies that ITC can only be claimed when the relevant goods or services satisfy the functional test. Although the functional test lacks a precise statutory definition, the judgment references several prior rulings, which may introduce complexity. Upon discussing specific case examples, many realized that navigating these issues could substantially simplify ITC claims.

Now, I share these insights with you to help mitigate the challenges of ITC claim rejections.

1. Multi-Dimensional Understanding of the Functional Test  

The functional test is a complex concept that requires a multi-dimensional understanding. Various courts have interpreted it from different perspectives, adding to its intricacy. This complexity underscores the need for a thorough understanding of the functional test.  

For instance, a two-judge bench of the Supreme Court concluded that a hotel is to be classified as immovable property and cannot be regarded as a 'plant.' Conversely, while agreeing in principle, a three-judge bench classified a dry dock — also immovable property — as a 'plant' because, in their view, the dry dock is an indispensable part of the business process (ship repairs). Without it, business operations would be significantly hampered, making it more than just a location but a critical operational tool. Thus, it becomes essential to distinguish between "sitting and means" when applying the functional test.

2. Controversy on the Lift ITC

Based on the functional test, one could argue that a lift qualifies as a 'plant.' However, numerous judgments have determined that a lift should be classified as immovable property, as it is permanently integrated into the building and requires governmental approval for installation. Consequently, lifts may also be classified as 'not a plant.' In such instances, reference must be made to rulings where immovable property has been recognized as a 'plant.' You should consider making an ITC claim not under Section 17(5)(c) but under the exceptions provided in Section 17(5)(d).

 3. Absence of a Universal Precedent  

It is crucial to acknowledge that no single judgment governs all scenarios. Each case must be assessed based on its unique facts and circumstances.

My perspective:

Our GST research indicates that every case presents its own nuances, and overconfidence should be avoided. There is always potential for claiming ITC, as every argument has two sides. It is vital to identify the aspects that favour your ITC claim. Therefore, I strongly recommend that, if you are a business owner, you seek the counsel of a GST expert to preserve your ITC claim under the exceptions outlined in Section 17(5)(d) of the GST Act. This expert advice will provide you with a sense of security and guidance in navigating the complexities of ITC claims.

Looking ahead:

In the coming days, we will further explore the various criteria involved in the functional test. Our discussions will ensure clarity on this subject, supplemented with case law and practical examples to assist you in navigating these complexities effectively.  

Thank you.

Vikash Dhanania

Founder of GST DOST, is a seasoned CA with exceptional expertise in GST. Honored with the prestigious Hariyana Pratibha Puruskaar, Vikash is known in the market as DOST, reflecting his friendly and supportive approach. He excels in leveraging AI, KI, and EI to deliver impactful solutions that satisfy clients. An accomplished author, prolific blogger, and creator of educational videos for the business community, he also launched the groundbreaking online GST talk show, "GST ki Baat Dost ke Saath."