Input Tax Credit on Demo Vehicles under GST

Introduction

Use of ‘Demo Vehicles’ is a very common practice in the automobile industry as ‘Demo vehicles’ are required for being used for marketing purposes such as test drive, showroom display etc. The main objective of using demo vehicle is not for their sale but to promote the sale of main product by inducing the customer. However, it is also an undisputed fact that the ‘Demo Vehicle’ is eventually sold by the automobile dealer after being used for a certain time period at the prevailing rates (not equal to prices of a new vehicle).

However, there has been a confusion over the eligibility of ITC on demo vehicles since the inception of GST. This confusion is owing to restriction placed by Section 17(5) of CGST Act, 2017 that ITC in respect of motor vehicles shall be allowed only when they are meant for further supply of motor vehicles. There have been contrary opinions on this issue that is also reflected in the divergent opinions rendered by the Advance Ruling Authorities. Undoubtedly, the demo vehicles are meant for outward supplies at any point of time after being used for the promotional purposes. In light of the above confusion, we would try to put focus on this topic by way of various advance rulings issued by the authorities and simultaneously try to understand the provisions of GST in concurrence.

Chowgule Industries Pvt. Ltd. GST-ARA-18/2019-20/B-121 dated 26.12.2019

• As per Section 16(1) of CGST Act, 2017, every registered person shall, subject to such conditions and restrictions as may be prescribed and, in the manner, specified in Section 49, be entitled to take credit of input tax charged on any supply of goods or services or both to him which are used or intended to be used in the course or furtherance of his business. The section does not make any distinction between capital goods and other goods for allowing credit of ITC. Hence, ITC in respect of capital goods, is available and can be taken.
• Demo cars fulfils the definition of capital goods, are received under a tax invoice and are used or intended to be used in the course or furtherance of business i.e. sale of motor vehicles. Hence, the applicant is eligible to avail ITC on such capital goods.
• ITC is also not blocked as per the provisions of section 17(5)(a) which states that “ITC shall not be available in respect of motor vehicles except when they are used for making further taxable supplies of such vehicles”. The reason behind this is the fact that demo cars are ultimately sold after a specified time period by the automobile dealer and there is no time limit prescribed in the GST Act for making such further taxable supplies.
• However, it should be noted that when the demo car is sold by the dealer, he shall pay an amount equal to ITC taken on the said demo vehicle reduced by such percentage points as may be prescribed or the tax on the transaction value of such demo vehicle, whichever is higher.
• In consequence, the automobile dealer is eligible to take ITC on demo vehicles as capital goods and utilize the same for the payment of output tax payable under the Act.

Similar decision was also tendered by Kerala Authorities in the case of M/s A.M. Motors which is quoted as below: -

A.M. Motors - Advance Ruling No. Ker/10/2018 dated 26.09.2018

• The supplier of vehicles supplied demo cars against tax invoice. The demo car is an indispensable tool for promotion of sales by providing trial run to customers and to understand the vehicle’s features.
• The applicant is eligible to take ITC in respect of demo vehicles as capital goods as demo vehicles are used in furtherance of business. Further, this activity does not come under the negative clause u/s 17(5) as after a limited period of use as demo car, the vehicles are sold at the written down value. However, on supply of such demo vehicles after the specified limited period, the automobile dealer shall pay an amount equal to ITC taken on the said capital goods as reduced by such percentage points as may be prescribed or the tax on transaction value of such demo vehicle, whichever is higher.

Thus, both the rulings had similar opinions in respect of ITC on use of any vehicle as demo vehicle. But in a recent ruling in the case of M/s Khatwani Sales and Services LLP, the MP authorities had a different opinion. We shall first discuss this ruling also before drawing any final conclusion.

Khatwani Sales and Services LLP- Order No. 13/2020 dated 23.07.2020

In this case, the applicant contended that the demo vehicles are used for imparting training about the features of car and training on driving such vehicles to the prospective buyer. The test drive of similar model will certainly generate revenue and thus help in furtherance of business by raising the sale of vehicles. Further, the ITC should be allowed as it satisfies the criteria mentioned in clause (A) of Section 17(5)(a) of CGST Act, as demo vehicles are used for furtherance of business by increasing the sale of similar vehicles and of Clause (C) of the section as demo vehicles are used for imparting training about the features of the car, training on driving such vehicles to the prospective buyer. The applicant also cited the above two orders as discussed in this article in the case of M/s A.M. Motors & Chowgule Industries Pvt. Ltd.

It was held that: -

• Under Section 17(5)(a) of CGST Act, ITC shall be available in respect of motor vehicles which are further supplied as such, used for transportation of passengers or which are used for imparting training of driving of such vehicles.
• It cannot be said that the demo vehicles are for further supply by subsequent sale of demo vehicle after one or two years. The sale of demo vehicle in the subsequent year on which depreciation has been charged is to be treated as a sale of used second-hand vehicle and not sale of a new vehicle.
• Further, the eligibility of ITC on demo vehicles cannot be decided on the basis of their capitalization or payment of GST at the time of their sale in the subsequent year.
• Hence, though the demo vehicles are for furtherance of business of the applicant but they are not eligible for ITC in view of provisions of section 17(5)(a) of CGST Act.

Our opinion:

Before reaching to any conclusion, we would reiterate that it is well settled principle that the any advance ruling holds a binding precedent only on the person who has sought the same and the department can very well take a contrary view. Therefore, in view of the above divergent rulings, the taxpayer should act prudently because if the department takes a contrary view, the same would cost heavily to the taxpayer in form of interest and penalties.

Another option which an automobile dealer has in this regard is to opt “Margin Scheme”. In this respect, a FAQ is also given by CBIC quoted below:

Reading the above FAQ, it is clear that the demo car can be treated as “used vehicle” and as such, the benefit of “Margin Scheme” can be availed. However, the basic requirement of the “Margin Scheme” is that ITC has not been availed on the vehicle at the time of purchase. In such situation, the car dealer shall pay tax on the difference of sales consideration of used car and its depreciated value at the prescribed rate & if negative, it shall be ignored. Opting “Margin Scheme” is a prudent manner of compliance instead of falling in unnecessary litigation in view of prevailing confusion and divergent rulings because there will be not much difference if “Margin Scheme” is opted except the timing of payment of output tax on the demo vehicle.