What is Input Tax Credit (ITC)

Input Tax Credit or ITC is the tax that a business pays on a purchase and that it can use to reduce its tax liability when it makes a sale. In other words, businesses can reduce their tax liability by claiming credit to the extent of GST paid on purchases.

Goods and Services Tax (GST) is an integrated tax system where every purchase by a business should be matched with a sale by another business. This makes flow of credit across an entire supply chain a seamless process.

How does ITC work

When a trader sells a good to consumers he collects GST based on the HSN of the goods sold and the place of destination. Let us assume that the MRP of the good is INR 1000 and the rate of applicable GST is 18%. The consumer will, therefore, pay a total of INR 1180 for the good which includes a GST of INR 180. Without ITC, the trader will have to pay INR 180 to the government. With input tax credit or ITC, the trader can reduce the total tax that it will have to pay the government. This is how it works.

Let us assume that the cost of the good in the hands of the trader is INR 825. This includes INR 125 as GST. The trader can claim INR 125 as input tax credit and reduce his original tax liability of INR 180 by this amount. In other words, the trader will need to pay only INR 55 (INR 180 – INR 125) to the government.

Conditions for claiming ITC

A business can claim ITC provided the following conditions have been met

• It has a GST-compliant invoice
• Its supplier has uploaded the invoice to the GSTN
• Its supplier has paid GST to the government
• Returns have been filed

A business under composition scheme cannot avail of the input tax credit. ITC cannot be claimed for personal use or for goods that are exempt.

Indirect Tax Regime Before GST

Before the implementation of GST, goods under the indirect tax regime in India were subject to tax both by the Centre and the States. Whereas services came exclusively under the ambit of the Central Government. As for the taxes levied on goods, the Central Government collected taxes up to the manufacturing stage. While the state governments collected tax on both intrastate as well as inter-state sales.

Hence, Central Excise, Customs, and Service tax were the three main components of indirect taxes for the Central Government. While Value Added Tax (VAT) and Central Sales Tax (CST) were major taxes for the State Governments along with Octroi, Entertainment Tax, etc.

Impact on Taxpayers

Such a complex tax structure resulted in a multiplicity of taxes and most importantly cascading of taxes. The cascading effect did not allow you to set-off taxes paid on inputs against output tax payable on goods and services or vice versa. Moreover, taxes paid in one state were not available for set-off against taxes payable in other states.

Hence, GST was implemented 1) to consolidate multiple indirect tax levies into a single tax and 2) to allow setting-off taxes throughout the value chain. That is to claim the input tax credit.

Input Tax Credit? 

In order to avoid the challenge of ‘tax on tax’, Input Tax Credit (ITC) mechanism was incorporated into the GST system.

The term ‘Input’ means any goods other than capital goods used or intended to be used by you in the course or furtherance of your business. And the taxes paid on the inward supply of inputs, capital and services are called input taxes. These may include Integrated GST, Central GST, State GST or Union GST.

Therefore, Input Tax Credit means deducting the tax paid on inputs from the tax payable on the final output by you as a registered taxable person. This means as a recipient of inputs or input services (e.g. a manufacturer), you can deduct the amount of tax paid on inputs or input services against the tax on your output. 

To have a better understanding of the ITC concept, let’s take a look at the following example:

Aryaman, a wholesaler supplies goods worth Rs 2,00,000 to Binoy, a retailer. Binoy further sells the goods to Charan, a consumer, for Rs 2,20,000 after minor processing. GST @18% was applicable.

Now, when Aryaman supplies goods to Binoy, he collects Rs 36,000 from Binoy against GST and pays the same to the government. When Binoy further sells the goods to Charan, he collects Rs 39,600 as GST from Charan.

Since Binoy had paid GST on inputs, he can claim an input tax credit of an amount equal to the GST paid on the inputs i.e. Rs 36,000. The balance Rs 3,600 is paid to the Govt. by Binoy. Lastly, Charan, the final consumer pays GST of Rs 39,600 to Binoy.

It is quite evident that there is no incidence of tax on any of the interim parties – neither the wholesaler nor the retailer. The reason is that the tax that each of them has paid can be set off against their respective tax liabilities on output. The final incidence of tax is only on the end consumer. 

This clearly displays the removal of the cascading effect of taxes that existed in the erstwhile indirect tax regime.

Eligibility And Conditions To Obtain ITC

 To become eligible for claiming ITC, section 16 of the CGST Act lays down conditions that you must meet as a supplier of goods or services: 

1. Firstly, you must be registered under the GST law. 
2. Then, you have the tax invoice or the debit note issued to you by the supplier of inputs or input services. 
3. You must receive the goods or services or both.
4. Your inputs supplier must have paid government the GST charged in respect of such a supply. 
5. As per section 39, you should have filed the returns.
6. In case you receive goods in lots or installments, you can claim ITC when the last lot is received.
7. If you have claimed depreciation on the tax part of the cost of your capital goods, then you cannot avail ITC on the said tax component.
8. You shall not be entitled to take ITC if the same is not claimed within the time limit. 

Documents Required For Claiming GST

As a registered taxable person, you can claim ITC on the basis of the following documents:

1. An Invoice issued by your supplier of goods or services.
2. Invoice issued by you as a recipient of goods and services supplied by an unregistered dealer. Such a supply comes under the reverse charge mechanism. This mechanism involves supplies made by an unregistered person to a registered person. 
3. A Debit note issued by your supplier in case the tax charged in an invoice is less than the tax payable in respect of such a supply.
4. A Bill of Entry or any similar document as required for an integrated tax on imports.
5. An Invoice or Credit Note issued by an Input Service Distributor as per the rules under GST.
6. A Bill of Supply issued by a dealer opting for composition scheme or an exporter or supplier of exempted goods.

Reversal of Input Tax Credit 

There are certain situations where the Input Tax Credit availed needs to be reversed. This happens if you:

1. Fail to pay your supplier within 180 days from the date of issue of invoice by the supplier.
2. Use goods and services for personal use
3. Utilize goods and services for producing exempt supplies
4. Make use of capital goods for personal use
5. Sell capital goods and plant and machinery
6. Switch from normal GST to composite Levy

The ITC also gets reversed if:

1. Your registration is canceled
2. Credit Note is issued to Input Service Distributor (ISD)
3. ITC on inputs used for exempted or non-business purpose is more than ITC reversed during the year
4. ITC reversed is more than the ITC on inputs used for an exempted or non-Business purpose

For more information, check out our article on the reversal of ITC.

Reconciliation of ITC

 After the due dates for filing GST returns, the process for ITC matching starts. The online portal of Goods and Services Tax Network (GSTN) carries out the ITC Matching process. All your inward supply details as per GSTR 2 filed by you as a buyer are matched with outward supplies as per GSTR 1 filed by your supplier.

If the details match, then ITC claimed by you as a recipient is considered valid. In case, there is a mismatch, the changes are reflected in GSTR 3.

If you fail to deposit tax on the due date or file return within time, then ITC can be denied. And in case any excess ITC is claimed, it is added back to your tax liability as a recipient.

Utilization of ITC

 ITC is credited to your electronic ledger. Such ITC can be used by you as a registered taxable person to pay your output tax liability. Therefore, ITC can be utilized in the following manner:

Your CGST liability can be extinguished by first utilizing ITC standing under CGST and then under IGST. Similarly, your SGST liability can be terminated by first using ITC standing under SGST and then under IGST. Finally, your IGST liability can be exhausted by first using ITC standing under IGST. Then, you can utilize ITC existing under CGST and lastly the ITC standing under SGST.

ITC under Special Cases

1. Goods Sent To Job Worker

 This case relates to the principal manufacturer who sends the goods to a job worker for further processing. In case you as a Principal manufacturer do so, you can claim ITC against taxes paid on the purchase of such goods sent to the job worker.

You can claim ITC even if you sell the final goods directly from the job worker’s place. That is without bringing the goods back to your (principal’s) place of business.

Thus goods sent to the job worker should either be brought back to the principal or sold directly from the job worker’s premises on behalf of the Principal:

–   Within 1 year in case of normal goods

–   And within 3 years in case of capital goods   

2. Input Service Distributor

 This concept relates to a company that has multiple units or offices. The Input Service Distributor (ISD) refers to an office that receives multiple invoices from the suppliers for the supply of goods and services to the company. Such an office can be any branch office, head office or the registered office of the company. 

Now, when ISD claims ITC for the inward supply of goods and services, it distributes the credit to the beneficiary units. The distribution of ITC among the beneficiary units is done on the basis of the units’ previous year’s turnover. 

The ISD shall distribute the credit under different categories like CGST, SGST, UTGST, IGST or Cess.

3. Capital Goods

 ITC can be claimed on the inward supply of capital goods. But, where the depreciation has been claimed on the tax component of cost of capital goods, no ITC will be allowed.

Further ITC is not available for:

1.  Capital Goods used for non-business or personal purposes
2.  Capital Goods used for making exempted goods

4. Sale, Merger, Demerger, Amalgamation or Transfer Of Business

This case relates to the one where there is a change in the constitution of a registered person due to sale, merger, amalgamation, lease or transfer of business. In such a situation the said transferor shall pass on the unutilized ITC in his electronic credit ledger to the transferee.

Framework For Infographic (For Designers Only)

You can take a human figure and give it a name, say Raman who is a manufacturer. You can start with a scenario where Raman, under the previous indirect tax regime, is absolutely confused while paying taxes as there are too many of them charged by both central and state governments at their individual level at different points throughout the value chain.

in respect of goods, the Centre had the powers to levy a tax on the manufacture of goods except for alcohol for human consumption, narcotics, narcotic drugs, opium, etc.

on which the state excise was imposed whereas the State governments had the powers to levy a tax on the sale goods. In respect of Services, only the Centre had the power to levy and collect Service Tax.

Hence, Central Excise, Customs, and Service Tax were the three main components of indirect taxes for the Central Government while Value Added Tax (VAT) and Central Sales Tax (CST) were the major taxes for the State Governments along with Octroi, Entertainment Tax etc.

Such multiplicity of taxes gave way to 

• Multiple taxable events where taxes were levied by different authorities on the same subject or transaction. 
• The taxes paid on input goods could not be set off against the output tax payable on services or vice versa.
• There was non-availability of set-off against other State or Central Government levies. This lead to cascading of taxes which ultimately increased the cost of goods.

Indirect Tax Structure Before GST

After demonstrating the scenario under the previous indirect structure, you can then explain the scenario under the GST regime. How Raman’s tax structure and payment would turn out to be under GST Regime? How there will be no ‘tax on tax’ situation now. And how Raman will be able to claim an input tax credit under the GST regime?

You can take the help of the example mentioned in the green box above: Suppose Raman supplies goods worth Rs 2,00,000 to Karan, a wholesaler. Karan, further sells the goods to Garv a retailer, for Rs 2,20,000 after minor processing. Finally, Garv sells the goods to Ananya for Rs 2,50,000. GST @18% was applicable.

Now, when Raman supplies goods to Karan, he collects Rs 36,000 from Karan against GST and pays the same to the government. When Karan further sells the goods to Garv, he collects Rs 39,600 as GST from Garv. Since Karan had paid GST on inputs, he can claim an input tax credit of an amount equal to the GST paid on the inputs i.e. Rs 36,000.

The balance Rs 3,600 is paid to the Govt. by Karan. Similarly, when Garv sells goods to Ananya, he collects Rs 45,000 as GST from Garv. Since Garv had paid GST on inputs, he can claim an input tax credit of an amount equal to the GST paid on the inputs i.e. Rs 39,600. The balance Rs 5,400 is paid to the Govt. by Garv. Lastly, Ananya, the consumer pays GST of Rs 45,000 to Garv.

Therefore, you conclude that there is no incidence of tax on any of the interim parties – neither the wholesaler nor the retailer. The reason is that the tax that each of them has paid can be set off against their respective tax liabilities on output. The final incidence of tax is only on the end consumer. 

This clearly displays the removal of the cascading effect of taxes in the erstwhile indirect tax regime.

• You can use human figures for Raman, Karan, Garv, and Ananya to illustrate this example.

From there, you can build on the definition and concept of Input Tax Credit Under GST. Say starting with ‘So What Is Input Tax Credit’. Explain the definition, first starting with:

1. What Are Inputs?
2. Then, What Are Taxes Paid On Inputs?
3. And Finally, Explain The Term Input Tax Credit

Then you can start the next section with ‘So How Will Raman Become Eligible For Claiming Input Tax Credit?’. This section will give the following checklist of conditions that Raman or registered taxable persons like Raman need to fulfill in order to claim Input Tax Credit:

• Raman must be registered. 
• Raman must be in possession of a tax invoice or a debit note issued by the supplier of inputs or input services. 
• Raman must receive the goods or services or both.
• The supplier of inputs must have paid the government GST charged in respect of such a supply.
• Raman should have filed the returns under section 39.
• In case goods are received in lots or installments, ITC can be claimed by Raman when the last lot is received.
• In case Raman has claimed depreciation on the tax part of the cost of capital goods, the ITC on the said tax component shall not be allowed.
• Raman shall not be entitled to take ITC if the same is not claimed within the time limit. 

Different icons can be used to demonstrate the conditions that Raman must satisfy in order to claim Input Tax Credit (ITC).

Once Raman becomes eligible for claiming, he needs to have certain documents in place to claim ITC. The next section will give a checklist of documents. :

• An invoice issued by the supplier of goods or services.
• An Invoice issued by the recipient of goods or services in case such supply is made by an unregistered person to a registered person.
• A Debit note issued by the supplier in case the taxable value or tax charged in the invoice is less than taxable value or tax payable in respect of such supply.
• A Bill of Entry or any similar document as required for an integrated tax on imports.
• An Invoice or Credit Note issued by an Input Service Distributor as per the rules under GST.
• A Bill of Supply issued by a dealer opting for composition scheme or an exporter or supplier of exempted goods.

Again different icons can be used to demonstrate the conditions that Raman must satisfy in order to claim Input Tax Credit (ITC).

But, while claiming ITC under GST, Raman has to keep in mind certain scenarios where ITC claimed gets reversed. So you can start the next section with, “But Hey! Raman Need To Be Aware Of Certain Scenarios Where ITC Claimed Under GST Gets Reversed’. All these scenarios should be written keeping Raman into the picture. Say if

• ‘Raman’ Fails To Pay The Supplier within 180 days from the date of issue of invoice by the supplier.
• If Raman Uses Goods And Services For Personal Use
• If Raman Uses Goods And Services For Exempt Supplies
• If Raman Uses Capital Goods For Personal Use
• If Raman Uses Sells Capital Goods And Plant And Machinery
• If Raman Switches From Normal GST To Composite Levy
• If Raman’s Registration Is Cancelled
• If Raman is one of the dealers of Input Service Distributor and a Credit Note Is Issued To Input Service Distributor (ISD), ITC Claimed by Raman Gets Reversed.
• If Raman Claims ITC On Inputs Used For Exempted or Non-Business Purpose More Than ITC Reversed During The Year
• If ITC Reversed by Raman Is More Than The ITC On Inputs Used For Exempted or Non-Business Purpose

Now, once Raman claims ITC, he can utilize the same to meet his output tax liability. Refer to the table above under the Utilization of ITC.

“Raman can first extinguish CGST Liability by first utilizing ITC standing under CGST and then under IGST. He can terminate his SGST liability by first using ITC standing under SGST and then under IGST. Finally, in case Raman has any IGST liability, that can be exhausted by first using ITC standing under IGST, then using ITC existing under CGST and lastly the ITC standing under SGST.

Lastly, Raman needs to reconcile the ITC claimed. Therefore, after the due dates for filing GST returns, the process for ITC matching starts. The online portal of Goods and Services Tax Network (GSTN) carries out the ITC Matching process. All the inward supply details as per GSTR 2 filed by the buyer are matched with outward supplies as per GSTR 1 filed by the supplier.

If the details match, then ITC claimed by Raman is considered valid. In case, there is a mismatch, the changes are reflected in GSTR 3.

If Raman fails to deposit tax on the due date or file return within time, then ITC can be denied. And in case any excess ITC is claimed, it is added back to the tax liability of Raman.

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