The introduction of GST has resulted in a major overhaul of indirect taxation and one of its key aims is to eliminate the cascading taxation (tax on tax) witnessed in case of the earlier VAT regime. Thus ideally, in case of GST, tax is applicable only once on a good or service. One of the key mechanism using which the GST regime eliminates cascading taxes is the input tax credit or ITC mechanism.
Meaning of Input Tax Credit
In the context of ITC, an input may refer to any goods that are used by the businesses in order to create the finished products provided to the end users. Subsequent to GST introduction, businesses/individuals are liable to pay GST on goods/services that are used as inputs. The input tax credit mechanism allows GST registered businesses to receive refunds on GST paid for the purchase of such inputs to prevent the cascading taxation effect. The following is an example of how input tax credit works:
Suppose the GST payable on supply of the final output of a manufacturer is Rs. 450 and the GST paid on inputs is Rs. 300. In such a case, the manufacturer can claim the Rs. 300 GST paid as ITC. This brings the net tax payable at the time of supply down to Rs. 150 only (Rs. 450 – Rs. 300). This way, the cascading effect of taxation is prevented.
Who can Claim Input Tax Credit?
Input Tax Credit (ITC) is available only to those businesses/individuals who have registered under the GST Act. This in effect means that ITC can be claimed by a wide range of businesses/individuals including but not limited to service providers, aggregators, e-commerce operators, agents, suppliers and/or manufacturers. In all the above cases, input tax credit claims can be made by the GST registered business/individuals on tax paid for the purchase of any business relevant inputs. Know more about GST Registration
Input Tax Credit Eligibility
There are some key criteria that these GST registered businesses/individuals need to fulfill in order to be eligible for input tax credit under current GST rules:
- Availability of GST invoice showing details of tax paid is mandatory
- The goods on which GST has been paid have been received
- The applicant has submitted the relevant tax returns
- The supplier of the goods has paid the due tax to the government
- The ITC applicant is registered under GST
- If goods have been received in installments, ITC can be claimed only after the final lot has been received
Input tax credit cannot be claimed in the following cases:
- Composition tax registered businesses/individuals paying GST on inputs
- If depreciation has been claimed on the tax component of a capital good
- On goods not used as business inputs such as supplies for personal use
- On goods on which ITC is not applicable under the GST Act such as exempt supplies
Documents Required to Avail Input Tax Credit
One or more of the following key documents are required for claiming input tax credit:
- Invoice provided by supplier of goods/services
- Debit note issued by the supplier to the recipient (if applicable)
- Bill of entry
- Bill of supply (may be a replacement for tax invoice in certain cases)
- Credit note/invoice issued by input service distributor (ISD) as GST invoicing rules
- A bill of supply issued by supplier of goods/services
The relevant document(s) need to be furnished when filing GST returns using GSTR-2 in order to apply for ITC.
Input Tax Credit for Capital Goods
Under GST Act, capital goods are defined as assets such as vehicles, tools, buildings and machinery that an organization may utilise to produce goods and services. Under existing GST Rules, the GST paid for purchase of capital goods is eligible for input tax credit subject to some key terms and conditions:
- ITC cannot be claimed for capital goods purchased for personal use
- ITC not allowed for capital goods purchased exclusively for the manufacture of exempted goods
- ITC is not allowed if depreciation has been claimed on tax component applicable to the capital good
Input Tax Credit on Job Work
In some cases, the principal manufacturer (principal) of goods may send their product to a job worker to produce the final product for the end user. Under GST Act, a job worker is defined as “any person who undertakes a treatment or process on goods belonging to another person”. In such situations, the principal manufacturer will be allowed to obtain input tax credit for GST paid on the purchase of goods sent to job worker. Thus ITC can be claimed if:
- Supply of good occurs from the principal manufacturer’s place of business or
- Supply of goods occurs directly from the supplier contracted by the principal
It is however mandatory for such goods to be received back by the principal within 1 year from date of initial supply for applicability of ITC. The time period allowed for input tax credit in case of capital goods is 3 years. Examples of job worker include an artisan receiving raw materials such as gold and gems from a jewelry store and sending back the finished jewelry for sale by the jewelry store. Similarly, another example of a job worker is one engaged in the making of shoes who receives the soles and the upper part of the shoe as inputs provided by the principal manufacturer. In each case, the principal manufacturer can receive ITC on the GST charged by the job worker for services provided.
ITC on Input Service Distributor
Under GST rules, an “input service distributor” or ISD can be the head office, registered office or branch office of a GST registered business. In case there are multiple offices making purchases for business activities of the entity, the input service distributor (ISD) can collect input tax credit on behalf of all the branch offices and distribute it under different heads such as IGST, CGST, SGST/UTGST or compensation cess.
Reconciliation of Input Tax Credit
It is mandatory for details specified in the ITC application to exactly match the details provided in the supplier’s GST returns. If there is a mismatch in these details, both the supplier and the ITC applicant will receive a communication regarding the discrepancies via the GST3 form. In such cases, the ITC claim has to be resubmitted with applicable corrections.
Input Tax Credit Reversal
In some cases, ITC that has been credited to the credit ledger of a registered business/individual may be reversed. The following are some reasons why reversal of input tax credit may occur:
- ITC reversal can occur if invoices are not paid within 180 days counted from issue date
- In case of ITC claims by ISD, reversal can occur if credit note is issued by the supplier
- In case supplies are used for both business and non-business purposes, ITC reversal may be applicable in proportion to non-business usage of such supplies The same may apply for ITC on capital goods used for both business and non-business purposes.
- If total ITC claimed on inputs exceeds the actual input tax credit reversed, then balance amount is reversed.
The details of reversal of input tax credit are furnished through the GSTR-02 form. Know more about GST Offline Tools to help you prepare your returns.
Calculate Input Tax Credit
Let’s assume the a company ABC Textiles decides to claim input tax credit on its supplies which are readymade garments made from cotton yarn. Additionally, let’s assume that to manufacture its finished product, the primary input for the company is cotton yarn supplied by XYZ Enterprises. Under current rules, GST on cotton yarn is 5% (2.5% CGST + 2.5% SGST). On the other hand, the GST on readymade garments costing more than Rs. 1000 per piece is 12% (6% CGST + 6% SGST).
For cotton yarn purchases of Rs. 10,000 the GST paid by ABC Textiles = 5% of Rs. 10,000 = Rs. 500. This is the amount that can be claimed as ITC by ABC textiles.
For readymade garments sold worth Rs. 20,000 the GST payable (for the relevant period) = 12% of Rs. 20,000 = Rs. 2400.
Thus by claiming back ITC on the the purchase of cotton yarn from XYZ enterprises, the effective GST payable by ABC Textiles would be Rs. 2400 – Rs. 500 = Rs. 1900.
How to Apply for Input Tax Credit
Continuing with the above example, let’s assume that both ABC Textiles (recipient) and XYZ Enterprises (supplier) are registered under GST. Once the two companies have reconciled their transactions, the recipient i.e. ABC Textiles can claim input tax credit as follows:
- XYZ Enterprises will provide details of GST payable on the cotton yarn using the GSTR-1 form. Know more about GST filing
- The details filled out in the GSTR-01 are automatically fetched to GSTR-2A as “Details of Inward Supply” for ABC Textiles. GSTR-2A will also display the transaction details.
- The records can subsequently be checked by ABC Textiles and modifications/additions made, if required.
- Based on the details available in GSTR-2A, input tax credit is automatically credited to the electronic credit ledger of ABC Textiles. This can be used to offset a range of future tax liabilities of the business.
This ITC can however be reversed in case the monthly filing figures of the companies do not match or the due tax is not paid by either of the parties.