Demystifying Input Tax Credit under the Model GST Law

Input Tax Credit, the word which every business person, accountant or cost accountant loves to listen to this and also avail the same on all the purchases made for business. We have seen tax reforms in India for input tax credit under various name, MODVAT was introduced in the year 1986 on certain items with an intention of passing on the tax credit on the purchases, and it has been modified from time to time and finally CENVAT Credit Rules 2004 were introduced where the input tax credit for the Central Excise Taxes was available on most of the inputs and in case of capital goods with some conditions. The taxes levied by the state governments is known as sales tax before the introduction of VAT, and the same were not eligible for input tax credit. As a result, there is an increase in the cost of production of goods and services. When Value Added Tax was introduced, this issues is also addressed, and input tax credit was available.  In spite so many tax reforms from time to time on the input tax credit front, the trade or industry is not happy as it is very restrictive when we take a holistic approach like

  1. Input tax on value added tax is not available for service providers
  2. Taxes on inter-state sales, e., CST is not eligible for input tax credit
  3. Inter utilization of input tax credit like VAT cannot be used for payment of Service tax or vice versa.
  4. Input tax credit cannot be availed on capital goods immediately as in the case of inputs for central excise or VAT. In the case of VAT, it varies from state to state.

These were some of the challenges which the trade or industry is facing with input tax credit, but going forward under GST, the same are addressed but with some restrictions / limitation. Input tax credit under the Model GST law is given to a large extent very clearly under sections 16 to 18 of Chapter V, Section 28 and Section 29 explains the process of input tax credit, provisional claim, reversal, etc. in chapter VIII, section 37A explains the process of transfer of input tax credit and Section 147 on the transitional provisions for cenvat and VAT tax credit.

Section 2, sub-section 54 defines what are inputs  “input” means any goods other than capital goods, subject to exceptions as may be provided under this Act or the rules made thereunder, used or intended to be used by a supplier for making an outward supply in the course or furtherance of business;

The input means any goods other than capital goods used or to be intended to be used for making the supply of goods or services. It means all inputs used for making of taxable supplies are eligible for input tax credit.

Section 2, sub-section 55 defines “input service” means any service, subject to exceptions as may be provided under this Act or the rules made thereunder, used or intended to be used by a supplier for making an outward supply in the course or furtherance of business;

Input service means any service used by the taxpayer / supplier for making of outward supplies.

Section 2, sub-section 57 defines input tax “input tax” in relation to a taxable person, means the {IGST and CGST}/{IGST and SGST} charged on any supply of goods and/or services to him which are used, or are intended to be used, in the course or furtherance of his business and includes the tax payable under sub-section (3) of section 7;”

Taxes paid on the purchase of goods and services which are eligible for input tax credit are used for making the output tax liability on the supply of goods and services.

Section 2, sub-section 20 defines capital goods as “capital goods” means: –

(A) the following goods, namely:-

(i) all goods falling within Chapter 82, Chapter 84, Chapter 85, Chapter 90, heading 6805, grinding wheels and the like, and parts thereof falling under heading 6804 of the Schedule to this Act;

(ii) pollution control equipment;

(iii) components, spares and accessories of the goods specified at (i) and (ii);

(iv) moulds and dies, jigs and fixtures;

(v) refractories and refractory materials;

(vi) tubes and pipes and fittings thereof;

(vii) storage tank; and

(viii) motor vehicles other than those falling under tariff headings 8702, 8703, 8704, 8711 and their chassis but including dumpers and tippers used-

(1) at the place of business for supply of goods; or

(2) outside the place of business for generation of electricity for captive use at the place of business; or

(3) for supply of services,

 (B) motor vehicle designed for transportation of goods including their chassis registered in the name of the supplier of service, when used for

(i) supplying the service of renting of such motor vehicle; or

(ii) transportation of inputs and capital goods used for supply of service; or

(iii) supply of courier agency service;

(C) motor vehicle designed to carry passengers including their chassis, registered in the

name of the supplier of service, when used for supplying the service of-

(i) transportation of passengers; or

(ii) renting of such motor vehicle; or

(iii) imparting motor driving skills;

 (D) Components, spares and accessories of motor vehicles which are capital goods for the taxable person.

Reading the above section, it is apparent that the definition is taken from the current provisions of the central excise and replaced with few words here and there. Going forward under GST also the treatment for inputs and capital goods will be same to a large extent expect in case of definition what is capital good and what is input.

Section 16 of the Model GST Act provides the provisions for input tax credit. Similar to the age-old excise registers, RG 23 Part I / II  – A /C for tracking the input credit maintained by the assesses, we have similar concept called electronic credit ledger and this ledger is maintained by the tax authorities / infrastructure provider of GST and all the taxes paid by the suppliers for the supplies made to this tax payers gets updated in the electronic ledger, the amount can be utilized for making payment of out liability, penalty, interest, or any amount as per provisions of section 35 of the Model GST Act.

Sub-section 2 of Section 16 provides a clear mandate that in case of a business or entity which has opted for the GST registration, the taxes paid by him on the stock held by him on input, semi-finished goods and finished goods immediately on the day he is eligible to pay tax, will be eligible to take input tax credit of such goods. The reason for providing such a provision is that as the tax is being levied on the sales immediately from the date of registration, the taxes paid on his purchases. These provisions are available for the following person

  1. Persons who have opted for registration on crossing of the threshold as specified under section 8, person who crosses the thresholds
  2. Persons who have opted for voluntary registration in spite of not crossing the threshold limits as prescribed

The eligible input tax credit in the above cases will be computed based on the following

  1. The tax invoice should not be more than 12 months old
  2. The amount of tax credit eligible will be computed based on the accepted accounted principles.

What does these accepted principles mean? There is no clarity on this. Hope this will not lead to some interpretation issues from the department on the valuation and also on the amount of input tax credit.

Sub-section 5 explains about the usage of goods and services brought but used for business as well as for personal consumption.

Where the goods and/or services are used by the registered taxable person partly for the purpose of any business and partly for other purposes, the amount of credit shall be restricted to so much of the input tax as is attributable to the purposes of his business.

Illustration

A Ltd buys laptops each costing Rs 45,000 and in that he gives one of the laptops for his college going, son.

In the above case, the input tax credit is eligible for only 4 laptops as the fifth one is not used for business purpose.

Sub-section 6 explains the manner of taking input tax credit in the case in the inputs procured are used for making taxable supplies and non-taxable supplies.

Where the goods and / or services are used by the registered taxable person partly for effecting taxable supplies and partly for effecting non-taxable supplies, including exempt supplies but excluding zero-rated supplies, the amount of credit shall be restricted to so much of the input tax as is attributable to the taxable supplies including zero-rated supplies.

Illustration

XYZ Ltd is an electronic goods manufacturer and manufactures both taxable and non-taxable supplies. XYZ Ltd purchases Polyvinyl chloride (PVC), and he makes industrial goods along with doors and windows for residential purpose. Industrial goods manufactured are taxable, and doors and windows used for the residential purpose are tax exempted. When PVC is purchased, it is not known who much will be used for taxable and non-taxable supplies.

The input credit on the purchase of PVC should be reversed to the extent used for manufacturing / sale of doors and windows as they are exempted from tax.

The government will notify the amount of the input tax credit to be reversed and the process to be followed in the above two cases. Based on that it has to be reversed.

In the normal course of business, the business establishment can be sold or merged, or the constitution of it can change from a partnership to the company, etc., in all such cases, the input tax credit will be allowed to be used by the new legal entity. The same is described in sub-section 8 of section 16.

Where there is a change in the constitution of a registered taxable person on account of sale, merger, demerger, amalgamation, lease or transfer of the business with the specific provision for transfer of liabilities, the said registered taxable person shall be allowed to transfer the input tax credit that remains unutilized in its books of accounts to such sold, merged, demerged, amalgamated, leased or transferred business in the manner prescribed.

Input tax credit is allowed only under the following conditions

  1. The supplier of goods and services has paid the tax
  2. The goods or services must be received / deemed to be received
  3. The buyer / recipient is in possession of the tax invoice
  4. The tax returns are filed by the supplier of goods / services
  5. Input tax credit can be taken within 1 year from the date of issue of tax invoice
  6. In case if input tax credit is taken on a provisional basis and the supplier does not pay the tax, the same will be reversed along with interest.
  7. In case if the supplier pays the tax after reversal, then he is eligible to take the input tax credit along with the interest.

As in the current taxation, input tax credit is not allowed in some cases, and such cases are listed clearly in the Model GST law clearly under sub-section 9 and 10 of section 16.

(a) motor vehicles, except when they are supplied in the usual course of business or are used for providing the following taxable services—

(i) transportation of passengers, or

(ii) transportation of goods, or

(iii) imparting training on motor driving skills;

(b) goods and / or services provided in relation to food and beverages, outdoor catering, beauty treatment, health services, cosmetic and plastic surgery, membership of a club, health and fitness centre, life insurance, health insurance and travel benefits extended to employees on vacation such as leave or home travel concession, when such goods and/or services are used primarily for personal use or consumption of any employee;

(c) goods and/or services acquired by the principal in the execution of works contract when such contract results in construction of immovable property, other than plant and machinery;

(d) goods acquired by a principal, the property in which is not transferred (whether as goods or in some other form) to any other person, which are used in the construction of immovable property, other than plant and machinery;

(e) goods and/or services on which tax has been paid under section 8; and

(f) goods and/or services used for private or personal consumption, to the extent they are so consumed.

Sub-Section 10   Where the registered taxable person has claimed depreciation on the tax component of the cost of capital goods under the provisions of the Income Tax Act, 1961, the input tax credit shall not be allowed on the said tax component.

Section 16A of the Model GST Act lays down the procedures for claiming input tax credit for materials / capital goods sent for job work.

Section 43 of the Model GST Act, gives the procedure for job work on GST. In the normal course of business, the material is received at the taxpayers place and then the same is shipped to the job worker or subcontractor if required for further processing. In such cases where the material is shipped directly to job worker, the input credit can also be claimed, and the process is prescribed under section 16A of the Model GST Act.

Input Credit in case of Inputs

  • Input tax credit on the material sent to job worker is allowed only when they are returned within 6
  • Credit can be availed only if the supplier pays the tax.
  • In the case of material already sent before the rollout of GST, 6 months should be computed from the accounted date of the GST rollout, mentioned in the transitional provisions of Section 150 of the Model GST Act.

Input Credit in case of Capital goods

The treatment for capital goods is different from that of the inputs for availing input tax credit.

  • The input credit for capital goods can be taken if the goods capital goods is used by the job worker and the same is returned within 2 years from the date on which it is sent out to job worker.
  • In case if the inputs or the capital goods are not returned within in the stipulated period, the taxpayer has to pay an equivalent amount of input tax credit availed along with interest. In such cases, interest is also required to be paid as prescribed under sub-section 1 of section 36.

The input tax credit will be allowed only if the supplies of the seller and buyer are matched, in the case of any mismatch, the same is informed to the supplier and recipient by the GSTN for rectifying the mistakes. The returns have to be matched as well as the taxes have to be paid for availing the credit. The process is mentioned in sub-section 28 and 29 of the Model GST Act.

There is a provision to take input tax credit on provisional basis by the recipient without waiting for the tax being paid by the supplier of goods or services. In such cases, the recipient has to enter these invoices manually in the GSTR -2. A window period of two months is given for matching of the records, and if the same does not happen within this period, the input tax credit taken on such invoices will be reversed along with the interest for the two months.

Once the supplier pays the same, the records will be verified and matched by GSTN, once it is matched, the recipient will be eligible to take the input tax credit along with the interest paid. The only challenge with is process is that the ratings of the recipient will be impacted as the department has taken the approach of giving ratings for all the taxpayers based on their tax payment, the filing of returns from time to time.

The taxpayer has to take a judicious call on to take the credit on the provisional basis or wait for payment of taxes till the supplier pays the taxes. In the case of the second approach, there may be some impact on the cash flows and working capital management. While making purchases or entering into contracts, the tax history of the supplier of goods and services also has to be considered along with the quality, delivery, prices and other factors. This will amount to change in the business process, and for this to be implemented, the concerned teams have to be trained accordingly.

Input Service Distributor

Under GST also there is a provision for registration as Input Service Distributor similar to the current provisions. Section 17 of the Model GST Act lays down the procedure for distribution of the input tax credit by Input Service Distributor.

The credit of CGST can be transferred as IGST input tax credit if the input service distributor and the recipient of credit are located in different States.

The credit of SGST can be transferred as IGST input tax credit if the input service distributor and the recipient of credit are located in different States.

The credit of SGST & IGST can be transferred as SGST input tax credit if the input service distributor and the recipient of credit are located in same State.

To conclude the input tax credit process is simple under GST as per the Model Law provisions but only the difference with the current regulations is that input tax credit can be availed only on payment of taxes by the supplier. The government wants to ensure that there is no revenue leakage on account of black sheep and also safeguard its revenue collections.

Utilization of Input Tax Credit

This is one the most important change in the input tax credit process compared to the current process under various tax regulations. The major drawbacks under the current tax regulations are

  1. Input tax credit on all business expenses is not allowed like VAT credit is not allowed for a service provider
  2. Excise / Service Tax credit, e., CENVAT Credit is not utilized for payment of VAT liability or vice versa
  3. Input tax credit is not eligible for all taxes like CST applicable on interstate transactions.

All these are being addressed in the GST to a large extent with some restrictions but by large very useful for the business / industry as a whole. This will ensure that input tax credit is available in whole supply chain process seamlessly and thereby providing a feasibility of lowering the cost of goods and services and pass on the benefits to the end consumer.

Central Goods and Service Tax – input tax credit of Central Goods and Service tax has to be utilized for payment of Central Goods and Service Tax liability, and if any amount is remaining, the same can be used for payment of a liability of Integrated State Goods and Service Tax.

CGST Credit

State Goods and Service Tax – input tax credit of State Goods and Service tax has to be utilized for payment of State Goods and Service Tax liability, and if any amount is remaining, the same can be used for payment of a liability of Integrated State Goods and Service Tax.

SGST Credit

Integrated State Goods and Service Tax – input tax credit of Integrated Goods and Service tax has to be utilized for payment of Inter-State Goods and Service Tax liability, and if any amount is remaining, the same can be used for payment of liability of Central Goods and Service Tax and if credit is still available the same can be used for payment of liability of Inter-State Goods and Service Tax.

IGST Credit

To conclude the input tax credit process is simple under GST as per the Model Law provisions but only the difference with the current regulations is that input tax credit can be availed only on payment of taxes by the supplier. The government wants to ensure that there is no revenue leakage on account of black sheep and also safeguard its revenue collections.

Any views or opinions represented above are personal and belong solely to the author and do not represent those of people, institutions or organizations that the owner may or may not be associated with in professional or personal capacity, unless explicitly stated. Any views or opinions are not intended to malign any religion, ethnic group, club, organization, company, or individual.

These examples are based on the model law and may change based on the actual law passed.

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