Learn when and how to reverse Input Tax Credit (ITC) under GST. This guide covers conditions, calculation rules, and reporting procedures.
Input Tax Credit reversal under GST applies when credit is wrongly availed, when payments to suppliers aren’t made within 180 days, or on exempt and personal-use supplies under Rules 42 and 43. Correct ITC reversal calculation protects you from interest and penalties.
Businesses are allowed to offset the Goods and Services Tax (GST) paid on their inputs, such as raw materials and services, against their output tax liability. This mechanism is known as Input Tax Credit (ITC). If this credit is mistakenly claimed, it must be reversed by settling the equivalent amount in the subsequent tax period. This document explores the concept, rationale, and various situations necessitating ITC reversal.
What does the reversal of ITC mean?
Even when the fundamental criteria for claiming Input Tax Credit (ITC) are met, there are specific circumstances requiring its reversal. An ITC reversal signifies that previously claimed input credits are added back to the taxpayer’s output tax obligations, thus canceling the initial credit. The timing of this reversal can also determine if interest payments are applicable.
Specific conditions for ITC reversal
ITC reversal is mandated under several scenarios outlined in the Act. Key situations are summarized below:
| Relevant GST section/ rule | Circumstances | When is ITC reversal required |
|---|---|---|
| CGST Rule 37 | The recipient fails to pay consideration to the supplier (whether fully or partly) for a particular supply | Within 180 days from the date of issue of the invoice. |
| CGST Rule 37A | The supplier fails to pay tax through GSTR-3B by 30th September of the following year | On or before 30th November of the following financial year. |
| CGST Rule 38 | Reversal of 50% of ITC by banking and other financial companies under special rules | At the time of filing regular returns. |
| CGST Rule 42 | Inputs used to make an exempt supply or for manufacturing supplies some of which were used for non-business or personal purposes. In the event of GST rate restructuring, a few items become newly exempt. | On a periodic basis (monthly/yearly) using a formula given below for common credits. |
| CGST Rule 43 | Capital goods used to make an exempt supply or for manufacturing supplies some of which were used for non-business or personal purposes | On a periodic basis (monthly/yearly) using a formula given below for common credits. |
| CGST Rule 44 | Cancellation of GST registration or switching to composition scheme | While filing form REG-16 or through ITC-03 when opting for the composition scheme. |
| CGST Rule 44A | Reversal of 5/6th of the ITC taken on gold dores in stock as on 1st July 2017 | At the time of supply of either the gold dore bar or the gold/gold jewellery. |
| Section 16(3) | Depreciation under the Income Tax Act has been claimed on the GST component of capital goods purchased | Reversal is required at the time of closing books of accounts for that financial year. |
| CGST Section 17(5) | ITC has been availed on ‘blocked credits’ | At the time of filing regular returns up to the date of filing annual returns. |
| CGST Section 17(5)(h) | Inputs used in goods that were lost, destroyed, stolen, etc. | At the time of filing the regular returns in relation to the month in which such loss had occurred. |
| CGST Section 17(5)(h) | Inputs used in goods that were given out as free samples | At the time of filing the regular returns in relation to the month in which such free samples were given out. |
| CGST Section 17(5)(i) | Tax paid in accordance with the provisions of Section 74 of the CGST Act (i.e., GST demands in fraud cases) | At the time of filing the regular returns in relation to the month in which the GST demand was paid. |
Calculation of ITC under various rules
Different rules prescribe methods for calculating the amount of ITC to be reversed. Before delving into each rule, total ITC can be categorized into two main parts:
Specific credit: This refers to ITC that can be directly attributed to a particular supply, whether taxable, non-taxable, or consumed for personal use.
Treatment:
- Separate this ITC amount from the total, as it is easily identifiable.
- The ITC amount solely and directly linked to a taxable supply can be utilized and is reflected in the electronic credit ledger.
- Taxpayers must reverse any wrongly availed ITC directly attributable to a non-taxable supply or personal consumption.
Common credit: This is the ITC amount that cannot be attributed to a specific supply but is used for both taxable and non-taxable supplies, or for personal consumption.
Treatment:
- Taxpayers must identify and reverse the proportionate ITC amount corresponding to non-taxable supplies or personal use.
- The remaining ITC is eligible for claim.
Rules 42 and 43 govern ITC reversal for supplies that are exempt or used for personal consumption. The calculation for ITC reversal varies for inputs or input services (covered by Rule 42) and capital goods (covered by Rule 43).
Rule 42: Reversal of ITC on inputs/input services
Step-1: Businesses must first isolate specific credits that are ineligible from the total ITC as follows:
| Variable used | Formulae/ Explanation |
|---|---|
| T | Total input tax paid credit on inputs and input services |
| T1 | Specific credit from ‘T’ attributable to inputs/input services intended for non-business purposes |
| T2 | Input tax amount from ‘T’ attributable to inputs/input services exclusively used for effecting exempt supplies |
| T3 | Input tax amount from ‘T’ deemed as ‘blocked credits’ under section 17(5) |
Note: T1, T2, and T3 must be reported in GSTR-3B at a summary level for each tax head.
Step-2: Reduce T1, T2, and T3 from the total ITC to determine the common credit:
| Variable used | Formulae/ Explanation |
|---|---|
| C1 | ITC credited to electronic credit ledger: T – (T1 + T2 + T3) |
| T4 | Specific credit on inputs/input services attributable exclusively to making taxable supplies (including zero-rated supplies like exports and supplies to SEZ) |
| C2 | Common credit: C1 – T4 |
C2 represents ITC on inputs assumed to be used partly in making taxable supplies and partly in making exempt supplies, or for a non-business purpose.
Step-3: Calculate the amount of ITC to be reversed from the common credit:
| Variable used | Formulae/ Explanation |
|---|---|
| D1 | ITC attributable towards exempt supplies from common credit: (E ÷ F) × C2 Where: E: Aggregate value of exempt supplies during the tax period F: Total turnover in the State of the registered person during the tax period Note: For building construction services, (E÷F) is calculated on a project basis, where E is the aggregate carpet area of exempt construction project or apartments sold after construction, and F is the aggregate carpet area of all apartments in the project. |
| D2 | Deemed ITC attributable for non-business purposes from common credit: 5% of C2 |
| C3 | Remaining eligible ITC from common credit: C2 – (D1 + D2) |
Based on these calculations, D1 and D2 represent the ITC amounts requiring reversal.
Illustration:
Consider the following scenario for July 2020 for supplies made in Karnataka:
| Particulars | Amount (in Rs) |
|---|---|
| Total ITC available (T) | 1,50,000 |
| ITC on inputs attributable to supply used by Director for personal use (T1) | 7,500 |
| ITC on inputs to be used exclusively for making exempt supply (T2) | 15,000 |
| Blocked credits (e.g., GST portion paid for taxi service) (T3) | 4,500 |
| ITC on inputs used exclusively for making taxable supplies (T4) | 1,05,000 |
| Aggregate value of exempt supplies made in July (E) | 2,25,000 |
| Total turnover in Karnataka (F) | 30,00,000 |
Solution:
C1 = T – (T1 + T2 + T3) = 1,50,000 – (7,500 + 15,000 + 4,500) = 1,23,000.
Common credit C2 = C1 – T4 = 1,23,000 – 1,05,000 = 18,000.
D1 = (E ÷ F) × C2 = (2,25,000 ÷ 30,00,000) × 18,000 = 1,350.
D2 = 5% of C2 = 900.
C3 = C2 – (D1 + D2) = 15,750.
Therefore, out of the initial ITC of Rs. 1,50,000, only C3 (Rs. 15,750) and T4 (Rs. 1,05,000) were ultimately credited to the electronic credit ledger, while D1 (Rs. 1,350) and D2 (Rs. 900) required reversal.
Rule 43: Reversal of ITC on capital goods
The first step is to ascertain if the ITC on capital goods falls into either of these categories:
- ITC related to capital goods exclusively used for non-business purposes or for making exempt outward supplies. OR
- ITC related to capital goods exclusively used for making supplies other than exempt supplies (including zero-rated supplies).
If the ITC falls under the first category, credit will not be permitted. If it falls under the second, credit will be allowed and transferred to the electronic credit ledger. The useful life of capital goods is considered five years from the invoice date.
If capital goods initially fell into category ‘A’ or ‘B’ but no longer do, the ITC is termed ‘common credit’ or ‘Tc’. In such cases, 5% must be deducted from this common credit for every quarter or part thereof during which it was covered under category ‘A’ or ‘B’.
Since the useful life of capital goods is taken as 5 years and the filing period is monthly, we first determine the monthly attributable ITC by dividing the credit by 60.
| Variable used | Formulae / Explanation |
|---|---|
| Tm | Tc ÷ 60: Amount of ITC attributable to a tax period (a month) on common capital goods during their useful life |
| Tr | Aggregate Tm of all capital goods with a remaining useful life at the beginning of the tax period |
| Te | Common credit attributable towards exempted supplies, calculated as: (E ÷ F) × Tr 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 Note: For building construction services, (E÷F) is calculated on a project basis, where E is the aggregate carpet area of exempt construction project or apartments sold after construction, and F is the aggregate carpet area of all apartments in the project. |
Thus, the calculated Te will be the ITC in respect of capital goods that must be reversed or added to the output tax liability. These calculations may slightly differ if the supply involves services under Paragraph 5(b) of Schedule II of the CGST Act.
Illustration:
A company in Karnataka availed the following ITC on capital goods purchased in July 2020:
| Particulars | Amount (in Rs) |
|---|---|
| ITC on Machine A (used exclusively in the supply of exempt goods) | 1,50,000 |
| ITC on Machine B (used exclusively in the supply of taxable goods) | 9,00,000 |
| ITC on Machine C (used exclusively for non-business purposes) | 20,000 |
| ITC on Machine D (used partly in the supply of taxable and exempt goods) | 4,50,000 |
The company also made the following output supplies in Karnataka in July:
Turnover in relation to exempt supplies: Rs. 20,00,000
Turnover in relation to taxable supplies: Rs. 80,00,000
Solution:
ITC on Machine A and C will not be credited to the electronic credit ledger (1,50,000 + 20,000 = 1,70,000).
ITC on Machine B will be credited to the electronic ledger: Rs. 9,00,000.
ITC on Machine D will also be credited to the electronic credit ledger:
Tc = 4,50,000
Tm = Tc ÷ 60 = 7,500 (which is also Tr in this case).
The amount of ITC to be reversed for July 2020 would be: Te = (E ÷ F) × Tr = (20,00,000 ÷ 80,00,000) × 7,500 = 1,875.
Thus, the total ITC credited to the electronic ledger for July 2020 = Rs. 10,70,000, and the total ITC reversed for July 2020 = Rs. 1,875.
Rule 44: Reversal of ITC in case of cancellation of GST registration or switches to composition scheme
This rule aims to reverse all ITC previously availed by a registered person who opts for the composition scheme or whose registration is cancelled for any reason.
The calculation is performed as follows:
- For inputs held in stock or contained in semi-finished/finished goods: The ITC to be reversed is calculated proportionate to the corresponding invoices on which credit was taken. ITC is only allowed up to the point the registered person transitions to the composition scheme or their registration is cancelled.
- In the case of capital goods: ITC availed is computed on a pro-rata basis based on its useful life in months. Therefore, ITC for the remaining useful life of the asset must be reversed when switching to the composition scheme or upon registration cancellation.
Rule 44A: Balance transitional ITC to be reversed on 1st July 2017 for gold dore bars
This rule pertains to ITC claimed under the transitional provisions of the CGST Act. It is based on CENVAT credit available under the previous taxation regime for additional duty of customs (Section 3(1) of the Customs Tariff Act, 1975) paid on imported gold dore bars. If a taxpayer holds stock of such gold dore bars (raw material) or gold jewellery (final product) on July 1, 2017, the ITC is restricted to 1/6th of the credit availed on the gold dore bar. Consequently, 5/6th of the availed credit must be reversed at the time of supply of either the gold dore bar or the gold/gold jewellery made from it.
Reporting of ITC reversal in GSTR-3B
Taxpayers are responsible for calculating the ITC reversal amount and reporting it in Table 4B of GSTR-3B. The reported ITC reversal is categorized into two types:
- ‘As per rules 42 & 43 of CGST/SGST Rules’: This field requires the ITC attributable to exempt or non-business supply, calculated using the prescribed formula, to be manually entered as it is not auto-populated.
- ‘Others’: This field is for reporting ITC reversals due to other circumstances.
Reporting of ITC reversal in GSTR-9
GSTR-9 (annual return) requires comprehensive details regarding ITC reversed for the entire year. While some details are auto-filled based on data from the monthly GSTR-3B, taxpayers can make necessary adjustments.
Table 7 of GSTR-9 provides a summary of ITC reversed and ineligible ITC for the financial year, where relevant annual details must be provided accordingly.
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Frequently Asked Questions
When is ITC reversal required?
ITC must be reversed for non-payment to suppliers within 180 days, exempt supplies, personal use, and blocked credits under Section 17(5).
How is common ITC reversed under Rule 42?
Rule 42 apportions common input/input-service ITC between taxable and exempt supplies; the exempt-attributable portion is reversed monthly and finalised annually.
Is interest charged on ITC reversal?
Yes, interest at 18% generally applies where ineligible ITC was availed and utilised.
Where is ITC reversal reported?
ITC reversal is reported in Table 4(B) of GSTR-3B and disclosed in Table 7 of the annual return GSTR-9.
