Rule 42 of GST Annual Return: When paying taxes to the government for purchases of products and services, such as labor or raw materials used in the manufacturing or sale of commodities, businesses are eligible to claim the GST credit. It’s called an input tax credit (ITC). If the input tax credit is wrongly claimed, it has to be reversed by paying the right amount the next month.
The article delves deeply into the meaning, intent, and circumstances that call for ITC reversal.
What does the reversal of ITC mean?
Rarely, even in cases where all conditions are met, is it necessary to withdraw an ITC claim. In the event of an ITC reversal, the output tax liability would be increased by the previously claimed input credit, rendering the earlier claim null and void. The date of the reversal may also indicate when interest is payable.
Specific Conditions for ITC Reversal
Scenarios are summarised 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 for producing supplies or to create an exempt supply, some of which were used for private or non-business reasons. | Periodically (monthly/yearly) using a formula given below for common credits |
| CGST Rule 43 | Cancellation of GST registration or switching to a composition scheme | Capital goods were used to make an exempt supply or for manufacturing supplies, some of which were used for non-business or personal purposes |
| CGST Rule 44 | When filing the regular returns, about the month in which such a loss had occurred. | When filing the regular returns, about the month in which such free samples were given out. |
| CGST Rule 44A | Reversal of 5/6th of the ITC taken on gold dores in stock as of 1st July 2017 | When filing the regular returns, about the month in which such free samples were given out. |
| 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, about the month in which such free samples were given out. |
| CGST Section 17(5)(h) | Inputs used in goods that were given out as free samples | When submitting form REG-16 in the numerous circumstances covered in detail in our article on canceling a GST registration, or when choosing a composition scheme and using ITC-03. |
Calculation of ITC under various rules
Let’s check the various guidelines provided for determining the amount of ITC that needs to be reversed:
Before delving into each rule, the overall ITC can be separated into the following components:
Common credit: ITC amount that is used to partially create both taxable and non-taxable supplies/supplies used for personal consumption, but cannot be linked to a specific supply.
Treatment:
- Taxpayers are required to calculate and reverse the relevant ITC amount if supplies are used for personal consumption or are not taxable.
- The claim is eligible for the remaining ITC.
Specific credit: A specific credit is an ITC directly associated with a supplier, regardless of whether it is taxable, non-taxable, or used for personal use.
- You can use the portion of the ITC that is only directly related to a certain taxable supply. The computerized credit ledger has it.
- Only when an ITC is mistakenly claimed to be directly related to a non-taxable or personal use supply must taxpayers reverse the amount of the ITC.
Rule 42 and 43: ITC reversal on the supplies that are exempt or used for personal consumption
The ITC to be reversed is calculated differently for:
- Inputs or input services- covered by rule 42
- Capital goods- covered by rule 43
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Reversal of ITC on inputs and input services (Rule 42)
Step 1: Businesses must first subtract the specific credits from the total ITC that aren’t claimable in the way listed below:
| Variable used | Formulae/ Explanation |
| T | Total input tax paid credit on inputs and input services |
| T1 | Out of ‘T’, the specific credit attributable to inputs/input services intended to be used for non-business purposes |
| T2 | Out of ‘T’, the total input tax owed on goods and services that are only supposed to be used to complete exempt supplies |
| T3 | Out of ‘T’, the amount of input tax that section 17(5) considers to be “blocked credits” |
Note: For each tax head, T1, T2, and T3 reports must be made at the summary level in GSTR 3B.
Step 2: Reduce T1, T2, and T3 from the total ITC and derive the common credit as follows:
| C1 | ITC credited to electronic credit ledger T – (T1 + T2 + T3) |
| T4 | Common credit C1 – T4 ITC on inputs that are thought to have been used partly for exempt supply and partly for taxable use or non-business purposes. |
| C2 | Common credit C1 – T4 ITC on inputs partially or entirely used in the manufacturing of taxable and exempt supplies, which are assumed to have been used for non-business reasons. |
Step 3: Determine how much ITC should be taken out of the common credit by using the following formula:
| D1 | The indicative tax credit (ITC) for exempt supplies from common credit is (E÷F) × C2. Where: E: Total value of exempt goods acquired during the tax year F: The total amount of money the registered person made in the state during the tax period Note: (E÷F) for building construction services will be determined project-by-project. where: E: represents the aggregate carpet area of an exempt building project or apartments sold following completion of construction. F: represents the aggregate carpet area of the apartments in the project |
| D2 | Deemed to be ITC attributable for non-business purposes out of common credit: 5% of C2 |
| C3 | Remaining eligible ITC out of common credit: C2 – (D1 + D2) |
Based on the above calculations, D1 and D2 will be the ITC that needs to be reversed.