Input Tax Credit Review Audit – GST

The GST audit under Section 35 (5) of CGST Act 2017 has to be done by a registered taxpayer whose annual turnover is more than Rs.5 Crores in a financial year (earlier threshold limit was Rs.2 Crores for FY 2017-18). However, the industry and trade need to carry out input tax credit review before the last date of filing of September return of the subsequent financial year. It is understood that there could be a number of errors of understanding, system errors and transactional mistakes. The registered persons would have a chance to ensure total reconciliation and proper availment is carried out before this time limit expires. Those who miss this window may have to face disputes and ligation if they were to avail the ITC after this date.

This article provides some insights into the possible coverage in this ITC review providing draft a step wise ITC review list with comments. Some of the common errors in ITC expected has also been provided for ensuring that the ITC review is effective.

Steps in ITC Review

1. Understand the business: The general background of industry, company, challenges in indirect taxes faced by them, type of vendors and type of customers. This would help in conduct of the review.
2. Confirm the existence of adequacy of systems and controls: Internal controls in indirect taxes has not been put in most organisation and change to GST may have further delayed it. Reliance on the normal audits check may not be adequate due to various reasons. The transactions which may not be reflected in the books of account like stock transfers to different states, Agent/ principal supply, supplies with related parties which are without consideration, reverse charge, etc. are normally not accounted in the financial system in the form of usual inward-outward supplies. These aspects may need confirmation of proper systems to comply and reconcile the liabilities as well as the credits. 
3. Review of procurement policy of the organization including imports: The importance of the tax clause to ensure optimisation of the credits and ensuring vendor has paid taxes owed on the supply. Further the knowledge of credits to the procurement team maybe limited. 
4. Invoice Validity: The requirement of payment on taxes only if indicated in the invoice along with specified particulars. Also, confirm that all invoices where credit has been taken are available for verification and preserved properly.
5. Review the nature of services and goods: The nature of expenses incurred to ascertain GST impact and to assess GST credits: Any goods and services used in furtherance of business are eligible for credit other than those blocked. All major value of inputs, capital goods and services need to be identified.
6. Review of Sources: The question of procurements made only through registered dealer/ manufacturer/ service provider needs to be confirmed. In case of procurement from unregistered dealer, the possibility of credit chain being broken and consequent increase in costs to be confirmed. 
7. Review the system of claiming credit: The time of supply would be important for availing credit in respect of Inputs, Capital goods and RCM expenses. Verify if the goods and services are actually received and proper documentation for the same is also maintained.
8. Review the major agreements/ orders: Review of sample agreements/orders with vendors with regard to major capital/revenue expenditure to understand the eligibility of credits and its impact under GST with respect to taxations.
9. Review of expenses liable for GST under RCM: Most of the RCM payments could also be eligible for credits. If so whether paid and availed to avoid payment of irrecoverable interest. 
10. Studying the nature of books of accounts maintained: The books to capture and identify that ITC has been availed. Review of financial ledgers to ensure that ITC are taken on all eligible heads. There may be a need to have bifurcation of accounts to enable the capture of such information.
11. Review of treatment of purchase returns to study the possible impact under GST: The tax reversed on purchases return shall be verified based on the credit notes issued by the vendors and the details of the same can also be verified with the details of credit notes available in Form GSTR-2A.
12. Review the foreign currency payments: To ascertain RCM liability and availment of ITC.
13. Review of goods / services at Branches/ Business verticals: Confirm if invoices are addressed properly for goods / services received at locations. Ensure that credit capture system and reconciliation is available in all branches within and outside the State. If expenses incurred at other than branches registered in the State, confirm that an input service distributor registration exists. 
14. Review terms of purchase orders vis a vis purchase invoices: Defective invoices can lead to disputes at a later date. They can however be rectified once identified.
15. Review of rate of taxes: This would be more important for goods or services supplied. It may also be value additive for the vendors if the customer confirms the taxes. This should not be the responsibility of the customer but as on date, it could be.
16. Review of method of capitalising the work in progress: This is to examine whether ineligible credits exist or eligible credits are not availed. This should be as per Accounting Standards and GST law. 
17. Review of credit availment mechanism and conditions to be fulfilled for credit: The need for having received the goods or services; the issue of a valid invoice, goods and/or services used in furtherance business. There may be a need to suggest improvement to automatically record the credit which can later be confirmed. This would be important in bringing down the cost of procurement of goods or services. 
18. Review if payments made within stipulated time for taking credit: There is a time limit for payment to vendors within 180 days. If where the payment to vendor is not made within 180 days, ITC needs to be reversed with interest, however the amendment for without interest reversal proposed under 28th GST council meeting yet to be notified. On payment to the vendor is made, the credit can be claimed back. System to capture such reversals in recoverable accounts and their periodic nullifying may be suggested.
19. Review if discounts agreed and valuation adopted by vendors: Ensure that they are in line with law and do not lead to loss of credits or double taxation.
20. Review of credit register: Look for patterns and confirm evidence captured/ filed in order to satisfy the scrutiny by internal / external auditors.
21. Review of documents: Verify the accuracy of import documents, job work inward invoices, stock transfer inward invoices, etc. Some of these may not be accounted in the system as they are not financial entries but have an impact on ITC.
22. Review if there are transactions of personal nature: If any credits are there in the nature of personal, in such cases credit is not available. 
23. Review of goods issued free of cost (FOC) or as samples: Verify the list of items given away as free samples or on FOC basis and confirm whether the appropriate reversal of ITC has been made on such supplies. 
24. Review of credit apportionment in case of supply of taxable and exempted supplies: The capture of credit specific to each and only the common credits being allocated is a preferred way forward.
25. Review of credit availment in case of assets put partially for non-business /non-taxable use: The reversal for non-business/ personal use needs to be confirmed.
26. Review of various returns: Review of Form GSTR-2A with Form GSTR-3B / ITC ledger for the review period and identification of differences in ITC if any, has to be done. [Reconciliation to be provided by Auditee]
27. Review of disputable credits: These credits could be availed and reversed with intimation to revenue avoid time limitation. 
28. Review of credit accumulations: Reason to be ascertained on accumulation of ITC and check if whether option can be exercised for encashment of such credits through refund. 
29. Review of important ratios: The credit availed and utilised to total GST, ITC/ Total purchases and expenses among others.
30. Common Errors: Identifying and correcting the errors observed in the above review and also confirming with a list of common errors (provided further).
31. Identification of Transactions between distinct persons: The transactions should have to identify with distinct persons e.g. support services by HO to factory situated in different state. If so cross charge of the same is to be looked into. 
32. Identification of other transactions: The identification of barter activities or transactions which may not reflect in books of accounts. In the same line identification of non-monetary consideration in any exchange transaction, which leads to revision of valuation.
33. Identification of wrong credit type: Identify credit type has to ascertain by the GSTIN of both the parties or place of supply (POS) under GST Law.

 Common Errors in ITC

The errors are expected to be mainly centered around vendor compliances impacting ITC, doubtful credits, missed or short credits. Excess or duplicate credits, debit/ credit note adjustments, capital goods credit vis a vis capitalization, reversal for exempt supplies and reverse charge. We examine some of them in more detail hereunder:

1. 1. Considering ITC balance to payoff liability under reverse charge:
      • Recipient cannot utilize ITC for discharging RCM liabilities. GST portal also does not allow such adjustment while filing returns.
      • ITC can be claimed in the same month where taxes are paid by the recipient under RCM.  
   2. Discharging GST under reverse charge on services u/s 9(3):
      • Auditor needs to understand place of supply especially for export or import of services.
      • The old service tax law and the GST Act differ and there are some transactions which no longer attract GST. If paid then refund can be sought as it is within limitation. Illustration: manpower services which were liable for RCM under earlier tax regime but not notified services under GST regime.  
   3. ITC could be claimed on the taxes paid under RCM on the GTA services: 
      • ITC is only restricted for provider of GTA service who pays at 5%. The customer who pays taxes under RCM could avail ITC if eligible.  
2. Treating export of goods/services as exempted goods/services and not availing eligible credits related to same:
   • Refund of taxes paid on the goods or services could be availed by the person making the exports even when output GST is not paid on exported goods/exported services.   
3. Non-reversal of ITC in cases where payment is not made to supplier within 180 days from the date of invoice:
   • Reversal of ITC with interest is required. (recently the amendment for no interest has been made- but retrospective applicability not made clear.) 
   • The care to enable re-credit on future payment can be suggested.    
4. Inter-State purchases made from unregistered persons:
   • Procure goods only from a registered vendor & avail eligible ITC.
   • ITC availed on the basis of invoice of registered dealer provided by the unregistered person would not be available. Further availing ITC on the basis of photocopies may be disputed
   • No restriction for availing 100% of ITC on the purchase of capital goods. [50% credit was in earlier central excise regime].  
5. Availing ITC on supplies specifically blocked u/s 17:
   • Not allowed and if availed - has to be reversed.  
6. Availing credit when the same is restricted by rate notification:
   • Where ITC was availed when the rate of outward supply is subject to a condition which restricts ITC. Credit to be reversed with interest.  
7. Availing ITC merely on receipt of invoice without actual receipt of goods/ services:
   • In case of bill to & ship to, the ITC can be availed by the bill to party considered as deemed receipt of goods/ services.
   • ITC could be availed only on receipt of invoice and goods (constructive receipts on instruction of purchaser included).  
8. Non-reversal of proportionate ITC in respect of exempted supplies, non-business purpose use:
   • Non-business, non-taxable or exempt supplies not eligible for credit. It would amount to non-compliance of Rule 42 and 43 of the CGST Rules, 2017. Supplies, where rate notification restricts availment of ITC (e.g. restaurant) shall be treated as exempt supplies for the purposes of computation of ITC reversal under Rule 42 & 43 of CGST Rules 2017.   
9. Non-availment of ITC on bank charges:
   • ITC could be availed as there is no specific restriction U/S 17(5)  
10. Non-reversal of ITC in respect of goods lost, stolen, destroyed, written off or distributed as gifts/free samples:
    • Where ITC is availed and then the goods lost, stolen, destroyed, written off or distributed as gifts/free samples, ITC has to be reversed with interest.
    • Written off could mean fully written off and therefore provision may not impact this. 
    • Inputs destroyed before putting into the production process would be covered.
    • Inputs sent as samples are covered in this section. Inputs contained in final products may not be impacted.  
11. Delay in availing ITC:
    • Avail the ITC on monthly basis and utilize for payment of output liability
    • The absence of proper mechanism/checklist to determine the eligibility of ITC of various purchase/procurement transactions.