The Goods and Services Tax is a game-changing reform for the Indian economy as it will bring the net applicable tax on goods and services down to a great extent, and make the very act of doing business simpler and easier. However, one of the biggest features that GST will bring to the table is the elimination of cascading effect of taxes through Input Tax Credit. But what is it anyway?
Simply put, Input Tax Credit allows you to reduce the total tax you pay on the goods/services you are selling. For instance, in the traditional system when you buy raw materials as inputs to produce and sell a certain product you pay tax on them. Similarly, when you finally sell the finished product you again have to pay a tax on it. Input tax credit allows you to eliminate this repeated tax. So, using the Input Tax Credit, you can deduct the tax you have paid on the inputs from the total amount or the final amount at the point of outputs.
Let’s consider an example to understand how ITC makes a difference in our current taxation system.
Selling a Product in the Current System
Let’s say a dealer A from Mumbai sells a product worth Rs. 1,000 to another dealer B in Nagpur. After levying VAT @ 10% the cost of the product becomes
Rs. 1000 + 10% of Rs. 1000 = Rs. 1000 + Rs. 100= Rs. 1100
Now, dealer B keeps the profit margin at Rs. 1000. So, the selling price of the product becomes:
Rs. 1,100 + Rs. 1,000 = Rs. 2,100.
Before selling he also has to levy a CST (Central Sales Tax) @10%. Thus, the actual selling price, i.e. the price the dealer C in Chennai will have to pay becomes:
Rs. 2,100 + 10% of Rs. 2,100 = Rs. 2,100 + Rs. 210 + Rs. 2,310.
Selling a Product in the new GST System
Taking the same example, the product is sold by the dealer A to dealer B at Rs. 1,000. However, in the GST regime, there are just two indirect taxes instead of VAT, which are CGST (Central GST and State GST). Let’s say they are both levied @ 5% each.
Thus, the price becomes:
Rs. 1,000. + 5% of Rs. 1,000 (CGST) + 5% of Rs. 1,000 (SGST)= Rs. 1,000 + Rs. 50 + Rs. 50= Rs. 1,100
Now, dealer B sells the product to the dealer C in Chennai after adding his profit margin i.e. Rs. 1,000. Thus, the selling price is:
Rs. 1,100 + Rs. 1,000 = Rs. 2,100.
Since it is an inter-state supply of goods and services; the center will collect another tax called Integrated GST (IGST).
If IGST is levied @ 10% then the tax amount is:
10% of Rs. 2,100= Rs. 210
However, the credit of both CGST and SGST can be taken against IGST.
Thus, the net applicable tax will be:
IGST- CGST-SGST= Rs. 210 – Rs. 50 – Rs. 50= Rs. 110
and the final price of the product is:
Rs. 2,100 + Rs. 110 = Rs. 2,210
Thus, this is how GST eliminates repeat taxes and makes the final cost of a product more reasonable.
Now, ITC has its advantages, but not everyone can avail them. You must satisfy the following conditions in order to use GST Input Tax Credit:
- You must be registered under the GST Common Portal.
- You can only claim ITC on those goods and services that have been used for commercial purposes.
- You can only claim ITC for zero rated (exports) or other taxable supplies.
- If you have sold or transferred your business then the unused ITC have to be transferred to the new business.
- You must possess a valid tax invoice or relevant customs importation documents (in the case of imports).
- The tax invoices must be issued under the name of the registered person.
Practical/Relatable Examples of How to Claim ITC under GST
Broadly speaking, there can be three different situations in which you can claim ITC:
- When you are liable (or have already applied) for GST registration
If you have been registered for GST then you are allowed to claim ITC. However, you must to do it within 30 days from the date you become liable for GST registration to avail the benefit. For a better understanding take a look at the example below.
Let’s say that you are a manufacturer of blankets and have crossed the threshold limit for GST registration on 5th November 2017. You have raw wool in stock worth Rs. 2 lakhs and have paid a GST @ 18% i.e. Rs. 36,000 on it. So, you must apply for GST registration before 5th December 2017 (within 30 days) if you want to claim the ITC i.e. Rs. 36,000.
- When you decide to register for GST on your own accord
Even if you have not crossed the threshold limit for GST registration and thus not liable, you can still apply for it voluntarily. By doing so, you automatically become eligible for claiming ITC. However, in this case you can only claim ITC on inputs on the goods held in stock on the day before the registration has been granted. Let’s consider an actual example now.
Let’s say you run a shoe store and even though you are not liable for GST registration you apply for it voluntarily on 26th September 2017. Thus, you are eligible for ITC on inputs held in stock as on 25th September 2017.
Circumstances in which you are ineligible for ICT
There are certain circumstances that make you ineligible for claiming ICT. These are:
- When purchased goods and/or services are used for personal consumption
Say you bought electronics worth Rs. 1 lakh from the manufacturer and paid a GST of Rs. 18,000 (18%). However, you picked a TV worth Rs. 10,000 out of the complete order for yourself. Thus, you can’t claim for the GST paid on the full amount but only on:
Rs. 1,00,000- 10,000 = i.e. Rs. 90,000
Since GST on Rs, 90,000 is = 18% of Rs. 90,000= Rs. 16,200. Thus, you can only claim an ITC of Rs. 16,200 instead of Rs. 18,000.
- When goods are stolen, damaged, lost, or disposed of as free samples or gifts
Taking the previous example, if you have bought electronics worth Rs. 1 lakh from the manufacturer and paid a GST of Rs. 18,000 (18%), and if one TV worth Rs. 10,000 gets damaged to the point that it is useless then again you can only claim an ITC of Rs. 16,200.
- When payment has not been made within 3 months from the date of invoice of a certain service received by you
For example- say you have received marketing service from a certain company and they have charged you:
Rs. 30,000 (cost of service) + Rs. 5,400 (GST at 18%) = Rs. 35,400
If it has been over 3 months and you haven’t cleared the invoice then the ITC i.e. Rs. 5,400 will be added to your liability and cannot be claimed.
There are many other situations in which you cannot claim ITC. For instance, you cannot claim ITC on motor vehicles and other conveyance, cosmetic surgery, outdoor catering, food, and beverages, etc.
Any more questions regarding GST? Ask in comments below.