Input Tax Credit (ITC) under GST

Input Tax Credit (ITC) under GST: A Detailed Guide

The Goods and Services Tax (GST) regime, implemented in India, revolutionized the indirect tax
system by consolidating various central and state taxes into a single, comprehensive tax. A
cornerstone of this system is the Input Tax Credit (ITC) mechanism, designed to prevent the
cascading effect of taxes and promote a seamless flow of credit across the supply chain. This
document provides an in-depth analysis of ITC under GST, covering its various aspects, including
eligibility, conditions, restrictions, and practical implications.

1. Introduction to GST and ITC:

GST is a destination-based tax levied on the supply of goods and services. It aims to eliminate the
cascading effect of taxes, where taxes are levied on taxes, leading to inflated prices for consumers.
ITC is a mechanism that allows registered businesses to deduct the GST paid on their inputs (goods
or services used in their business) from the GST payable on their output (goods or services they sell).
This ensures that businesses only pay tax on the value added at each stage of the supply chain.

2. Understanding the Mechanics of ITC:

Imagine a manufacturer who purchases raw materials for ₹100 and pays ₹18 as GST. They use these
materials to produce finished goods, which they sell for ₹200, charging ₹36 as GST. Without ITC, the
manufacturer would have to pay the entire ₹36 to the government. However, with ITC, they can
claim credit for the ₹18 GST paid on the raw materials. This means they only need to pay the
difference, ₹18 (₹36 - ₹18), to the government. This simple example illustrates the core principle of
ITC – reducing the tax burden by allowing businesses to offset input tax against output tax.

ITC on Transfer of Business

This applies in cases of amalgamations/mergers/transfer of business. The transferor will have

ITC for Banks and Financial institutions

Banks and financial institutions can claim ITC on taxable supplies, but they must follow a unique
calculation method. The law allows a 50% ITC claim on inputs, capital goods, and input services for
banks and financial institutions. This special provision is to address the mixed nature of taxable and
exempt supplies popular among banks as they also handle exempt financial services.

3. Eligibility for Claiming ITC:

Not all businesses are eligible to claim ITC. The primary eligibility criteria include:

• Registration under GST: The business must be a registered taxpayer under GST. Unregistered
businesses cannot claim ITC.
• Taxable Supplies: The business must be engaged in making taxable supplies of goods or
services. Businesses dealing exclusively in exempted supplies are not eligible for ITC.

• Valid Tax Invoice: The business must possess a valid tax invoice issued by the supplier. This
invoice is the primary document for claiming ITC.

4. Conditions for Availing ITC:

Even if a business is eligible, certain conditions must be met to avail ITC:

• Possession of a Valid Tax Invoice: The invoice must be in the prescribed format and contain
all the necessary details, such as the supplier's GSTIN, the recipient's GSTIN, the description of goods
or services, the quantity, the value, and the GST amount.

• Receipt of Goods or Services: The goods or services must have actually been received by the
business. ITC cannot be claimed on goods that have not been received.

• Supplier Has Paid GST: The supplier must have actually paid the GST to the government. ITC
cannot be claimed if the supplier has defaulted on their tax payment.

• Recipient Has Filed GST Returns: The recipient business must have filed their GST returns.
ITC claims are typically verified against the information provided in the returns.

5. Documents Required for Claiming ITC:

The key documents required for claiming ITC include:

• Tax Invoice: This is the most important document.

• Debit Note: Issued by the supplier to the recipient in case of price reductions or returns.

• Credit Note: Issued by the recipient to the supplier in case of price increases.

• Bill of Entry: For imported goods.

• Invoice Issued under Reverse Charge Mechanism: When the recipient is liable to pay GST
under reverse charge.

6. Time limit to claim input tax credit under GST

Input tax credit can be availed in GSTR-3B on or before the expiry of the time limit defined by the
GST law. The time limit to claim ITC on invoice or debit note issued in a financial year is earlier of the
below two dates-

• 30th November of the year following such financial year, or

• The date of filing the annual returns for that financial year.

Note: Even though 30th November of next year is the deadline. Since ITC is reported in GSTR-3B, we
consider the due date of GSTR-3B as the deadline without late fee. The due date of GSTR-3B for
October of year following the financial year is due by the 20th of following month. If anyone missed
filing GSTR-3B of October by the due date of 20th November, they can still claim pending ITC for a FY
in that return filed on or before 30th November with late fees.

For example, an invoice was issued on 30th December 2023 to ABC Company. They have not yet
filed the annual returns for FY 2023-24 yet. The company can claim ITC given on this invoice before
30th November 2024. However, they can claim such ITC in the GSTR-3B of October 2024 due on 20th
November 2024.

ITC must be claimed within the prescribed time limit. Generally, ITC can be claimed within the
financial year in which the invoice is issued. However, it's crucial to refer to the latest GST rules and
regulations for specific timelines, as these can be subject to change.

Reversal of Input Tax Credit

ITC can be availed only on goods and services for business purposes. If they are used for non-
business (personal) purposes, or for making exempt supplies ITC cannot be claimed . Apart from
these, there are certain other situations where ITC will be reversed.

ITC will be reversed in the following cases-

A) Non-payment of invoices in 180 days– ITC will be reversed for invoices which were not paid within
180 days of issue.

B) Credit note issued to ISD by seller– This is for ISD. If a credit note was issued by the seller to the
HO then the ITC subsequently reduced will be reversed.

C) Inputs partly for business purpose and partly for exempted supplies or for personal use – This is
for businesses which use inputs for both business and non-business (personal) purpose. ITC used in
the portion of input goods/services used for the personal purpose must be reversed proportionately.

D) Capital goods partly for business and partly for exempted supplies or for personal use – This is
similar to above except that it concerns capital goods.

E) ITC reversed is less than required- This is calculated after the annual return is furnished. If total ITC
on inputs of exempted/non-business purpose is more than the ITC actually reversed during the year
then the difference amount will be added to output liability. Interest will be applicable.

The details of reversal of ITC will be furnished in GSTR-3B. Read our article to understand more
about the segregation of ITC into business and personal use and subsequent calculations.

ITC Reconciliation decoded

ITC reconciliation is essential since it helps businesses to make sure that they are claiming the
correct input tax credits (ITC), thereby reducing the risk of legal issues, such as penalties or the
cancellation of their GST registration. Download GSTR-2B data from the government portal and
match the details prepared in draft GSTR-3B. Identify differences and correct the same.
ITC claimed by the person in GSTR-3B has to match with the details specified by his supplier in his
GSTR-1 and appearing in the Invoice Management System (IMS), thereafter if accepted, will flow into
the GSTR-2B. Once the supplier saves a document, it will flow from GSTR-1/IFF/1A to the IMS of the
recipient. Thereafter, when the supplier files the respective GSTR-1/IFF/1A, the document gets
populated into GSTR-2B of the recipient. If no action is taken, the invoice is automatically accepted
and added to GSTR-2B. Running GSTR-2B vs purchase register reconciliation for ITC actions is
henceforth critical. Not using IMS exposes enterprises to a higher risk of notices from tax authorities
due to potential over-claimed ITC.

In case of any mismatch between GSTR-3B, purchase register and GSTR-2B, the supplier and
recipient would be communicated regarding discrepancies after the filling of GSTR-3B. Please read
our article on the detailed explanation of the reasons for mismatch of ITC and procedure to be
followed to apply for re-claim of ITC.

Using an automated, AI-based GST reconciliation engine, such as in Clear GST Max, will help identify
discrepancies here with 100% accuracy as against undertaking this exercise manually.

7. ITC on Capital Goods:

Input Tax Credit (ITC) is available to all individuals registered with the GST, according to Section 16 of
the CGST Act. The registered person is eligible to use the ITC for business expansion or other related
reasons. When capital items are utilised only for commercial endeavours, the GST input tax credit is
applicable. The taxpayer must include a record of the business transaction with their GST return to
be eligible for the input tax credit on capital goods. Nevertheless, capital goods utilised solely for
personal use or to effectuate exempt supply are not eligible for an input tax credit on capital goods
purchases. The taxpayer is not eligible to get an input tax credit for the products in question if GST is
applied at a zero rate for the goods supplied. This will likewise hold for the things that are exempt.
Because of this, the taxpayer is only eligible to claim the Input Tax Credit on capital goods if the sales
are taxable and the individual is included in the book.

8. Types of ITC for Capital Goods

Capital goods for exempted sales or utilised for personal purposes

Capital goods utilised in exempt sales or purchases made for personal use are not eligible for an ITC.
This will not be credited to the computerised credit ledger; instead, it will be noted in GSTR-3B.
• Exempted sales: To turn wheat grains into flour, X has invested in a small flour mill for his
grocery store. The fact that he is manufacturing unbranded flour exempts it from GST. He cannot
claim an input tax credit (ITC) on the GST he paid for the mill, as it is an exempted sale.

• Personal use: Y bought a refrigerator. She will not be eligible to claim any Input Tax Credit
(ITC) on the GST she paid for the fridge because it was a completely personal purchase and not
necessary for her business.

9. ITC in Special Cases:

Several special scenarios exist concerning ITC, including:

• Goods Sent on Approval: ITC can be claimed only when the goods are approved by the
customer.

• Goods Returned: ITC needs to be reversed if the goods are returned to the supplier.

• Free Samples: Generally, ITC is not allowed on free samples.

10. ITC Restrictions:

Certain goods and services are specifically excluded from ITC. These restrictions are in place for
various reasons, such as preventing misuse of the ITC mechanism or promoting certain policy
objectives. Common examples of ITC restrictions include:

• Goods/Services for Personal Consumption: ITC is not allowed on goods or services used for
personal consumption.

• Exempted Supplies: Businesses making exclusively exempted supplies cannot claim ITC.

• Composition Scheme Taxpayers: Businesses opting for the composition scheme cannot claim
ITC.

• Motor Vehicles and Conveyances: ITC on motor vehicles and conveyances is generally
restricted, except in certain specific cases.

• Construction Services: ITC on certain construction services is also restricted.

• Food and Beverages: ITC on food and beverages is often restricted.

11. ITC and Composition Scheme:

The composition scheme is a simplified tax scheme for small businesses. Businesses opting for this
scheme pay a lower percentage of tax on their turnover but cannot claim ITC. This is a key difference
between the regular GST scheme and the composition scheme.

12. Reversal of ITC:

• Non-Payment to Supplier within 180 Days: If the recipient fails to pay the supplier within 180
days of the invoice date, the ITC claimed must be reversed.

• Goods/Services Used for Non-Business Purposes: If the goods or services on which ITC was
claimed are subsequently used for non-business purposes, the ITC must be reversed.

• Invoices Not Matched: If the invoices are not matched by the GST system due to
discrepancies, the ITC claimed may need to be reversed.

13. Importance of ITC:

ITC plays a crucial role in the GST regime, offering several benefits:

• Reduces Tax Burden: ITC reduces the overall tax burden on businesses, making them more
competitive.

• Eliminates Cascading Effect: By allowing businesses to offset input tax against output tax, ITC
eliminates the cascading effect of taxes, leading to lower prices for consumers.

• Promotes Efficiency and Competitiveness: ITC encourages businesses to procure inputs from
registered suppliers, promoting transparency and efficiency in the supply chain.

• Simplifies Tax Compliance: ITC simplifies tax compliance by providing a clear and transparent
mechanism for claiming credit for input tax.

14. Challenges and Issues Related to ITC:

Despite its benefits, the ITC mechanism also faces certain challenges:

• Matching of Invoices: The matching of invoices between suppliers and recipients is crucial
for seamless ITC claims. Discrepancies in invoices can lead to delays and complications.

• Timely Filing of Returns: Timely filing of GST returns is essential for availing ITC. Delays in
filing can result in ITC being disallowed.

• Reversal of ITC: The provisions related to ITC reversal can be complex and require careful
attention. Businesses need to be aware of the situations where ITC needs to be reversed to avoid
penalties.

• Blocked Credits: Certain goods and services being ineligible for ITC can pose challenges for
businesses, especially those operating in sectors where these restrictions apply.

15. Conclusion:

Input Tax Credit is a fundamental aspect of the GST regime, designed to prevent the cascading effect
of taxes and promote a seamless flow of credit across the supply chain. Understanding the
intricacies of ITC, including eligibility criteria, conditions for availing credit, restrictions, and reversal
provisions, is essential for businesses to optimize their tax liability and ensure compliance with GST
regulations. Businesses should maintain accurate records of their input and output tax and ensure
timely filing of returns to maximize the benefits of ITC and avoid potential issues. Consulting with a
tax professional is highly recommended for specific guidance related to ITC and other GST matters.
The continuous evolution of GST laws and regulations necessitates staying updated on the latest
amendments and pronouncements to ensure accurate and compliant ITC claims. By effectively
utilizing the ITC mechanism, businesses can enhance their competitiveness, reduce their tax burden,
and contribute to a more efficient and transparent tax system.