The Goods and Services Tax (GST) system in India offers businesses a significant advantage through the Input Tax Credit (ITC) mechanism. This allows taxpayers to claim credit for taxes paid on business-related purchases, reducing the cascading effect of paying tax on tax. By using the input tax credit formula, businesses can effectively claim credits for taxes paid on goods and services used in their operations. A thorough understanding and accurate calculation of ITC are essential for ensuring tax compliance and optimizing tax liabilities.

In this blog, we will break down the various aspects of ITC, including the formula, conditions for claiming it, and the process involved. Additionally, we will highlight key benefits, common challenges faced by businesses, and practical tips to ensure seamless ITC management. By the end of this guide, you will have an in-depth understanding of how to maximize ITC benefits for your business.

Understanding Input Tax Credit

Input Tax Credit is a mechanism under the GST regulation that allows businesses to claim credit for the tax paid on inputs used in the production or provision of goods or services. As per Section 17 of the CGST Act, ITC is allowed on the taxes paid on purchases, subject to certain conditions and restrictions. This credit can then be set off against the tax payable on the output supply. ITC is a fundamental component of the GST structure, ensuring that businesses are not taxed twice on the same transaction, thus avoiding cascading tax effects. 

Types of Input Tax Credit

There are several categories of ITC, each related to a specific type of tax under GST. Understanding each category is essential for determining how they apply to your business operations.

1. IGST (Integrated Goods and Services Tax)

The ITC on IGST is applicable when a business engages in inter-state transactions. IGST is charged on goods and services sold across state boundaries. The ITC paid on such purchases can be used to offset the IGST liability on sales, with any excess either carried forward or refunded.

2. CGST (Central Goods and Services Tax)

The CGST is applicable to intra-state supplies, where both the supplier and the buyer are located within the same state. The ITC on CGST can only be used to offset CGST liability on sales within the same state. If the CGST input exceeds the output CGST, the balance can be carried forward or refunded.

3. SGST (State Goods and Services Tax)

The SGST is applicable to intra-state transactions where the supplier and buyer are in the same state. The ITC of SGST is used to pay SGST liability. Any excess ITC can be carried forward to future returns or claimed as a refund.

4. UTGST (Union Territory Goods and Services Tax)

The UTGST is applicable in Union Territories that do not have their own SGST laws. The ITC on UTGST is similar to SGST in its application, and it can be claimed to offset the UTGST liability for intra-Union Territory transactions.

Since the conditions for claiming ITC differ based on the type of GST applicable to your business, the following sections will provide a detailed overview of the eligibility criteria for the claiming process.

Conditions for Claiming ITC

Before claiming ITC, certain conditions must be met to ensure the credit is legitimately available, and businesses do not misuse the system. Let's explore the key conditions for claiming ITC.

• Registered Dealer: The person must be registered under GST in order to claim ITC.

• Possession of Tax Invoice or Debit Note: The claimant must have a valid tax invoice, debit note, or other documents issued by a registered supplier.

• Receipt of Goods/Services: The business can claim ITC on goods or services only when they have been physically received or made available to them.

• Goods/Services Used for Business: The purchased goods or services should be used for the business. ITC cannot be claimed for personal use.

• GST Paid to Supplier: The supplier must have paid the GST to the government. If the supplier has not paid the GST, the ITC cannot be claimed.

• Filing of GST Returns: The business must file GST returns (GSTR-1 and GSTR-3B) on time. The ITC is available only when the supplier's details are reflected in the GST return.

• Matching of Invoices: ITC can only be claimed on the basis of invoices that are matched with the records of the supplier in the GST portal.

• Time Limit for Claiming ITC: ITC must be claimed by the due date for filing the GST return for September following the end of the financial year, or the actual date of filing the annual return, whichever comes first.

• Blocked Credits: Blocked Credits refer to goods and services on which ITC cannot be claimed, typically including personal or non-business expenses and items not directly related to taxable activities.

• No ITC on Capital Goods in Certain Cases: In some cases, if capital goods are used for both business and non-business purposes, the ITC will be allowed only proportionately.

• Fraudulent ITC: ITC cannot be claimed if it involves fraudulent activities, like fake invoices or fictitious transactions.

Once these conditions are met, it is essential to understand the elements necessary for calculating ITC accurately and efficiently.

Key Elements for Calculating ITC

Businesses must carefully track their purchases, maintain valid tax invoices, and calculate the eligible credit accurately. The following are the essential components for calculating ITC:

1. Sources for Calculation of ITC

The first step in calculating ITC is to gather all relevant sources, including tax invoices for inward supplies, ensuring these documents reflect the correct amount of tax paid. ITC can then be claimed using valid tax invoices, debit notes, or proof of customs duty paid for imports, such as the bill of entry.

2. Balance of Electronic Credit Ledger (ECL)

Once you have the required documents, the next step is to verify the balance in your electronic credit ledger. This ledger is a digital record of all the input tax credits claimed by your business. It is maintained on the GST portal that reflects the available credit for use. This ECL is updated automatically with the following details:

• ITC received from suppliers via GSTR-2A / GSTR-2B.

• Tax payments made on reverse charge via self-declaration in GSTR-3B.

• Adjustment of ITC if there is any mismatch in details or returns are filed incorrectly.

3. Inward Supplies Received – Tax Invoice

Inward Supplies are purchases made by the taxpayer from a supplier. If these purchases are taxable, ITC can be claimed on the tax paid. To claim ITC, the taxpayer must possess valid tax invoices for inward supplies received. Below are the essential details that must be included in a valid tax invoice to claim ITC for inward supplies under GST:

• GSTIN of the supplier

• Invoice number and date

• Description of goods/services

• Taxable value and GST rate applied to the supply

• Total amount of tax charged (CGST, SGST, IGST)

The taxpayer must ensure that the supplier has uploaded the invoice in the GST portal for the ITC to be available for claiming.

Understanding these preconditions helps simplify the process and ensures compliance with GST law. Once the prerequisites are met, let's proceed to understand how to calculate the ITC.

Calculation of Input Tax Credit

The calculation of the ITC involves determining the eligible tax paid on inputs that can be set off against the tax liability on output supplies. Following are the steps to calculate the Input Tax Credit under GST:

• Step 1: Sum up the total GST paid on all purchases made during the tax period.

• Step 2:  Identify the purchases that qualify for ITC.

• Step 3: Calculate the eligible ITC by multiplying the total GST paid on purchases by the percentage of eligible input tax credit.

Eligible ITC = (GST Paid on Purchases) x (Eligible ITC Percentage)

• Step 4: Subtract the eligible ITC from the GST payable on sales made during the tax period.

For example:

• A business purchases goods worth ₹40,000 with a GST rate of 10%, resulting in a total GST paid of ₹4,000.

• The business then sells goods worth ₹50,000 with the same 10% GST rate, resulting in a GST payable of ₹5,000.

• If 80% of the inputs are eligible for ITC, the ITC amount would be ₹4,000 x 80% = ₹3,200

• The eligible ITC would be calculated as: GST payable (₹5,000) – ITC claimed (₹3,200) = ₹1,800 payable

Thus, after claiming the ITC, the business would only need to pay ₹1,800 in GST.

With this understanding of ITC calculation, let us now proceed to discuss the claim process, which is equally important for businesses to comprehend.

Claiming Process for Input Tax Credit

The process for claiming ITC under the GST system in India is governed by specific sequences for IGST, CGST, and SGST. Below is the detailed procedure for each type of ITC:

1. Claim Sequence for IGST

• Step 1: IGST paid on inward supplies can be set off against IGST on outward supplies first.

• Step 2: If there is any excess IGST available after setting it off against IGST on outward supplies, it can first be set off against CGST, and any remaining balance can be set off against SGST.

• Step 3: The IGST credit can be carried forward to the next tax period if not fully utilized.

2. Claim Sequence and Restrictions for CGST

• Step 1: CGST paid on inward supplies must first be set off against CGST on outward supplies.

• Step 2: If any excess CGST is left after setting it off against CGST on outward supplies, it can be set off against IGST.

• Step 3: CGST cannot be set off against SGST (as per the law, CGST is not allowed to be adjusted against SGST).

• Step 4: If not fully utilized, CGST credit can be carried forward to the next period.

3. Claim Sequence and Restrictions for SGST

• Step 1: SGST paid on inward supplies must first be set off against SGST on outward supplies.

• Step 2: If any excess SGST is left after setting it off against SGST on outward supplies, it can be set off against IGST.

• Step 3: SGST cannot be set off against CGST (similarly, SGST is not allowed to be adjusted against CGST).

• Step 4: If not fully utilized, SGST credit can be carried forward to the next period.

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Understanding the ITC claiming process for all types of ITC is essential, as is being aware of the deadlines for claiming ITC to ensure businesses don't miss out on eligible credits. Let us now explore these key timeframes.

Time Limits for Availing ITC

Under the GST system, businesses must comply with specific time limits for availing ITC. Failure to claim ITC within the prescribed time frame may result in the loss of eligible credits. 

1. One Year from the Date of Issue of Tax Invoice

ITC must be claimed within one year from the date of issue of the tax invoice. After this period, the credit becomes ineligible for claim.

2. After Filing of Return for September of the Next Financial Year

ITC must be claimed in the GST return for the month of September of the next financial year in which the invoice was issued. If ITC is not claimed by this date, it will no longer be eligible for claim.

3. Post-filing of Annual Return by December 31st of the Next Financial Year

The final date for claiming ITC is the due date for filing the annual return, which is December 31st of the subsequent financial year.

With the time limits for availing ITC outlined, we now turn our attention to the allocation and utilization of ITC, a key factor for businesses seeking to improve their profit margins.

Apportionment of ITC

Businesses engaged in both taxable and non-taxable activities must allocate ITC accordingly. The ITC related to business activities can be fully claimed, but the portion related to non-business activities must be excluded. The following rules govern the apportionment of ITC: 

• Rule 42: For taxable and exempt supplies, businesses must follow Rule 42 of the GST law. The total credit for inputs is reduced based on the proportion of exempt supplies in relation to total supplies.

• Rule 43: For capital goods used for both taxable and exempt purposes, Rule 43 applies. The credit on capital goods is also apportioned based on the same criteria as Rule 42.

Businesses must apportion ITC for taxable and non-taxable activities, ensuring the credit is allocated appropriately based on the nature of the supplies.

Now, let's explore the utilization restrictions that ensure ITC is applied in compliance with GST regulations, guiding the proper use of accumulated ITC and maintaining system integrity.

Utilization Restrictions on Specific Taxes

Specific rules under GST define the conditions under which businesses can apply the ITC they have accumulated. In this context, the Central Board of Indirect Taxes and Customs issued Circular No. 98/17/2019-GST, which provides further clarification on the utilization of input tax credit under GST. These guidelines are designed to ensure that ITC is utilized in compliance with GST rules, preventing misuse and ensuring that businesses only claim ITC for legitimate business-related expenses. The following are the key utilization restrictions for specific taxes under GST.

1. IGST (Integrated GST)

The ITC on IGST must be utilized in the following sequence: firstly, against the IGST liability, followed by the CGST liability, and finally, the SGST liability. It cannot be used for CGST or SGST liabilities unless the IGST liability is fully settled. 

2. CGST (Central GST)

ITC on CGST can only be utilized to discharge CGST or IGST liabilities. It is not permitted to be used for settling SGST liabilities.

3. SGST (State GST)

ITC on SGST must be applied to settle SGST liabilities before being utilized for IGST liabilities. It cannot be used for CGST liabilities under any circumstances.

4. Reversal of ITC

ITC must be reversed if the supplier does not pay tax to the government after receiving payment from the buyer. Additionally, reversal is required if goods or services are used for non-business purposes or exempt supplies.

5. ITC on Capital Goods

ITC on capital goods must be apportioned when such goods are used for both taxable and exempt purposes. Any unutilized ITC must be reversed if the capital goods are disposed of before the completion of their useful life.

6. Blocked Credits (Ineligible ITC)

ITC is not eligible for motor vehicles, food and beverages, outdoor catering, and beauty treatments unless directly used for business purposes. Additionally, ITC is blocked on membership fees for clubs or works contract services related to immovable property.

7. ITC Reversal on Exempt Sales

ITC related to exempt supplies must be reversed in proportion to the ratio of exempt supplies to total supplies. The calculation for reversal is based on the formula:

ITC to be reversed =Total ITC x (Exempt SuppliesTotal Supplies)

To effectively manage ITC, businesses must understand the utilization restrictions, as well as the situations where ITC cannot be claimed. When claiming ITC on assets, businesses must consider the impact of depreciation on these assets to ensure compliance with GST regulations.

Impact of Depreciation Claim on ITC

Depreciation affects the ITC claim by reducing the asset's value. Proper adjustments must be made to ensure compliance and avoid discrepancies between depreciation and ITC.

1. No Double Benefit

A business cannot claim both ITC and depreciation on the same asset. If ITC has been claimed on an asset, the depreciation should be calculated on the net value after accounting for the ITC already claimed.

2. Impact on Capital Goods

For capital goods, if depreciation is claimed, ITC must be adjusted. Depreciation is calculated on the reduced value of the asset after considering the ITC.

3. Reversal of ITC on Sale of Depreciated Asset

If an asset, after depreciation, is sold or discarded, the ITC claimed earlier must be reversed based on the depreciated value of the asset.

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Businesses must ensure proper adjustment of ITC to avoid double benefits and comply with GST regulations. Tools like Pazy can assist by simplifying compliance with GST rules and tax management, ensuring accurate ITC claims and efficient expense management.

Pazy: Your Partner for Seamless ITC Calculation

Pazy is an all-in-one financial management platform designed to simplify the calculation of ITC for businesses. It automates the process, ensuring accurate and timely ITC calculations and helping businesses stay compliant with tax regulations. By reducing manual errors and saving time, Pazy enhances efficiency and provides businesses with a seamless experience in managing their tax credits.

• AI-Driven Precision for ITC Management

With AI technology, Pazy enhances the accuracy of ITC calculations, reducing human error and ensuring precise tax credit management.

• Maximize Tax Credits

Pazy simplifies ITC calculations, ensuring businesses fully utilize available tax credits while maintaining compliance with GST regulations.

• Automated GST Reconciliation

Pazy's ITC module connects directly with the GST portal and performs reconciliations thrice daily, ensuring that advertisement expenses are continuously synced with the latest tax data.

• Real-Time Error Alerts for ITC Calculations

Instant alerts help resolve discrepancies, ensure no input tax credit is lost, and maintain compliance. This feature helps businesses stay on top of their claims and avoid costly mistakes.

• 2A/2B Reconciliation for ITC

Pazy efficiently reconciles GSTR 2A and 2B, ensuring that only eligible tax credits are claimed, thus minimizing discrepancies.

Furthermore, Pazy simplifies GST management across various business sectors, automating processes like GST reconciliation and input tax credit claims. It enhances compliance, optimizes cash flow, and integrates with accounting tools to reduce workloads. Whether for SMBs, finance teams, industry-specific businesses, or startups, Pazy offers customized solutions to drive growth and efficiency of your business.

Maximize your Input Tax Credit (ITC) potential with Pazy. Contact us today for expert GST and ITC support, ensuring your business remains compliant while effortlessly optimizing tax credits with precision and accuracy.

Conclusion

Calculating ITC under GST is a crucial process for businesses to optimize their tax liabilities and ensure compliance. By understanding the input tax credit formula, the key conditions for claiming ITC, and the necessary documentation, businesses can manage their GST obligations effectively. Additionally, adhering to timelines, ensuring proper reconciliation, and apportioning ITC help avoid discrepancies and financial losses while ensuring smooth operations.  

Pazy simplifies these ITC calculations by automating the tracking of eligible purchases and GST paid, ensuring accuracy and efficiency. Its integration with accounting systems simplifies the management and reconciliation of input tax credits, minimizing manual effort and the risk of errors, making it an effective tool for optimizing the ITC process.

Schedule a Demo today and see how Pazy can help you save time, reduce tax errors, and simplify ITC calculations. Enhance your GST compliance with Pazy's seamless automation. Take the next step!

FAQs

1. What are the penalties for incorrect ITC claims?

Incorrect ITC claims can lead to penalties, interest, and potential reversal of credits.

2. Can I claim ITC on GST paid for freight or delivery charges?
Yes, ITC can be claimed on freight or delivery charges if they are related to the supply of goods and services for business purposes.

3. Can ITC be claimed on GST paid for legal or consultancy services?
Yes, ITC can be claimed on GST paid for legal or consultancy services, provided they are for business-related activities.

4. Can I claim ITC on GST paid on repair or maintenance services?
Yes, ITC can be claimed on repair or maintenance services if they are used for business purposes, such as maintaining machinery or office equipment.