Thursday, November 20, 2025

The Most Exhaustible Professional Guidance Note On ITC For Leases, Repairs & Renovation

By CA Surekha S Ahuja

GST jurisprudence on leasing of industrial and commercial premises has reached a decisive turning point. With the Agartas AAAR ruling, authorities have made it very clear that input tax credit will not be protected merely because GST was paid—it survives only when the transaction structure, contractual wording, cost allocation, and asset treatment all align with the statutory framework.

What increasingly defeats ITC claims is not the law itself, but misaligned leases, unclear renovation responsibilities, group-company arrangements that appear artificial, and civil works inadvertently falling into the Section 17(5) net.

This guidance note is designed to be the most exhaustive and practical reference on the web. It brings together:

  • the complete legal framework under Sections 16, 17(5), and Schedule II,

  • the four critical tests every lease must pass,

  • the exact failure triggers highlighted in Agartas,

  • a fully practical cost allocation model (who should bear what),

  • an actionable contract-drafting strategy,

  • the rules for repairs, renovations, and capitalisation,

  • the heightened risks where lessor and lessee are from the same group, and

  • the future-proof compliance architecture for unassailable ITC entitlement.

If followed, these principles will ensure that businesses—whether industrial units, warehousing operators, manufacturers, or group entities—can secure and protect full and legally defensible GST input credit on their lease arrangements.

The Legal Foundation: Sections 16, 17(5), and Schedule II

1 Section 16(1): Business Nexus Test

ITC is allowed only when the input is used in the course or furtherance of business.
Lessee must demonstrate:

  • commercial use,

  • direct functional linkage,

  • uninterrupted business occupation,

  • operational dependence on the premises.

2 Schedule II: Lease Classified as a Supply of Service

A valid lease requires:

  • transfer of right to use,

  • exclusive possession,

  • clear enjoyment rights.
    If these are absent, the “lease” may be treated as an internal arrangement—not a taxable supply.

3 Section 17(5): Construction & Immovable Property Restrictions

ITC is blocked on:

  • construction of immovable property,

  • capital improvements,

  • civil works,

  • works contract resulting in immovable property,
    irrespective of whether GST is paid.

4 The Anti-Avoidance Principle

Authorities examine:

  • substance over form,

  • commercial justification,

  • arm’s-length nature,

  • independent operational identity,

  • real business benefit.

This is the test many group-company leases fail.

Lessons from Agartas AAAR: Why ITC Failed

The Agartas ruling provides a practical roadmap of what not to do. The ITC failed because:

  1. The agreement did not establish genuine business purpose.

  2. Rent was not linked to market realities, indicating non-commercial intent.

  3. Use, possession, and operational control were not clearly evidenced.

  4. Structural and non-structural works were mixed, with civil improvements charged to the lessee.

  5. Renovation documentation lacked clarity, especially around who owned and benefited from the improvements.

  6. Group-company dynamics created an appearance of internal shifting rather than a real lease.

  7. Invoices did not match the legal intent, blurring ownership and usage of improvements.

  8. Capitalisation patterns indicated building improvements, triggering Section 17(5).

All these failures are preventable.

Repairs, Renovation & Capitalisation: Full ITC vs Blocked ITC

1 ITC Allowed (Safe Category)

These do not create immovable property:

  • painting and refurbishing

  • minor repairs, patchwork, restoration

  • electrical work not embedded permanently

  • modular partitions

  • air-conditioners (non-ducted), HVAC movable units

  • IT, CCTV, networking and surveillance equipment

  • furniture and fixtures

  • safety equipment

  • housekeeping, security, AMC

  • industrial machinery and equipment

  • movable office infrastructure

These may be capitalised as Plant & Machinery or Furniture, ensuring Section 17(5) does not apply.

2 ITC Blocked (High Risk Category)

These create or improve immovable property:

  • structural changes or civil reconstruction

  • new walls or demolition

  • flooring replacement, re-tiling, cementing

  • plumbing, drainage, heavy electrical rewiring

  • expansion, alteration, or enhancement of the building

  • construction of mezzanine floors

  • ducted HVAC systems

  • permanent fixtures that increase building life

  • any work capitalised into Building / Immovable Property

Under Section 17(5), ITC is barred even if the expense is business-related.

Cost Allocation Framework: Who Should Bear What?

The single most important factor for ITC survival is which entity bears which cost.

1 Costs the LESSOR Must Bear (to protect ITC)

Lessor must pay for all immovable property-related works:

  • civil works

  • structural changes

  • major repairs

  • fire and safety building upgrades

  • electrical load enhancement on building side

  • plumbing & drainage changes

  • construction of walls, floors, roofs

  • renovation impacting structural integrity

  • capital improvements

  • waterproofing

  • fixed ducted HVAC systems

If the lessee pays, ITC is blocked.

2 Costs the LESSEE Can Safely Bear (Full ITC)

Lessee can pay for all operational, movable, or non-civil works:

  • interiors not attached permanently

  • modular partitions

  • AC units (movable)

  • furniture & fixtures

  • IT equipment, CCTV, networking

  • safety equipment

  • AMC, maintenance, housekeeping

  • minor repairs

  • branding and signages

  • consumables

These are business inputs, and ITC is allowed.

3 Shared Costs — Only with Strict Clauses

Cost sharing must clearly state:

  • no creation of immovable property,

  • no enhancement to building value,

  • lessee’s share is purely for movable fixtures or operational enhancements.

Special Rules for Group-Company Leasing (High Scrutiny Zone)

When lessor and lessee are related, authorities examine:

1 Arm’s-Length Rent

Mandatory valuation report.

2 Business Evidence File

  • operations photographs

  • staff deployment

  • utility usage proofs

  • production or service data

  • layout mapping

3 Independent Identity of Lessee

  • separate signage

  • separate access

  • separate billing

  • separate employees

4 No cross-charging of civil improvements

Any civil work billed to lessee becomes a 17(5) ITC block.

5 Matching capitalization

If the lessee capitalises work as “Building,” ITC is gone—even if technically movable.

Trigger Points That Lead to ITC Disallowance

These must be eliminated:

  1. Lessee paying for civil or structural work

  2. Rent far below market value

  3. Absence of clear operational independence

  4. Shared ownership of improvements

  5. Internal adjustments between group entities

  6. Lack of documentation showing commercial use

  7. Capitalisation patterns inconsistent with law

  8. No revenue linkage to the premises

  9. Signage or possession not evident

  10. Invoices not aligned with agreement clauses

Any one of these can make the transaction vulnerable.

Future-Proof Strategy: How to Make ITC Defensible

1 Before Agreement

  • Draft GST-compliant lease

  • Finalise cost allocation

  • Attach layout and usage plans

  • Rent benchmarking report

  • Separate lists for movable vs immovable items

2 During Tenancy

  • Utility bills in lessee’s name

  • Photo and usage evidence

  • AMC and maintenance documentation

  • Proper capitalization

  • GST registration showing premises

3 Annual Review

  • Review all renovation costs

  • Reconfirm classification under Plant & Machinery

  • Recheck documentation for business nexus

  • Ensure consistency with financial statements

Contract Clauses That Protect ITC (Mandatory)

  1. Business Purpose Clause
    Specifies commercial and operational use.

  2. Possession & Control Clause
    Lessee has full operational access and signage.

  3. Cost Allocation Clause
    Lessor handles immovable property; lessee handles moveables.

  4. Renovation Clause
    Lessee will not create immovable property.

  5. ITC Protection Clause
    Both parties shall structure transactions to comply with Section 17(5).

  6. Valuation Clause
    Rent based on arm’s-length valuation.

  7. Capitalisation Clause
    Both parties will classify assets in line with GST law.

  8. Compliance Clause
    Premises declared as place of business.

The core message from Agartas AAAR and the broader GST jurisprudence is simple:

ITC on leased premises is not determined by who pays the GST—it is determined by the nature of the work, the structure of the lease, and the economic substance of the arrangement.

When the lease is drafted correctly, when civil works remain with the landlord, when the tenant restricts itself to movable and operational enhancements, and when documentation clearly establishes commercial use—the ITC is not just admissible, it is legally unassailable.

For businesses—especially those within the same group—the path forward is to adopt this new GST architecture:
clean drafting, clean cost allocation, clean capitalization, clean documentation, and clear business purpose.



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