Enabling ITC on Construction Inputs for Commercial Leasing in India

The authors are Umang Binayakia and Samparna Tripathy, Penultimate Year Students (3 Year LLB.Hons) from National Law University Odisha.

1. Introduction 

The GST (Goods and Service Tax) framework in India today denies ITC (Input Tax Credit) for expenses incurred in construction inputs for businesses involved in commercial leasing of real estate (such as office parks, malls, and warehouse facilities). However, since leasing is a taxable supply, developers need to pay GST to the government on the rents charged. This double taxation escalates the cost of construction for developers, who then pass it down to their tenants. Between 2022 and 2025, rentals in India’s top six cities grew by 18.35%, [1] a trend partly attributable to the escalated input costs borne by developers. 

Against this backdrop, a wave of relief was brought by the verdict of the Supreme Court in Chief Commissioner of CGST vs Safari Retreats Pvt. Ltd, which provided ITC to construction input in construction projects being leased or rented brought a wave of relief to the developers. This did not last long as a legislative amendment practically overturned the decision. The paradox is that though it appreciates leasing as a useful taxable supply, it prevents the same ITC that it requires to support it. Such inconsistencies can discourage investment, adversely affect foreign inflows, and stifle job creation in an industry that is estimated to contribute up to 13% of the GDP in 2025. Besides, there is also the question of restrictive ITC provisions encouraging informal transactions. [2] 

Considering that such denial of ITC on construction inputs for commercial leasing raises fundamental questions of equity and economic efficiency within the GST framework, it warrants a closer legal and policy scrutiny.

2. The Conceptual Architecture of GST & ITC

The true promise of GST was taxing value addition while preventing cascading tax. In the same breath, ITC is not a concession but a structural feature essential to GST’s consumption based character. [3] However, Section 17(5) of the CGST Act carves out exceptions to this principle by blocking ITC in specified situations. Among these, Section 17(5)(d) denies ITC on goods and services used in the construction of immovable property (other than “plant and machinery”) when such property is capitalized, even if such property is used for business. This leaves the sector of construction for commercial leasing in a lurch, wherein output (i.e. leasing or renting of commercial property) is taxed under GST but no claim of ITC can be made on construction inputs. The tension inherent in such a mismatch came under scrutiny in the case of Safari Retreats Private Limited in the Orissa High Court in 2019 and Supreme Court in 2022. 

3. The Safari Retreats Case: The Controversy around ITC on Construction Inputs 

1. Statutory Context and Factual Background: 

Safari Retreats constructed a shopping mall with the purpose of commercially leasing out its units. During construction, it incurred approximately ₹34 crores as GST on construction inputs, which it sought to avail as ITC. Once the construction of the mall was completed and its units were leased out, Safari Retreats was liable to pay to the government GST on such rental income accrued under Section 7(1) read with Schedule II of the CGST Act. When Safari Retreats sought to set off ITC against its outward GST liability, the authorities denied the claim citing Section 17(5)(d) of CGST Act. 

2. Revenue’s Justification for Denial of ITC on Construction Inputs

The denial of ITC on construction inputs under Section 17(5)(d) of the CGST Act was justified by the revenue authorities on three principal grounds: 

1. Capitalisation of Immoveable Property: Once a building is completed and capitalized, it is retained as an asset in the business with enduring benefits rather than being “supplied” further as a production input (as in the case of plant and machinery). Hence, allowing ITC on construction of such buildings would be principally unfair as it would be equivalent to subsidizing the cost of creating one’s own assets. 

   
   

2. Alleged Break in the Credit Chain: Even though the building is later used for supplying taxable services such as leasing, the revenue authorities argued that at the time of construction itself, there is no taxable output against which input credits can be matched. When the building is later leased out, the taxable event is the service of renting (under Schedule II Entry 2(b) of the CGST Act) and not the construction itself. Since the input tax on construction and output tax on leasing are disconnected in time and nature, there is no provision for claiming ITC here. On the contrary, when a builder builds for sale during construction itself, a taxable supply of construction service is created. Since the link between the taxes on construction inputs and construction services rendered isn’t broken, ITC on construction expenses is permitted in such cases. Hence, in essence, ITC on construction inputs is blocked in self use/rental model and allowed in sale for construction model. 

   
   

3. Risk of Tax Evasion and Administrative Complexity: Since construction involves multiple layers (suppliers, subcontractors, main contractors, developers), revenue authorities fear that tracking whether each input is legitimately linked to taxable output could be resource intensive and difficult to monitor. This increases the risk of fraud. Also, in the absence of any taxable output to set off the ITC, the accumulated input credit would have to either be refunded by the government or left on the books unused. Hence, a blanket ban is justified to maintain the integrity of the GST system. 

3. Constitutional Challenge to ITC Denial under Article 14

Safari Retreats argued that Section 17(5)(d) of CGST Act denies ITC on arbitrary and irrational grounds, thus violating Article 14 of the Indian Constitution. First this section mets out the same tax treatment to two different business models i.e. construction for sale and construction for lease. In construction for sale, once a completed building (i.e. where the completion certificate is already issued) is sold to the buyer, the developer incurs no output GST on that sale (excluded under Schedule III of the CGST Act). In construction for lease, the building is tied to an ongoing taxable supply in the form of rents. For offsetting any ITC on construction inputs, there is no outward tax liability in the former case but it very much exists in the latter. Also, the nature of asset utilization is different. The asset is alienated from the developer in a sale but retained by the landlord in a lease. Hence, clubbing these two unlike models is an arbitrary classification. 

Moreover, prohibiting ITC for construction on lease has no rational nexus with the purpose of the law (i.e. prevent cascading and promote tax neutrality). In fact, it does exactly the opposite. It forces the landlord to treat GST paid on construction inputs as a part of the total cost of construction and then recover it from tenants by charging inflated rents. When GST is further levied on this inflated rent, it is basically taxing not just the value added via the leasing service but also the embedded, unrecoverable tax on the construction inputs. This cascading effect of “tax on tax” defeats the entire purpose of GST. 

4. Stance of the Orissa High Court

The Orissa High Court held that the construction of the mall and renting of shops are two stages of one commercial activity. Denying ITC on construction inputs while GST is charged on rental output breaks the chain of credit. This leads to double taxation which frustrates the very purpose of the GST Act. It also found the blanket ban on ITC for all construction of immovable property regardless of end use (i.e. sale and lease) arbitrary (i.e. violative of Article 14) since the economic and tax treatments of both categories differ. In fact, the court relied on the SC ruling in Collector v. Modi Rubber [4] to establish that any credit provisions should be interpreted liberally in favour of the assessee. In that case too, the government had adopted a restrictive position on Modvat/Cenvat credit fearing misuse by manufacturers. However, the SC had pushed back stating that ITC is not a concession but a structural entitlement meant for ensuring fairness and neutrality in indirect taxation. Therefore, the Orissa High Court read down Section 17(5)(d) allowing ITC in construction for leasing. [5] 

5. Stance of the Supreme Court of India 

When this case came to the SC in 2022, a different question of law came to the fore. Under Section 17(5)(d) of the CGST Act, twin exceptions apply where ITC is allowed on expenses incurred for inputs for a construction of an immovable property (1) in the nature of “plant or machinery” or (2) not on his own account. 

Relying on earlier precedents such as CIT vs Taj Mahal, [6] Safari Retreats argued that their shopping mall was not just a building but a “plant” because it was a structure specifically designed to perform technical/commercial functions integral to the business of leasing. The tax authorities opposed this argument on the grounds that the intention of the legislature was to allow that exception for ITC for “plant and machinery” used in other places of the Act and that the use of “or” instead of “and” was a drafting error. However, the assessees pointed out that the earlier model GST law used “and” in Section 16(9)(d) which was changed to “or” in its corresponding Section 17(5)(d) in the final GST Act. This change could be interpreted as a clear expression of parliamentary intent to use “or” instead of “and” in the final version. This line of reasoning of the assessee was accepted by the SC. The court then stated that malls could qualify as “plant” on a case by case basis if they satisfied the functionality test. 

The court also noted that when a property is constructed to be leased or rented, it is not “on his own account” which includes personal use (ex: building an office for assessee’s internal operations) or business setting use (ex: a hotel or cinema where the structure is merely a setting for business). In contrast, a mall is an active asset or instrument without which the taxable supply of leasing cannot take place. Hence, ITC should be allowed to flow in the case of construction inputs for a mall. 

6. Legislative Overruling of the Safari Retreats Judgement

The relief provided for allowing ITC on construction for leasing in the Safari Retreats judgement was short lived. The 55th GST Council meeting recommended a change in Section 17(5)(d) of the Act via Clause 119 of the Finance Bill, 2025. The expression “plant or machinery” was substituted by “plant and machinery” retrospectively from July 1, 2017. An added explanation stating that this section has always meant “plant or machinery” as “plant and machinery” overrules any prior judgements, orders or decrees (including Safari Retreats) implying the contrary. This means that ITC for construction on malls, warehouses, or similar structures that were previously argued to be “plant” under the functionality test is not allowed unless they satisfy the stricter “plant and machinery” requirement. In addition, the tax authorities have also filed a review petition before the SC in Jan 2025 signalling their intent to challenge the functional interpretation of “plant or machinery”. [7] 

This legislative intervention has left the broader policy question surrounding ITC on construction inputs for commercial leasing largely unaddressed while effectively closing off the alternative route for judicial interpretation. In this backdrop, it becomes necessary to examine how other VAT/GST jurisdictions treat similar construction related credits, thus resolving the inherent tension between revenue protection and tax neutrality. 

4. Comparative Jurisprudence of ITC on Construction Inputs 

1. United Arab Emirates (UAE) 

• ITC Eligibility: In UAE, VAT registered lessees and commercial lease companies can recover input vat incurred on expenses related directly to their taxable business operations, including maintenance and construction of commercial premises, property management and utility services, and professional and agent charges. To recover input VAT, the property has to be utilized for VAT-taxable activities (i.e. commercial leasing and not exempt residential leasing). 

  
  

• Safeguards against misuse: Under the Capital Asset Scheme (Article 60 of the VAT Decree Law), if a VAT registered business constructs a high value capital asset (ex: a commercial building costing more than AED 5 million excluding VAT), it can claim the entire input VAT upfront in the first VAT return itself. However, the asset usage is tracked for its useful life (i.e. 10 years for buildings and real estate) and in case of any changes, adjustments in the reclaimed VAT are made. 

  
  

• Administrative feasibility: All of these data points are recorded in the Capital Asset Register (CAR) maintained by the business. This allows the Federal Tax Authorities (FTA) to audit how VAT was handled throughout the asset’s life. 

Lessons for India

The UAE’s Capital Asset Scheme offers upfront ITC on high-value assets while ensuring long-term adjustments based on actual use, balancing liquidity for businesses with revenue protection. For India, this model highlights the benefits of easing cash flow and preventing cascading taxes. However, implementing decade-long asset tracking in India’s fragmented, SME-heavy economy under a dual GST structure would pose significant administrative challenges and compliance burdens. Instead of going for universal adoption, a threshold based or project specific adaptation could be evaluated on a pilot basis for India. 

2. New Zealand

• ITC Eligibility: Under Section 8 of New Zealand’s GST Act, GST is levied on taxable supplies. Unless the commercial lease agreement specifies GST-inclusive rent, commercial lease rent is normally charged at the current 15% GST rate. Under Section 20 of the same Act, registered persons can claim input tax credit on goods and services used in making such taxable supplies.  

  
  

• Safeguards against misuse: Rather than relying on intensive GST specific controls, New Zealand supplements its GST regime with income tax depreciation deductions on commercial assets. Commercial property owners can claim depreciation deductions for their buildings usually spread over 5 years. Such a relief partially offsets the cost of GST outflow for landlords. Landlords having annual turnover exceeding NZD 60,000 are required to be GST registered. They have an obligation to charge GST on rents, file GST returns, and claim input GST on expenses related to property. [8] 

  
  

• Administrative Feasibility: Leasing of commercial property is taxable or excepted and the Tax Council Office has determined that premises used as commercial accommodation by hostels and boarding houses, qualifies as a commercial dwelling as regards GST. [9] 

Lessons for India

New Zealand’s unitary GST system with a single rate and centralized administration simplifies ITC tracking and minimizes fraud risk. While this approach ensures transparency and ease of compliance, replicating it in India is difficult due to the sheer volume of invoices, risk of fake transactions, and the complexity of a dual GST regime. Achieving similar simplicity would require structural reforms and strong consensus, which is challenging in India’s diverse fiscal landscape. However, a key takeaway for policymakers is evaluating complementary tax measures outside GST (such as depreciation or investment linked reliefs) that can partially offset construction related tax burdens without expanding ITC entitlements. 

3. Japan

• ITC Eligibility: Under Japan’s national consumption tax regime, businesses can claim input tax credit (ITC) on taxable purchases, including construction materials for commercial properties, if used for taxable activities.[11] Completed buildings are depreciable assets, and consumption tax paid on acquisition or construction is creditable when supported by qualified invoices.[12] 

  
  

• Safeguards against misuse: Japan’s Qualified Invoice System (effective October 1, 2023) requires suppliers to register as Qualified Invoice Issuers (QIIs) and issue invoices with specific details: QII registration number, transaction date, description, taxable amount, tax rate (10%), and tax amount. Electronic record-keeping under the amended Electronic Books Preservation Act (from January 2024) enables digital audits.

  
  

• Administrative Feasibility: Japan’s National Tax Agency keeps businesses on their toes by proactive, routine audits. Small businesses below 10 million yen turnover are exempt from tax but often register as QIIs due to market preference. These measures ensure transparency and accountability in ITC claims.[13] 

Lessons for India

Japan’s approach underscores that ITC integrity depends on strong invoice-based compliance, digital record-keeping, and market-driven incentives for supplier registration. Rather than resorting to blanket ITC prohibition in capital intensive sectors such as commercial real estate, India should pivot to a framework that combines qualified invoicing, electronic audit readiness, and indirect compliance pressure through buyer-supplier linkages. This would enhance transparency, reduce litigation, and align GST with its core principle of seamless credit.

4. European Union 

• ITC Eligibility: In EU countries such as Germany (Section 13b of the German VAT Act (UStG)[14]) and France (“Autoliquidation”[15]), reverse charge mechanism (RCM) is applicable wherein the buyer and not the supplier is responsible for calculating and paying VAT. This is particularly useful in construction where there may be many small or foreign vendors who may not be VAT registered. This system of RCM where the buyers self-report both output and input VAT in the same returns ensures that buyers are not penalized with blocked ITC because their suppliers did not comply. Structured audits help scrutinize compliance to VAT returns, invoice integrity, and reverse charge use.[16] In case of errors identified during audits, penalties are from per invoice to 40% of VAT payable.[17] 

  
  

• Safeguards against misuse: Member states conduct Annual Adjustment Audits under Article 187-191 of the VAT Directive to reconcile ITC claims against actual use of assets of capital nature (such as commercial premises) during the 5–20 year adjustment period.[18] If the actual use shifts from taxable (i.e. commercial leasing) to exempt (i.e. residential), the corresponding ITC is clawed back. 

  
  

• Administrative Feasibility: While receipts are digitally signed and stored for 7 years in France, they are auto-exported in a timestamped format from POS devices in Germany.[19] The secure digital trail means that tax authorities can reconstruct business activity and catch any dubious bills issued by subcontractors or suppliers in the value chain. In a few EU countries, there are continuous transaction control (CTC) systems (ex: Spain’s Verifactu and Italy ‘s SDI) which require businesses to submit invoices in real-time to prevent circulation of fake or unreported invoices. [20] 

  
  

Lessons for India

EU experience shows that a robust reverse charge mechanism (RCM) can prevent ITC blockages caused by supplier non-compliance, especially in sectors like construction with fragmented subcontracting chains. India could take a leaf out of this playbook to realize that long-term ITC adjustments for capital assets and audit-based enforcement, rather than ITC denial, can possibly reduce litigation, enhance compliance, and uphold GST’s goal of a seamless credit chain.

5. Way Forward for India 

   
   

Ultimately, the debate on ITC to commercial leasing construction inputs is not to renew a fiscal concession, but to bring back sanity to the GST system. Safari Retreat's experience proves the ineffectiveness of fixing structural design flaws by relying solely on judicial interpretation, and comparative practice indicates that revenue protection need not come at the cost of tax neutrality. An indexed statutory solution, one that will allow ITC to be used to a well-defined form of commercial usage but introduce a strict set of compliance protection measures, would be a more sustainable solution than continued recourse to blanket exclusions.In light of the above, the following points are set out as recommendations:

1. Refining Section 17(5)(d): Allowing ITC for Commercial Use: Amend Section 17(5)(d) to (i) clarify ambiguous statutory terms such as "or/and," and (ii) explicitly include immovable property constructed and used exclusively for taxable outward supplies such as leasing of commercial properties, malls, office complexes, warehouses, and other business assets within the scope of "plant and machinery," to ensure certainty and fair treatment consistent with global standards.

   
   

2. Threshold-Based ITC and Compliance Safeguards: India's tax reform efforts could begin with amending Section 17(5) of the CGST Act to allow ITC on high-value commercial projects, for instance those with construction costs exceeding Rs. 50 crore and include smaller business in a phased wise implementation approach from time-to-time, as the government may deem fit. Drawing inspiration from the UAE's model, such projects could be mandated to maintain a CAR on the GSTN portal, capturing invoices, asset usage details, and annual adjustments over a ten-year period. In the case of blended projects involving both commercial and residential components, a safe harbour clause could be introduced to minimise disputes.

   
   

3. Sustainability-Linked Incentives: Environmental sustainability may also be incentivised by offering an additional ITC benefit of 2-3% for projects certified by bodies such as the Indian Green Building Council. This would encourage the use of green construction materials and sustainable design practices. Such an approach draws parallels with New Zealand’s depreciation benefits and could help offset existing ITC restrictions on leasing, while supporting India’s 2070 net-zero emissions target and mitigating expected slowdowns in commercial leasing activity.

   
   

4. Supply-Chain Compliance and Administrative Support: Since developers are dependent on compliance by smaller subcontractors to claim ITC, it would also be necessary to ensure that such SMEs are brought within the formal GST framework. Pilot initiatives could be explored, including the introduction of a free GSTN mobile application offering personalised guidance on ITC rules, automated return filing, and real-time error flagging to reduce compliance gaps in GSTR-3B filings.

   Alternatively, in select urban centres, a limited pilot of reverse charge compliance placing responsibility on developers, inspired by the German model could be tested. These measures could be complemented by market-driven incentives such as preferential access to government contracts or low-cost financing for verified e-invoice compliance, drawing inspiration from Japan's QIS.

   
   

5. Enforcement and Transitional Measures: The proposed framework could be supported by simplified circulars clarifying ITC eligibility and a six-month amnesty for rectifying past compliance errors. India has already made significant progress through tools such as GSTR-2B, auto-drafted ITC statements, and AI-based fraud detection systems. Building on this foundation, a more proactive enforcement approach through real-time monitoring, fiscalized receipts, and periodic audits could further address tax evasion while preserving the GST regime's objective of neutrality.

---

References

1. Top six cities sees average growth of 18% in office space rents in three years’ (ET Realty, 10 November 2025) 

   https://realty.economictimes.indiatimes.com/news/commercial/indias-office-space-rentals-surge-18-growth-in-top-cities/121373351

2. India Brand Equity Foundation, Indian Real Estate Industry (2025) https://ibef.org/industry/real-estate-india  accessed 3 October 2025.

3. National Academy of Customs, Indirect Taxes & Narcotics, ‘Input Tax Credit – GST: Module 1’ (e-Book, 26 March 2025) https://www.nacin.gov.in/Documents/e-Books/ITC-V1-26-03-2025-F3.pdf

4. Collector v. Modi Rubber (1999) 2 SCC 361 

5. Safari Retreats Private Limited and Ors. Vs. Chief Commissioner of Central Goods & Service Tax and Ors. MANU/OR/0322/201.9

6. CIT, Andhra Pradesh v. Taj Mahal Hotel, Secunderabad 1971 SCC 3 550. 

7. Rishab J and Prahalad Sriram, ‘Scope for Legislative Overruling of the Safari Retreats Judgment’ (Bar & Bench, 2025) https://www.barandbench.com/view-point/scope-for-legislative-overruling-of-the-safari-retreats-judgment

8. BH Accounting, Commercial rent and GST: Find out what you need to know as an investor or tenant (BH Accounting blog, 14 May 2025) https://bh-accounting.co.nz/commercial-rent-gst/ accessed 10 August 2025.

9. New Zealand Tax Accountant (Shruti), GST Application on Commercial Dwelling, Residential Establishment, Zero-Rated of the Sale of Land and Reduced Rate of GST (New Zealand Tax Accountant, date not stated) https://taxaccountant.kiwi.nz/index.php/tax-updates/498-gst-application-on-commercial-dwelling-residential-establishment-zero-rated-of-the-sale-of-land-and-reduced-rate-of-gst accessed 10 August 2025.

10. National Tax Agency, Basic Knowledge: Consumption Tax (National Tax Agency) https://www.nta.go.jp/english/taxes/consumption_tax/01.htm accessed 20 August 2025.

11. International Comparative Legal Guides (ICLG), ‘Corporate Tax Laws and Regulations – Japan Chapter’ (Practice Areas, published 12 December 2024) https://iclg.com/practice-areas/corporate-tax-laws-and-regulations/japan accessed 20 August 2025.

12. Eric Margolis, ‘Freelancers aren’t happy with Japan’s new invoice system’ (Japan Times, 25 September 2023) https://www.japantimes.co.jp/community/2023/09/25/how-tos/freelancer-tax-system/ accessed 20 August 2025.

13. Dilara İnal, ‘Japan: New e-Invoice Retention Requirements’ (Sovos, 23 May 2023, last updated 4 August 2023) https://sovos.com/blog/vat/japan-e-invoice-retention-requirements/ accessed 20 August 2025.

14. Umsatzsteuergesetz (German VAT Act), § 13b.

15. Code général des impôts (French General Tax Code), art 283(I).

16. KPMG, Germany – Indirect Tax Guide (KPMG International 2024) https://home.kpmg/xx/en/home/insights/2020/05/germany-indirect-tax-guide.html accessed 16 September 2025.

17. Code général des impôts (French General Tax Code), art 283(I); Loi n° 2015-1785 du 29 décembre 2015 de finances pour 2016, art 88.

18. Council Directive 2006/112/EC of 28 November 2006 on the common system of value added tax [2006] OJ L347/1, arts 187–191.

19. Bundesministerium der Finanzen, Digitale Schnittstelle der Finanzverwaltung für Kassensysteme (DsFinV-K 2.0) (BMF 2020) https://www.bundesfinanzministerium.de accessed 16 September 2025.

20. European Commission, VAT Gap in the EU: Report 2024 (European Union 2024) https://taxation-customs.ec.europa.eu/taxation/vat/fight-against-vat-fraud/vat-gap_en accessed 16 September 2025.