Resolving distortions of the inverted duty structure: Disconnect between the legal and economic perspectives

Partner: Himanshu Sinha, Senior Associate: Tushar Joshi, Associate: Samyak Jain. A version of this article was first published by the International Bar Association. You can read the original here.

Introduction

VAT on goods and services regimes across the globe envisage the full credit of tax paid on underlying inputs, such as goods and services, for the payment of outward tax applicable to the principal transaction. This is to ensure that there is no cascading effect of tax, that is, ‘tax-on-a-tax’, after every stage in the supply chain.

However, an anomaly arises in the inverted duty structure, where the rate of tax on inputs is higher than the rate of applicable tax on the outward supply. In such cases, taxpayers are left with an ever-increasing pool of unutilised credit that is not utilised for the payment of output tax.

Because credit accumulation on account of unutilised input tax credit (ITC) can result in higher tax costs to businesses and/or a rise in the hidden tax cost for consumers, governments have sought to address this issue in different ways.

Position across the globe

The position of law, in general, across developed economies is that the unutilised credit of tax paid on inputs is to be either carried forward for a prescribed period and/or refunded if enough output tax is not present to absorb the input tax credit.

In the European Union, the VAT Directive prescribes that, in the case of excess input tax deductions ie, credit), Member States may either refund the said deductions or carry them forward to the next period for utilisation in the future. It further provides that such a refund or carry forward may not be allowed if the amount of excess deductions is insignificant.

In France, VAT credit is carried forward as a rule. However, the refund of unutilised credit can also be claimed subject to the fulfilment of certain monetary thresholds. The refund can be claimed on a monthly, quarterly or half-yearly basis. Separately, the refund of a certain minimum amount can be claimed at the end of each calendar year. By contrast, in Germany, there is no provision for carrying forward credit, and an application for a refund is required to be filed in the form and manner prescribed under local regulations. Similarly, in the United Kingdom, if any credit of a taxpayer remains unutilised in an accounting period, it becomes refundable to the taxpayer. In Japan, enterprises are required to pay consumption tax on taxable sales. If the amount of consumption tax on purchases to be deducted is more than the amount of consumption tax payable on the taxable sales made by the taxpayer, a refund of the difference can be claimed in the tax return. In New Zealand, the relevant tax authority may set off the unutilised deduction of excess input tax against the taxpayer’s liability under other statutes.

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