Input Tax Credit Reversal Rules Following GST Rate Adjustments Under Section 18(4)
This article details the implications of recent GST rate reductions, particularly on the reversal of Input Tax Credit (ITC) as per Section 18(4) of the CGST Act. It clarifies that a mere decrease in GST rates does not necessitate ITC reversal, as long as goods and services remain taxable. Reversal is primarily required if supplies become wholly exempt or a business transitions to the composition scheme. Businesses are advised to maintain diligent records and remain updated on compliance requirements.
Effective September 22, 2025, significant revisions to Goods and Services Tax (GST) rates have been implemented across India. This article examines these GST rate reductions, specifically focusing on the shift from 12% to 5% and 28% to 18%, and delves into the associated compliance obligations for Input Tax Credit (ITC) reversal under Section 18(4) of the CGST Act.
Understanding GST Rate Adjustments
India's Goods and Services Tax (GST) landscape experienced significant and extensive modifications in 2025:
- As of September 22, 2025, the GST Council streamlined the tax slab structure from four to primarily two rates: a 5% merit rate for essential and priority commodities, and an 18% standard rate for most other goods and services. Additionally, a specific 40% rate applies to luxury and sin goods.
- Products previously subject to a 12% tax rate are now largely classified under the 5% slab. This reduction makes daily necessities, packaged foods, and agricultural machinery more affordable for consumers.
- High-value products, including automobiles, electronic devices, and electrical appliances, have seen their GST rates decrease from 28% to 18%.
- Luxury and "sin" products, such as pan masala, tobacco items, and aerated beverages, are now subject to a significantly elevated 40% tax rate. (It is important to note that the revised tobacco rate will be effective from a later date to be officially announced, following the resolution of compensation cess liabilities).
These updated rates are designed to enhance the affordability of essential items and stimulate both household spending and economic expansion. Even after rate reductions, goods and services continue to be taxable, enabling businesses to utilize Input Tax Credit (ITC) for these items. ITC claimed on inputs when output goods were taxed at higher rates (12% or 28%) remains valid for use, despite the outputs now being taxed at lower rates.
Understanding Section 18(4) of the CGST Act
Section 18(4) of the CGST Act mandates the reversal of Input Tax Credit (ITC) on inputs, semi-finished goods, and capital goods under specific conditions:
- When supplies become entirely exempt from GST.
- When the taxpayer transitions from the standard GST framework to the Composition Scheme.
It is crucial to understand that a simple reduction in the GST rate does not trigger an ITC reversal obligation. This provision specifically addresses changes to a supply's taxable status (i.e., becoming exempt) or a change in the business's tax scheme, rather than mere adjustments to tax slabs. Therefore, businesses are only required to reverse ITC if their goods or services become fully exempt, or if they opt for the composition scheme; rate reductions alone do not necessitate such reversals.
ITC Reversal Guidelines for Rate Adjustments
When GST rates are reduced, as seen in 2025, specific guidelines govern ITC reversal:
| Scenario | GST Implication | Example |
|---|---|---|
| Supply becomes exempt after a rate change | ITC must be reversed in accordance with Section 18(4) | If items were acquired at 5% GST and subsequently become exempt, ITC on those items must be reversed. |
| Rate reduction on output supplies, or rate increase on input supplies | No ITC reversal is required; ITC claims can continue. A refund may be possible under an inverted duty structure if the output supply differs from the input supply. | As per Circular No.135/05/2020, if goods are procured at 18% before a rate reduction and then sold at 5% GST afterward, the ITC claim remains valid without reversal. Accumulated ITC may be refunded if the output is not identical to the input. |
| Input utilized for both taxable and exempt supplies | General credit rules are applicable; ITC must be apportioned, and the exempt portion reversed as per Rules 42 and 43. | For inputs partially used for supplies that became exempt due to a rate alteration, common credit regulations necessitate the allocation of ITC, with the portion attributed to exempt supplies being reversed. |
Quick Reference: ITC Reversal Decision Flow
This guide provides a quick overview for determining when ITC reversal is necessary:
| Scenario | GST Implication | ITC Reversal Needed? |
|---|---|---|
| Rate decrease from 18%/12% to 5% | Supply remains taxable | No |
| Rate decrease from 28% to 18% | Supply remains taxable | No |
| Supply becomes entirely exempt | Output tax is zero | Yes |
Transitional Guidelines for Businesses
For the 2025 GST rate changes, businesses should adhere to these transitional compliance guidelines:
- Continue to claim Input Tax Credit (ITC) for supplies whose GST rates have been reduced, provided these supplies continue to be taxable.
- Reverse ITC on any supplies that transition from taxable to exempt status following the rate adjustment, calculating the reversal proportionally to the value of exempt supplies in accordance with GST rules.
- It is essential for businesses to routinely review their inventory and the GST input credits they have claimed, particularly in anticipation of any new tax exemptions for specific industries.
- Comprehensive documentation must be maintained for all rate transitions, eligible ITC, and reconciliation processes.
Official pronouncements and GST Council meeting minutes explicitly state that a mere reduction in GST rates does not trigger a requirement for businesses to reverse input tax credits. Nevertheless, if a business's offerings become entirely exempt from tax, ITC reversals are then mandatory as per GST regulations.