Understanding ISD Mechanism- Mandate Effective from April 1, 2025

When GST was first implemented in 2017, the government also introduced the mechanism of Input Service Distributor (ISD). This concept primarily aimed to help the businesses operating through multiple branches across India under the same PAN to distribute their input tax credits (ITC) for services used across multiple branches. However, since ISD registration was optional, businesses did not feel compelled to adopt it unless they faced significant ITC mismatches or compliance issues.

To ensure that such challenges don’t occur, the government announced on August 6, 2024, that the ISD mechanism would become mandatory from April 1, 2025. This mandate aims to ensure fair ITC distribution, reduce tax disputes, and enhance compliance.

The blog here will delve into the meaning and significance of the ISD mechanism, latest update for mandate, its operational framework, and the impact of this mandate.

What is the Input Service Distributor (ISD) Mechanism?

In official terms, “Input Service Distributor (ISD) means an office of the supplier of goods or services or both which receives tax invoices towards receipt of input services and issues a prescribed document for the purposes of distributing the credit of central tax (CGST), State tax (SGST)/ Union territory tax (UTGST) or integrated tax (IGST) paid on the said services to a supplier of taxable goods or services or both having same PAN as that of the ISD.”

In simple terms, ISD is the main/head office of a company that incurs the cost or invoice for services used by all/some branches. The head office then shares the tax benefits known as input tax credit (ITC) on the payment of such services with all the branches using that service. This way, each branch using the service will get a fair share of their tax credits.

For example, let us assume a company that operates in Kolkata, Bengaluru, Gurugram, and Pune. They have their head office in Bengaluru registered as ISD. The head office issues an invoice for advertising services. The advertising campaign runs across all the branches of the company. Now, if the head office in Bengaluru was not an ISD, it would claim the entire ITC on the payment of these advertising services itself. However, since it is an ISD, it will distribute the input tax credit available on that payment across all the branches as per the ratio of their turnover.

Latest Updates- 2024 &2025

The ISD Mechanism has undergone several updates over time. Here’s how it has evolved:

– Union Budget 2024 Announcements: The Union Budget 2024 brought significant changes to the GST law, particularly in the realm of ISD. Amendments proposed in Section 2(61) and Section 20 of the CGST Act, 2017. These were:

1. Section 2(61): Redefined the role of ISD, emphasizing its responsibility for receiving tax invoices related to input services and distributing the ITC.
   
2. Section 20: Outlined the obligations of an ISD, including mandatory registration and the process for distributing ITC.

– Mandatory ISD Mechanism (Effective April 1, 2025): On August 6, 2024, the government announced that the ISD mechanism would become mandatory from April 1, 2025. These were the key aspects of this announcement:

1. Mandatory Registration: Businesses must register as an ISD to distribute ITC for common input services.
   
2. Monthly ITC Distribution: ITC must be distributed within the same tax period in which it is received.
   
3. Proportional Distribution: ITC must be distributed based on the turnover of each branch.

– Inclusion of Reverse Charge Mechanism (RCM) ITC: The Finance Act, 2024, and the Finance Bill, 2025, extended the ISD applicability to services covered under the Reverse Charge Mechanism (RCM). This means that ISD has to distribute ITC on services liable to tax under RCM through the ISD mechanism.

How Does the ISD Mechanism Work?

Let’s understand the ISD mechanism step-by-step:

1. ISD Registration: The head office of a company registers itself as an ISD on the GST portal.
2. Collection of Invoices: The head office registered as ISD collects invoices for services used by some/all the branches. For example, if the head office pays for a software subscription used by all the branches, it collects an invoice for the same.
3. Calculation of ITC: Now, the head office will calculate the ITC on such invoices. This is the tax they pay on such services which can be claimed back.
4. Assessment of Branches’ Turnover: The next step is to determine the turnover of all the branches.
5. Distribution of ITC: Once the turnover is calculated, ISD will distribute the tax credits in the proportion of turnover. This way, branches with higher turnover will receive more ITC.
6. Issuance of ISD Invoices: After the ISD has determined the amount of tax credits for each branch, it will issue the invoices to each branch. These invoices show the amount of ITC allocated to each branch.
7. GSTR-6 Filing: Lastly, the ISD will be responsible for filing GSTR-6 to report the ITC received and distributed. It is notable that only the ISDs are responsible for GSTR-6 filing.

Rules and Regulations for Input Service Distributor

Here are the updated regulatory requirements for an ISD under GST in India:

• Mandatory Registration: Obtain separate registration using Form GST REG-1.
• Invoice Requirements: Issue an ISD invoice as per Rule 54 (1) of the CGST Rules, 2017.
• Monthly Returns: File Form GSTR-6 by the 13^th day of the subsequent month.
• Pro-Rata Distribution as per Turnover: Distribute tax credit paid on input services based on respective turnover of the branches.
• Same PAN: ISD registration is mandatory for businesses with multiple GSTINs under the same PAN.
• Monthly Distribution: ITC must be distributed in the same month it is received and cannot exceed the available credit.
• RCM Inclusion: Distribute ITC for taxes paid under RCM among its suppliers of taxable goods or services under the same PAN.

Understanding the Mandate for ISD- Why Did the Government Do It?

We know that the government mandated ISD registration. But why? Let’s understand that.

ITC Claims Before the ISD Mandate

1. Head Office Claims Full ITC: The head office claimed the entire Input Tax Credit (ITC) for a service because it received the invoice.
2. Branches Do Not Get ITC: The branches do not get any ITC, even though they use the service.
3. Tax Mismatches: During GST audits, tax authorities notice that the head office claimed ITC for services used by multiple branches, leading to mismatches and potential disputes.
4. Increased Tax Burden on Regional Branches: The branches must pay their own GST on sales without the benefit of the ITC from the service, increasing their overall tax burden.

After the ISD Mandate (Effective April 1, 2025)

1. Mandatory ISD Registration: Every company’s head office registers its head office as an ISD.
2. Proportional ITC Distribution: The service vendor issues an invoice to the ISD GSTIN. The head office distributes the ITC to the branches based on their turnover proportion.
3. Fair Allocation: The ITC is allocated to all branches fairly as per the turnover.
4. Compliance and Reporting: The ISD files a monthly return (GSTR-6) to report the ITC received and distributed

Penalties for Not Following ISD Mandate

Failure to comply with the ISD mandate can lead to several significant consequences for businesses:

– Denial of ITC: If businesses do not follow the ISD mechanism, they may not get their eligible Input Tax Credit (ITC). This can increase their overall tax liability.

– Recovery Actions: Incorrect ITC allocation may lead to recovery actions by tax authorities. Businesses may need to repay the ITC claimed incorrectly, along with interest.

– Monetary Penalties: A minimum fine of ₹10,000 or the amount of irregular ITC, whichever is higher, may be imposed on businesses that do not comply with the ISD mechanism.

– Compliance Issues: Non-compliance with the ISD mechanism can lead to further scrutiny and audits by tax authorities. This will result in increased administrative burden on businesses.

Adapting to the ISD Mandate

The ISD mandate, effective from April 1, 2025, is a crucial step toward improving ITC distribution and ensuring compliance. By making ISD registration compulsory, the government aims to prevent tax mismatches and create a more transparent tax system. Businesses must act now to understand the ISD framework, update their processes, and ensure smooth implementation.

Adapting to these changes may seem challenging, but the right tools can simplify compliance. GSTrobo^® offers automated solutions to help businesses seamlessly manage ITC distribution and stay compliant with evolving GST regulations. Explore our features like PAN-level reco and return filing, parameter-based reports, and more. Book a demo to know more.

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