When a buyer purchases goods and services, they pay GST at the time of purchase. Additionally, if the buyer, being a registered person, uses these goods or services to provide taxable supplies, he can utilize this GST as Input Tax Credit (ITC). He can further use this ITC to discharge the output tax liability. However, in certain scenarios, the recipient cannot avail of this ITC, thus necessitating ITC reversal. Consequently, ITC reversal under GST means that the recipient must repay the ITC utilized earlier by adjusting it against their Output Tax Liability.
In this blog, we will discuss the conditions requiring ITC reversal, ITC reversal calculations, penalties for non-compliance, and effective strategies for managing ITC reversals.
Read more:- Input Tax Credit (ITC) under GST: Understanding ITC Eligibility and Reversals
Specific Conditions under CGST Act requiring ITC Reversal
The CGST Act, 2017, lays down conditions under which a recipient must reverse the ITC claimed on input goods, services, or capital goods. Here are some of those scenarios:
1. When the recipient fails to pay the supplier within 180 days from the invoice date.
2. If the recipient avails ITC not allowed as per section 17(5) of the CGST Act, 2017.
3. Where the recipient uses capital goods or inputs partly for exempt supplies and partly for taxable supplies.
4. When the recipient claims depreciation on the GST component of capital goods.
5. Where a supplier issues credit note to the ISD.
6. If the supplier fails to deposit the GST by the due date of filing GSTR-3B.
7. Banking companies, financial institutions, and NBFCs requiring reversal of 50% of ITC as per rules.
8. Using Capital Goods and Inputs for Exempt Supplies.
9. When recipient switches to Composition Scheme or Goods become Exempt
10. ITC reversal on capital goods as per Rule 44A of CGST Rules, 2017
Rule 42, 43 and 44 of CGST Rules, 2017 for ITC Reversal
Rules 42, 43 and 44 of the CGST Rules, 2017 are essential provisions that form the backbone of ITC reversal under GST. Also, these rules are akin to three pillars that ensure the correct calculation and reversal of ITC for various scenarios involving inputs, input services, and capital goods.
Rule 42 of CGST Act, 2017 – ITC Reversal of common credit used for taxable and exempt supplies
When the recipient uses common inputs for providing taxable as well as exempt supplies, the CGST provisions require reversal of ITC for the exempt supplies. Rule 42 lays down the rules for segregation of common ITC in such scenario:
Steps for Calculation
Step 1: Firstly, businesses must identify and denote the ITC as follows:
| Total ITC on inputs and input services | T |
| GST on input/input services intended to be used for non-business purposes | T1 |
| GST on input/input services attributable exclusively for exempt supplies | T2 |
| Blocked Credits u/s 17(5) | T3 |
Step 2: Next, determine ITC credited to Electronic Credit ledger
Reduce T1, T2 & T3 from Total ITC (T)
ITC credited to Electronic Credit Ledger (C1) = T-T1-T2-T3
Step 3: Next, calculate the Common Credit (C2) by reducing T4 from C1
T4 – Specific credit on input/input services attributable exclusively for taxable supplies. This also includes zero rated supplies like exports and supplies to SEZ.
Common Credit (C2) = C1-T
Step 4: Lastly, determine the amount of ITC reversal from Common Credit
(i) Calculate proportionate credit attributable to exempt supplies using below formula
ITC attributable to exempt supplies (D1) = Common Credit (C2) x Exempt Supplies (E) Total Supplies (F)
(ii) Next, reduce 5% as deemed credit for non-business purposes
Deemed Credit (D2) = 5% of Common Credit (C2)
Eligible ITC (C3) = C2 – D1 – D2
ITC Reversal = D1+D2
Let’s understand with the help of an example:
Total ITC on inputs and input services (T): ₹1,00,000
GST on inputs intended for non-business purposes (T1): ₹5,000
GST on inputs exclusively for exempt supplies (T2): ₹10,000
Blocked Credits under Section 17(5) (T3): ₹15,000
Specific credit on inputs exclusively for taxable supplies (T4): ₹50,000
Exempt Supplies (E): ₹2,00,000
Total Supplies (F): ₹10,00,000
Step 1: We already have segregation of total ITC. We can move to Step 2
Step 2: Next, determine ITC Credited to Electronic Credit Ledger
ITC credited to Electronic Credit Ledger (C1) = T – (T1 + T2 + T3)
C1 = ₹1,00,000 – (₹5,000 + ₹10,000 + ₹15,000)
C1 = ₹70,000
Step 3: Next, calculate Common Credit (C2)
Common Credit (C2) = C1 – T4
C2 = ₹70,000 – ₹50,000
C2 = ₹20,000
Step 4: Lastly, determine the ITC Reversal from Common Credit
(i) Calculate Proportionate Credit Attributable to Exempt Supplies (D1)
ITC attributable to exempt supplies (D1) = Common Credit (C2) x Exempt Supplies (E)
Total Supplies (F)
ITC attributable to exempt supplies (D1) = 20000 x 200000
1000000
ITC attributable to exempt supplies (D1) = 4000
(ii) Determine Deemed Credit for Non-Business Purposes
Deemed Credit (D2) = 5% of 20000 (C2)
Deemed Credit (D2) = 1000
(iii) Calculate Eligible ITC & ITC Reversal
Eligible ITC (C3) = C2 –D1-D2
C3 = ₹20,000 – ₹4,000 – ₹1,000
C3 = ₹15,000
ITC Reversal (Amount) = D1 + D2
ITC Reversal = ₹4000 + ₹1000 = ₹5,000
Rule 43 of CGST Rules, 2017 – ITC on Capital Goods
As per provisions of CGST Act, 2017, the registered person should use the Capital Goods for business purposes.
However, sometimes registered person may use capital goods partly for personal and partly for business purposes or partly for normal sales including zero rated supplies and partly for exempt sales. In such cases, they must calculate ITC as per Rule 43 of CGST Rules, 2017.
The total amount will be credited to electronic ledger out of which taxpayer must reverse the ITC attributable to exempt supplies.
Calculation of ITC attributable to Exempt Supplies
We will follow the following steps for calculation of eligible ITC from common credit
1. First, we will assign following variables for different components required for calculation:
| Tc | Common Credit on Capital Goods |
| Tm | Amount of ITC attributable to a tax period on common capital goods during their useful life |
| Tr | Aggregate Tm of all capital goods having useful life remaining in the beginning of tax period. |
| Te | Common Credit attributable to exempt supply |
| E | Exempt Supplies |
| F | Total Supplies |
2. For those capital goods used both for exempt as well as taxable supplies, assume useful life of 5 years
3. Next, divide the whole of common ITC by 60 to get credit attributable to a month (Tm).
4. Now calculate aggregate of monthly credits of all capital goods which have useful life remaining at the beginning of the tax period. Denote this by Tr
5. Now, from this monthly ITC, calculate proportionate ITC for exempt and taxable supplies using below formula
ITC Reversal (Te)= Common Monthly Credit (Tr) x Exempt Supplies (E)
Total Supplies (F)
Let’s understand with an example:
- ITC on
- Machine A (for Exempt Supply) – ₹180000
- Machine B (for Taxable Supply) = ₹800000
- Machine C (for non-business purpose) = ₹30000
- Machine D (for taxable and exempt supply) = ₹600000
- Exempt Supply (E) = ₹2000000
- Taxable Supply = ₹8000000
Total Supply = ₹10000000
Calculation :
ITC on Machine A and C will not be credited to ECL = ₹180000+₹30000 = ₹210000
Full ITC on Machine B will be eligible for ITC and credited to ECL = ₹800000
Next, for ITC on Machine D, calculate eligible ITC and ITC Reversal as per Rule 43
For this, assume useful life of machine to be 5 years
Common ITC for the tax period (Tm) = 600000/60 = 10000
ITC Reversal (Te)= Common Monthly Credit x Exempt Supplies (E)
Total Supplies (F)
ITC Reversal (Te)= 10000 x 2000000 = 2000
10000000
Rule 44 of CGST Rules, 2017 – ITC Reversal under special circumstances
Rule 44 prescribes method for ITC reversal on stock, semi-finished goods, finished goods, and capital goods under specific situations such as:
(i) cancellation of registration
(ii) switching from normal scheme to composition scheme
(iii) when the supply becomes wholly exempt
This rule ensures that any ITC claimed on inputs and capital goods that are no longer used for taxable supplies is appropriately reversed and accounted for in the GST returns
Steps for Calculation for different types of Inputs
1. Inputs Held in Stock:
For inputs held in stock, semi-finished or finished goods, calculate ITC proportionately based on the original purchase invoices.
2. Capital Goods:
Calculate the ITC for the remaining useful life of capital goods on a pro-rata basis. The useful life is considered as five years.
Penalty for non-compliance of ITC Reversals
Penalties are prescribed under CGST Act, 2017 for wrong availment and utilization of ITC as follows:
| Section 50 | Interest not exceeding 24% as may be notified by the Government on wrong availment and utilization of ITC. |
| Section 122(2)(a) | Penalty of Rs.10000 or 10% of the tax whichever is higher on wrong availment or utilization due to reason other than fraud, wilful misstatement or suppression of facts |
| Section 122(2)(b) | Penalty of Rs.10000 or 100% of the tax due whichever is higher on wrong ITC availment or utilization due to fraud, wilful misstatement or suppression of facts |
With retrospective amendment in section 50 vide Finance Bill 2022, interest on wrong availment of ITC is now payable only when the ITC is both wrongly availed and utilized, rather than just availed.
How to reverse ITC in GSTR3B?
When supplier files GSTR1, purchases automatically reflect in GSTR-2A and GSTR 2B. Whereas, GSTR3B is the return which recipient prepares to report purchases and ITC. Hence, any excess ITC needs to be reversed in GSTR3B.
Steps to reverse ITC in GSTR3B
1. Enter the ITC reversal details in Table 4 of GSTR-3B under the “ITC Reversed” heading.
2. Table 4 Breakdown:
(i) Table 4(B)(1): Rules 38, 42 & 43 and Section 17(5) of the CGST Rules
Enter only that ITC here which taxpayer does not want to reclaim later.
(ii) Table 4(B)(2): Other Reversals
Whereas here, enter ITC to be reclaimed later. ITC Reversal under 4(B)(2) can be reclaimed in later tax period in table 4(A)(5)
ITC reversal on non-payment of invoice within 180 days
If the recipient does not pay the supplier within 180 days, ITC reversal should be handled in GSTR-3B in following ways:
1. The recipient should reverse the ITC along with interest as per Section 50 of the CGST Act, 2017.
2. For this, the recipient must report the ITC reversal in Table 4(B)(2) of GSTR-3B, as this can be re-claimed later.
Reversal of Blocked Credits u/s 17(5)
The CGST Act specifically prohibits the utilization of ITC for some transactions. Hence, these are called Blocked Credits under Section 17(5).
To understand these conditions in detail read our blog (add link)
Reversal of Blocked Credits under Section 17(5)
1. The ITC pertaining to blocked credits may appear in the eligible credits section of GSTR-3B if the seller has updated the same in their GSTR-1.
2. Hence, it is the duty of the recipient to identify all such ineligible credits.
3. Moreover, blocked credits are non-reclaimable. Hence, the recipient must reverse all such credits in Table 4(B)(1) of GSTR3B: Rules 38, 42 & 43 and Section 17(5) of the CGST Rules.
Achieving Effective ITC Reversal Management
To implement effective ITC Reversal Management, organizations must align their business processes with GST provisions. Additionally, they should ensure that accounting staff stay up-to-date with the latest GST amendments through regular training sessions. Moreover, strong internal controls are necessary to prevent errors and ensure compliance. Furthermore, utilizing automation software can optimize ITC matching and reconciliation processes. Also, automated alerts can highlight discrepancies. In addition, conducting periodic internal audits helps verify ITC claims and reversals. Following these steps, businesses can maintain effective ITC reversal management, thereby ensuring compliance with GST laws and avoiding potential penalties.
