This is a neutral professional article. The judgment is analysed in the context of its factual background, issues framed, and conclusions reached by the Court.

2026 (7) TMI 220 - MADRAS HIGH COURT

At a Glance

• Renting of immovable property is treated as a supply of services under Schedule II. That characterisation does not, by itself, make construction-related input tax credit available.
• The general entitlement in Section 16 is expressly subject to statutory restrictions. The central restriction for property developers and lessors is contained in Section 17(5)(c) and (d).
• Section 17(5)(c) blocks credit on works contract services used for construction of immovable property, except where the service is an input service for further supply of works contract service. Section 17(5)(d) separately blocks credit on goods or services received for construction of immovable property on the taxpayer's own account, even where used in the course or furtherance of business.
• The decision reported as 2026 (7) TMI 220 - MADRAS HIGH COURT holds, on its facts, that a taxpayer engaged in renting and leasing could not claim construction-related credit merely because rental receipts were taxable. The Court also sustained invocation of the fraud-and-suppression demand provision.
• The distinction between a building constituting ordinary immovable property and a building that may satisfy the functionality test as a "plant" was recognised in 2024 (10) TMI 286 - Supreme Court. The inquiry is fact-specific and cannot be presumed from the fact that a building is commercially let out.

Background & Context

The dispute arose from availment of input tax credit on construction-related inputs, capital goods and services by a taxpayer whose outward activity was renting and leasing of immovable property. The credit covered, among other things, construction materials, sanitary and plumbing materials, electrical goods, architecture, landscaping, construction and labour services, works contract services, and related expenditure.

The taxpayer had initially refrained from taking credit because of the restrictions in Section 17(5)(c) and (d). It subsequently claimed credit after a High Court decision had read down Section 17(5)(d) in the context of property constructed for letting out. That earlier approach treated a continuing stream of taxable rent as preserving the tax chain and therefore as warranting credit.

The Court rejected the taxpayer's challenge to the demand. It held that the subsequent availment was contrary to the statutory restrictions and was also beyond the applicable time limit under Section 16. The Court further held that a unilateral communication seeking departmental approval, which was never approved or answered, could not create a bona fide basis for availment of blocked credit or defeat proceedings under Section 74.

The decision is significant because it separates two propositions that are often conflated: first, renting is a taxable supply of services; secondly, the construction-stage inward supplies satisfy the independent conditions for credit. Under the CGST framework, the former does not neutralise a specific blocked-credit provision.

Key Issues / Provisions

Renting and works contract as supplies of services

Schedule II, paragraph 5(a), provides that "renting of immovable property" shall be treated as a supply of services. Paragraph 6(a) likewise treats a "works contract as defined in clause (119) of section 2" as a composite supply of services.

The relevant definition in Section 2(119) describes a works contract as a contract for building, construction, fabrication, completion, erection, installation, fitting out, improvement, modification, repair, maintenance, renovation, alteration or commissioning of immovable property where transfer of property in goods is involved in execution of the contract. This definition is material because Section 17(5)(c) specifically addresses works contract services.

General entitlement and time limit

Section 16(1) confers entitlement to credit of input tax charged on supplies used or intended to be used "in the course or furtherance of" business, subject to prescribed conditions and restrictions. This opening entitlement is not absolute. Section 16(2) additionally requires, among other conditions, possession of the prescribed tax document, receipt of goods or services, payment of tax to the Government in the prescribed manner, and furnishing of the return.

Section 16(4) states that credit on an invoice or debit note cannot be taken after the thirtieth day of November following the end of the relevant financial year or furnishing of the relevant annual return, whichever is earlier. The statutory text also contains specific provisions for identified earlier financial years. For the dispute decided in 2026 (7) TMI 220 - MADRAS HIGH COURT, the Court held that the credit had not been availed within the applicable Section 16 time limit. That conclusion governs the case decided.

Blocked credits for construction of immovable property

Section 17(5) begins with a non-obstante clause: "Notwithstanding anything contained in sub-section (1) of section 16 and sub-section (1) of section 18, input tax credit shall not be available" in respect of the specified categories. Thus, even a business nexus under Section 16(1) cannot prevail over a credit block within Section 17(5).

Section 17(5)(c) blocks credit on "works contract services when supplied for construction of an immovable property" other than plant and machinery. The express exception is where the works contract service is an input service for further supply of works contract service. A person supplying renting services is not, merely because of that outward supply, within this further-supply exception.

Section 17(5)(d) blocks credit on "goods or services or both received by a taxable person for construction of an immovable property" other than plant and machinery "on his own account including when such goods or services or both are used in the course or furtherance of business." The words "including when" are consequential: commercial use, including use for an outward rental business, does not on its own remove the bar.

Explanation 1 to Section 17(5)(c) and (d) provides that "construction" includes reconstruction, renovation, additions, alterations or repairs, to the extent capitalised to the immovable property. The Explanation to Section 17 defines "plant and machinery" as apparatus, equipment and machinery fixed to earth by foundation or structural support and used for making outward supplies; it includes the relevant foundations and structural supports, but excludes land, building or other civil structures, telecommunication towers and pipelines laid outside factory premises.

The supplied statutory text also contains Explanation 2 to Section 17(5)(d), which clarifies that, notwithstanding anything contrary in any judgment, decree or order, a reference to "plant or machinery" in clause (d) shall be construed, and shall always be deemed to have been construed, as a reference to "plant and machinery." The precise consequence of this text for a particular credit period must be assessed against the statutory provisions applicable to that period and the facts of the claim.

Detailed Analysis

Taxable rent does not displace the construction credit block

The Court in 2026 (7) TMI 220 - MADRAS HIGH COURT treated the statutory embargo as decisive. The taxpayer's business of renting and leasing did not alter the character of inward construction-related goods and services as supplies used for construction of immovable property on its own account. The Court therefore held that the credit was impermissible under Section 17(5)(c) and (d).

This approach follows the statutory sequence. Section 16 determines whether there is a general business-related entitlement. Section 17 then limits that entitlement. Where inward supplies fall within either clause (c) or clause (d), the fact that the completed property is deployed in earning taxable rent is insufficient, without more, to establish credit eligibility.

The functionality inquiry under the Supreme Court decision

2024 (10) TMI 286 - Supreme Court is central to the meaning of the earlier expression "plant or machinery" in Section 17(5)(d). The Court held that this expression could not automatically be equated with the defined phrase "plant and machinery" appearing in the Explanation to Section 17. The disjunctive wording had to be given effect and could not be judicially rewritten.

The Court upheld the constitutional validity of Section 17(5)(c), Section 17(5)(d) and Section 16(4), emphasising that input tax credit is a statutory entitlement and that the legislature may prescribe exceptions to it. At the same time, it held that a mall, warehouse or other building may, in an appropriate factual case, qualify as a "plant" for the earlier wording of Section 17(5)(d). The test is functional: whether, considering the registered person's business and the role performed by the building, construction of that building was essential to carrying out the taxable activity. The Court remitted the factual determination rather than treating commercial use or rental use as conclusive.

The primary decision does not treat every rented building as a plant. On the facts before it, the Court found the construction credit to be blocked and held that the earlier High Court basis on which the credit was claimed had been removed by the Supreme Court ruling. Accordingly, a functionality-based contention requires clear, contemporaneous material demonstrating the building's operative and essential role in the particular business; it cannot rest solely on the existence of taxable rental income.

Earlier letting-out view and its reversal

2019 (5) TMI 1278 - ORISSA HIGH COURT had read down Section 17(5)(d) to permit credit for construction of property intended for letting out where the tax chain was said to remain unbroken. Its reasoning focused on avoidance of cascading and the taxable nature of rental receipts. That view explains why taxpayers engaged in leasing may have considered construction credit to be available.

However, 2024 (10) TMI 286 - Supreme Court set aside the reading down of Section 17(5)(d). The constitutional challenge to the blocked-credit provisions failed. The relevant inquiry, under the statutory wording examined by the Supreme Court, was not whether rent was taxable but whether the property could factually be characterised as a plant by applying the functionality test. The primary decision applies this later position and does not preserve the earlier letting-out rationale as an independent ground for credit.

Foundation and structural-support exception

2025 (8) TMI 551 - APPELLATE AUTHORITY FOR ADVANCE RULING, GUJARAT concerned a concrete structure supporting manufacturing equipment. The authority held that the structure was an essential foundation and structural support for plant and machinery and therefore fell within the statutory Explanation. Credit on inputs and input services used for its construction was held available.

That ruling is factually distinct from construction of premises for renting. Its relevance lies in the analytical distinction it draws between an ordinary civil structure and a foundation or structural support that is integral to identified plant and machinery used for outward supplies. A lessor seeking to rely on this exception must establish that the claimed expenditure relates to the qualifying foundation or support, rather than to the building as such.

Pre-GST CENVAT authorities: contextual but not determinative

2018 (9) TMI 1135 - MADRAS HIGH COURT accepted CENVAT credit on construction services used to provide renting of immovable property services. It proceeded on the earlier CENVAT input-service definition and the nexus between construction and the output renting service. The ruling demonstrates the different statutory design of the pre-GST regime; it does not override the non-obstante block in Section 17(5).

Similarly, 2022 (12) TMI 472 - KARNATAKA HIGH COURT upheld CENVAT credit on construction-related inputs and input services used for a renting business. Its rationale was that the constructed building was used in the business of providing the output service. Under GST, that broad nexus reasoning must yield where the express conditions of Section 17(5)(c) or (d) are attracted.

2022 (12) TMI 139 - PUNJAB AND HARYANA HIGH COURT likewise addressed the former CENVAT definition of "input service", including its setting-up limb, and held that a later exclusion was not retrospective for the period in issue. It is useful for understanding the earlier credit position, but it cannot determine eligibility under the CGST Act's separately worded blocked-credit provisions.

Demand, interest and penalty exposure

Section 74(1) authorises a notice where input tax credit has been wrongly availed or utilised "by reason of fraud, or any wilful-misstatement or suppression of facts to evade tax." The notice must require the taxpayer to show cause against tax, interest under Section 50 and penalty equivalent to the tax stated in the notice. Section 74(10) prescribes a five-year period for issuance of the adjudication order, calculated from the due date of the annual return for the relevant financial year or from the date of erroneous refund, as applicable.

In the primary decision, the taxpayer relied on a previous communication to the department. The Court held that an unresponded request for approval, made outside the GST return mechanism, was not departmental concurrence. It also considered the wider actual availment, compared with the proposed credit stated in that communication, while holding that a case for the extended period had been made out. The decision underlines that disclosure arguments depend on the nature, completeness and statutory mode of disclosure, not merely on the existence of correspondence.

Section 50(3) provides that where credit has been wrongly availed and utilised, interest is payable on the wrongly availed and utilised credit at a rate not exceeding twenty-four per cent, in the prescribed manner. Further, Section 122(2)(b) prescribes, where the wrong availment or utilisation is by reason of fraud, wilful misstatement or suppression of facts to evade tax, a penalty equal to ten thousand rupees or the tax due, whichever is higher. Section 74 also contains statutory closure mechanisms on payment within the periods specified in sub-sections (5), (8) and (11).

Practical Implications

• Credit reviews for rented commercial property should separately identify works contract services, materials, capitalised repair expenditure, movable equipment, and foundations or structural supports. A single project-level conclusion is unlikely to be reliable.
• The claim should first be tested under Section 16, including the relevant time limit and documentary conditions. It should then be tested independently against both Section 17(5)(c) and Section 17(5)(d).
• The fact that rental income is taxable, and that construction was commercially necessary to generate that income, does not itself satisfy either the works-contract exception or the plant-and-machinery exception.
• Where a plant or structural-support argument is available, records should address functional necessity, technical design, identified machinery, the connection between the structure and that machinery, capitalisation treatment, and the nature of outward supplies.
• Representations or letters to the department should not be treated as approval unless an express statutory approval or determination has actually been issued. Return disclosures and reconciliations should accurately identify ineligible credit and reversals.
• In a Section 74 dispute, the defence must separately address substantive eligibility, timing under Section 16, the statutory basis for alleging fraud, wilful misstatement or suppression, utilisation of credit for interest purposes, and the consequences of any reversal or payment.

Key Takeaways

• Renting of immovable property is a supply of services, but taxable outward rent does not automatically permit credit on construction of the rented property.
• Section 17(5)(c) and (d) are specific overrides of the general business-use entitlement in Section 16(1).
• The historical read-down that allowed credit merely because property was let out has been set aside. The Supreme Court's functionality analysis does not create a blanket rental-property exception.
• A claim based on plant, plant and machinery, or qualifying foundation and structural support is necessarily evidence-driven and fact-specific.
• Belated availment and incomplete statutory disclosure can compound substantive credit disputes by exposing the taxpayer to proceedings under Section 74, interest under Section 50(3), and penalty consequences.

Full Text:

2026 (7) TMI 220 - MADRAS HIGH COURT