The Goods and Services Tax in India was introduced with the vision of bringing uniformity in the indirect tax system and ensuring that businesses operate under a single tax regime across the country. A fundamental principle of GST is the availability of input tax credit, which enables a registered person to offset the tax paid on inward supplies against the liability on outward supplies. This concept of seamless credit flow eliminates the cascading effect that was inherent in the earlier system of excise duty, service tax, and state-level VAT.
At the same time, the legislature recognized that unrestricted credit could be misused if taxpayers began claiming input tax credit on personal or non-business expenses. For this reason, the Central Goods and Services Tax Act, 2017 introduced specific provisions under Section 17(5) that bar input tax credit in respect of certain goods and services. These restrictions are known as blocked credit provisions.
Blocked credit forms one of the most important compliance aspects under GST because businesses are expected to identify such ineligible credits and reverse them while filing returns. Incorrect claims often lead to interest liability, penalties, or prolonged disputes with the tax department.
Understanding the Concept of Blocked Credit
Input tax credit under GST is guided by a simple principle: if goods or services are used in the course or furtherance of business, credit should be available. Blocked credit is an exception carved out to this general principle. It refers to cases where the law denies input tax credit even if the goods or services are used for business.
The objective behind blocked credit is twofold. First, it prevents credits on items that have a strong element of personal consumption, such as food, beverages, or personal vehicles. Second, it ensures that the government’s revenue is not compromised by claims on goods and services that are not directly linked with taxable outward supplies.
For example, if a company distributes gifts to its employees or dealers, the GST paid on such goods cannot be claimed as input tax credit. Similarly, if a firm constructs an office building and capitalizes the cost, the tax paid on works contract services for such construction is not eligible for input tax credit.
Evolution of Section 17(5) of the CGST Act
When GST was introduced in July 2017, Section 17(5) contained several clauses restricting credit. However, the provisions were worded broadly, leading to interpretational disputes. Businesses often faced difficulty in understanding whether credit on certain items was permissible, especially in relation to motor vehicles and services connected with them.
To address these concerns, the legislature amended the provisions through the CGST (Amendment) Act, 2018, which came into effect on 1st February 2019. Clauses (a) and (b) were substituted by new clauses (a), (aa), (ab), and (b). The amendment introduced clarity by linking blocked credit on motor vehicles with seating capacity and by explicitly covering insurance, servicing, repair, and maintenance of vehicles, vessels, and aircraft.
This amendment marked a shift from a blanket denial to a more nuanced approach where credit restrictions were limited to smaller passenger vehicles and certain specific services. Larger vehicles, goods transportation, and business-critical uses were excluded from the blocked category, thereby aligning the law with commercial realities.
Legal Structure of Section 17(5)
Section 17(5) of the CGST Act specifies categories of goods and services where input tax credit shall not be available, notwithstanding that such supplies may be used in the course or furtherance of business. This means the restrictions override the general eligibility conditions under Section 16 of the Act.
The provisions under Section 17(5) can broadly be grouped into the following categories:
- Motor vehicles, vessels, and aircraft and related services
- Food and beverages, health services, life and health insurance, and similar personal services
- Membership of clubs, fitness centres, and employee travel benefits
- Works contract services and construction of immovable property
- Supplies from composition dealers
- Goods and services received by non-resident taxable persons
- Goods and services used for personal consumption
- Goods lost, stolen, destroyed, written off, or distributed as gifts or free samples
- Tax paid as a consequence of fraud, seizure, or confiscation
Each of these categories represents a conscious policy decision to restrict credit in situations where the supply is not directly linked to taxable business activity or where misuse could occur.
Motor Vehicles and Blocked Credit
The most significant restriction under Section 17(5) relates to motor vehicles. According to the amended provisions, input tax credit on motor vehicles for transportation of persons having an approved seating capacity of not more than 13 persons, including the driver, is blocked. This restriction extends not only to the purchase of such vehicles but also to leasing, renting, or hiring of the same.
Furthermore, input tax credit on general insurance, servicing, repair, and maintenance of such motor vehicles is also blocked. The idea is that small passenger vehicles such as cars and jeeps are often used for mixed purposes, including personal consumption, and hence input tax credit should not be allowed.
Exceptions to the Restriction on Motor Vehicles
There are specific exceptions where input tax credit on motor vehicles is allowed even if the seating capacity is 13 or less. These are:
- When the motor vehicle is used for further supply of such vehicles. For example, a car dealer purchasing vehicles for resale is entitled to input tax credit.
- When the vehicle is used for transportation of passengers. For instance, a taxi operator or ride-hailing company purchasing vehicles for its fleet can avail credit.
- When the vehicle is used for training in driving such vehicles. Driving schools that acquire cars for training purposes are eligible to claim credit.
In addition, if the recipient is engaged in manufacturing such vehicles or providing insurance services relating to them, input tax credit on leasing, renting, or hiring is permitted.
Practical Illustration
Suppose a corporate house buys a sedan with seating capacity of five for use by senior management. The GST paid on purchase, as well as on its insurance and maintenance, will not be eligible as input tax credit. However, if a cab operator buys the same model of sedan for running passenger transport services, the credit will be admissible since the vehicle is used directly for outward taxable supply.
Vessels and Aircraft under Section 17(5)
Similar to motor vehicles, Section 17(5) also blocks input tax credit on vessels and aircraft, including leasing, renting, or hiring. Input tax credit is also restricted on insurance, servicing, repair, and maintenance of such vessels and aircraft.
Exceptions for Vessels and Aircraft
Credit is allowed when these are used for:
- Further supply of vessels or aircraft,
- Transportation of passengers,
- Training on navigation or flying, or
- Transportation of goods.
Additionally, if the recipient is in the business of manufacturing such vessels or aircraft or is engaged in providing insurance services related to them, input tax credit is admissible.
Practical Illustration
An airline company purchasing aircraft for passenger flights can claim input tax credit because the aircraft is directly linked to taxable outward supply of transportation services. On the other hand, if a corporate entity acquires a private jet for use of executives, the input tax credit will be blocked, even though the asset may be capitalized in the books of accounts.
Implications for Businesses in Transportation and Logistics
The restrictions under Section 17(5) have wide implications for businesses across industries. Passenger transport companies benefit from the exceptions, as their fleets often consist of smaller vehicles. Similarly, logistics companies using larger vehicles or vessels for movement of goods are not impacted because the restriction applies only to vehicles used for passenger transport with a seating capacity of 13 or less.
Manufacturers, insurers, and training providers in the automotive and aviation sectors are also entitled to input tax credit on such purchases, ensuring that their business operations remain tax-efficient.
However, businesses outside these industries face blocked credit when they purchase or lease cars for corporate use, or when they incur expenses on insurance and maintenance of such vehicles. For them, these costs become part of operating expenditure without any credit benefit, thereby increasing the overall tax burden.
Food and Beverages, Outdoor Catering, and Related Services
The supply of food and beverages, outdoor catering, beauty treatment, health services, cosmetic and plastic surgery, life insurance, and health insurance are categories where input tax credit is restricted under Section 17(5)(b)(i). The logic is straightforward: these are personal in nature and often enjoyed by individuals rather than being consumed for the purpose of making outward taxable supplies.
Exceptions for Business Use
There are important exceptions where input tax credit is allowed. If a registered person receives these inward supplies and uses them for making outward taxable supply of the same category of goods or services, credit is admissible. Similarly, if they form part of a taxable composite or mixed supply, credit is available.
For instance, a catering company that purchases food and beverages for preparing meals and supplying them to customers can claim input tax credit because the items are directly linked to outward supply. Likewise, a hospital performing cosmetic or plastic surgery as part of taxable health services can claim credit on related inputs.
Employer Obligations
Another exception exists where an employer is required under law to provide such services to employees. For example, under certain labor laws, it may be mandatory for employers to provide canteen facilities or health insurance coverage. In such cases, input tax credit is allowed because the expense is not discretionary but a statutory obligation directly tied to employment law compliance.
Membership of Clubs, Health and Fitness Centres
Section 17(5)(b)(ii) explicitly blocks input tax credit on membership fees for clubs, health, and fitness centres. The reasoning is that these expenses are primarily personal in nature and do not contribute directly to taxable outward supply.
Even when companies bear these costs for employees or executives, the law treats them as personal benefits rather than business necessities. Unlike canteen or insurance services required under statutory obligations, membership fees for recreational or wellness activities do not fall under mandatory categories, and hence credit remains blocked.
Practical Illustration
If a corporate house pays for its executives’ membership in a prestigious social club, the GST paid on such membership is not eligible for input tax credit. Even if the company argues that such memberships help in building client relationships or networking, the law does not recognize them as business-linked expenses for credit purposes.
Travel Benefits Extended to Employees
Under Section 17(5)(b)(iii), input tax credit is not available on travel benefits extended to employees on vacation, such as leave travel concession or home travel concession. These benefits are part of compensation packages and are considered personal in nature.
The provision ensures that companies cannot claim tax credit on travel expenses provided for personal holidays of employees or their families. While business travel undertaken by employees for official purposes is eligible for credit as part of business expenditure, travel benefits linked to personal vacations remain blocked.
Employer Compliance
Many large organizations provide travel concessions as part of their employment policies. While the cost may be borne by the employer, the law makes a clear distinction between business travel and personal vacation. Input tax credit is admissible only for travel expenses directly connected with business operations.
Works Contract Services and Construction of Immovable Property
Works contract services represent another major area of blocked credit under Section 17(5). Specifically, input tax credit is not available when works contract services are supplied for construction of immovable property, other than plant and machinery, unless such services are used for further supply of works contract service.
Scope of Construction
The term construction has been defined broadly to include reconstruction, renovation, additions, alterations, or repairs to the extent of capitalization in the books of accounts. This means that any expenditure incurred on immovable property which is capitalized, whether for a new building or for significant modifications to an existing structure, will not be eligible for input tax credit.
Plant and Machinery Exclusion
The law provides an important exclusion for plants and machinery. Plant and machinery refers to apparatus, equipment, and machinery fixed to the earth by foundation or structural support that is used for making outward supply of goods or services. It includes such foundations and supports but excludes land, buildings, and civil structures, telecommunication towers, and pipelines laid outside factory premises.
Thus, businesses investing in plant and machinery can avail input tax credit, while expenditure on construction of office buildings, warehouses, or other immovable structures remains blocked.
Practical Illustration
If a company engages a contractor to construct a new head office, the GST paid on works contract services for this construction cannot be claimed as input tax credit. However, if the same company sets up a new production line in its factory and incurs expenditure on installation of heavy machinery with structural supports, the tax paid on such works contract services will be eligible for credit.
Construction on Own Account
Section 17(5)(d) further restricts credit on goods or services used for construction of immovable property on own account, even if used in the course or furtherance of business. This means that even when a business undertakes construction activity directly without involving a contractor, the input tax credit on such goods and services will not be allowed if the resulting property is immovable.
This provision ensures that businesses cannot circumvent the restriction on works contract services by procuring materials and services separately and executing the construction themselves.
Illustration of Own Account Restriction
Suppose a company decides to build a guest house for visiting directors and purchases cement, steel, and other construction materials directly. Even though the guest house is for business use, the GST paid on these inputs will not be eligible as credit since the property is immovable and the construction is on its own account.
Business Implications of Construction Restrictions
The denial of credit on works contract services and construction of immovable property significantly impacts sectors such as real estate, infrastructure, and corporate offices. For businesses, these costs become part of the project cost and cannot be offset against output tax liability.
Developers of residential or commercial properties, in particular, face challenges as they incur significant GST on input materials and services, which becomes embedded in the overall cost. Similarly, companies investing in large office buildings or commercial spaces must account for higher effective costs due to blocked credit.
Comparison between Plant and Machinery and Immovable Property
A recurring area of litigation is distinguishing between plant and machinery and immovable property. Courts and tax authorities have often been called upon to decide whether certain assets should be treated as plant and machinery or as immovable property. The classification directly impacts credit eligibility.
For example, heavy industrial machinery that requires civil foundation may qualify as plant and machinery, thereby allowing credit. On the other hand, items like office buildings, showrooms, or employee accommodation are treated as immovable property, resulting in blocked credit.
Employee Welfare and Input Tax Credit Challenges
The provisions under Section 17(5) relating to employee welfare highlight the tension between statutory obligations and discretionary benefits. While credit is permitted where employers are required by law to provide facilities such as canteens or health insurance, it is blocked where the benefit is voluntary or personal in nature.
Businesses therefore need to carefully evaluate which employee-related expenses qualify for credit. Documentation of statutory requirements becomes critical to defend claims in case of departmental audits. Many companies maintain detailed records of obligations under labor laws to ensure that credit on canteen or insurance services is not disputed.
Compliance and Accounting Perspective
From a compliance perspective, businesses must establish robust systems to segregate eligible and ineligible input tax credit. Since blocked credit forms part of operating cost, accurate classification is essential for financial reporting and tax planning.
Companies typically adopt strategies such as:
- Maintaining separate ledgers for blocked credit
- Reviewing supplier invoices to identify restricted categories
- Establishing internal controls for employee-related expenses
- Seeking legal opinions on ambiguous cases such as renovation costs or plant and machinery classification
By following systematic practices, businesses minimize the risk of wrongful credit claims and the associated liabilities.
Goods and Services under the Composition Scheme
Clause (e) of Section 17(5) specifies that no input tax credit is allowed on goods or services or both on which tax has been paid under Section 10 of the CGST Act, also known as the composition scheme.
Rationale behind Restriction
The composition scheme was introduced to simplify compliance for small taxpayers by allowing them to pay tax at a fixed rate on turnover without the requirement of maintaining elaborate records or availing credit. Since suppliers under this scheme cannot charge tax separately from recipients, the question of credit availability does not arise.
The law ensures that recipients of supplies from composition taxpayers cannot claim input tax credit on such purchases, thereby maintaining the simplicity of the scheme and preventing misuse.
Impact on Businesses
For businesses procuring goods or services from composition dealers, the GST paid becomes part of the cost. They cannot offset it against output tax liability. This discourages larger entities from relying heavily on composition dealers for supplies, ensuring that the scheme remains limited to its intended small-scale user base.
Example of Composition Restriction
If a restaurant operating under the composition scheme sells food to a registered business, the tax paid under the scheme cannot be claimed as input tax credit by the recipient. Instead, it becomes part of the expense borne by the purchasing business.
Goods or Services Received by a Non-Resident Taxable Person
Clause (f) of Section 17(5) restricts input tax credit on goods or services received by a non-resident taxable person, except on goods imported by them.
Understanding Non-Resident Taxable Persons
A non-resident taxable person refers to any individual or entity that occasionally undertakes transactions involving the supply of goods or services in India but has no fixed place of business or residence within the country. Such persons are required to register under GST and comply with tax obligations when carrying out taxable activities in India.
Restriction on ITC
The law denies credit to non-resident taxable persons on goods or services received locally in India. However, the restriction does not apply to goods imported by them, as the government recognizes imports as legitimate business inputs subject to customs duty and integrated GST.
Business Impact
This provision ensures that non-resident taxable persons meet their tax obligations without creating opportunities for credit leakage. It also ensures that only actual imports intended for business use are considered for input credit, reducing the scope of manipulation in cross-border transactions.
Example of Non-Resident Restriction
Suppose a foreign company temporarily registers as a non-resident taxable person in India to supply specialized equipment at an exhibition. If the company hires local services for event management, the GST paid on such services cannot be claimed as input tax credit. However, if the company imports machinery for display, the integrated GST paid at the time of import would be eligible for credit.
Goods or Services Used for Personal Consumption
Clause (g) of Section 17(5) specifies that input tax credit is blocked on goods or services or both used for personal consumption.
Objective of the Restriction
Input tax credit is intended for business-related expenses and not for personal use. Allowing credit on personal consumption would distort the system by extending tax benefits to non-business expenditures. By clearly blocking such credit, the law ensures that GST functions strictly as a tax on business transactions.
Examples of Personal Consumption
- A business owner purchasing household furniture in the name of the company but using it in their personal residence.
- Company funds being used for employee gifts not related to statutory obligations.
- Services such as family vacation bookings made under the company’s GST registration.
In all these cases, the tax paid is considered part of personal consumption and therefore blocked from input tax credit.
Business vs Personal Use Distinction
A recurring challenge arises when distinguishing between personal and business use. For instance, purchasing laptops for employees is a business expenditure and credit is admissible, but purchasing high-value electronics for personal gifting is considered personal use. Companies are required to maintain proper documentation to substantiate business usage to claim credit.
Goods Lost, Stolen, Destroyed, or Given Away
Clause (h) of Section 17(5) blocks input tax credit on goods lost, stolen, destroyed, written off, or disposed of by way of gift or free samples.
Reasoning Behind the Restriction
The underlying principle is that input tax credit is only admissible when goods or services are used for making taxable outward supplies. If goods are lost, destroyed, or otherwise disposed of without consideration, they no longer form part of taxable supply and therefore do not qualify for credit.
Practical Scenarios
- Goods lost during transportation due to accidents or theft – input tax credit is blocked.
- Stock destroyed by fire or natural calamity – credit cannot be claimed on such goods.
- Promotional free samples given to customers – tax paid on such goods is not eligible for credit.
- Gifts distributed during festivals by companies – credit remains blocked even if the expense is related to business promotion.
Impact on Business Practices
This restriction has significant implications for sectors like FMCG and pharmaceuticals, where free samples and promotional goods are a common practice. Businesses must factor in the GST cost of such goods as part of marketing expenditure rather than expecting relief through credit.
Accounting and Documentation
Proper records of destroyed or written-off goods must be maintained as part of compliance. During audits, tax authorities often scrutinize such entries to ensure that no ineligible credit has been claimed.
Tax Paid under Specific Penal Provisions
Clause (i) of Section 17(5) states that input tax credit cannot be claimed on any tax paid in accordance with Sections 74, 129, and 130 of the CGST Act.
Explanation of Relevant Sections
- Section 74 deals with tax not paid, short paid, or erroneously refunded due to fraud, willful misstatement, or suppression of facts.
- Section 129 relates to detention, seizure, and release of goods and conveyances in transit.
- Section 130 covers confiscation of goods or conveyances and levy of penalties.
The common thread among these provisions is that they address fraud, non-compliance, or penal actions. Allowing input tax credit in such cases would effectively reward non-compliance, which is why the law expressly prohibits it.
Business Consequences
Companies found guilty under these sections not only face additional tax liabilities but also lose the opportunity to claim credit on taxes paid. This increases the overall financial burden and acts as a strong deterrent against fraudulent practices.
Illustrative Example
If a business is caught transporting goods without proper documentation and pays tax under Section 129 for release of the goods, the GST paid cannot be claimed as credit. Similarly, if goods are confiscated under Section 130 and tax is levied as part of penalty proceedings, such tax payments remain outside the scope of credit.
Broader Implications of Blocked Credit
The blocked credit provisions discussed in clauses (e) to (i) reflect the broader philosophy of GST law: to allow input tax credit only for genuine business expenses directly linked to taxable outward supplies.
Preventing Misuse
By restricting credit on personal consumption, gifts, lost goods, or penal tax payments, the law prevents misuse of the input tax credit mechanism. It ensures that the credit chain is preserved only for legitimate business transactions.
Increasing Business Costs
While these restrictions maintain the integrity of the system, they also increase business costs in certain situations. For example, marketing activities involving free samples or gifts attract tax costs that cannot be neutralized through credit. Similarly, investments in real estate or immovable property carry a higher tax burden due to ineligible input credit.
Importance of Documentation
Given the complexities of Section 17(5), businesses must focus on strong documentation and compliance frameworks. Proper classification of expenses, detailed record keeping, and periodic internal audits help in ensuring that blocked credits are correctly identified and not claimed inadvertently.
Sectoral Impact
- FMCG and Pharmaceuticals: High impact due to frequent use of promotional goods and free samples.
- Real Estate and Construction: Significant cost implications due to restrictions on works contract and immovable property.
- Multinational Companies: Complexities in distinguishing between business expenses and employee benefits.
- Logistics and Transport: Exposure to risks under Section 129 in case of documentation lapses during goods movement.
Conclusion
The introduction of the goods and services tax in India was a landmark reform intended to create a unified indirect tax framework, minimize the cascading of taxes, and facilitate the seamless flow of input tax credit across supply chains. While the credit mechanism is one of the strongest features of GST, the legislature also recognized the need to impose boundaries to protect revenue, prevent misuse, and ensure that credit is available only in relation to genuine business activities. Section 17(5) of the CGST Act embodies these boundaries by clearly listing down categories of goods and services where input tax credit is blocked.
Discussion of Section 17(5) highlights how the law distinguishes between business-related expenses that contribute to taxable supplies and those which fall outside the scope of commercial utility. The denial of credit on motor vehicles, vessels, food and beverages, membership subscriptions, and employee travel benefits reflects an effort to prevent indirect benefits on personal or luxury consumption. Similarly, restrictions on works contracts and immovable property ensure that tax benefits are not unduly extended to capital assets not directly linked with day-to-day business supply chains.
The provisions covering goods and services from composition dealers, inputs used by non-resident taxable persons, personal consumption, lost or destroyed goods, gifts, and penal tax payments further reinforce the principle that input tax credit must strictly align with taxable business use. They also act as a safeguard to discourage evasion, fraud, and non-compliance while maintaining transparency in the system.
From a business perspective, Section 17(5) creates an added layer of responsibility. Organizations must carefully analyze their procurement patterns, distinguish between eligible and ineligible credits, and establish robust internal controls for compliance. Sectors like construction, FMCG, hospitality, and pharmaceuticals feel the direct impact of blocked credit provisions due to the nature of their operations, making tax planning and documentation even more critical.
Overall, Section 17(5) strikes a balance between allowing input credit as a fundamental feature of GST and restricting it in cases where business nexus is weak or potential misuse is high. While blocked credit provisions increase costs in specific situations, they are essential for preserving the integrity of the input credit system. For taxpayers, the key lies in understanding the nuances of the law, maintaining accurate records, and ensuring that credit claims are made only in genuine cases where the linkage with taxable output supplies is clear and defensible.