Services on capital account whether input services or capital goods

[Sanjay Kumar]

Under the GST Act, 'services' have been defined as anything other than 'goods.' Further, 'capital goods' are defined as goods the value of which is capitalized in the books of accounts and which are used or intended to be used in the course or furtherance of business.

In many instances, businesses procure certain services—such as architectural fees, design and engineering services, license fees, etc.—which are directly attributable to the creation or installation of plant and machinery. These service-related costs are often capitalized along with the value of the plant and machinery in the books of accounts.

The issue arises regarding the treatment of such capitalized services for the purpose of Input Tax Credit (ITC) availment or reversal. Specifically:

1. Whether such services, though capitalized as part of plant and machinery, should be treated as 'input services' or as 'capital goods' under the GST framework; and
2. Accordingly, whether ITC on such services should be subject to reversal under Rule 42 (applicable to input and input services) or under Rule 43 (applicable to capital goods).

Additionally, Para 6(a) of Schedule II to the CGST Act deems works contracts as a supply of services. In cases where a Lump Sum Turnkey (LSTK) contract is awarded—for example, for the construction of a large industrial plant—the entire scope of the contract (inclusive of both goods and services) is considered as a works contract service.

In such cases, the entire value of the LSTK contract is capitalized as part of the plant and machinery. The clarification sought is:

3. Whether ITC on such LSTK contracts, being deemed as works contract services and capitalized in the books, should be treated as input services or capital goods for the purpose of ITC availment and reversal under Rules 42 and 43 of the CGST Rules.

[Shilpi Jain]

This is a question like plant AND machinery and plant OR machinery u/s 17(5) (as brought out during Safari Rretreats case) which will have to get answered by the Courts.

The answer to this can go either way.

Though, the consideration of this either way may not have huge ramifications. Since reversals are required under both the rules on similar considerations (i.e. revenue) but surely there would be a difference.

If some business has a huge ramification and requires an answer to this, could consider making a representation to the GST Council to seek a clarification, which may or may not be as per legal interpretation, but would at least give some clarity to businesses and save from department dispute to some extent.

Though this view is surely an argument to come up in future in the Courts.

[YAGAY andSUN]

Classification of Capitalized Services and Works Contract Services for Input Tax Credit (ITC) Reversal under GST Rules

Background:

Under the GST regime, the definition of "services" is provided residually as "anything other than goods." On the other hand, "capital goods" are defined under the CGST Act as goods whose value is capitalized in the books of account and which are used or intended to be used in the course or furtherance of business.

In practice, businesses often incur certain service-related expenses—such as architectural fees, design and engineering consultancy, license fees, etc.—which are directly attributable to the creation or installation of plant and machinery. These service expenses are frequently capitalized along with the plant and machinery in the financial books.

This raises the issue of whether such capitalized services should be treated as 'input services' or as 'capital goods' under GST, and consequently, whether the reversal of ITC should be undertaken in accordance with Rule 42 (which governs inputs and input services) or Rule 43 (which applies to capital goods).

Further, in the case of Lump Sum Turnkey (LSTK) contracts—where the entire supply, including goods and services for the construction of an industrial plant, is treated as a works contract service under Schedule II, Para 6(a) of the CGST Act—the total cost is capitalized as part of plant and machinery. This brings forth a related question as to the classification of ITC on such LSTK contracts for reversal purposes under Rules 42 and 43.

Analysis:

1. Capitalized Services: Input Services vs Capital Goods

As per the statutory definition, only "goods" can qualify as "capital goods." Even if a service is capitalized for accounting purposes, it does not alter its fundamental character as a "service" under the GST law. Capitalization in the books of accounts may be relevant for accounting and depreciation, but it does not convert the nature of a service into that of a good.

Hence, services such as architectural, design, engineering, and license fees, even if capitalized as part of plant and machinery, continue to retain their character as "input services" under the GST framework.

Conclusion: Such capitalized services are to be treated as "input services" and not as "capital goods." Accordingly, any ITC availed thereon is to be addressed under Rule 42, not Rule 43.

2. LSTK Contracts and Works Contract Services

As per Schedule II, Para 6(a) of the CGST Act, a works contract relating to immovable property is deemed to be a supply of services. Most LSTK contracts for construction and commissioning of large industrial projects fall within this scope and are treated as composite works contract services.

Even if the value of the LSTK contract is capitalized as plant and machinery in the books, the supply remains a "service" under the GST law. Accordingly, the ITC on such works contract services, if eligible (subject to Section 17(5)), would be classified as ITC on input services.

Conclusion: For the purpose of reversal, such ITC would also fall under Rule 42, not Rule 43.

However, it must be noted that if the plant being constructed qualifies as immovable property (e.g., buildings or structures), then ITC on the works contract may be restricted under Section 17(5)(c) unless used for further supply of works contract service.

3. Relevance of Safari Retreats Case

The Safari Retreats case (Orissa High Court) highlighted the ambiguity regarding the phrase “plant and machinery” in the context of immovable property. While the Court adopted a liberal interpretation, allowing ITC on construction of a mall (which was to be let out), this judgment is currently under challenge and does not represent settled law.

This illustrates that the distinction between “plant and machinery” and “immovable property” remains a subject of judicial interpretation and may be argued differently depending on the facts of the case.

Implications:

While the end result under Rules 42 and 43 (reversal based on taxable vs exempt turnover) may appear broadly similar, the classification has implications for:

• Timing of reversal
• Methodology of calculation
• Annual compliance (such as GSTR-9 and GSTR-9C)
• Potential disputes with GST authorities

Given the ambiguity and possible revenue implications, businesses facing significant ITC exposures on such capitalized services or LSTK contracts may consider making a formal representation to the GST Council or CBIC, seeking clarification or issuance of a circular. This would provide administrative certainty, even if the legal position remains open to interpretation.

Summary Table:

Item	Classification under GST	Rule for ITC Reversal
Capitalized services (e.g., architectural fees)	Input Services	Rule 42
LSTK contract (works contract services)	Input Service	Rule 42 (subject to s.17(5))
Capital goods (goods capitalized and used in business)	Capital Goods	Rule 43

Recommendation:

Where substantial ITC is involved or the nature of the asset (immovable vs movable) is ambiguous, businesses should:

• Seek a legal opinion based on contract structure and asset type.
• Maintain clear documentation on capitalization treatment.
• Consider a representation to the GST Council for clarification.

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AI Summary

Services Capitalized in Plant and Machinery Classified as Input Services Under GST Rule 42 for ITC Reversal A discussion forum explores the classification of capitalized services and works contract services under GST regulations. The key issue involves determining whether services capitalized in plant and machinery should be treated as input services or capital goods for Input Tax Credit (ITC) reversal purposes. Participants analyze statutory definitions, highlighting that capitalized services remain 'input services' subject to Rule 42, not Rule 43, despite being recorded in capital accounts. Recommendations include seeking legal opinions and potential representations to the GST Council for clarity.