Availability of Input Tax Credit on Demo Vehicles – A Detailed Analysis
Introduction:
The question of whether authorized vehicle dealers can claim Input Tax Credit (ITC) on demo vehicles has been a matter of much discussion. Demo vehicles, used to showcase features and provide test drives to potential customers, are a key part of a dealer’s sales strategy. These vehicles are usually purchased from manufacturers, capitalized in the dealer’s books of account, and later sold at a depreciated value. This article delves into the recent clarification issued by the Central Board of Indirect Taxes and Customs (CBIC) regarding the eligibility of claiming ITC on demo vehicles, as outlined in Circular No. 231/25/2024-GST, and provides a deep dive into the provisions of Section 17(5) and Section 16(3) of the CGST Act.
The Issue:
Dealers often purchase demo vehicles and capitalize them as business assets. However, ambiguity existed about whether these vehicles qualify for ITC under the CGST Act, 2017. The main issues raised were:
1. Availability of ITC on demo vehicles that are capitalized in the books of the dealer.
2. Whether demo vehicles, used for trial runs and demonstrations, qualify for ITC under Section 17(5) of the CGST Act, which generally restricts ITC on motor vehicles used for transportation of persons.
Section 17(5) – Explanation of Provisions:
Section 17(5) of the CGST Act places restrictions on the availability of ITC on certain goods, specifically motor vehicles used for the transportation of persons. ITC is blocked for motor vehicles with a seating capacity of not more than 13 persons, including the driver, unless they are used for one of the following purposes:
1. Further supply of such motor vehicles.
2. Transportation of passengers.
3. Imparting training on driving such motor vehicles.
The key question was whether demo vehicles used by dealers for test drives and feature demonstrations fall under the first exception—further supply of motor vehicles.
Availability of ITC on Demo Vehicles:
The CBIC's clarification states that demo vehicles are used by authorized dealers to provide trial runs and to demonstrate the features of the vehicle to potential buyers. These demo vehicles play a direct role in promoting the sale of similar types of motor vehicles. Therefore, under Section 17(5) (a) (A) of the CGST Act, they qualify as being used for the further supply of motor vehicles, even though the specific vehicle being demonstrated may not be immediately sold.
This distinction is important because the use of the term "such motor vehicles" in the law indicates that it is not necessary for the demo vehicle itself to be sold immediately. The fact that it promotes the sale of similar vehicles is sufficient to exclude it from the blockage of ITC under Section 17(5).
Key Takeaways:
Demo vehicles qualify for ITC because they are considered to be used for the further supply of motor vehicles.
Other uses, such as transporting staff or employees, would block ITC.
Capitalization of Demo Vehicles – Section 16(1) and ITC Eligibility:
When demo vehicles are capitalized in the dealer’s books, they are treated as capital goods under Section 2(19) of the CGST Act. The term “capital goods” refers to goods whose value is capitalized and are used in the course of business.
According to Section 16(1) of the CGST Act, every registered taxpayer is entitled to claim ITC on the tax charged on the supply of goods and services, including capital goods, provided these goods are used in the course of business. Therefore, demo vehicles that are capitalized by the dealer for the purpose of promoting sales are eligible for ITC.
Depreciation and Restrictions – Section 16(3):
While Section 16(1) allows ITC on capitalized demo vehicles, Section 16(3) introduces an important restriction. If the dealer claims depreciation on the tax component of the capitalized vehicle under the Income Tax Act, 1961, the ITC on that tax component will not be allowed.
In practice, this means that dealers need to carefully manage their financial records. They can claim ITC on the purchase of demo vehicles, provided they do not claim depreciation on the GST portion of the vehicle's cost.
Sale of Capitalized Demo Vehicles – Section 18(6) and Rule 44(6):
When a demo vehicle that has been capitalized is eventually sold, the dealer must comply with the provisions of Section 18(6) of the CGST Act and Rule 44(6) of the CGST Rules. These provisions require the dealer to pay the applicable tax or an amount equivalent to the ITC that was originally claimed. This ensures that the tax credit is properly accounted for when the vehicle is sold at a depreciated value.
Summary of Key Points:
• Demo vehicles used by dealers for test drives and demonstrations are considered to be used for the further supply of motor vehicles, making them eligible for ITC under Section 17(5).
• Demo vehicles that are capitalized in the dealer’s books qualify as capital goods under Section 2(19) of the CGST Act.
• ITC can be claimed on demo vehicles, subject to the condition that depreciation is not claimed on the GST portion of the vehicle’s cost, as per Section 16(3).
• When a capitalized demo vehicle is sold, the dealer must comply with Section 18(6) and Rule 44(6), ensuring that appropriate tax is paid or ITC is reversed.
Conclusion:
The clarification issued by the CBIC brings much-needed uniformity in the interpretation of the law regarding ITC on demo vehicles. For authorized dealers, this means they can confidently claim ITC on demo vehicles, provided they are used for promoting the sale of motor vehicles. However, they must remain vigilant about the conditions imposed by Section 16(3) regarding depreciation and ensure compliance with the rules when selling capitalized vehicles.
This clarity not only benefits dealers by reducing their tax burden but also ensures that the law is applied uniformly across different tax jurisdictions. As demo vehicles play an essential role in vehicle sales, being able to claim ITC on them can significantly improve a dealer's cash flow and financial efficiency.
Disclaimer: This material and the information contained herein is intended for clients and other Chartered Accountants to provide updates and is not an exhaustive treatment of such subject. We are not, by means of this material, rendering any professional advice or services. It should not be relied upon as the sole basis for any decision which may affect you or your business.
