Banks Can Claim Depreciation on Lapsed GST Input Tax Credit

CASE ANALYSIS

Banks Can Claim Depreciation on Lapsed GST Input Tax Credit

Kerala High Court Quashes GST Department’s Show Cause Notices Against South Indian Bank & Federal Bank

I. Background & Legal Context

The intersection of the Central Goods and Services Tax Act, 2017 (CGST Act) and the Income Tax Act, 1961 has long been a source of tension for banking and financial institutions in India. A specific provision — Section 16(3) of the CGST Act — prohibits a registered person from claiming Input Tax Credit (ITC) on the tax component of capital goods if depreciation has been claimed on that same component under the Income Tax Act. The rationale is straightforward: the law intends to prevent a taxpayer from obtaining a double benefit — once through ITC under GST law and again through depreciation deduction under income tax law.

However, banking companies face a unique GST landscape. Unlike regular taxpayers, they supply a mix of taxable services (such as fee-based banking services) and exempt services (such as interest on loans and advances). Under Section 17(2) of the CGST Act, ITC must be apportioned between taxable and exempt supplies — a computationally complex exercise. To ease this compliance burden, Parliament enacted Section 17(4), which provides an optional simplified route: banks and financial institutions may, instead of undertaking the complex apportionment under Section 17(2), simply avail 50% of their eligible ITC each month, with the remaining 50% lapsing permanently.

This judgment arose from a dispute over whether Section 16(3)’s prohibition — triggered by depreciation claimed on a tax component — applies to the entire GST paid on capital goods, or only to the portion in respect of which ITC was actually availed. The GST Department took the former position; the banks contested with the latter. The Kerala High Court, in a significant ruling, sided with the banks.

II. Facts of the Case

A. The DGGI Investigation

The Directorate General of GST Intelligence (DGGI), Kochi Zonal Unit, received intelligence that most banking companies were availing ITC on capital goods in contravention of Sections 16(3) and 17(4) of the CGST Act, 2017. Acting on this, an investigation was initiated against South Indian Bank Ltd. — a bank with branches pan-India — to verify whether ineligible ITC had been availed.

The investigation revealed the following factual matrix applicable to all the petitioner banks:

1.   The banks, being banking companies within Section 17(4), exercised the option available under that provision instead of complying with the apportionment mechanism under Section 17(2).

2.   By exercising this option, the banks availed 50% of their eligible ITC on capital goods and input services each month. The remaining 50% was reversed/lapsed in Form GSTR-3B, as mandated by Rule 38 of the CGST Rules.

3.   The 50% of the tax component that was not claimed as ITC (the lapsed portion) was capitalised to the respective assets and included in the gross block of assets for Income Tax purposes.

4.   Depreciation was claimed on this gross block (which included the lapsed GST component) under the Income Tax Act, 1961.

B. The Department’s Allegation

The GST Department argued that by claiming depreciation on the tax component (even the lapsed 50%), the petitioner banks had violated Section 16(3) of the CGST Act. According to the Department, Section 16(3) operates as a complete bar — once depreciation is claimed on any part of the tax component of capital goods, ITC on the entire tax component becomes ineligible. Accordingly, show cause notices were issued to South Indian Bank and Federal Bank under Section 74 of the CGST Act (fraud/willful misstatement). In the case of South Indian Bank’s earlier WP, an Order-in-Original had already been passed under Section 73, also incorporating this allegation alongside other irregularities.

C. The Petitioners’ Stand

The banks challenged the show cause notices and the order before the Kerala High Court. They argued, through Senior Counsel Sri. G. Shivadas, that Section 16(3) is a targeted provision aimed at preventing double benefit — and no double benefit arises when ITC was never claimed for the portion on which depreciation is sought. Since the banks had already reversed 50% of the ITC in GSTR-3B (i.e., that ITC was never availed), claiming depreciation on that lapsed amount cannot attract Section 16(3).

III. Relevant Statutory Provisions

IV. Legal Discussion & Court’s Reasoning

A. The Purposive Interpretation of Section 16(3)

The Court began by carefully examining the language of Section 16(3) and identified the phrase ‘the said tax component’ as the pivot of interpretation. The prohibition under Section 16(3) is not against the entire tax paid on capital goods — it is targeted specifically at ‘the said tax component’ on which depreciation has been claimed. The Court concluded that this expression is deliberately narrow, implying that only the specific portion of tax on which depreciation is claimed would be disentitled from ITC; the bar does not extend to the remaining tax component.

The Court reaffirmed that the undisputed objective of Section 16(3) is to prevent a double benefit to the taxpayer — claiming ITC under GST and simultaneously claiming depreciation on the same amount under the Income Tax Act. This purposive approach was central to the Court’s analysis. The question then became: can a double benefit arise in respect of a tax component on which ITC was never claimed at all?

B. The Section 17(4) Deeming Fiction

The Court then analysed the scheme of Section 17(4) and Rule 38. Under Section 17(4), a bank choosing this option avails only 50% of eligible ITC, and the remaining 50% is mandatorily lapsed/reversed. The Court observed that this 50% lapsing is not a mere reduction of credit — it is a statutory deeming fiction. The provision treats the lapsed 50% at par with the exempt supply component contemplated under Section 17(2) of the CGST Act.

Under Section 17(2), ITC is not available at all for the tax attributable to exempt supplies. The Court drew a direct parallel: just as depreciation claimed on the tax component attributable to exempt supplies would not attract Section 16(3) (because ITC was never available for that portion), similarly, depreciation on the lapsed 50% under Section 17(4) cannot attract Section 16(3), because the very concept of ITC has ceased to exist for that lapsed portion.

C. No Double Benefit Possible on Lapsed Credit

A critical element of the Court’s reasoning is that the lapsed portion of ITC is extinguished — it ceases to be a tax credit at all once reversed in GSTR-3B. Since the bank never claimed ITC on the lapsed 50%, no benefit from the GST statute was obtained. If the bank then capitalises this lapsed GST amount and claims depreciation on it under the Income Tax Act, only one benefit is being taken (depreciation), not two. The rationale of Section 16(3) — preventing double benefit — is simply not triggered.

D. The Unreasonable Classification Argument

The Court went a step further, observing that accepting the Department’s interpretation would lead to an unreasonable classification. Banks opting for Section 17(4) would be placed in a worse position than banks following Section 17(2): under Section 17(2), the tax attributable to exempt supplies is simply not eligible for ITC, and claiming depreciation on it carries no GST consequences. But if the Department’s reading of Section 16(3) were accepted, a bank under Section 17(4) that claims depreciation on the identical (lapsed) portion would suddenly become liable to lose the ITC it had legitimately availed on the other 50% as well. This disparity, the Court held, would be an unreasonable classification between two similarly situated taxpayers using equally valid statutory options.

E. Distinguishing ‘Tax Component’ from ‘Eligible Credit’

The Court’s interpretation effectively distinguishes between two concepts: the ‘tax component’ in an accounting sense (the GST paid on the invoice) and the ‘tax component’ as understood in the context of ITC eligibility under the CGST Act. For the purpose of Section 16(3), ‘the said tax component’ must be read in the context of the ITC scheme — i.e., only the portion of tax that was actually available and claimed as ITC can be disallowed under Section 16(3). The portion that was statutorily lapsed and thus never formed part of any ITC claim is outside the scope of this provision.

V. Held

The Kerala High Court held as follows:

VI. Our Comment

A. A Sensible and Commercially Sound Ruling

This judgment is a welcome development for the banking sector and reflects a thoughtful, purposive approach to statutory interpretation. The Court correctly identified that blind textualism — reading Section 16(3) as an absolute bar on the entire tax paid on capital goods whenever any depreciation is claimed — would produce outcomes that are both commercially unreasonable and internally inconsistent with the broader CGST framework.

The reality for banks is that the GST paid on capital goods has two distinct components once they opt for Section 17(4): a credit component (50%, which is availed as ITC) and a lapsed component (50%, which is irrecoverably extinguished by law). Treating these two components identically for Section 16(3) purposes makes no logical sense, and the Court rightly refused to do so.

B. Parallel with Exempt Supplies — The Crucial Analogy

Perhaps the most compelling element of the Court’s reasoning is the analogy it draws with Section 17(2). Under Section 17(2), the tax attributable to exempt supplies is entirely outside the ITC framework — no credit is available for it. If the law were interpreted as the Department urges, a bank following Section 17(2) could freely claim depreciation on the exempt portion without any Section 16(3) consequences (because there is no ITC claim to disallow), whereas a bank following Section 17(4) would face Section 16(3) consequences for claiming depreciation on the functionally equivalent lapsed portion. This double standard lacks statutory justification and the Court was right to reject it.

C. The ‘Lapsed Credit’ Issue — A Broader Principle

The Court’s holding that the lapsed ITC under Section 17(4) ‘cannot have the nature of a tax component for the purpose of taking credit’ is significant beyond this case. It suggests a broader principle: once an amount is extinguished from the ITC register (whether by reversal, lapse, or statutory bar), it reverts to being a pure cost element — available for capitalization and depreciation under income tax law — without any continuing GST liability or restriction. This aligns well with standard accounting treatment, where unreclaimable taxes are treated as part of the cost of assets.

D. Caution: Scope Limited to Section 17(4) Banks

It must be emphasized that this ruling is specific to banking and financial institutions availing the Section 17(4) route. For regular taxpayers who have eligible ITC available under Section 17(1) and 17(2) on capital goods, claiming depreciation on the full cost including the tax component will continue to attract Section 16(3). The judgment does not disturb the general principle that double benefit is impermissible — it merely clarifies that no double benefit exists when the credit was never availed in the first place.

E. Possible Department Appeal

Given the significant revenue implications — the DGGI investigation was industry-wide and similar proceedings may be pending against numerous banks — it is quite possible that the GST Department may seek to challenge this ruling before a Division Bench of the Kerala High Court or the Supreme Court of India. The industry would do well to monitor any further developments on this front before treating this ruling as settled law.

VII. Significance of the Judgment

1.  Relief for the Banking Sector

Banks and financial institutions across India availing the Section 17(4) route have been caught in this crossfire between GST law and income tax law for several years. This judgment provides substantial relief by clarifying that the two tax regimes need not be mutually exclusive in the way the Department had alleged. Banks that had received similar show cause notices — and there appear to be many, based on the DGGI investigation — now have a strong precedent to rely upon.

2.  Purposive Interpretation Over Literal Textualism

The judgment is a notable example of the High Court applying purposive interpretation to tax statutes. Rather than reading the words of Section 16(3) in isolation, the Court examined the object of the provision, its interaction with Sections 17(2) and 17(4), and the practical implications of alternative interpretations. This approach is consistent with the Supreme Court’s longstanding principle that taxing statutes must be read in a manner that gives effect to the legislative intent, not to produce absurd results.

3.  Guidance on Section 16(3) Scope

Before this ruling, the scope of Section 16(3) was ambiguous in the context of partial ITC availment. The judgment now provides clarity: Section 16(3) is a targeted, not a blanket, restriction. The disallowance is limited to the specific tax component on which depreciation was claimed and for which ITC was available and availed. This reading is consistent with the text (‘the said tax component’) and with the no-double-benefit principle.

4.  Accounting and Tax Compliance Alignment

From a compliance perspective, the ruling aligns GST law with sound accounting practice. When a bank capitalises the lapsed GST amount as part of the cost of an asset, it is merely treating an irrecoverable cost as what it is — a cost. Denying depreciation on this amount would effectively impose an additional cost on banks for following the statutory option provided to them under Section 17(4), which Parliament clearly did not intend.

5.  Broader Precedential Value

While the immediate beneficiaries are banking companies, the judgment’s reasoning could potentially apply to other partial-ITC scenarios, including cases where ITC is reversed due to non-payment to suppliers within 180 days, or where goods are partly used for non-business purposes. In all such cases, the question of whether Section 16(3) applies to the entire tax or only the availed credit portion may arise, and this judgment will serve as persuasive authority.

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Disclaimer: This case analysis is prepared for academic and informational purposes only and does not constitute legal advice. Readers are advised to consult qualified legal counsel before acting on the basis of this analysis.

CA Ankit Gulgulia (Jain)

FCA, CWM (AAFM-US), CBV, CIFRS, R-ID, B.COM (H), RV* (IBBI)

Practising Chartered Accountant in Delhi NCR Since 2011. He can be contacted at ankitgulgulia@gmail.com or +91-9811653975.