Reversal of common ITC availed on inputs and input services

Credit Mechanism is the backbone of the indirect tax regime which allows the assessee to take credit of tax paid on purchase of goods and services availed, in the course of business, though with some conditions and restrictions. Credit under GST is available if used for business purpose and in proportion of its usage for making taxable supplies. Reversal of input tax credit (ITC) is required in respect of procurements that are commonly used for taxable and exempted & non-business supplies or if used for making only exempt supplies or used for non-business purposes.

In this article we would like to explain the credit reversal mechanism for input and input services under various business scenarios, to see how the provision is beneficial is some cases and in some cases not so.

Credit Reversal under Goods & Services Tax

Section 17(2) of the CGST Act, 2017 (hereinafter referred to as the ‘Act’) restricts ITC in case where supplies are used for effecting taxable and exempt supplies whereby ITC shall be available only to the extent attributable to taxable supplies including zero rated supplies. The said provision read with rule 42 of the CGST Rules, 2017 (hereinafter referred to as the ‘Rules’) specify the manner of determining the amount of reversal of ITC.

Section 17(3) of the CGST Act, 2017 provides that the value of exempt supply shall include the following:

1. Supplies on which recipient is liable to pay tax on reverse charge basis
2. Transactions in securities
3. Sale of land
4. Sale of building (subject to clause (b) of paragraph 5 of Schedule II)

As per rule 42 of the CGST Rules, 2017 the reversal of ITC in respect of goods/services used commonly for both taxable and exempt supplies (hereinafter referred to as common ITC) shall be calculated per the formula below:

D1 = E/F*C2

D1=amount of input tax credit attributable towards exempted supplies

E = the aggregate value of exempted supplies

F= the total turnover in the State

C2=common credit pertaining to taxable as well as exempted supplies

The above shall be calculated for every tax period and finally re-calculated again for the financial year. Any short or excess credit resulting thereby can be availed/reversed by September of the following year, in terms of rule 42(2) of the Rules. This can be understood with an illustration:

Say ABC Ltd manufactures two varieties of footwear, one is exempt hawai slippers and the other is taxable shoes. Its turnover w.r.t exempt supplies is Rs. 1,00,000/- and taxable supplies is Rs. 2,00,000/- in a particular tax period and credit that is used commonly for both these supplies is Rs. 15,000/-. Then,

ITC to be reversed = Rs. 5,000/- (i.e. 15,000 * 1,00,000 / (1,00,000+2,00,000)).

Now let’s discuss a few more scenarios to understand the same in detail:

Scenario 1: M/s. ABC Ltd has turnover of Rs. 45 lakhs from Jul ’17 to Mar ’18 as below:

1. Jul’17 to Feb’18 - only taxable turnover of Rs. 5 lakhs per month
2. Mar ’18 - taxable turnover of Rs. 3 lakhs and exempted turnover of Rs. 2 lakhs

Further, total ITC during Jul ’17 to Mar ’18 is Rs. 4,20,000/- out of which common ITC is Rs. 20,000/- during Mar ’18.

Thereby, amount of ITC to be reversed for Mar ’18 would be Rs. 8,000 (i.e. 20,000 * 2 lakhs / 5 lakhs)

However, as per sub rule 2 of rule 42, ITC as determined above needs to be finally calculated for the entire year as below:

20,000 * 2 lakhs / 45 lakhs = Rs. 889 only. Hence it can be seen that on re-computing the ITC reversal for the financial year, the amount of reversal has reduced substantially.

Scenario 2: M/s. XYZ Ltd. being a company engaged in poultry farming and has 2 units as below, having same GST registration:

Unit A (Rs. 100 crores turnover for FY) – 90% taxable turnover, 10% exempt turnover

Unit B (Rs. 1000 crore turnover for FY) – 20% taxable turnover, 80% exempt turnover

Thereby, total exempt turnover = Rs. 810 crores

Further, Unit 2 has a major chunk of its credits used for exempt supplies and a fraction of common credit, whereas Unit 1 has a major chunk of its credit being common credit. The following are the details of common ITC at both these units during the FY:

Unit A – Rs. 12 lakhs

Unit B – Rs. 20 lakhs

Total common ITC = Rs. 32 lakhs

In this case the ITC reversal for M/s. XYZ would be Rs. 23.56 lakhs [ i.e. 32 * 810/1100]

However, if these 2 units were separately registered under GST then the credit reversal would be as under:

Unit A = Rs. 1.2 lakhs [i.e. 12 * 10%}

Unit B = Rs. 16 lakhs [i.e. 20 * 80%]

Total ITC reversal = Rs. 17.20 lakhs

Thereby, it can be seen that by taking separate registration, the quantum of reversal of common credits for Unit A would reduce substantially.

Scenario 3: M/s. DEF Ltd is registered and engaged in providing construction services of residential complex. M/s. DEF Ltd. has sales even after obtaining Occupancy Certificate (OC), and if entire consideration for sale of a unit is received after OC, the same would be exempt. The following are details of the project.

From the above it can be seen that in Year 1 there were no sales and since M/s. DEF intended to sell all the units before OC, there is no common credit and the entire credit is eligible. In Year 2 bookings were made and amounts were received from customers. There being no exempt turnover, no common ITC whereby entire ITC would be eligible.

In Year 3, during the second half of the year OC was received and there were certain bookings done after receipt of OC. Further, the construction of all the ‘before OC’ units has been completed. In this regard, it is to note that until the receipt of OC, whatever credit has been accumulated is not a common credit but a credit intended to be used for taxable supplies. Thereby fully eligible credit and no reversal is required. However, once OC is received, any ITC accumulated would be in the nature of common credit and this credit alone will have to be proportioned as per rule 42.

Say credit of:

1. Year 1 = Rs. 26 Lakhs
2. Year 2 – 18 Lakhs
3. Year 3 -  Rs. 6 lakhs (for before OC procurements) and Rs. 2 lakhs (for after OC procurements)
4. Year 4 – Rs. 1 Lakh

The credit of Year 1, 2 & before OC credit of Year 3 i.e. Rs. 50 Lakhs would be fully eligible. Credit reversal in this case in terms of rule 42 of the Rules will be only for the credit of Rs. 2 lakhs of the Year 3. The Year 4 credit of Rs. 1 Lakh would be fully ineligible.

In Year 4, any credit accumulated would be relating to exempt supplies and thereby entire credit would not be eligible.

Thus, from the above it can be seen that credit reversals would have to be done on a financial year basis and that too only relating to the common credits. Further, such reversal would be required only when there is any exempted turnover in such financial year. Revisiting the credits availed earlier is not required as there is no express provision in this regard in the law.

Conclusion:

Thus, we can observe that even if there is unequal reversal of ITC during different months due to varied pattern of turnover, the same would be streamlined at the end of the financial year when the credit reversal will have to be calculated by adopting the turnover of the entire year. This could be beneficial in some cases and not so in others. Further, in case of construction service, where financial year-wise reversal of credit is only envisaged, the department may dispute and require the assessee to reverse credits by considering the revenue from the entire project. To mitigate the risk of any possible demand and penalty, the assesses could consider intimating the calculations under rule 42 and 43, on annual basis, to the department.

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