Whether redemption of securities require reversal of ITC/Cenvat Credit?

1. Introduction

One can see a general trend of investment of surplus funds in deposits, securities, Banking products, etc. either for short period or for long period. This is because of the simple fact that keeping funds idle is not a good decision.

The GST law[1] as well as the erstwhile Cenvat Credit Rules[2] provides for the reversal of Input tax credit/Cenvat credit on the rendering of exempted services. The erstwhile Cenvat Credit Rules included the activity of trading in securities within the scope of exempted services. Further, the GST law also covers the ‘transaction in securities’ within the scope of ‘value of exempt supply’ and thus require reversal of Input tax credit.

Therefore, in general, a trader of securities would require to reverse the credit when it makes the transactions of trading in securities.

Does the question arise whether redemption of securities by investing entities also require any reversal of credit under the GST and also under the erstwhile Cenvat Credit regime?

In this article, we have discussed the above question of law in the context of the erstwhile Cenvat Credit regime as well under the GST regime.

2. Relevant Legal provisions

Under the erstwhile Service Tax regime (read with Cenvat Credit Rules), the definition of goods included securities within its scope and the activity of ‘trading of goods’ was covered within the Negative list of services[3]. The definition of exempted services was defined to include transactions that are covered within the Negative list of services. Therefore, trading in securities being trading in goods were treated as exempted services for reversal of Cenvat Credit.

Under the GST regime, the definition of goods and services has been defined to exclude ‘securities’ from its scope, therefore, for the sale of securities, no GST would apply. Further, Input tax credit reversal provisions[4] provide that the value of exempt supply shall include ‘transaction in securities’ within its scope. Further, the explanation to Rule 45 of the CGST Rules provides that for determining the value of exempt supply the value of security shall be taken as 1% of the ‘sale’ value of such security.

3. Our Comments – Cenvat Credit Regime

We may note that the activity of trading is not equivalent to the activity of investment. Under the erstwhile regime of Cenvat credit ‘trading of securities’ was covered within the meaning of exempted services. Thus, if a person invests in security then there is no reversal of Cenvat Credit was required.

In this regard, reference can be taken from the judgment[5] of Hon’ble Bangalore Tribunal, where the appellant was a service provider of Commercial Training and Coaching services and invested in the securities and returned the security units to the issuer of such securities on the maturity.

The Department considered the investment in securities as trading in securities and presumed that investment in securities is exempted service provided by the appellant and thus appellant is required to pay for exempted supplies as per the CENVAT credit Rules.

The Bench held that ‘trading’ means an activity where a person is engaged in selling the goods and occupy to make a profit but certainly trading is different from the redemption of securities. The intention or objective of purchasing such securities is considered as an important element to decide whether such purchase is an investment or trading of securities.

In trading activity, there is a relationship of ‘buyer’ and ‘seller’ while in investing activity there is the relationship of ‘investor’ and ‘investee’. Thus, determining whether the transaction is an investment or trading activity becomes vital for the reversal of Cenvat Credit.

In another case,[6] the same bench of the Hon’ble Tribunal has taken a similar view and also referred to the treatment of the transaction under the Income-tax laws.

4. Our Comments – GST regime

The GST provisions[7] provide that the value of exempt supplies includes the value of the transaction in securities within its scope. Here the question arises that whether the activity of redemption of securities would cover within the expression ‘transaction in securities’?

In this regard, we may note that the expression ‘transaction in securities’ has not been defined under the GST laws. Thus department may take a wider interpretation to say that the activity of redemption of securities would include within the scope of transaction in securities and, therefore, it would require reversal of input tax credits.

However, in our view, the activity of redemption of securities is an investment in securities where the purchaser has purchased such securities with the intent to invest in them. This is because of the following reasons:

• • Redemption of the principal amount is nothing but a transaction in money
  • The expression transaction in security should be read in conjunction with the value of exempt ‘supply’ as mentioned in Section 17(2). One should not read this phrase independently. There needs to be a consideration between two persons. The relationship between such two persons must be of ‘supplier’ and ‘recipient’ and not of ‘investor’ and ‘investee’
  • The intention of lawmaker can also be referred from the CGST Rules where the reversal is required only for the ‘sale’ of securities

Given the above, in our considered view, the redemption of securities would not invite any reversal of input tax credit.

5. Conclusion

Though we have seen few favourable orders under the erstwhile regime of Cenvat Credit. However, under the GST regime apart from qualifying the test that the transaction is investing in nature, the taxpayers would also require to satisfy the authorities that the intent of expression ‘transaction in securities’ does not include investing activities. In our view, the investing activity would not require any reversals but authorities would take a wider view and demand reversal of common input tax credits.

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[1] Section 17(2) of the CGST Act, 2017

[2] Rule 6 of CENVAT Credit Rules-2004

[3] Section 66D of the Finance Act, 1994

[4] Section 17(2) of the CGST Act, 2017

[5] [2021] 126 taxmann.com 215 (Bangalore – CESTAT)[15-04-2021]

[6] Space Matrix Design Consultants Pvt. Ltd.vs Commissioner of Central Tax (Order No. 20363/2019)

[7] Section 17(2) of the CGST Act 2017