What is Input Tax Credit (ITC)?
Input Tax Credit (ITC) is a mechanism under the GST system that allows businesses to claim credit for the tax paid on inputs (goods or services) used in the course of their business. When you buy raw materials, services, or other inputs and pay GST on them, you can offset that amount against the GST you owe on your sales.
This prevents the cascading effect of taxes, where you would otherwise pay tax on tax. Proper use of ITC helps lower your tax burden and boosts your working capital and cash flow.
How Does Input Tax Credit Work?
The mechanism of Input Tax Credit is straightforward:
- GST Paid on Purchases: When a registered business purchases goods or services, it pays GST to the supplier, which is recorded as Input Tax Credit (ITC).
- ITC Set-Off Mechanism: The GST paid on purchases (input tax) can be set off against the output tax liability, reducing the actual tax payable.
- Prevents Tax Cascading: This mechanism avoids tax-on-tax at each stage of the supply chain.
Example: If you purchase raw materials for Rs. 10,000 and pay 18% GST (Rs. 1,800), and then sell the finished product for Rs. 15,000 charging 18% GST (Rs. 2,700), your net tax payable is Rs. 900 (Rs. 2,700 Output Tax - Rs. 1,800 ITC).
Eligibility and Ineligibility for Claiming ITC
Eligible to Claim ITC
- Registered person under GST.
- Goods or services used for business purposes.
- Possession of a valid tax invoice or debit note.
- Goods or services have been received.
- Supplier has paid GST to the government and filed GSTR-1.
- ITC is reflected in GSTR-2B.
Ineligible to Claim ITC (Blocked Credits - Section 17(5))
- Motor vehicles for personal use (with exceptions).
- Food, beverages, outdoor catering, beauty treatment, health services (unless used for making outward taxable supply of same category).
- Club membership, health & fitness centre fees.
- Rent-a-cab, life & health insurance (unless mandatory by law).
- Works contract services for construction of immovable property (except plant & machinery).
- Goods lost, stolen, destroyed, written off or disposed of by way of gift or free samples.
Calculation and Set-Off Rules
The government has laid down a specific order for utilizing the available credit:
- IGST Credit: First used to pay IGST liability, then CGST, and lastly SGST/UTGST.
- CGST Credit: Used only for CGST and then for IGST. Cannot be used for SGST/UTGST.
- SGST/UTGST Credit: First applied to SGST/UTGST and then to IGST. Cannot be used to pay CGST.
Formula: Net GST Payable = Output Tax Liability - Eligible Input Tax Credit.
Documents Required to Claim ITC
To claim Input Tax Credit, you must possess one of the following documents:
- Tax Invoice: Issued by a registered supplier.
- Debit Note: Issued by the supplier for increase in taxable value or tax.
- Bill of Entry: For imported goods.
- Invoice for Reverse Charge: Issued by the recipient if liable to pay tax under RCM.
- ISD Invoice: Issued by an Input Service Distributor.
Reversal of Input Tax Credit
ITC must be reversed (added back to output liability) in certain situations:
- Non-Payment to Supplier: If payment is not made to the supplier within 180 days.
- Exempt/Non-Business Use: Inputs/services used for exempt supplies or personal purposes.
- Goods Lost/Destroyed: ITC on goods lost, stolen, destroyed, or given as free samples.
- Capital Goods: If capital goods are sold or used for non-business purposes.
