Introduction
Input Tax Credit (ITC) is a tax benefit that allows you to offset the tax you’ve paid on your purchases (inputs) against the tax you need to pay on your sales (outputs). Essentially, if you’re a GST registered manufacturer, agent, supplier, e-commerce operator, or aggregator, you can claim a credit for the tax you’ve paid on the inputs you bought. For instance, let’s consider a manufacturer who paid Rs.2000 as tax on the product they manufactured (output) and Rs.800 on the materials they purchased (input). With ITC, they can claim a credit of Rs.800, reducing the amount they need to pay in taxes of Rs.1200 only.
This article provides comprehensive insights into the concept of ITC reversal under the GST Act of 2017, explaining how businesses can benefit from this tax mechanism and optimize their tax liabilities while staying compliant.
Events under which ITC is required to be reversed
1. Recipient of supply doesn’t pay to the supplier within 180 days of issue of the invoice.
2. In the case of non-payment of tax by the supplier.
3. Claim of credit by a banking company or a financial institution.
4. Recipient of supply uses input goods/services for any purpose other than business (personal purpose), or for exempted supplies.
5. Recipient of supply uses capital goods for any purpose other than business, or for supplying exempted supplies.
6. A person transfers his regular GST registration into Composite Scheme or Cancels GST registration.
Before delving into the specifics of each rule, it’s essential to understand the breakdown of Input Tax Credit (ITC) to optimize its utilization:
Specific Credit: This refers to ITC directly linked to a particular supply, be it taxable, non-taxable, or for personal use. This portion can be clearly identified and separated from the total ITC.
Utilizing Specific ITC: The ITC that is distinctly linked to a taxable supply can be effectively utilized and is accessible in the electronic credit ledger.
Reversal of Wrongly Availed ITC: Taxpayers need to reverse the ITC amount associated with a supply that is non-taxable or utilized for personal consumption, but only if it was initially claimed incorrectly.
Commonly Used Inputs: Some inputs are utilized for both taxable and exempted outputs or even non-business purposes. In such cases, calculating the ITC reversal amount from the common credit is necessary, following guidelines outlined in Rule-42 and Rule-43 (for capital goods).
Let us now delve into the details of the provisions related to each such events separately.
Reversal of ITC in case of Non-payment of consideration by Recipient within 180 days : Rule 37
If a registered person who has availed input tax credit on any inward supply of goods or services or both, but fails to pay the supplier within a period of 180 days, then ITC availed is to be reversed. If part of the invoice is paid then ITC will be reversed on a proportionate basis. In such cases, the amount of input tax credit derived for reversal shall be added to the output tax liability of the registered person. The registered person shall be liable to pay interest not exceeding 18% for the period starting from the date of availing the credit till the date when the amount added to the output tax liability.
Reversal of ITC in case of Non-payment of Tax by the Supplier: Rule 37A
According to Rule 37A, if a taxpayer has claimed input tax credit in their GSTR 3B return but the supplier hasn’t filed the corresponding GSTR-3B return for the tax period linked to that transaction until the 30th of September after the respective financial year, the taxpayer must reverse the credited amount. This reversal should take place when submitting the GSTR-3B return by the 30th of November after the end of that financial year.
Reversal for Claim of Credit by Banking Company/Financial Institution (NBFC): Rule 38
Under CGST Rule 38, if a banking company, financial institution, or NBFC (non-banking financial company) is involved in offering services like accepting deposits or providing loans or advances without complying with Section 17(2) provisions, they must reverse 50% of the input tax credit they claimed in Form GSTR 3B. This rule emphasizes adherence to tax regulations in the financial sector, promoting accountability and ensuring a fair tax credit system.
Reversal of ITC when the Recipient of Supply uses Input Goods/Services for a Purpose other than Business or for Exempted Outward Supplies: Rule 42
Step 1: Calculate Common Credit:
Common Credit = Total ITC on Input Supplies
(Less) ITC on input supplies used for Personal purposes (non-business)
(Less) ITC on input supplies used for exempt supplies
(Less) ITC on which credit is not available (Blocked Credit) u/s. 17(5)
(Less) ITC on input supplies used for zero rated supplies
In simple words, Common Credit is ITC on inputs which is partly used for exempt supplies or personal use along with business purpose use.
Step 2: Calculate ITC to be reversed out of common Credit:
(i) Amount of reversal of input tax credit attributable to inputs partly used for Exempt supplies = (Common Credit) * Value of exempt supplies/ Total Turnover in the State
(ii) Amount of reversal of ITC attributable to inputs partly used for Non-Business Purpose (Personal Use) = 5 % of Common Credit
The ITC amounts as calculated above are to be reversed in the GSTR 2 filed by the registered person. This reversal of input tax credit has to be done on a monthly basis.
Reversal of ITC on inputs used for exempted/non-business purpose is more than the ITC reversed during the year: If the total of ITC on input supplies for exempted/non-business is more than total ITC reversed during the year in GSTR-2, then the differential amount should be reversed in GSTR-2 i.e., it should be added to the output tax liability.
ITC reversed during the year is more than ITC on inputs used for exempted/non-business purpose: At the year-end after filing GSTR-9 (Annual Return), if the total of ITC reversed is more than the ITC on inputs used for exempted/non-business purpose, the differential amount should be reclaimed as ITC i.e., it should be reduced from output tax liability.
Reversal of ITC when the Recipient of Supply uses Capital Goods for any Purpose other than Business, or for Exempted Outward Supplies: Rule 43
The initial step involves determining whether the Input Tax Credit (ITC) meets specific criteria:
(A) ITC linked to capital goods used solely for non-business purposes or for producing exempt outward supplies.
OR
(B) ITC linked to capital goods used solely for producing supplies other than exempt ones, including zero-rated supplies.
If the ITC falls under category ‘A,’ credit won’t be allowed for it. Conversely, if it falls under category ‘B,’ the credit will be approved and recorded in the electronic credit ledger. The assumed useful life of capital goods is five years from the invoice date.
This approach ensures that if capital goods were initially categorized under ‘A’ or ‘B’ but later fall outside these categories, the ITC becomes ‘common credit’ (Tc). In such cases, 5% is deducted from this common credit for every quarter or part of a quarter during which it was categorized under ‘A’ or ‘B.’
Given that the useful life of capital goods is considered five years, we align this with our filing period, which corresponds to supplies made or received within a specific month. To ascertain the ITC attributable to a month, we divide the credit by 60.
Formula:
(i) Amount of ITC attributable to a tax period (a month) on common capital goods during their useful life (Tm)
= Tc /60
(ii) Tr = Amount of ITC attributable to a tax period (a month) on common capital goods during their useful life
(iii) Common credit attributable towards exempted supplies (Te) = Tr * E/F
Where:
E = Aggregate value of exempt supplies made during the tax period
F = Total turnover in the State of the registered person during the tax period
Thus, “Te” calculated above will be the ITC in respect of capital goods attributable to exempt supplies and that is required to be reserved or added to the output tax liability.
Reversal of ITC when a Person Transfers his Regular GST Registration into Composite Scheme or Cancels GST Registration: Rule 44
The purpose of this rule is to ensure a reversal of Input Tax Credit (ITC) claimed by a registered individual in scenarios where they opt for the composition scheme or face a registration cancellation.
Here’s how the calculation works:
For inputs present in stock or utilized in semi-finished and finished goods in stock, the ITC to be reversed is calculated proportionally to the respective invoices on which the credit was initially taken. Essentially, ITC is allowed only up to the point when the registered individual switches to the composition scheme or cancels their registration.
Concerning capital goods, the ITC claimed is based on their useful life in months, computed on a pro-rata basis. This means that the ITC for the remaining useful life of the asset needs to be reversed when transitioning to the composition scheme or cancelling the registration.
Section 16(3): Reversal of ITC in case of availing depreciation benefit
According to Section 16(3) of the GST Act, a registered individual cannot claim Input Tax Credit (ITC) if they have already claimed depreciation on the tax component of capital goods and plant/machinery under the Income Tax Act, 1961 (43 of 1961). If ITC is mistakenly claimed, it must be reversed during the closure of accounts for that financial year.
In simpler terms, if a business has already taken tax benefits related to depreciation on certain assets under the Income Tax Act, they cannot double-dip by claiming the same benefit as Input Tax Credit. If this error occurs, the excess credit claimed needs to be rectified during the financial year’s closing accounts.
Section 17(5): Reversal in some special cases
In accordance with Section 17(5) of the GST Act, there are specific cases where a registered entity cannot claim Input Tax Credit (ITC), and any such credits claimed erroneously need to be reversed. This reversal takes place when filing regular returns up to the date of filing annual returns.
In simple terms, this section outlines situations where businesses are not allowed to benefit from tax credits. If, by mistake, they claim these credits, they are required to correct this during the regular return filing, ensuring compliance with GST regulations
Reporting ITC Reversal
Taxpayers are encouraged to accurately report any reversal of Input Tax Credit (ITC) and ineligible ITC in Table 4 of GSTR-3B on the GST Portal. Additionally, they need to provide these details in Table 7 of GSTR-9.
Conclusion
These rules ensure compliance and proper handling of input tax credit in such scenarios, ultimately promoting transparency and adherence to GST regulations. Understanding and following these regulations is crucial for businesses aiming to manage their tax credits effectively. This systematic process helps manage ITC effectively and ensures compliance with GST regulations. Moreover, by implementing these measures, the GST system maintains fairness and accountability, ensuring compliance when businesses make significant changes in their tax scheme or registration status. Understanding and adhering to these rules are crucial for smooth transitions and compliance within the GST framework.
For more details about ITC rules, you may follow the Link of GST Council-https://gstcouncil.gov.in/sites/default/files/Agenda/13th-meeting/Agenda%20Item%202(2)%20-%20ITC%20Rules.pdf
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