Q: What are the provisions of Sales Tax Law in case raw material is purchased from un-registered person and is exclusively used in taxable supplies?
Ans: If raw material is purchased from an un-registered person, input tax (if any) is not admissible, but output tax is to be charged and paid on such supplies regardless of the fact whether the supplies are made to a registered person or to a non-registered person.
With respect to the fact that a certain amount of raw materials purchased from unregistered person is wholly used in taxable supplies, it must be noted that this fact does not have any effect on the computation and it cannot be used to reduce the input tax credit.
The ‘purchase/sale ratio’ has been invented and used by some to limit the input tax paid on purchases from registered persons. There is no such ratio in the Sales Tax Act, 1990, or Sales Tax Rules, 2006, and the restriction on input tax in such a way in not intended by the law maker. (I must say it’s a smart idea, though, but without any legal basis.)
The whole concept has been derived from Rule 25 of the Sales Tax Rules, 2006, which relates to allocation/proration of input tax. The said rule says:
- Input tax paid on raw materials relating wholly to taxable supplies is wholly admissible.
- Input tax paid on raw materials relating wholly to exempt supplies is not admissible.
- Input tax paid on raw materials relating to both taxable supplies and exempt supplies (called ‘residual input tax’) is to be apportioned according to the following formula.
Residual input tax credit on taxable supplies
Value of Taxable supplies
(Value of Taxable + Exempt Supplies)
Residual input tax
Here, the gross value of taxable supplies for the month is to be taken for denominator and numerator (as computation is done on monthly basis) and not the value reduced by any ‘purchase/sale ratio’.
Note that ICAP has examined this point at least twice in Spring 2011 and Autumn 2009 and in its suggested answers has not used any ‘ratio’ to reduce the input tax credit. ICAP suggested answer is correct and in accordance with law and rules of sale tax.
To sum up:
- Input tax (if any) on purchases from unregistered person is not allowable.
- Output tax is chargeable on supplies made to registered person, as well as un-registered person.
- If it is given that a specified amount of raw material is purchased from unregistered person and is used exclusively in taxable supplies, ignore it and don’t use any formula not provided in the law/rules to reduce the input tax credit.
- Input tax paid on raw materials relating wholly o taxable supplies is wholly admissible as adjustment.
- Input tax paid on raw material relating to wholly exempt supplies is not admissible.
- Input tax paid on raw materials relating to both taxable supplies and exempt supplies (called ‘residual input tax’) is to be apportioned according to the aforesaid formula.