Refund Rights under Section 54 of the CGST Act From Single Bench Liberalism to Division Bench Restraint

1. Introduction

The Goods and Services Tax (GST) regime in India, introduced on 1 July 2017, brought with it a seamless flow of input tax credit (ITC) to eliminate the cascading effect of taxes. One of the fundamental objectives of GST is to maintain tax neutrality for businesses, meaning the tax paid on inputs should not exceed the tax on outputs. However, situations such as the closure of a business, where unutilised ITC remains in the electronic credit ledger, have given rise to complex legal disputes.

Refund of unutilised ITC has been extensively litigated under Indian courts, particularly because the statute, specifically Section 54 of the Central Goods and Services Tax Act, 2017 (CGST Act), does not explicitly provide for refunds arising solely from business closure. The tension arises between a literal interpretation of the statute, which limits refunds to certain categories like zero-rated supplies or inverted duty structures, and the principle of equity and fairness that business taxpayers invoke.

This article examines the judicial journey regarding such refund claims, focusing on a case initially decided by a Single Judge, subsequently revised by a Division Bench. The discussion explores statutory provisions, doctrinal interpretations, Constitutional dimensions, and practical implications for businesses and compliance professionals.

2. Significance of Refunds in GST

Refunds under GST are critical to ensure the principle of tax neutrality. Tax neutrality ensures that the effective tax burden is only on the value addition at each stage, and no extra burden is imposed on businesses that act as intermediaries in the supply chain. Refunds become particularly significant in the following circumstances:

1. Inverted Duty Structure: When the GST rate on inputs exceeds the rate on outputs, businesses may accumulate ITC that exceeds their output tax liability. Refunds are the only mechanism to release this blocked credit.
2. Zero-Rated Supplies: Exports and supplies to SEZs often result in ITC accumulation since the output tax is effectively zero. Refunds allow exporters to claim the taxes paid on inputs.
3. Business Closure: When a taxpayer ceases operations, unutilised ITC may remain in the ledger. While theoretically refundable, the law does not explicitly provide for this situation.

Section 54 of the CGST Act, which governs refunds, is comprehensive for zero-rated supplies and inverted duty situations but remains silent on business closure. This gap has prompted litigation, as taxpayers seek equitable relief, and the revenue authorities resist claims outside the statutory ambit.

3. Pre-GST Judicial Background

Prior to GST, under the CENVAT Credit Rules, courts had occasionally allowed refunds on closure, recognizing the taxpayer’s right to recover taxes paid on inputs that were never utilised. For example:

• Slovak India Trading Co. (Karnataka High Court): The court allowed refund of unutilised CENVAT credit upon business closure, emphasizing that retaining such credit would amount to an unfair exaction.
• Gauri Plasticulture (Bombay High Court): Conversely, the court denied refund on closure, stating that the statute must be strictly interpreted, and courts cannot expand the scope of statutory benefits based on equity.

These divergent approaches created uncertainty. The introduction of GST, with its explicit statutory framework, has shifted the balance towards stricter interpretation.

4. Legislative Framework

4.1 Section 49 – Electronic Cash and Credit Ledgers

Section 49 establishes the electronic ledgers for maintaining tax payments and ITC:

• Cash Ledger: Contains amounts paid in cash for GST liability.
• Credit Ledger: Maintains ITC available for utilization.

Section 49(6) stipulates that unutilised ITC may be used only in accordance with provisions of Section 54. This links refunds directly to the statutory scheme, making Section 54 the touchstone for eligibility.

4.2 Section 54 – Refund of Tax

Section 54 of the CGST Act is the primary provision governing refunds:

• Sub-section (1): Allows refunds of tax or ITC where an applicant is eligible under the Act.
• Sub-section (3): Specifically allows refund of unutilised ITC in the case of:
  1. Zero-rated supplies.
  2. Inverted duty structures.
• Sub-section (8): Prescribes the order of priority for refund claims.

Business closure is not mentioned in these provisions, which forms the basis of disputes.

5. Doctrinal Nature of Refunds

Refunds under GST are statutory in nature. Unlike pre-GST CENVAT, which occasionally allowed refunds based on principles of equity, GST mandates that refunds can be claimed only where explicitly provided in the statute.

Retention of unutilised ITC does not automatically violate Article 265 of the Constitution, which prohibits taxation without law. Courts have emphasized that until the statute confers a right to refund, the tax authorities are not obligated to release ITC. The key principle is that equity cannot override statutory provisions.

6. Original Single Judge Judgment

6.1 Facts

In the case of SICPA India, the taxpayer had ceased operations and applied for a refund of approximately Rs. 4.37 crore of unutilised ITC. The tax authorities denied the refund, citing Section 54(3), which does not explicitly permit refunds on business closure.

6.2 Assessee Arguments

The taxpayer contended that:

• Section 49(6) allows ITC to be refunded in accordance with Section 54(1), which authorizes refunds generally.
• Retention of ITC after business closure would violate the principle of equity and constitute an unlawful exaction.
• Precedents like Slovak India Trading Co. supported refund on closure.

6.3 Department Arguments

The revenue authorities argued:

• Refunds are statutory and strictly confined to Section 54(3).
• The CENVAT-era judgments are distinguishable in the GST regime.
• Allowing refunds on business closure could create a precedent leading to revenue leakage.

6.4 Reasoning

The Single Judge relied on principles of fairness and the right of the taxpayer to recover taxes paid, interpreting the absence of explicit exclusion as a justification for allowing refund. The court reasoned that:

• ITC is a vested right, and withholding it would be inequitable.
• The statute should be read to prevent injustice to taxpayers.

6.5 Outcome

The court allowed the refund, extending the scope beyond Section 54(3) to include unutilised ITC due to business closure.

7. Revision by Division Bench

7.1 Background

The Union government appealed against the Single Judge judgment, seeking to clarify the statutory limits of refunds under GST.

7.2 Key Questions

The Division Bench examined:

1. Whether refunds can be granted solely on business closure.
2. Applicability of pre-GST CENVAT precedents.
3. Implications of Article 265 regarding retention of ITC.

7.3 Arguments

Appellant (Revenue):

• Refund provisions are statutory and exhaustive.
• Equity cannot expand the scope of Section 54.

Assessee:

• Section 49(6) and Section 54(1) provide a basis for refund.
• Retention of ITC is inequitable.
• CENVAT precedents and international practices support refund.

7.4 Reasoning

The Division Bench rejected the Single Judge’s liberal interpretation, emphasizing:

• Refunds are statutory, not inherent.
• Section 54(3) is exhaustive, and closure is not included.
• Pre-GST CENVAT cases are not binding under the GST framework.
• Retention of ITC does not violate Article 265.
• Courts cannot legislate under the guise of equity.

7.5 Outcome

Refund on business closure was denied, and the Single Judge judgment was reversed.

8. Comparative Analysis

8.1 CENVAT vs GST

The CENVAT Credit Rules allowed more equitable interpretations, permitting refund on closure in some cases. Under GST, the law is explicit, and refund rights are confined to categories enumerated in Section 54(3). The Supreme Court in VKC Footsteps India Pvt. Ltd. - 2021 (9) TMI 626 - Supreme Court reinforced the principle of statutory exhaustiveness, limiting judicial discretion.

8.2 International Practices

In jurisdictions like the European Union, Australia, and Singapore, refunds on business closure are allowed, aligning with tax neutrality. India, however, prioritizes revenue protection over such equity principles. This divergence illustrates the policy choice underpinning the GST refund framework.

9. Constitutional & Doctrinal Insights

Refunds are statutory concessions, not fundamental rights. Courts have consistently emphasized:

• Article 265 requires taxation only under law; it does not mandate refunds unless law provides.
• Retention of unutilised ITC is lawful in the absence of statutory provision.
• Judicial restraint is required to prevent courts from assuming legislative functions

10. Practical Implications

10.1 Businesses

• Unutilised ITC on closure constitutes a sunk cost.
• Businesses must plan ITC utilization strategically before cessation.
• Transfer of business may preserve ITC rights.

10.2 Compliance & Audit

• ERP systems should track ITC balances and utilisation.
• Documentation of ITC usage or forfeiture should be transparent for audit purposes.

10.3 Policy Considerations

• Denial of refunds on closure can be viewed as a deviation from GST neutrality.
• Legislative amendments may balance fairness and revenue protection.

11. Forward-Looking Issues

• Transferability of ITC on sale or merger.
• Classification of ITC as capital or revenue expenditure for refund purposes.
• Transitional credit claims for closed businesses.
• Potential need for statutory amendment to incorporate closure-related refunds.

12. Conclusion

The judicial trajectory highlights the tension between equity and strict statutory interpretation in GST refunds. Key conclusions:

• Refunds are statutory and cannot be claimed outside the provisions of Section 54.
• Business closure is not a valid ground for refund under the current statute.
• Article 265 is not violated by retention of ITC.
• Equity cannot override explicit statutory limits.
• Businesses must plan ITC utilisation proactively.
• Legislative reform could enhance fairness and align India with international practices.