ITC Reversal Rule 42 & 43 under GST | Input Tax Credit Calculation, Conditions & Examples

 ITC Reversal Rule 42 & 43 under GST | Input Tax Credit Calculation, Conditions & Examples

ITC Reversal Rule 42 & 43 under GST deal with the reversal of input tax credit (ITC) on inputs, input services, and capital goods used for both taxable and exempt supplies. These rules ensure that ITC is available only on taxable supplies and the proportionate credit for exempt supplies is reversed, thus maintaining compliance with GST regulations and preventing undue advantages to businesses. To avoid a wrong claim for interest or even penalties, proper computation of ITC demands the understanding of the rules provided below.

Rule 42: ITC Reversal for Inputs & Input Services

Applicability of Rule 42

Rule 42 applies when ITC is claimed on inputs and input services that are used for both taxable and exempt supplies. The rule 42 and 43 provide formulas to specific determine the portion of ITC that must be reversed. This is relevant for businesses engaged in both taxable and exempt supply activities, such as Sugar Industries having sale of Electricity, hospitals, educational institutions, and real estate developers. Understanding Rule 42 ensures proper ITC allocation and prevents unnecessary tax liabilities.

Additionally, businesses must periodically review their ITC computations and make annual adjustments as required under GST laws to avoid compliance issues and financial penalties. Rule 42 applies when ITC is claimed on inputs and input services that are used for both taxable and exempt supplies. The rule provides a formula to determine the portion of ITC that must be reversed.

Formula for ITC Reversal (Rule 42)

Rule 42 provides a systematic approach to determine the amount of input tax credit (ITC) that must be reversed when inputs and input services are used for both taxable and exempt supplies. The reversal ensures that ITC is availed only for taxable supplies, maintaining compliance with GST provisions.

Step 1: Compute Common ITC (C1)

C1 = Total ITC on inputs & input services – (ITC used for non-business purpose + ITC used for exempt supplies + Blocked ITC under Section 17(5))

Step 2: Compute ITC Eligible for Common Use (C2)

C2 = C1 - ITC exclusively used for taxable supplies

Step 3: Compute ITC for Exempt Supplies (D1)

D1 = (Turnover of Exempt Supplies ÷ Total Turnover) × C2

Step 4: Compute ITC for Non-Taxable Purposes (D2)

D2 = 5% of C2 (presumed to be used for non-taxable purposes)

Step 5: Compute Final Eligible ITC (C3)

C3 = C2 – (D1 + D2)

This formula ensures accurate allocation of ITC, reducing the risk of incorrect claims and penalties under GST regulations.

Example for Rule 42

A company has the following details:

• Total ITC on inputs & input services = Rs.1,00,000
• ITC used for non-business purpose (T1) = Rs.5,000
• ITC used for exempt supplies (T2) = Rs.15,000
• Blocked ITC under Section 17(5) (T3) = Rs.10,000
• ITC exclusively used for taxable supplies (T4) = Rs.50,000
• Turnover of exempt supplies (E) = Rs.20,00,000
• Total turnover (F) = Rs.1,00,00,000

Step-by-Step Calculation

1. C1 = Rs.1,00,000 - (Rs.5,000 + Rs.15,000 + Rs.10,000) = Rs.70,000
2. C2 = Rs.70,000 - Rs.50,000 = ₹20,000
3. D1 = (Rs.20,00,000 / Rs.1,00,00,000) × Rs.20,000 = Rs.4,000
4. D2 = 5% of Rs.20,000 = Rs.1,000
5. C3 = Rs.20,000 - (Rs.4,000 + Rs.1,000) = Rs.15,000

Thus, ITC available for taxable supplies is Rs.15,000, and ITC of Rs.5,000 must be reversed.

Rule 43: ITC Reversal for Capital Goods

Applicability of Rule 43

Rule 43 applies when capital goods are used for both taxable and exempt supplies. Unlike inputs and input services, capital goods provide benefits over an extended period. To ensure fair ITC allocation, the credit availed on such capital goods is reversed over 60 months. This rule is especially relevant for industries like manufacturing, healthcare, and real estate, where capital goods are frequently used for mixed purposes.

Formula for ITC Reversal (Rule 43)

Step 1: Compute Monthly Common ITC (Ams)

Ams = Total ITC on Capital Goods ÷ 60

Step 2: Compute ITC for Exempt Supplies (Dms)

Dms = (Turnover of Exempt Supplies ÷ Total Turnover) × Ams

Step 3: Compute Final Eligible ITC

Eligible ITC = Ams - Dms

Example for Rule 43

A company purchases capital goods worth ₹6,00,000 and avails ITC of Rs.1,08,000.

• Turnover of exempt supplies = Rs.30,00,000
• Total turnover = Rs.1,50,00,000

Step-by-Step Calculation

1. Ams = Rs.1,08,000 ÷ 60 = Rs.1,800 per month
2. Dms = (Rs.30,00,000 / Rs.1,50,00,000) × Rs.1,800 = Rs.360 per month
3. Eligible ITC = Rs.1,800 - Rs.360 = Rs.1,440 per month

Thus, ₹360 per month must be reversed for the next 60 months.

Additional Considerations for Rule 43

• If a capital good is exclusively used for taxable supplies, full ITC is allowed without reversal.
• If a capital good is used exclusively for exempt supplies, no ITC can be claimed.
• If a business starts using a capital good exclusively for taxable supplies after an initial mixed-use, the remaining ITC becomes fully available from that point onwards.
• Conversely, if a capital good initially used for taxable supplies starts being used for exempt supplies, a proportionate ITC reversal is required.

By applying these provisions correctly, businesses can maintain accurate GST compliance and avoid financial liabilities due to incorrect ITC claims.

Conclusion

• Rule 42 applies to inputs & input services, ensuring only the ITC for taxable supplies is claimed.
• Rule 43 applies to capital goods, with ITC reversals spread over 60 months.
• Proper record-keeping and compliance are crucial to avoid penalties and ensure smooth GST filings.

By following these rules, businesses can efficiently manage their ITC claims and remain GST-compliant.