Preferential GST Rate for Commercial Building Rentals Where ITC Is Blocked Under Section 17(5)
The GST regime is premised on neutrality and avoidance of cascading by granting seamless Input Tax Credit (ITC). However, in the context of commercial buildings constructed on own account and subsequently rented out, Section 17(5) of the CGST Act creates a break in the credit chain by disallowing ITC on such construction. When full GST is simultaneously levied on the rental income from that very property, the assessee effectively suffers tax-on-tax.
This article contends that, to preserve coherence within the GST framework and to satisfy the mandate of equality and non-arbitrariness under Article 14 of the Constitution of India, renting of commercial buildings in situations where ITC is blocked should logically attract GST at a concessional rate of 5% without ITC, in line with the legislative pattern visible in multiple GST notifications.
1. Structural Design of GST and the Role of ITC
1.1 GST as a value-added tax
GST has been designed as a destination-based value-added tax, where:
- Tax is intended to be levied only on the incremental value at each stage; and
- ITC is the key instrument that avoids multiple taxation of the same value.
In a typical scenario:
- The supplier charges GST on output.
- The supplier claims credit of GST paid on eligible inputs and input services.
- Only the net liability (output minus input) is paid in cash.
Blocking ITC at any intermediate stage while continuing to levy full tax on the outward supply causes the effective tax cost to rise beyond the intended value-add, undermining the central design of GST.
1.2 Statutory nature of ITC and legislative control
Judicial pronouncements have consistently held that:
- ITC is not an inherent or constitutional right; it is a statutory entitlement.
- The Legislature has the competence to prescribe conditions, limitations or even to deny ITC in specified situations.
In Union of India v. VKC Footsteps India Pvt. Ltd., the Hon’ble Supreme Court observed that:
GST is a destination-based consumption tax and input tax credit is an important feature of the GST framework. However, ITC is governed by the statute and can be restricted by Parliament.
Thus, while courts acknowledge the centrality of ITC for avoiding cascading, they also uphold the Legislature’s wide discretion to regulate or curtail ITC.
2. Blocking ITC on Construction of Commercial Buildings
2.1 Effect of Section 17(5) on commercial property
Under Section 17(5) of the CGST Act, ITC on goods and services used for the construction of immovable property on own account is generally disallowed, even when such property is used for business.
For an assessee who:
- Constructs a commercial building on own account, incurring significant GST on inputs and input services; and
- Thereafter lets out the building for commercial use liable to GST;
the denial of ITC on construction costs means that:
- GST paid on materials, works contracts, architect services, etc., forms part of the capital cost of the property; and
- Full GST is again levied on rental income without any offset for the initial GST suffered.
This dual layer of tax leads to tax cascading in a sector where the output supply is itself under the GST net.
2.2 Unequal treatment between similarly situated classes
The problem becomes more pronounced when compared with situations where:
- ITC is allowed in full and output GST is charged at the standard rate; or
- A concessional rate (e.g., 5%) is prescribed explicitly without ITC.
In many other GST entries, whenever ITC is barred, the Legislature has compensated the assessee by prescribing a lower GST slab. In contrast, for commercial building rentals where construction ITC is blocked under Section 17(5), full-rate GST continues to apply, resulting in a heavier burden on this category of assessees despite comparable economic activity.