Functionality test propounded in Safari Retreats case: An opportunity or new challenge for taxpayers?

The Safari Retreats decision by the Hon’ble Supreme Court has been awaited with bated breath by the industries and the legal fraternity at large. The pathbreaking decision not only upholds the validity of Section 17(5)(c) and (d) of the CGST Act but also enunciates the “functionality test” to determine whether a building, mall or warehouse other than a hotel or cinema theatre, plays the role of a ‘plant’ in the business of the assessee and accordingly could be considered for input tax credit (ITC).

The Court has distinguished the phrase “plant or machinery” used in section 17(5)(d) vis-a-vis “plant and machinery” defined in Explanation to Section 17 and held that even a ‘building’ could be considered as ‘plant’, having regard to the business of the assessee and the role that the building plays therein.

It is notable that the term ‘plant’ by itself, has nowhere been defined under the extant provisions of the GST law. Consequently, the interpretation of the term ‘plant’ under Section 17(5)(d) has to be understood in reference to the commercial parlance and trade understanding in which a particular business is carried out.

For instance, previously the Supreme Court in the context of income tax has noted that even ‘sanitary fittings’ and ‘pipelines’ installed in a hotel may constitute a ‘plant’ as they represent an essential amenity for providing comfort and convenience to the residents of the hotel.

In another case, it was held that even drawings, designs, charts, and other literature, not having any mechanical operation, may qualify as a ‘plant’ where they served as essential tools for the assessee’s trade with enduring utility. A building having insulated walls used as a freezing chamber has also been considered a ‘plant’ as it formed a part of the cold storage for the assessee.

In various judicial pronouncements, it has been held that where the building becomes more than just a ‘setting’ or a ‘canopy’ under which hotel business is carried on, it would qualify as a ‘plant’. Further, it has been held that where a dry dock, i.e., a concrete dry structure plays an essential part in getting large vessels into a position such that manufacturing of the ships can be undertaken, then such dry docks may also be considered a ‘plant’. Where the building was such that it enabled the sterilisation of surgical instruments and bandages to be carried on, then it may qualify as a ‘plant’ for running a nursing home.

On the contrary, it has also been held that merely because some special fittings or controlling equipment is attached for the purpose of carrying on hotel business, it will not take it out of the category of building and make it a ‘plant’. In another case, it was held that where the component parts can be treated as separate units having different purposes, it cannot be held that the building housing such components can be characterized as a ‘plant’. Furthermore, where the assessee who had constructed a building having atmospheric controls like moisture, temperature and provision for filtered air in order to manufacture saccharine, the Delhi High Court has held that the building merely served as a ‘setting’ for carrying on the business and therefore, would not qualify as a plant.

It is important to recognize that in all these instances, the term ‘plant’ has been defined in relation to the ‘specific trade or business’ which was being conducted. Furthermore, the courts have generally focused on the utility or function that a particular article provides in support of that business. Thus, in light of the above, the question that whether a ‘building’ or a ‘structure’ merely functions as the premises wherein the business operations are undertaken or whether such ‘building’ plays an essential part in the business operations, becomes extremely relevant. This principle has been prescribed by the apex court as the ‘functionality test’ for determining whether a building constitutes a ‘plant’ or not. Accordingly, we may note that the 'functionality test' is an extremely dynamic concept which adapts to the particular nuances of the facts in each and every case.

In the Safari Retreats decision, the apex court noted that whether a ‘building’ qualifies to be considered as ‘plant’ or not is a question of fact i.e., if it is found that a building has been so planned and constructed as to serve an assessee’s special technical requirements, it will qualify to be treated as a plant for the purposes of Section 17(5)(d) of the CGST Act. Therefore, it was held that if a building qualifies to be a plant, ITC can be availed against the supply of services in the form of renting or leasing the building or premises.

With this test in place, the real challenge for the assesses now is to determine the applicability in their own facts and ascertain the availability of input tax credit. The opportunity really is to see if the reasoning and the interpretation enunciated in the Safari Retreats judgment can be applied to other ‘structures’ such as prefabricated buildings, silos, warehouses, integrated cement or steel plants, dry docks, cold storage solutions, etc. which may qualify as a ‘plant’ based on their functionality towards the taxpayer’s business and avail input tax credit thereon if the test laid down by the Supreme Court is met.

Moving further, it is also important to highlight that that the Safari Retreats judgment has also provided a definitive interpretation of the term "on his own account," while identifying it as one of the exceptions under Section 17(5)(d). This expression is interpreted to mean either (a) that the property is used for personal purposes rather than for providing a service, or (b) that it serves as a setting for conducting one’s own business. Notably, the Court stated that the construction of immovable property does not qualify as on one’s own account if the intention is to sell, lease, or license the same. However, the Court also mentioned that if the ‘leased’ premises qualify as "plant" under Section 17(5)(d), then ITC may be permissible for those premises. By virtue of these simultaneous observations, it becomes unclear whether the exceptions relating to the terms "plant or machinery" and "on his own account" function independently or in conjunction with one another.

In conclusion, while the Safari Retreats judgment provides a glimmer of hope for taxpayers seeking to claim Input Tax Credit (ITC), it also introduces new challenges.

Firstly, the  the 'functionality test' necessitates a detailed analysis of the specific facts of each case. Further, there remains ambiguity regarding whether the exceptions to Section 17(5)(d) related to the expressions 'plant or machinery' and 'own account' function independently or in conjunction under Section 17(5)(d), especially in light of the Supreme Court's observations concerning leasing and renting of immovable property. Thus, the Safari Retreats judgment offers both a ray of hope for availing ITC as well as a challenge in the form of the application of ‘functionality test’ for the taxpayers. 

About the authors: Anshul Mathur is an Executive Partner, Vinayak Kohli is a Principal Associate and Sahil Aggarwal is an Associate at Lakshmikumaran and Sridharan attorneys.

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