[Analysis] ITC Reversal for Time-Expired Goods under the CGST Act – Interpretations | Case Laws

What is ITC Reversal for Time-Expired Goods?

ITC Reversal for time-expired goods refers to the process where manufacturers must reverse the Input Tax Credit (ITC) claimed on goods that have expired and are no longer sellable. This typically occurs when such goods are returned by distributors or retailers and are subsequently destroyed or written off in the books of accounts. The reversal is mandated under specific tax laws (like Section 17(5)(h) of the CGST Act in India) to ensure that tax credits are only claimed for goods that are actually used in taxable sales. This prevents businesses from benefiting from tax credits on goods that do not contribute to taxable output.

Table of Contents

1. Introduction
2. Relevant Legal Provisions
3. CBIC Clarification and Contradictory Jurisprudence
4. Our Comments

1. Introduction

Across various industries such as Pharmaceuticals, Restaurants, Bakeries, and FMCG, the issue of unsold stock of expired products is a prevalent concern. Manufacturers often bear the cost of these expired goods, which are subsequently returned through the supply chain by distributors or retailers. Often, these expired goods are either destroyed or written off in the books of accounts.

This action may trigger the requirement for Input Tax Credit (ITC) reversal under Section 17(5)(h) of the CGST Act for the manufacturer. However, there exists uncertainty regarding whether ITC should be reversed on ‘inputs’ when finished products are destroyed.

This ambiguity extends to situations where time-expired goods are returned throughout the supply chain by stockists, wholesalers, or retailers to the manufacturer.

In this article, we explore the understanding of Section 17(5)(h) concerning time-expired goods, along with the ambiguities surrounding the reversal of ITC in such cases.

2. Relevant Legal Provisions

Section 17(5)(h) of the CGST Act provides that notwithstanding anything contained in Section 16(1) and Section 18(1) of the CGST Act, ITC shall not be available in respect of goods lost, stolen, destroyed, written off or disposed of by way of gift or free samples.

Accordingly, as per the above provision, ITC would be restricted concerning inputs where goods have been destroyed and written off.

2.1. Whether time expired goods fall within the scope of clause (h)?

Interpretation of the term ‘written-off’

Although the GST law does not define the term ‘written off’. As per the Merriam-Webster dictionary, write-off means an elimination of an item from the books of account. As per the Cambridge Dictionary write something off means to decide that a particular thing will not be useful, important, or successful. Hence, it covers within its scope, writing off the goods in any manner.

Interpretation of the term ‘destroyed’

The meaning of the term ‘destroyed’ is not defined under the GST law. As per the Merriam-Webster dictionary, destroyed means to ruin the structure, organic existence, or condition of. Further, as per the Cambridge Dictionary, ‘destroyed’ means to damage something so badly it cannot be used.

Therefore, considering the above interpretations, when time-expired goods are returned to the manufacturer and subsequently destroyed or scrapped, resulting in a write-off in the books of accounts, this scenario falls within the scope of the aforementioned clause.

2.2. No need for ITC reversal on ‘inputs’ where finished goods are expired

One cannot directly conclude from the GST provisions on whether ITC reversal is required even on ‘inputs’ where finished products are destroyed or written off.

Referring to the wording of clause (h), which states that

“input tax credit shall not be available ‘in respect of‘ the goods lost, stolen, destroyed, written off ….”,

it is unclear whether the expression ‘ITC in respect of goods‘ can be interpreted to restrict ITC in respect of inputs used in the finished goods.

One school of thought is that once the goods (inputs), on which credit is taken, are consumed in the manufacturing process and are converted in the final product, they lose their identity. Hence, the ITC reversal on such inputs cannot be demanded. Thus, ITC restriction does not extend to inputs contained in the finished goods after being put to use.

The above interpretation is also followed in a case before the Maharashtra AAR¹ where inputs were used in the manufacturing of finished goods which were sent out for testing and few of such finished goods got destroyed during the testing process, it was held that no ITC is required to be reversed on finished goods that are destroyed during testing. The AAR observed that inputs are actually used in the manufacture of final goods which are then sent for testing and thus, it cannot be said that the said inputs are destroyed.

Interpretation of ‘in respect of’

While analysing the term ‘in respect of’, the Hon’ble Supreme Court (‘SC’) held² that in Indian tax laws the expression ‘in respect of’ is synonymous of expression ‘on’. In this case, the assessee purchased raw tobacco and converted it by a manufacturing process into chewing tobacco. Excise duty was paid on purchase of raw tobacco. As per the applicable provisions, the turnover was determined after the deduction of excise duty paid ‘in respect of’ the good sold by him. The assessee argued that the expression ‘in respect of’ should be given a very wide connotation and the duty paid on procurement of raw material for manufacturing tobacco products should be allowed as a deduction. The Apex Court held that no deduction of excise duty is permitted to the assessee. Hence, the expression in the given case was read as excise duty paid ‘on’ goods sold and thus deduction of excise duty paid on procurement was not allowed.

In light of the above discussion, ‘in respect of’ should be interpreted as ‘on’, suggesting that the requirement of ITC reversal arises only concerning goods that are actually destroyed and written off. In other words, the provision does not mandate the reversal of ITC concerning inputs used in the manufacture of finished goods that are scrapped and destroyed.

However, despite the relevance of the above discussion, contradictory interpretations are followed in rulings and CBIC clarifications.

3. CBIC Clarification and Contradictory Jurisprudence

The CBIC has provided a contradictory clarification through a Circular³ that in the case of the pharmaceutical sector when time-expired goods, returned by the wholesaler, are destroyed by the manufacturer, the manufacturer is required to reverse the ‘ITC attributable to the manufacturer‘ of such goods in terms of Section 17(5)(h) of the CGST Act. This means reversal of ITC is required even in cases where the nature of inputs on which the ITC was claimed has changed by being converted into finished goods which are then destroyed.

The above clarification was also followed by the Gujarat AAR⁴ where perishable cakes and pastries, manufactured by the applicant, were returned after expiry and subsequently destroyed by discarding them. It was held that ITC on inputs used in manufacturing expired cakes and pastries is not admissible and required to be reversed.

Also, in another case, the Telangana AAR⁵ held that ITC is required to be reversed on raw materials purchased and used in the manufacture of finished goods which are destroyed completely in a fire accident. The AAR observed that when the taxable supplies are not made, ITC is not available under Section 17(2) and Section 17(5)(h). The AAR highlighted that this interpretation is further supported by Section 18(4) which provides for ITC reversal requirement on inputs when finished goods becomes exempt and where any ITC is already utilized, such credit needs to be paid back.

4. Our Comments

The ambiguity surrounding the requirement of ITC reversal for returned time-expired goods presents a complex scenario for manufacturers and other stakeholders in the supply chain. While Section 17(5)(h) of the CGST Act outlines the conditions under which ITC is not available, the interpretation and application of this provision remain contentious.

The CBIC through Circular⁶ provides clarification on the procedure to be followed in respect of the return of time-expired drugs or medicines. It has been clarified that where the expired drugs are being returned, the supplier can opt for either of the following two options for returning such goods:

• Issuing credit note for returning the goods
• Treating return as fresh supply

Notably, there is no confusion in the case of second option, when returns are treated as fresh supplies by the wholesaler and such goods are destroyed by manufacturers. In such case, the CBIC clarified that ITC is required to be reversed on ITC availed on the return supply and not the ITC that is attributable to the manufacture of such time-expired goods. However, in case where the expired goods are returned under the cover of credit note, the ambiguity exists on the ITC reversal of ‘inputs’ based on the above discussion.

The prevalent industry practice leans towards returning expired goods under the cover of credit notes. In such instances, arguments can be made before the authorities that there is no requirement to reverse ITC on inputs already consumed in the manufacturing process, as discussed earlier.

Despite these practices, some manufacturers are taking a conservative approach and reversing ITC on returned goods. Given the contradictory views and inconsistent practices, further clarification is needed regarding the reversal of ITC for goods under Section 17(5)(h) of the CGST Act, including scenarios where goods are disposed of by way of gifts and free samples.

1. General Manager Ordnance Factory Bhandara, In re [2019] 106 taxmann.com 246 (AAR – Maharashtra)
2. Swasthik Tobacco Factory [1966] taxmann.com 5 (SC)
3. Circular No. 72/46/2018-GST, dated 20-10-2018
4. Kanayalal Pahilajrai Balwani, In re [2021] 130 taxmann.com 209 (AAR – Gujarat)
5. Geekay Wires Ltd., In re [2023] 154 taxmann.com 384 (AAR – Telangana)
6. Circular No. 72/46/2018-GST, Dated 26-10-2018