Union of India & Ors. v. VKC Footsteps India Pvt. Ltd.

01 · Facts of the case and issues

The batch resolved conflicting Gujarat and Madras High Court decisions about refund of accumulated GST credit under an inverted duty structure. In the lead footwear dispute, counsel recorded that outward footwear supplies attracted 5% GST, while many purchased goods and services attracted 12% or 18%. Synthetic leather and PU Polyol were examples of input goods; job-work and goods-transport-agency services were examples of input services. Credit therefore remained in the electronic credit ledger after payment of output tax. These are the historical facts recorded for the litigation, not a statement of present footwear rates.

Rule 89(5), operative from 1 July 2017, initially drew its Net ITC definition from Rule 89(4), covering credit on inputs and input services. Notification 21/2018-Central Tax dated 18 April 2018 restricted that definition to inputs. Notification 26/2018-Central Tax dated 13 June 2018 gave the substituted rule retrospective effect from 1 July 2017. The lead assessee disputed refusal of service-credit refunds and recovery of refunds previously granted, as recorded in its submissions.

The Gujarat High Court accepted the challenge and required input-service credit to be included in the refund computation. The Madras High Court, on 21 September 2020, upheld the statutory distinction and rejected the challenge. The principal issues were whether clause (ii) of the first proviso to section 54(3) merely identified eligible cases or substantively restricted refundable credit; whether excluding input services violated Article 14 or exceeded delegated power; and whether the formula itself had to be read down because it deducted the whole output-tax liability from credit attributable only to input goods.

Source: Official judgment, paras 1–10, 13(i)–(x), 14–22 and 95–100; pp. 4–10, 21–60 and 122–126.

02 · Discussion and reasoning of the Hon’ble Court

1. Credit entitlement and cash refund are distinct. Sections 2(59) and 2(60) separately define input goods and input services; sections 2(62) and 2(63) allow input tax and its credit to embrace both. Sections 16 and 49 permit eligible credit to enter a common ledger and be utilised, but section 49(6) makes refund subject to section 54. A common credit pool does not itself establish an unrestricted cash-refund right.

2. The first proviso restricts the refund. Reading section 54(3) as a whole, together with Explanation (1), the Court distinguished the ability to claim unutilised credit from the statutory circumstances in which a refund can be allowed. Clause (i) concerns zero-rated supplies without payment of tax; clause (ii) concerns accumulation caused by input-goods tax rates exceeding output-supply rates. The latter is a substantive restriction, not simply a threshold after which every kind of accumulated credit becomes refundable. Inputs takes its meaning from the defined input, which excludes capital goods and does not include input services. The plural form supplies no basis for enlarging that definition. The 2018 departmental circular about credit on multiple input goods could not expand the statute to encompass input services.

3. The constitutional challenge failed. GST neutrality and the avoidance of cascading explain the legislation, but those policy objectives cannot authorise a court to redraw clear statutory limits. Goods and services remain distinguishable constitutional and statutory categories. Parliament has substantial latitude in fiscal classifications, including refunds and concessions, subject to constitutional limits. The Court rejected the Article 14 challenge to the restricted refund rather than treating every person with accumulated credit as an indistinguishable class.

4. Rule 89(5) was within delegated power. Section 164 permits rules implementing the Act even where the particular provision does not use an express prescription formula. Rules must remain consistent with the parent statute. A turnover-based attribution formula was a permissible means of identifying credit referable to inverted-rated supplies, particularly where other supplies were also made. Since section 54(3) itself restricted the refund, defining Net ITC by reference to input goods did not contradict it. The Court declined to sever the input restriction from Explanation (a).

5. The formula had recognised imperfections. Its then-existing second limb deducted the whole output-tax liability from credit attributable to input goods, effectively assuming that input-service credit had not discharged any output tax. The Court accepted that this could reduce the refund in the Revenue’s favour. It also recognised that mandating use of all service credit first could tilt the result the other way, and mentioned a possible proportionate statutory assumption. These alternatives were policy possibilities, not an adopted judicial formula.

6. An anomaly did not justify rewriting the rule. The formula was neither ambiguous nor unworkable and was consistent with the limited refund Parliament chose. Fiscal rules are not invalid merely because their practical effects contain inequities. The Court therefore declined the suggested reading down and strongly urged the GST Council to reconsider the formula. Paragraph 113(iii) required the Council to consider paragraphs 104–111 and take a considered view according to law; it did not invalidate the formula or command a particular amendment.

Source: Official judgment: point 1, paras 35–48; point 2, paras 49–55, 62 and 67–70; point 3, paras 58–62 and 71–81; point 4, paras 82–94; point 5, paras 95–105; point 6, paras 106–113(iii).

03 · Judicial decision and operative relief

The Union of India’s appeals against the Gujarat High Court judgment and connected decisions were allowed and the impugned judgment was set aside. The assessees’ appeals against the Madras High Court judgment of 21 September 2020 and connected cases were dismissed; the assessee writ petition was also dismissed. The Court affirmed the Madras approach and disapproved the Gujarat approach, leaving the challenged refund restriction and formula intact. There was no order as to costs. The GST Council was required to consider the Court’s observations in paragraphs 104–111 so that it could take a considered view in accordance with law. Pending applications were disposed of. No refund was ordered for the assessees and no substitute computation formula was judicially enacted.

Source: Official judgment, paras 112–114; pp. 138–140. Paragraph 113(i)–(iii) contains the operative directions.

04 · In favour of

In favour of the Union of India / Revenue on the substantive statutory and constitutional challenge. The assessees obtained recognition of formula anomalies and a direction that the GST Council consider those observations, but this was not an award of refund, a remand of individual refund claims, or a merits victory for the taxpayers.

Source: Official judgment, paras 105–107, 111 and 113(i)–(iii).