As we all know, the GST system brought significant changes in the traditional Indian Tax system. It has replaced multiple indirect taxes with a single unified tax and has eliminated the cascading effect of taxes through the Input Tax Credit (ITC). Input Tax Credit (ITC) is the benefit you get for paying tax on business purchases in GST. It helps in reducing your tax liability on outputs and ultimately lowers your overall cost of goods and services.
In this blog, we will understand the basics of Input Tax Credit in a simple way, what it means, how it works, who can claim it, and what rules must be followed.
What is Input Tax Credit (ITC)?
To understand Input Tax Credit, let us break the term into two parts:
- Input Tax: This is the tax you pay on purchases you made for your business, such as raw materials, goods, or services.
- Credit: You can use this tax you paid to reduce your tax liability (i.e., the tax you owe to the government).
In simple words, Input Tax Credit is the benefit you get for paying tax on business purchases in GST. You can subtract this tax from the tax you collected on your sales, and pay only the balance to the government.
Illustration
Imagine you run an electronics shop:
- You buy a washing machine from your wholesaler for ₹20,000 plus 18% GST (₹3,600).
- You then sell it to a customer for ₹25,000 plus 18% GST (₹4,500).
Now, when you collect ₹4,500 GST from your customer, you don’t have to pay the full amount to the government. You can subtract the ₹3,600 GST you already spent on the purchase.
So, you will pay only:
₹4,500 to ₹3,600 = ₹900 to the government.
This ₹3,600 is your Input Tax Credit.
Why is ITC Important?
Input Tax Credit is important because:
- Avoids double taxation: ITC eliminates the tax-on-tax effect by allowing businesses to claim credit for the tax paid on purchases.
- Reduces cost of production: By claiming credit on input taxes, the overall cost of goods and services reduces, which benefits both businesses and consumers.
- Improves cash flow in the business: Businesses pay less tax out-of-pocket, which helps them manage working capital more efficiently.
- Encourages compliance: To claim ITC, businesses have to maintain proper invoices, records, and books of accounts. This practice in future promotes disciplined tax practices.
- Enhances transparency: ITC creates a clear audit trail of transactions, reducing the chances of tax evasion.
- Support supply chain in the business: Credit is passed on through each stage of the supply chain, encouraging suppliers and buyers to stay within the formal economy.
Who Can Claim Input Tax Credit?
Anyone who is a registered taxpayer under GST and has a valid GSTIN (GST Identification Number) is eligible. Casual taxpayers, those under the composition scheme, or unregistered dealers cannot claim ITC.
Conditions to Claim ITC
You must meet the following eligibility criteria to claim ITC:
- You must be a GST-registered taxpayer and have a valid GSTIN.
- You must have a valid tax invoice issued by a registered supplier.
- You must have received the goods or services.
- The supplier must have filed their GST returns and paid the tax to the government.
- You must have filed your own GST return.
- The goods or services must be used for business purposes, not personal use.
- If the goods are received in parts (like machinery delivered in pieces), you can claim ITC only after you receive the last piece.
- You must claim ITC within the time limits allowed (explained below).
Blocked credits: when you cannot claim ITC
There are certain items where Input Tax Credit is not allowed, even if you paid GST on them. These are called “blocked credits”, and include:
- Personal expenses (like goods or services used for personal consumption),
- Motor vehicles for personal use,
- Food and beverages, beauty treatment, club memberships (unless used for official supply),
- Construction of an immovable property (like buildings) for your use,
- Goods lost, stolen, destroyed, or given as free samples,
- Goods purchased for exempt or non-taxable supplies.
Time limit to claim ITC
There is a deadline for claiming Input Tax Credit. You must claim it:
- Before the 30th of November, following the end of the financial year, or
- Before filing the annual return, whichever is earlier.
Reversal of ITC: When you have to give ITC back
There are some situations where you need to reverse the ITC you claimed earlier, such as:
- If you return the goods or cancel the service.
- If you fail to pay your supplier within 180 days from the invoice date, you will be charged.
- If goods are used partly for business and partly for personal use, then only the business portion is eligible for ITC.
- If your business moves from regular GST to the composition scheme.
- If you make exempt supplies, you must reverse ITC on inputs used for them.
In these cases, you must adjust or repay the credit using your next GST return.
How to Claim ITC in GST Returns?
To claim ITC, you need to:
- Ensure your supplier uploads the invoice, and it appears in your GSTR-2B.
- Log in to the GST portal and go to the GSTR-3B form.
- In Table 4, enter eligible ITC under relevant headings (like inputs, capital goods, input services).
- File the return and adjust the credit against your tax liability.
If your ITC is more than your tax payable, the balance can be carried forward or claimed as a refund (in certain cases).
Common Mistakes to Avoid
You need to avoid the following common errors that businesses should avoid while claiming ITC:
- Claiming ITC on invoices not yet filed by the supplier.
- Claiming credit on goods for personal use.
- Not reconciling GSTR-2B with purchase records.
- Delaying payment to vendors beyond 180 days is not recommended.
- Missing the deadline to claim ITC.
How ITC Works Across Different Types of Supplies
There are three main types of GST: CGST, SGST, and IGST. The rules for ITC across these types are:
- ITC of IGST can be used to pay IGST, CGST, and SGST (in that order).
- ITC of CGST can be used to pay CGST and then IGST.
- ITC of SGST can be used to pay SGST and then IGST.
- CGST cannot be used to pay SGST, and vice versa.
Special Situations
- Capital Goods – You can also claim ITC on capital goods (like machinery or equipment used in business), but you cannot claim ITC if those goods are used for exempt supplies or personal use.
- Input Services – Services used in business operations, such as legal advice, marketing, training, or software subscriptions, are also eligible for ITC if used for business purposes.
- Job Work – If you send goods to a job worker (someone who processes goods on your behalf), you can still claim ITC on them, provided they return the goods within the prescribed time.
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