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What is Input Tax Credit (ITC)?

ITC (Input Tax Credit) is the Goods and Services Tax (GST) paid on business purchases that can be claimed against future tax liabilities.

  • 2,510 Views | Updated on: Mar 21, 2024

GST, India’s comprehensive tax system, revolves around the seamless flow of credit from producing goods to the final consumer. This smooth transfer is powered by Input Tax Credit (ITC), a crucial business element.

The Goods and Services Tax (GST) and Input Tax Credit (ITC) are closely linked, forming a dynamic duo that shapes the Indian business market. GST, a single, comprehensive tax levied on goods and services, aims to eliminate cascading taxes and promote transparency. ITC, its powerful partner, allows businesses to offset the tax paid on their inputs against the tax liability on their output.

What is ITC (Input Tax Credit)?

GST can be a complex tax for businesses, but Input Tax Credit (ITC) simplifies the equation. It allows companies to offset the GST they pay on their purchases against the GST they owe on their sales. ITC effectively turns their investments into tax-saving opportunities, lowering their overall tax burden and rewarding them for efficient business practices.

Goods Included and Excluded Under Input Tax Credit

Generally, ITC is available under GST for all goods and services used for business purposes. However, there are specific inclusions and exclusions you need to be aware of:

Inclusions in ITC

  • Raw materials, machinery, and equipment: These directly contribute to the production and qualify for ITC. Examples include garment fabric, manufacturing machinery, and office work computers.
  • Office supplies and stationery: Essential for business operations, including pens, paper, ink cartridges, and printer equipment.
  • Utilities: Electricity, water, internet, and telephone bills used for business purposes are eligible.
  • Transportation costs: Fuel and maintenance for business vehicles and freight charges for transporting goods are covered.
  • Rent for business premises: Rent paid for office space, warehouses, or production facilities used for business purposes is eligible.
  • Other business-related expenses: Marketing materials, travel expenses incurred for business trips, subscriptions to business publications, and professional services like legal or accounting fees can be included.

Exclusions from ITC

Specific rules and limitations for ITC eligibility may vary depending on the nature of your business and the type of goods or services purchased:

  • Goods and services used for personal consumption: Anything used by employees or owners, like food, beverages, or recreational items, is excluded.
  • Alcoholic beverages and tobacco products: These are generally not considered business necessities and are excluded from ITC.
  • The purchase of land or buildings: Land purchasing is a capital expenditure and is not considered input for ITC purposes.
  • Destroyed or lost goods: For goods and services that are lost, confiscated, or destroyed, the ITC claim cannot be made.
  • Purchased services: If you purchase services exempt from GST, like educational or healthcare services, they would not be eligible for ITC.

Who can Claim ITC?

Only businesses registered under GST are eligible to claim ITC, including:

  • Manufacturers and Traders: Companies involved in the production or trading of goods.
  • Service Providers: Businesses offering services like IT, consulting, or healthcare.
  • Importers and Exporters: Companies involved in the import or export of goods.
  • Other Businesses: Any entity registered under GST can claim ITC on purchases related to their taxable business activities.

How to Claim ITC?

Claiming ITC involves a few key steps:

  • Maintain proper records: Keep invoices, bills, and other documents related to your purchases for at least four years.
  • File GST returns: Regularly file your GST returns on time to claim the ITC you are entitled to.
  • Follow specific procedures: The exact process for claiming ITC may vary depending on your location and tax authority. Generally, you must declare the ITC claimed in your GST returns and provide supporting documents as required.
  • Time limits: Be aware of any time limitations for claiming ITC. In India, for example, you can claim ITC for purchases made within the current or previous financial year.

When Should ITC be Reversed?

While claiming Input Tax Credit (ITC) helps businesses reduce their tax burden, certain situations require them to reverse this credit and adjust their tax liability.

Unpaid Invoices

If invoices remain unpaid beyond 180 days from the issue date, the corresponding ITC claims must be reversed. Unpaid invoices prevent businesses from claiming credit on purchases they have yet to settle.

ISD Credit Note

For Input Service Distributors (ISDs), if the seller issues a credit note to the Head Office (HO), any ITC previously claimed on the related transaction must be reversed. It ensures accurate credit accounting within the ISD network.

Capital Goods and Non-business Use

Like the previous scenario, the ITC claimed that the non-business portion must be reversed if capital goods are used for business and non-business purposes. It applies specifically to long-term assets like machinery or equipment.

Annual Return Discrepancy

During annual return filing, a crucial calculation takes place. The difference is added to the output tax liability if the total ITC claimed on non-business/exempt inputs exceeds the reversed amount. It ensures accurate tax accounting and prevents credit misuse. Additionally, interest may be charged on this outstanding amount.

Final Thoughts

ITC has emerged as a game-changer for businesses. It transforms purchases into tax-saving opportunities, rewarding efficient practices and lowering overall burdens. This powerful incentive encourages investment, optimizes operations, and ultimately fuels the success of businesses across the nation.

As India strives for economic prosperity, GST and ITC remain indispensable instruments, paving the way for a brighter and more competitive future.

Key Takeaways

  • GST is a single tax on goods and services, while ITC lets businesses offset the GST paid on purchases against their sales tax.
  • ITC effectively rewards efficient businesses by turning their purchases into tax-saving opportunities, lowering their overall tax burden.
  • Only registered businesses can claim ITC by maintaining records, filing returns, and following specific procedures within time limits.
  • ITC needs to be reversed in certain cases like unpaid invoices, credit notes for service distributors, or mixed-use of inputs for personal or exempt purposes.

- A Consumer Education Initiative series by Kotak Life

Amit Raje
Written By :
Amit Raje

Amit Raje is an experienced marketer who has worked in various Fintechs and leading Financial companies in India. With focused experience in Digital, Amit has pioneered multiple digital commerce in India. Now, close to two decades later, he is the vice president and head of the D2C business department. He masters the skill of strategic management, also being certified in it from IIMA. He has challenged his challenges and contributed his efforts in this journey of digital transformation.

Amit Raje
Reviewed By :
Prasad Pimple

Prasad Pimple has a decade-long experience in the Life insurance sector and as EVP, Kotak Life heads Digital Business. He is responsible for developing user friendly product journeys, creating consumer awareness and helping consumers in identifying need for life insurance solutions. He has 20+ years of experience in creating and building business verticals across Insurance, Telecom and Banking sectors

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