Reversal of ITC where Capital Goods used for both taxable & exempt sales


Section 17(1) and Section 17(2) of CGST Act 2017 provides that where Capital Goods are used in the business for common purposes (i.e. to effect taxable as well as exempt supplies) or used for business as well as non-business purposes, then, a registered person under GST can claim Input Tax Credits in relation to Taxable supplies or business purposes only. Any amount of usage of such capital goods for exempt supplies or non-business purposes would be reversed in the manner prescribed under CGST Rules.

Rule 43 of CGST Rules provides the detail procedure for calculation of amount to be reversed and the manner of reversal thereof.

In this article, we will discuss following two situations in respect to Input Tax Credits of Capital goods:-

  • Where the Capital goods used by the registered person partly for the purpose of any business and partly for other purpose. (In this case, the amount of credit shall be restricted to so much of the input tax as is attributable to the purposes of his business).
  • Where the Capital goods are used by the registered person partly for effecting taxable supplies including zero-rated supplies and partly for effecting exempt supplies. (In this case, the amount of credit shall be restricted to so much of the input tax as is attributable to the said taxable supplies including zero-rated supplies).

Before we proceed further, it is imperative here to check the definition of Capital Goods.

As per Section 2(19) of CGST Act 2017, “capital goods” means goods, the value of which is capitalised in the books of account of the person claiming the input tax credit and which are used or intended to be used in the course or furtherance of business;

As per definition, Capital Goods must have all the following features:-

  • These should be Goods;
  • Value of Goods should be Capitalised in Books of Account;
  • ITC should be claimed by same person who has capitalise goods in books of account;
  • Goods should be used or intended to be used in the course of furtherance of business.

Thus, goods shall only be considered as capital goods if the same are recorded in Books of Account as such. Intention of owner is a decisive test for categorisation of goods for their Capital nature.

Section 16(3) of CGST Act, 2017 provides that where the registered person has claimed depreciation on the tax component of the cost of capital goods and plant and machinery under the provisions of the Income-tax Act, 1961, the input tax credit on the said tax component shall not be allowed. Hence, any goods whose ITC component has also been capitalised and depreciation claimed over that under Income Tax laws, such goods are excluded from the provisions of Capital Goods under the GST laws.


Rule 43 of CGST Rules 2017

Rule 43 is a very vast rule which prescribes the manner of determination of input tax credit in respect of capital goods and reversal thereof in respect of following cases:-

  • A supplier supplying services as covered by clause (b) of paragraph 5 of the Schedule II of the CGST Act, 2017; and
  • A supplier supplying goods or services or both other than covered by clause (b) of paragraph 5 of the Schedule II of the Act.

Clause (b) of Paragraph 5 of Schedule-II of CGST Act, 2017 includes supply of services  by way of construction of a complex, building, civil structure or a part thereof, including a complex or building intended for sale to a buyer, wholly or partly, except where the entire consideration has been received after issuance of completion certificate, where required, by the competent authority or after its first occupation, whichever is earlier.

This article is restricted to the provisions of Rule 43 applicable to every registered person in general except supplying services covered by clause (b) of paragraph 5 of the Schedule II of the CGST Act, 2017.


As per Rule 43(1)(a), Input tax credit shall not be allowed in respect of capital goods exclusively used or intended to be used for :

(i)      Non-business purposes; and/or

(ii)     Exempt supplies


Rule 43(1)(b)  provides that Input tax credit (ITC) will be allowed to claim in respect of capital goods exclusively used or intended to be used for :

(i)      Supplies other than Exempt Supplies; and/or

(ii)    Zero Rated supplies


Common Credits

Where any capital goods could not get the space in provisions of Rule 43(1) (a) and Rule 43(1) (b), Input Tax Credits regarding these capital goods are generally known as “Common Credits”. There is no calculation procedure for exclusively used capital goods as said in Rule 43(1) (a) and Rule 43(1) (b).

However, for Common Credits, there is a lot of calculation work because there may be (among other) following possibilities in any business for usage of Capital goods:-

  1. Any Capital Good which was earlier used exclusively for Non Business purposes or for exempt supplies, but after some period, used exclusively for taxable supplies or zero rated supplies.
  2. Any Capital Good which was earlier used exclusively for Non Business purposes or for exempt supplies, but after some period, used commonly for taxable supplies or zero rated supplies and for Non Business purposes or for exempt supplies.
  3. Any Capital Good which was earlier used exclusively for taxable supplies or zero rated supplies, but after some period, used exclusively for Non Business purposes or for exempt supplies.
  4. Any Capital Good which was earlier used exclusively for taxable supplies or zero rated supplies, but after some period, used commonly for taxable supplies or zero rated supplies and for Non Business purposes or for exempt supplies.

Above said examples are cases of transition once in lifetime of Capital Assets. Now, think where such transitions happen multiple times during its lifetime of such assets.

Rule 43 (1) (c) and Rule 43 (1) (d) provides detailed manner for determination of ITC in respect of Common Credits and reversal thereof along with treatment of ITC in above listed transitions to the usage of Capital Goods.

Rule 43(1)(c) provides that such Credits shall be available to claim in the tax period to which date of Invoice pertains. For these credits, useful life of capital goods shall extend upto five years from the date of the invoice for such goods.

After 100% claim of Tax Paid as ITC, It’s the time to reverse the portion of ITC which pertains to exempt supplies as per Rule 43(1)(d) to 43(1)(h), which is given below:-

Process to calculate proportionate share of tax credits (of common capital goods) used for exempt supplies

  • Useful life of such assets shall be taken as five years from the date of the invoice for such goods.
  • Calculate monthly amount of input tax credits (“ITC”) on such common capital goods by dividing total common credits to sixty (5 years = 60 months). It is important to note that such monthly calculation of ITC will be started from the following month to the date of purchase. For instance, an asset purchased in July 2017, then, monthly calculation will commence from August 2017 onward. (Such monthly calculated amount to be denoted as ‘Tm’)
  • Then, make a sum total of all available monthly input tax credits ‘Tm’ (i.e. of those assets whose time span of 5 years not finished yet). (Such total amount to be denoted as ‘Tr’).
  • Calculate portion of credits relevant to exempted supplies (to be denoted as ‘Te’) using following formula:

Te = ( Exempt supplies ÷ Total Turnover )  x Tr

  • the amount Te along with the applicable interest shall, during every tax period of the useful life of the concerned capital goods, be added to the output tax liability of the person making such claim of credit.

Important Points:-

If value of both ‘Exempt Supplies’ and ‘Total Supplies’ not available in any tax period, values may be picked from last tax period.

The amount ‘Te’ (credits proportionate to exempted supplies) shall be computed separately for input tax credit of central tax, State tax, Union territory tax and integrated tax.

In the above process, Total Turnover to be taken as turnover of the state under common GST registration.

Whereas, Value of Exempt Supply shall not include:

  • the value of activities or transactions specified in Schedule III of CGST Act 2017, except those specified in paragraph 5 of the said Schedule.
  • the value of services by way of accepting deposits, extending loans or advances in so far as the consideration is represented by way of interest or discount, except in case of a banking company or a financial institution including a non-banking financial company, engaged in supplying services by way of accepting deposits, extending loans or advances; and
  • the value of supply of services by way of transportation of goods by a vessel from the customs station of clearance in India to a place outside India.

And whereas, for determining the value of an exempt supply :-

(a) the value of land and building shall be taken as the same as adopted for the purpose of paying stamp duty; and

(b)the value of security shall be taken as one per cent. of the sale value of such security.

Further, aggregate value of exempt supplies and the total turnover shall exclude the amount of any duty or tax levied under entry 84 and entry 92A of List I of the Seventh Schedule to the Constitution and entry 51 and 54 of List II of the said Schedule.

 

Exempt supplies include:-

nil rated supplies

exempt supplies

non-taxable supplies

supplies on which the recipient is liable to pay tax on reverse charge basis 

transactions in securities

sale of land

sale of building, subject to clause (b) of paragraph 5 of Schedule II


Transition of Usage of Capital Goods

Case 1 : What if capital goods earlier used only for exempt supplies or non-business purposes subsequently used as Common capital goods for taxable as well as exempt supplies?

Ans: If such transition happens within the period from 1st July 2017 to 31st March 2020:-

In this case, amount of Credits calculated after reducing by 5% per quarter or part thereof from the amount of original input tax credits on such common goods till the date of conversion of its usage, shall be added as Input Tax Credits in Electronic Credit Ledger:

Credits available as on date of conversion = Total Credits of such asset minus 5% per quarter or part thereof

For Instance:

Total Input Tax Credits on the original date of Purchase

Rs 800.00

Less: 5% per quarter

Rs   40.00

Less: 5% of next quarter

Rs   40.00

Less: 5% of subsequent quarter and so on till the date of conversion to its usage

Rs  XX.00

Balance Input Tax Credits (on the date of conversion)

XXX.00

After this, all the process given to calculate proportionate share of tax credits (of common capital goods) used for exempt supplies (Rule 43(1)(d) to 43(1)(h)) above to be followed. In this process, life of an asset for the purpose of input tax credits is always taken as five years from the date of Transition. Monthly amount (Tm) will be calculated on the basis of five years from the date of such transition.

Ans: If such transition happens on or after 1st April 2020:-

Where any capital goods earlier used only for “exempt supplies or non-business purposes” is subsequently covered under this clause, Amount of tax as mentioned on Invoice is eligible to be claimed as Input Tax Credit in the month of Transition of usage of capital assets.

After this, all the process given to calculate proportionate share of tax credits (of common capital goods) used for exempt supplies (Rule 43(1)(d) to 43(1)(h))  above to be followed. Life of Capital Asset shall be taken as Five years from the Date of Invoice.  Hence, This exercise shall continue till the expiry of five years from the date of invoice.

In addition to this, amount of Ineligible credit to be calculated at the rate of 5% of Tax mentioned on invoice for every quarter or part thereof and such ineligible credit shall be added to the output tax liability of the tax period in which such credit is claimed.

Amount of ineligible credit shall be computed separately for input tax credit of central tax, State tax, Union territory tax and integrated tax and declared in FORM GSTR-3B.


 

Case 2 : What if capital goods earlier used only for taxable supplies subsequently used as Common capital goods for taxable as well as exempt supplies?

Ans : If such transition happens within the period from 1st July 2017 to 31st March 2020:-

In this case, dealer had already claimed full amount credit in electronic credit ledger in the month of purchases.

At the time of conversion of use of such Capital Goods as Common Goods, input tax credits proportionate to Exempt supplies will be required to pay to government as Outward Liability in the manner given in Rule 43(1)(d) to 43(1)(h) (discussed above).

For this, First of all, we will calculate input tax credits available as on date of conversion through following formula :

Credits available as on date = Total Credits of such asset minus 5% per quarter or part thereof

After this, all the process given to calculate proportionate share of tax credits (of common capital goods) used for exempt supplies (Rule 43(1)(d) to 43(1)(h))  above to be followed. In this process, life of an asset for the purpose of input tax credits is always taken as 5 years. Monthly amount (Tm) will be calculated on the basis of five years from the date of such transition.

Ans: If such transition happens on or after 1st April 2020:-

In this case, dealer had already claimed full amount credit in electronic credit ledger in the month of purchases.

At the time of conversion of use of such Capital Goods as Common Goods, input tax credits proportionate to Exempt supplies will be required to pay to government as Outward Liability in the manner given in Rule 43(1)(d) to 43(1)(h) (discussed above).

In this process, useful life of an asset for the purpose of input tax credits is always taken as 5 years. Monthly amount (Tm) will be calculated on the basis of five years from the date of Invoice of such asset. 

After 1st April 2020, only such amount which is proportionately available for remaining useful life of such asset would be liable for reversal.

Before 1st April 2020, the position was very worse. Even if (e.g. 2 years), a long period already expired, even then, useful life for remaining amount was taken as 5 years from date of transition.


Example:

(to be applicable where transition happens within the period from 1st July 2017 to 31st March 2020)

Mr. A has purchased a Capital Asset on July 15, 2017 for Rs 10,00,000 paying GST of Rs 180,000/- on this. While filing GST return of July 2017, he has claimed full amount of credit of Rs 180,000/- declaring asset used for taxable supplies only.

In Feb 2018, he realised that this capital asset is used for the purpose of taxable as well as exempt supplies.

What is the procedure to be followed by Mr A to reverse input tax credits of such asset against exempt supplies?

Ans: In the month of Feb 18, Mr A will follow the process given below:

  • Calculate Input tax credits available as on date of conversion against this asset:
Credits at the time of Purchase in July 2017

180,000.00

Less: Credits used in between July to Feb 2018

No. of Quarters passed :

1) 15 July 2017 to 14 October 2017

2) 15 October 2017 to 14 January 2018

3) 15 January 2018 to 31st Jan 2018

3 Quarters passed till Jan 2018

Reduction at the rate of 5% per Quarter

So, total reduction will be: Rs 180,000 x 5% x 3 = 27,000/-

27,000.00

Credits available in Feb 18

153,000.00

  • Calculate Input tax credits proportionate to Exempt Supplies:

1. Monthly amount of Credits against all supplies (Tm) = 153,000 ÷ 60 = Rs 2,550/-

2. Credits proportionate to Exempt supplies for the month = Rs 2,550 x Exempt Supplies ÷ Total Supplies

3. Amount calculated in point 2 will be reported and paid as Outward liability in monthly return.

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