Rule 42 of GST Annual Return: Businesses can claim the GST credit when paying taxes to the government for purchases of goods and services such as raw materials or labor used in the production or sale of goods. The term for it is an input tax credit (ITC). Should the input tax credit be incorrectly claimed, it must be reversed by making the appropriate payment the following month.
The article delves deeply into the meaning, intent, and circumstances that call for ITC reversal.
What does the reversal of ITC mean?
In rare situations, ITC claims need to be retracted even though the prerequisites are met. In the event of an ITC reversal, the input credit that was previously claimed would now be added to the output tax liability, nullifying the former claim. The timing of the reversal may also dictate when interest must be paid.
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 to make an exempt supply or for manufacturing supplies, some of which were used for non-business or personal purposes | 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 | Cancellation of GST registration or switching to composition scheme | Cancellation of GST registration or switching to a composition scheme |
| CGST Rule 44A | Reversal of 5/6th of the ITC taken on gold dores in stock as of 1st July 2017 | At the time of filing the regular returns, about the month in which such a loss had occurred. |
| 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 | While filing form REG-16 under various situations explained in detail in our article on the cancellation of GST registration or through ITC-03 while opting for a composition scheme. |
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:
Specific credit: ITC that can be directly linked to a supply—whether it be taxable, non-taxable, or used for personal consumption is known as a particular credit.
- 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 that it is directly related to a non-taxable or personal use supply must taxpayers reverse the amount of the ITC.
Common credit: ITC amount that cannot be attributable to a specific supply but is used to partly make both the taxable and non-taxable supplies/supplies used for personal consumption.
Treatment:
- If supplies are utilized for personal consumption or are not taxable, taxpayers must determine and reverse the appropriate ITC amount.
- The claim is eligible for the remaining 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
Read This Also: 53rd GST Council Meeting Highlights
Reversal of ITC on inputs and input services (Rule 42)
Step 1: Companies must first deduct the particular credits from the overall ITC that are not eligible for the claim in the following manner:
| 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 presumed to have been utilized for non-business purposes or partially for taxable and partially for exempt supply. |
| C2 | Common credit C1 – T4 ITC on inputs that are presumed to have been utilized for non-business purposes or partially in the production of exempt supplies and taxable supplies. |
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: stands for aggregate carpet area of an exempt construction project or apartments sold after construction is over F: stands for 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.
Illustration:
Think about the following situation about supplies manufactured in Karnataka in July 2020:
| 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 (for example, GST portion paid in respect of taxi service obtained) (T3) | 4,500 |
| ITC on inputs used exclusively for making taxable supplies (T4) | 1,05,000 |
| The 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); C1 = 1,50,000 – (7,500+15,000+4,500), therefore, C1 = 1,23,000.
The common credit C2 = C1 – T4, i.e., C2 = 1,23,000-1,05,000, i.e., C2 = 18,000.
D1 = (E÷F) × C2, i.e., D1 = (2,25,000 ÷ 30,00,000) × 18,000, i.e., D1 = 1,350.
D2 = 5% of C2, i.e., D2 = 900.
C3 = C2 – (D1 + D2), i.e., C3 = 15,750.
Therefore, only C3 (Rs. 15,750) and T4 (Rs. 1,05,000) of the initially available ITC of Rs. 1,50,000 were finally credited to the electronic credit ledger, and D1 (Rs. 1,350) and D2 (Rs. 900) had to be reversed.