GST Shake-Up Leaves Auto Dealers Stranded With Dead Credits

A major restructuring of the Goods and Services Tax, announced at the 56th GST Council meeting on September 3, has left automobile dealers across India in a precarious position. The Council's decision to abolish the compensation cess on cars could result in a collective loss of approximately ₹25 billion in unusable tax credits, according to the Federation of Automobile Dealers Associations.

The compensation cess was originally introduced under the GST regime through the GST (Compensation to States) Act, 2017 to compensate states for potential revenue losses. Automobile dealers paid this cess when procuring vehicles and would later offset this amount against the cess collected on retail sales.

However, with the new GST structure coming into effect on September 22, the compensation cess will no longer be levied. This leaves dealers with a significant amount of accumulated input tax credit of compensation cess they have already paid on their existing inventory. Under current rules, this credit has nowhere to go, which leaves a severe dent in the working-capital position of automobile dealers across India.

The primary obstacle is a specific provision in the GST (Compensation to States) Act, 2017—specifically, the proviso to Section 11(2)—which explicitly ring-fences these credits. The rule states that ITC from the compensation cess can only be used to pay for the compensation cess liability on the sale of goods. With this liability on output disappearing, the accumulated ITC effectively becomes stranded, impacting dealers' working capital and raising concerns about the fairness of the GST framework.

The government has so far offered little reassurance. Central Board of Indirect Taxes and Customs Chairman Sanjay Kumar Agarwal has clarified the government's stance, stating, "As far as the stocks as on September 22, in cases like automobiles, if compensation cess is paid and input tax credit is taken, in that scenario, ITC taken on compensation cess will lapse. Since they don’t have to discharge compensation cess from September 22, there is no question of utilisation of ITC on compensation cess.”

Auto dealers may have legal recourse, and it can be argued that the accumulated credit is a vested right that cannot be arbitrarily extinguished. In a landmark decision by the Supreme Court in Eicher Motors Ltd. & Anr. v. Union of India, which was delivered in the context of MODVAT under the erstwhile Central Excise regime, the court held that a taxpayer's right to credit becomes absolute once the inputs are used. 

This principle was later reaffirmed by the Supreme Court in the Samtel India Ltd. case.
More recently, in an analogous situation, concerning compensation cess on coal, the Gujarat High Court in cases like Patson Papers (P.) Ltd. v. Union of India allowed businesses to claim refunds for stranded compensation cess credits in the case of exports. The court noted that the legal bar on cross-utilisation would not apply in such scenarios, offering a glimmer of hope for the auto industry.

To allay the apprehensions of the auto industry, an alternative path to resolution should come from the central government or the legislature, either in the form of a one-time transitional credit, allowing dealers to claim a refund of the stranded cess or transfer the balance to their usable GST electronic credit ledgers. A similar transitional mechanism was successfully implemented when the GST regime was first launched in 2017 to provide relief to businesses.

The absence of an option to utilise the ITC accumulated prior to the GST rate restructuring will also be seen as an imposition of retrospective tax impact on automobile dealers. This is against the doctrine of legitimate expectation, as the incidence or burden of this tax was never meant to be on automobile dealers.

Ideally, in the interest of responsive policymaking, the government should create the opportunity for automobile dealers to utilise accumulated ITC on compensation cess. This would avoid unnecessary litigation and improve the investor-friendly image of the government, since many dealers partner with international automakers.

*With inputs from Drona Negi, Advocate