GST Input Tax Credit Reversal: Common Disputes Over Rule 42 and Rule 43

If your business makes both taxable and exempt supplies, you cannot take full input tax credit on common inputs and input services. Section 17 and Rules 42 and 43 of the CGST Rules require a proportionate reversal. Mistakes in this calculation lead to many notices. This guide explains the rules in plain language and the points on which disputes arise.

Who Must Reverse Credit Under Rule 42?

Rule 42 applies to inputs and input services used partly for taxable (including zero-rated) supplies and partly for exempt supplies or non-business purposes. Examples include a trader who also supplies exempt goods, a school or clinic with taxable ancillary services, or a developer with mixed supplies. If an input is used wholly for taxable supplies, full credit is available subject to the other conditions. If wholly for exempt supplies, no credit is available.

How Does the Rule 42 Calculation Work?

In outline, credit is divided into three parts. Credit on inputs used exclusively for exempt supplies or non-business use is not available. Credit on inputs used exclusively for taxable supplies is available. Common credit is apportioned in the ratio of exempt turnover to total turnover. The reversal is calculated provisionally each month, and a final adjustment is made at year end with interest on any shortfall. The exact formula, the time for the annual adjustment and the treatment of blocked credit are set out in the Rules, and should be applied from the current text.

What Is the Position for Capital Goods Under Rule 43?

Rule 43 deals with capital goods used partly for taxable supplies and partly for exempt supplies or non-business use. The credit on capital goods is treated as spread across a useful life of five years, and a portion is attributed to exempt use each month based on the exempt turnover ratio. Where capital goods are used exclusively for exempt supplies or non-business purposes, the credit is not available at all. Capital goods that are sold before five years require further adjustment.

What Are the Usual Points of Dispute?

• Whether certain income, such as interest on deposits or loans, should be counted as exempt turnover in the ratio
• Whether supplies of land or completed buildings after a completion certificate are exempt supplies for the ratio
• What counts as common credit, and what is credit exclusively for exempt supplies
• Treatment of blocked credit under Section 17(5)
• Whether reversal was computed monthly and adjusted annually, with the right interest
• Capital goods credit where the use changes from taxable to exempt

How Can You Defend a Notice on Reversal?

Prepare a working that shows turnover from each category, split of credit and the month-wise reversal. Show how you treated each input and why. Many notices proceed on an incomplete view of your turnover, or ignore a legal amendment, for example the clarification on treatment of interest. Correct data often reduces the demand.

What If Your Calculation Was Wrong?

If you under-reversed credit, pay the shortfall with interest, preferably before the notice becomes an order, and record it in the return. If you over-reversed, the credit can generally be reclaimed within the permitted time. Do not delay: the time limit to claim credit is explained in our article on Section 16(4) ITC time limit.

How Does This Relate to Other ITC Disputes?

Reversal under Rules 42 and 43 is different from denial of credit for supplier default or mismatch. See our guides on ITC disputes including supplier default and reversal and GSTR-2B vs GSTR-3B mismatch. A single notice can mix several issues, and each should be answered separately.

What Are the Remedies Against an Order?

After the officer’s order, you can file an appeal under Section 107 within three months, with a pre-deposit, and can go further to the Tribunal and the High Court. Where a pure question of law is involved, the High Court has examined interpretation of the Rules in writ proceedings. Review our article on the appellate hierarchy.

Need Help With ITC Reversal?

Our GST and Tax practice reviews ITC computations and represents clients in notices and appeals in Chennai. Book a consultation through our website and bring your returns, the turnover workings and the notice. This article is general information and not legal advice. Please verify the current rules and amendments before you act.