Guide on Rule 42 of GST Act (ITC Reversal)

Introduction to Rule 42 of GST Act

Rule 42 of the Central Goods and Services Tax (CGST) Rules, 2017, prescribes the manner of determining the input tax credit (ITC) attributable to taxable and exempt supplies under GST. It ensures that ITC is availed only on inputs and input services used for taxable supplies and taxable outward supplies.

Understanding Input Tax Credit (ITC) Under GST

Under GST, businesses can claim ITC on goods and services used for business purposes. However, if the inputs and input services are used for both taxable and exempt supplies, Rule 42 provides a mechanism to proportionately reverse the ITC attributable to exempt supplies.

Applicability of Rule 42

Rule 42 applies in cases where:

• The registered person uses inputs and input services for both taxable and exempt supplies.
• The registered person also uses inputs for non-business purposes along with business activities.

Breakdown of ITC Segregation Under Rule 42

1. Total ITC Available (T): This is the total input tax credit available on inputs and input services.
2. ITC Exclusively Used for Non-Business or Exempt Supplies (T1 & T2):
3. ITC Exclusively Used for Taxable Supplies (T3): This is the ITC on inputs and input services exclusively used for taxable supplies and is fully eligible for credit.
4. Common ITC (C1): The ITC on inputs and input services used for both taxable and exempt supplies, calculated as:
5. Exempt Portion of Common ITC (D1 & D2):
6. Eligible ITC (C3):

Reversal and Reporting of ITC Under Rule 42

• The reversal of ITC attributable to exempt supplies and non-business purposes must be done in Form GSTR-3B.
• Any difference found at the end of the financial year must be adjusted in the return for September of the following financial year.

Illustration of Rule 42 Computation

Example: A registered taxpayer has the following details for a tax period:

• Total ITC on inputs and input services (T) = ?1,00,000
• ITC for non-business use (T1) = ?5,000
• ITC for exempt supplies (T2) = ?15,000
• ITC for taxable supplies (T3) = ?50,000
• Total turnover (F) = ?10,00,000 (Taxable: ?7,00,000, Exempt: ?3,00,000)

Now,

• C1 = T - (T1 + T2 + T3) = ?1,00,000 - (?5,000 + ?15,000 + ?50,000) = ?30,000
• D1 = (E/F) × C2 = (?3,00,000/?10,00,000) × ?30,000 = ?9,000
• D2 = 5% of ?30,000 = ?1,500
• C3 = ?30,000 - (?9,000 + ?1,500) = ?19,500 (Eligible ITC)

Thus, the business can claim ?19,500 as ITC in GSTR-3B, and ?10,500 must be reversed.

Key Points to Remember

1. Annual Adjustment: At the end of the financial year, businesses must compare the annual exempt turnover and reverse any excess ITC claimed.
2. Separate Treatment for Capital Goods: Rule 42 applies only to inputs and input services. Capital goods are covered under Rule 43.
3. ITC Reversal is Mandatory: If the taxpayer does not reverse the ITC on exempt supplies, penalties and interest may apply.