Karnataka High Court: ITC Under KVAT Act Permissible in Month of Accounting, Not Confined to Invoice Date
Background and Context
The Karnataka High Court recently delivered a significant ruling in Sonal Apparel Private Limited Vs State of Karnataka, addressing a long-standing dispute concerning the correct interpretation of Section 10(3) of the Karnataka Value Added Tax Act, 2003 (KVAT Act). A batch of writ petitions was filed by manufacturers who challenged both the constitutional validity and the administrative interpretation of the said provision, contending that the Assessing Authorities had adopted a reading of the law that was fundamentally at odds with the legislative intent and the overall framework of the KVAT Act.
To appreciate the significance of this dispute, it is necessary to understand the historical backdrop. The KVAT Act replaced the Karnataka Sales Tax Act, 1957 (KST Act), which operated on a single-point levy system. Under the KST Act, tax was imposed only on the first sale of a commodity. However, since goods frequently changed form during manufacturing and processing, tax ended up being levied multiple times — once on each new commodity that emerged — before the final product reached the end consumer. This cascading accumulation of taxes inflated prices and burdened consumers across Karnataka.
To address this structural problem, the KVAT Act was enacted with effect from April 1, 2005. Its foundational philosophy was to tax only the incremental value added at each stage of the supply chain. This was operationalised by allowing registered dealers to offset the tax paid on their purchases (input tax) against the tax payable on their sales (output tax). The net tax liability of a dealer is therefore the difference between output tax and input tax. The Statement of Objects and Reasons to the KVAT Act explicitly refers to "removing of cascading effect" through "input rebating."
The Petitioners' Situation and the Core Dispute
The assessee-companies involved in these petitions were engaged in manufacturing activities. They regularly purchased taxable raw materials and consumables, paying applicable tax to their suppliers. These payments qualified as "input tax" under Section 10(2) of the KVAT Act. In line with standard accounting practices, the assessees claimed input tax credit in the month in which purchases were recorded in their books of accounts — not necessarily in the month when the supplier's invoice was generated.
The divergence between the invoice date and the accounting date arose due to several genuine business constraints:
- Audit verification: Goods received from suppliers were recorded only after an independent internal auditor verified quantities and prices against purchase orders. This process occasionally spanned across calendar months.
- Quality and quantity disputes: When goods were found to be defective or in incorrect quantities, they were returned to the supplier for replacement. Accounting was deferred until acceptable replacement goods were received.
- Transit timing: Suppliers located at distances within Karnataka sometimes dispatched goods and raised invoices on the 30th or 31st of a month, while the assessee received physical delivery only on the 1st or 2nd of the following month. In such cases, accounting naturally occurred in the subsequent month.
These scenarios were not isolated incidents but routine occurrences in the commercial life of a manufacturing enterprise. The assessees had consistently followed this accounting practice from the very inception of the KVAT Act in 2005, without any objection from the Revenue.
The Trigger: Centum Industries Judgment and Revenue's Changed Stance
The conflict ignited following a Division Bench decision dated July 31, 2014, in State of Karnataka vs. Centum Industries Limited, (2014) 80 KLJ 65, wherein the Court interpreted Section 10(3) to mean that a dealer must claim input tax credit in the return filed for the month in which input tax is paid. The Court in that case also noted that if credit was not claimed in the correct month, the dealer could file a revised return under Section 35(4) of the KVAT Act within six months from the end of the relevant tax period.
Drawing upon this judgment, Revenue authorities adopted the position that input tax credit could only be claimed in the month corresponding to the date on which the selling dealer raised the purchase invoice. This interpretation led to a wave of reassessment orders from late 2014 onwards, disallowing input tax credit wherever it had been claimed in a month different from the invoice month — irrespective of how legitimate the commercial reasons for the variance were.