The Constitutionality of Section 140(3)(iv) of the CGST Act: A Critical Analysis

This article analyzes the constitutional validity of Section 140(3)(iv) of the CGST Act, 2017, which imposes a 12-month age restriction on invoices for claiming transitional input tax credit. It argues that this restriction, as applied to first-stage dealers, is manifestly arbitrary and violates Article 14 of the Constitution. The provision retrospectively extinguishes a dealers ability to pass on credit, a function that was never time-barred under the CENVAT regime. This analysis contrasts the conflicting judgments of the Gujarat High Court in Filco Trade Centre and the Bombay High Court in JCB India Ltd., concluding that the JCB ruling misapplied the CENVAT rules and that the credit, for a first stage dealer, was not a ‘concession’ but a fundamental part of the tax-pass-through mechanism.

INTRODUCTION

GST aims to bring various taxes together into a single system, making it necessary to have proper transitional provisions. These provisions ensure a smooth and trouble-free shift to the GST regime and prevent the loss of any credit earned under the previous indirect tax framework. For this GST incorporates Section 140, which is a transitional provision, to ensure transition of credit in erstwhile indirect tax laws to the goods and service tax regime. These provisions address the treatment of pre-GST stock, carryover of Input Tax Credit (ITC) from the previous regime, and other related concerns arising from the change in tax structure. The aim was to ensure seamless migration from pervious indirect tax regime into the GST regime.

Objectives:

• Prevent double taxation: The primary objective of transitional provisions is to prevent businesses from paying tax twice on the same goods or services, once under the old regime and again under GST.
• Protecting accumulated credit: Transitional provisions enable taxpayers to carry forward eligible ITC accumulated under the previous tax systems to the GST regime, ensuring they do not lose out on valuable tax benefits.

Section 140(3)(iv) of the CGST Act imposes a 12-month restriction on invoice-age for transitional ITC for dealers and other specified classes. This restriction, which never existed under the earlier CENVAT (Central Value Added Tax) regime for dealers, retrospectively extinguishes credit in respect of stock held as on 1.7.2017. The issue is whether such a restriction is constitutional.

A CONFLICT IN HIGH COURTS

The dispute stem from two conflicting judgments from different high court. The High Court of Gujarat in the case of FILCO TRADE CENTRE PVT. LTD. Versus UNION OF INDIA - 2018 (9) TMI 885 - GUJARAT HIGH COURT, held that Section 140(3)(iv) of the CGST Act, which imposed a 12-month invoice-age restriction for claiming transitional ITC, was unconstitutional as applied to first-stage dealers. The High Court held that dealers historically had no such time limit for credit passthrough, and that the 12-month condition retrospectively extinguished their vested entitlement to migrate excise duty embedded in stock, lacking any rational nexus and violating Article 14. This judgment was appealed to the Supreme Court, which granted a stay on the Gujarat High Court’s ruling and kept all related questions of law under Section 140 of the CGST Act open for consideration. While the other judgment was delivered by the Bombay High Court in the case of JCB India Limited, Suyaan Infrastructure Pvt. Ltd., Siddharth Auto Engineers Pvt. Ltd. And Ratnapprabbha Motors Versus Union of India, The Goods and Service Tax Council, The Commissioner Central Tax GST Nasik, The Commissioner Central Tax GST, Pune And Central Board of Excise and Customs - 2018 (4) TMI 585 - BOMBAY HIGH COURT, where the court upholds the constitutionality of section 140(3)(iv). Reliance was places upon CENVAT Rules 2004. A portion from the judgment is produced below:

“From the CENVAT Credit Rules, 2004 it is evident that the fifth proviso to sub-­rule (7) of Rule 4 would indicate that availment of CENVAT credit is conditional upon the satisfaction of all the provisos. Thus, there is a period stipulated for availment of this CENVAT credit. In addition, thereto, there are conditions imposed for the availment. To our mind, therefore, the learned Additional Solicitor General is right in his contention that a CENVAT credit is a mere concession and it cannot be claimed as a matter of right.”

It is relevant to note that a Special Leave Petition has been filed against the judgment of the Bombay High Court in JCB India Ltd. v. Union of India, and the issue is presently pending before the Supreme Court. The judgments in Filco Trade Centre and JCB India are both under challenge. The Supreme Court has not yet decided upon the constitutional validity of Section 140(3)(iv) of the CGST Act and has kept the questions of law open. As the matters stands, the conflict between the High Courts remains unresolved.

AN ANALYSIS

The Bombay High Court in JCB relied heavily on the fifth proviso to Rule 4(7) of the CENVAT Credit Rules (a time-limit applicable to manufacturers/service providers), concluding that CENVAT credit was merely a concession and conditions on the use of the same can be imposed.

The CENVAT Rule 4, Sub-rule 7, Proviso 5 is produced below:

“[Provided also that the manufacturer or the provider of output service shall not take CENVAT credit after [one year] of the date of issue of any of the documents specified in sub-rule (1) of rule 9 [, except in case of services provided by Government, local authority or any other person, by way of assignment of right to use any natural resource] read with section 174.”

The said proviso inserts a 12-month bar on the invoice for the purpose of credit availment. But that proviso did not apply to first-stage dealers in the way JCB assumed. Rule 4(7)s one-year rule addresses fresh availment only by manufacturers or service providers. Importing a manufacturer-type limit into the dealer class ignores the clear and factual distinction between the two. The two classes were treated differently pre-GST and must be treated accordingly. For first-stage dealers, no such time limit existed under the old regime.

Manufacturers had a 12-month bar because they themselves availed and consumed credit, needing discipline. Under Rule 9 of the CENVAT Credit Rules and RG-23D registers, first stage dealer’s obligation was to record, preserve, and pass on the duty element correctly when selling to the next buyer. They weren’t consuming the inputs themselves, but enabling credit flow downstream because their role was mechanical, there was no policy reason to time-bar them from passing credit. Extending the manufacturer’s restriction to dealers under Section 140(3)(iv) was new, retrospective and arbitrary.

Prior to the introduction of GST, the first stage dealers could hold excise-paid stock indefinitely and, upon sale, seamlessly pass forward the duty element through their invoices, enabling buyers to avail CENVAT credit without regard to the age of the stock. Even goods purchased more than twelve months earlier retained full creditability, and there was no risk of cascading. However, after 1 July 2017, clause (iv) of Section 140(3) retrospectively disrupts this flow by declaring that only invoices not older than twelve months may be transitioned. This cut-off renders the excise already embedded in older stock ineligible for credit, so that when the dealer sells such stock under GST, the buyer must pay GST on a value that still carries stranded excise. The buyer thereby suffers double taxation, and the dealer is compelled to discount or absorb the burden to remain competitive. Transitional credit is therefore not a windfall but a necessary safeguard to preserve the value of pre-GST stock and prevent cascading of taxes.

The rational-nexus test requires the impugned condition to bear a reasonable relation to the legislative objective. The Gujarat High Court, in Filco, found no plausible connection between the 12-month bar and the stated objectives (identification of goods, administrative convenience, anti-abuse). The very same objectives existed under the old CENVAT rules without any time limit for dealers.

The 12-month restriction on invoices lies in Rule 4(7), fifth proviso of the CENVAT Credit Rules, which applied only to manufacturers and service providers. For them, credit was availed to set off their own duty liability, and it was a legitimate policy choice to insist that such availment be time-bound so that credits were taken contemporaneously and revenue accounts remained current. Dealers, however, stood on an entirely different footing: they were never availing credit for their own use but merely passing forward the duty component through invoices and RG-23D records. Since their function was documentary, there was no danger of indefinite availment or revenue leakage, and accordingly no time-bar was ever prescribed for them under the earlier law. By importing a 12-month restriction into Section 140(3)(iv), Parliament transplants a rationale that had no historical or functional application to the first stage dealers, thereby retrospectively depriving them of the ability to migrate credit and rendering the clause manifestly arbitrary. If no such conditions existed under the previous law for availing that right, then adding an arbitrary and unreasonable condition in the current regime would render the provision unconstitutional under Articles 14 and 19(1)(g).

A VESTED RIGHT OR A MERE CONCESSION

A long-standing issue has been whether CENVAT credit is a vested right or a mere concession. This distinction is important because if its just a concession, the government can place restrictions on it such as the 12-month invoice restriction under Section 140(3)(iv). But if its a vested right, it can be claimed as a matter of right, without such restrictions.

Across both the former indirect tax framework and the current GST regime, courts have taken two views. Some judicial pronouncements refer to Credit as a “mere concession”, particularly when addressing the failure to meet statutory preconditions. But this view cannot apply to credit that has been duly earned. After the taxpayer satisfies all mandatory conditions, the entitlement becomes complete and turns into an indefeasible vested right. This accumulated credit is treated as “property,” which brings it under the constitutional protection of Article 300A. This view can be supported through various High Court judgments in cases such as M/s. Aadinath Industries & Anr. Versus Union Of India & Ors. - 2019 (10) TMI 91 - DELHI HIGH COURT, M/s SIDDHARTH ENTERPRISES THROUGH PARTNER MAHESH LILADHAR TIBDEWAL Versus THE NODAL OFFICER - 2019 (9) TMI 319 - GUJARAT HIGH COURTand Brand Equity Treaties Limited, Micromax Informatics Ltd., Developer Group India Private Limited, Reliance Elektrik Works Versus The Union of India And Ors. - 2020 (5) TMI 171 - DELHI HIGH COURT (though the Supreme Court has stayed the order, and the matter is still pending).The Supreme Court had already established this vital distinction in the pre-GST era. It held that CENVAT credit, once accrued, cannot be arbitrarily extinguished by subsequent rules in EICHER MOTORS LTD. Versus UNION OF INDIA - 1999 (1) TMI 34 - Supreme CourtandCOLLECTOR OF CENTRAL EXCISE, PUNE Versus DAI ICHI KARKARIA LTD. - 1999 (8) TMI 920 - Supreme Court (LB). Therefore, the transitional credit covered by Section 140, being the balance of credit already vested under the prior law, is a substantive right. It cannot be defeated by merely procedural restrictions.

CONCLUSION

The legislative intent behind Section 140 was to ensure a smooth transition of credits to prevent double taxation. However, Section 140(3)(iv) achieves the opposite for first-stage dealers. By inserting a 12-month restriction, one that was applied only to manufacturers under the erstwhile laws, onto dealers, the provision retrospectively extinguishes the right of credit on the legitimate, duty-paid stock.

The Bombay High Courts judgment in JCB is based on a flawed premise. The court misapplied the CENVAT rules that were only in relation of manufacturer and were never intended for dealers. The Gujarat High Court’s reasoning in Filco Trade Centre, which struck down the provision as arbitrary and contrary to Article 14, fits better with both the historical background and the realities of how the supply chain works.

While the Supreme Court has not yet decided whether CENVAT credit is a vested right or only a concession, the specific case of first-stage dealers presents clear arbitrary state action. A right that was unconditionally available to them under the previous regime has been extinguished without a rational nexus to the objective of the law. As the issue remains pending before the Supreme Court, a large number of taxpayers are left in uncertainty, disadvantaged by a transitional provision that failed to transition their credit.