All you need to know about Input Tax Credit under GST

As India is welcoming the big GST rollout, one of the most important concepts that every tax payer needs to understand is input tax credit(ITC). Before diving in depth into where input tax credit comes into play under GST, we’ll need to have a thorough understanding of what it means.

What does Input Tax Credit mean and how is it beneficial?

Let us first understand what input and output tax mean. Input tax is the tax that you pay when you purchase goods or services for your business. This can include anything from raw materials to capital goods to items used for storage and maintenance. Output tax is the tax that you charge your customers when you sell your goods or services to them.

The GST taxation structure allows businesses across India to claim input credit for the tax they paid while purchasing capital goods for their company. Thus, at each stage of the supply cycle, the buyer gets credit for the input tax paid, and they can use it to offset the GST that needs to be paid to the Centre and State governments.

To understand this concept better, let’s take the example of a company called MK Kitchen Knives which sells custom-made kitchen knives. They purchase steel and plastic worth Rs.2000 from a vendor at a GST rate of 12.5%. Thus, the input tax they pay is Rs.250. The company now sells the manufactured knives for Rs.4000, plus an output tax of 12.5%, making the total selling price Rs.4500 (Rs.4000 + Rs.500).

Thus, the tax that MK Kitchen Knives owes to the Government = Output tax - Input tax credit = Rs.500 - Rs.250 = Rs.250

The next question that naturally arises is, which businesses will be eligible to claim input tax credit? Under the new regime, all businesses will be eligible for input tax credit except those dealing in goods or services that are exempt from GST or items for personal consumption.

The basic regulations to be followed for availing Input Tax Credit

There are some rules that businesses need to adhere to before they can start claiming input tax credit under GST. These include:

The taxpayer must possess a valid tax invoice, debit note, or other prescribed document issued by a registered dealer.
The taxpayer must have received the good or service. If the product is being received in installments, then the credit can be claimed against the tax invoice for the last installment.
The supplier must have paid the tax due on your purchases to the government either in cash or by claiming input tax credit.
Finally, the supplier must have filed GST returns.

The most unique and unprecedented change GST brings to this entire tax setup is that you’re allowed to claim input tax credit on your purchases only if your supplier is GST compliant and has paid the tax he or she collected from you.

Time limits for claiming Input Tax Credit

As with most government-ordained benefits, there are certain time limits associated with input tax credit. ITC can only be claimed for tax invoices and debit notes which are less than a year old. In any other case, the last date to claim ITC is the earlier of the following:

Before filing valid GST returns for the September following the end of the financial year applicable to that invoice, or
Before filing a relevant annual return.

Claiming and reconciling ITC

The GST comprises of 3 types of taxes: CGST, SGST, and IGST.

CGST (Central GST) - Collected by the Central Government for transactions within one state.

SGST (State GST) - Collected by the State Governments for transactions within one state.

IGST (Integrated GST) - Single levy collected by the Central Government for transactions between states.

The three tax credits can be used to offset one another.

CGST credit can be used to offset CGST liability; if there is credit left over, it can be applied toward IGST liability next.
SGST credit can be used to offset SGST liability; if there is credit left over, it can be applied toward IGST liability next.
IGST credit can be used to offset IGST liability; if there is credit left over, it can be applied toward CGST liability first and then toward SGST liability.

Reconciliation of these credits is done by matching your transactions with those of your customers or vendors. This will help the Tax Department verify the transactions from both ends. The GST Identification Number (GSTIN) is used to match transactions together.

Let us now use an example to understand how this reconciliation process works:

Suppose MK Kitchen Knives (recipient) purchased 10 tons of steel from GH Steelware Inc. (supplier) which is also registered for GST. The two companies will reconcile their transactions, and the recipient will claim the input tax credit, as follows:

GH Steelware Inc. will file the GSTR-1 report (Details of outward supply).
The details furnished in the GSTR-1 will be auto-populated in the GSTR-2A (Details of inward supply) for MK Kitchen Knives, where they will be able to see the transaction details.
MK Kitchen Knives will then check the records and make any necessary modifications/additions. Once the changes are made, this information will be automatically pulled when they will file the GSTR-2. The correct input credit will then be credited to their electronic credit ledger.
GH Steelware Inc can then use the GSTR-1A form to view and accept the changes that MK Kitchen Knives made in the GSTR-2.
Finally, once GH Steelware Inc. has filed the monthly returns (GSTR-3), MK Kitchen Knives will be able to avail the input tax credit and apply it to future output tax liabilities.

In cases where the tax on purchases is higher than the tax on sales, the extra input credit can be carried forward or claim a refund. Existing CENVAT credits can be converted to GST input tax credits as well — learn more about CENVAT credits.

Adjusting ITC for interstate and intra-state transactions

Let’s now look at how Input Tax Credit can be used to offset output tax liabilities for both interstate and intrastate transactions.

Let’s say MK Kitchen Knives is based in Tamil Nadu. The details of their last four intra-state transactions are tabulated below, including the tax liability.

In the above example, MK Kitchen Knives has a total input tax credit of Rs.80,000 (Rs.50,000 + Rs.30,000) from both CGST and SGST.
Based on the tax offsetting rules under GST, they use the CGST input tax credit worth Rs.80,000 to offset the CGST liability of Rs.87,000 (Rs.47,000 + Rs.40,000). Once this adjustment is completed, the remaining CGST liability is Rs.7,000 (Rs.87,000 - Rs.80,000).
Similarly, they use the SGST input tax credit worth Rs.80,000 to offset the SGST liability of Rs.87,000 (Rs.47,000 + Rs.40,000). Upon completion, the SGST liability amounts to Rs.7,000 (Rs.87,000 - Rs.80,000).
The total tax liability is thus Rs. 14,000 (Rs.7,000 + Rs.7,000).

If there is any CGST credit left over after setting off the CGST tax liability, it cannot be used to offset SGST. Thus, the balance of the CGST credit will be carried over to the next period. The same applies to unused SGST credit; it can only be carried forward, not applied to CGST liability.

Consider another set of transactions for MK Kitchen Knives. This time, it’s a mix of interstate and intrastate transactions.

As illustrated above, MK Kitchen Knives has an IGST credit of Rs.40,000(Rs.10,000 + Rs.10,000 + Rs. 20,000), and tax liabilities of IGST 20,000, CGST 10,000 and SGST 15,000.
According to the tax offsetting rules under GST, IGST credit needs to be used first to offset IGST tax liability. Whatever IGST credit is left can be used against CGST liability, then against SGST liability (in that order).
MK Kitchen Knives first uses their IGST credit to offset their IGST liability of Rs.20,000.
The remaining credit of Rs.20,000 (Rs. 40,000 - Rs.20,000) is used to offset the CGST liability of Rs.10,000.
After this adjustment, the remaining IGST credit of Rs.10,000 can be used to offset part of the SGST liability worth Rs.15,000.
Once the entire IGST credit has been utilized, we’re left with an SGST liability of Rs.5,000 (Rs.15,000 - Rs.10,000).