Streamlined GST Input Tax Credit Utilization Order

Under the Central Goods and Services Tax (CGST) Act of 2017, the utilization of Input Tax Credit (ITC) adheres to a mandatory sequence. The government established these structured guidelines through Sections 49A, 49B, and Rule 88A to facilitate the systematic use of ITC across Integrated Goods and Services Tax (IGST), Central Goods and Services Tax (CGST), and State Goods and Services Tax (SGST) categories. For businesses, comprehending these ITC utilization regulations is vital for improving cash flow, reducing working capital needs, and maintaining GST compliance. This article will detail the required sequence for ITC utilization, along with practical strategies for effective ITC management.

Understanding Amended ITC Set-Off Regulations

On April 23, 2019, CGST Circular No. 98/17/2019 was released to clarify the sequence for ITC utilization for each tax category. Before Rule 88A of the CGST Rules was fully integrated into the GST portal, taxpayers were instructed to follow the portal’s existing functionality until July 2019. This updated functionality became available starting with July 2019 tax returns. The CGST Act introduced two key sections:

• Section 49A: This mandates that input tax credit from central, state, or union territory taxes can only be used for corresponding tax payments after all available Integrated Goods and Services Tax (IGST) input tax credit has been fully exhausted.
• Section 49B: This grants the government the authority, based on Council recommendations, to specify the precise order and method for utilizing input tax credits from IGST, central, state, or union territory taxes for any tax payment.

Subsequently, Rule 88A was enacted through CT notification no. 16/2019 on March 29, 2019, implementing these new provisions.

Rule 88A: Sequence for Input Tax Credit Use

Integrated Goods and Services Tax (IGST) input tax credit must first be applied against IGST liability. Any remaining IGST credit can then be used to pay central tax, state tax, or union territory tax liabilities in any sequence. However, input tax credit from central tax, state tax, or union territory tax can only be utilized for integrated tax, central tax, state tax, or union territory tax payments after all available IGST input tax credit has been fully utilized.

Circular No. 98/17/2019 further clarified that the original Section 49 of the CGST Act strictly required IGST credit to be used first for IGST, then CGST, and then SGST, in that specific order. This rigid approach sometimes forced taxpayers to use their electronic cash ledger for one tax type (e.g., State tax) while having unutilized input tax credit for another (e.g., Central tax) in their electronic credit ledger.

The introduction of Rule 88A in the CGST Rules now permits the use of IGST input tax credit for central tax, state tax, or union territory tax payments in any chosen order, provided that the entire IGST input tax credit is completely used up before any central tax, state, or union territory input tax credit is applied.

Post-Rule 88A, the revised order of ITC utilization is as follows:

Under these updated regulations, it is mandatory to completely exhaust all available IGST in the electronic credit ledger before utilizing ITC from CGST or SGST. The remaining IGST ITC can be offset against CGST or SGST output liabilities in any proportion or order after its primary use for IGST output.

Limits on ITC Utilization for GST Liability

As of January 1, 2021, a regulation limits certain taxpayers from using the electronic credit ledger to settle more than 99% of their GST liability for a given tax period. This implies that a minimum of 1% of the tax liability must be paid via cash. This restriction applies to taxpayers whose monthly taxable supplies exceed Rs. 50 lakh (excluding exempt or zero-rated supplies). However, several categories of taxpayers are exempt from this rule:

• Registered taxpayers who have paid over Rs. 1 lakh in income tax during the previous two financial years through belated income tax returns, either for themselves, their proprietor, any two partners, managing director, trustee, or board members.
• Registered taxpayers who have received refunds exceeding Rs. 1 lakh for unutilized input tax credit under GST, resulting from zero-rated supplies made without tax payment or due to an inverted tax structure.
• Registered taxpayers who have consistently paid over 1% of their GST liability using only their electronic cash ledger for all tax periods within the current financial year.
• Government departments, Public Sector Undertakings (PSUs), local authorities, and statutory bodies.

For further details on the implications, refer to the article on Rule 86B.

Practical Illustrations of GST Set-Off

To illustrate the practical application of these provisions, let's examine two examples.

Illustration I: Understanding the IGST Credit Set-Off Sequence

The primary change involves the procedure for utilizing IGST credit. For a practical understanding of the set-off process, consider Mr. X with the following GST liabilities and input tax credits: (All figures in INR)

Under the previous system, the set-off procedure was as follows: (All figures in INR)

This demonstrates that CGST or SGST liabilities were primarily settled using their respective credits. However, with the revised set-off procedure, the available IGST credit must first be utilized. Here are three possible scenarios for this utilization:

Scenario 1: Complete Set-Off of Remaining IGST Credit Against CGST

(All figures in INR)

Scenario 2: Complete Set-Off of Remaining IGST Credit Against SGST

(All figures in INR)

Scenario 3: Partial Set-Off of Remaining IGST Credit Equally Against CGST and SGST

(All figures in INR)

It is important to note that while these scenarios illustrate different approaches, the law does not mandate a specific way to attribute unutilized IGST credit wholly to either CGST or SGST liability. Taxpayers can distribute IGST credit in any proportion and order, provided the entire IGST credit is exhausted before using CGST or SGST credits. For optimal credit utilization, following Scenario 3 is generally recommended.

Illustration II: Business Implications of the New Rule

Building on Illustration I, where total GST output liability exceeded total GST input, we now consider a situation where total GST input is higher than total GST output. Mr. X has the following liabilities and input credits for a tax period: (All figures in INR)

Let’s examine three scenarios for utilizing the IGST credit:

Scenario 1: Complete Set-Off of Remaining IGST Credit Against CGST

(All figures in INR)

Scenario 2: Complete Set-Off of Remaining IGST Credit Against SGST

(All figures in INR)

Scenario 3: Partial Set-Off of Remaining IGST Credit Equally Against CGST and SGST

(All figures in INR)

The law provides flexibility, not strict rules, on how unutilized IGST credit is applied to CGST or SGST. Taxpayers must fully utilize IGST credit before moving to CGST or SGST. Scenarios 1 and 2 might lead to cash payments for one tax type while an equivalent credit for another remains in the Electronic Credit Ledger (ECL). However, following Scenario 3 eliminates the need for cash payment for CGST or SGST liabilities and allows for carrying forward equal amounts of CGST and SGST in the ECL. This balanced approach helps optimize future credit utilization, especially if inter-state or intra-state purchase and sales patterns shift. This strategy requires careful monitoring.

Business Implications of Revised ITC Rules

The revised GST offset regulations necessitate the full utilization of IGST input credit prior to applying CGST or SGST input credit. As demonstrated in Illustration II, a taxpayer with significant inter-state purchases may accumulate higher IGST input credit, especially if their sales are predominantly intra-state. Inadequate utilization of this credit can lead to a considerable blockage of working capital.

If a taxpayer adopts Scenario 1 or 2 from Illustration II, they effectively postpone the use of CGST or SGST credit balances, deferring their utilization across multiple tax periods. This practice can result in a prolonged lock-up of working capital.

An alternative approach involves awaiting a future period when inter-state sales (and thus IGST liability) are higher than intra-state sales, allowing for the complete utilization of carried-forward CGST or SGST credit balances. However, by adhering to Scenario 3—utilizing available credit equally for CGST and SGST—taxpayers can circumvent immediate tax payments and prevent working capital blockages.

From the government's standpoint, this new provision serves as a prompt mechanism to facilitate an equitable distribution of IGST revenue.

Key Takeaway

The GST portal offers taxpayers the flexibility to manually offset input tax credit against their output liabilities. It is crucial for taxpayers to strategically allocate credits each tax period to achieve optimal ITC utilization.

When managed effectively, the updated offset mechanism does not inherently increase working capital requirements compared to the previous system.

For situations involving carried-forward credits, it is highly advisable to maintain an equal balance in both CGST and SGST/UTGST ledgers. This equilibrium aids in optimizing future credit utilization.

An effective method to achieve this is to equally distribute any remaining IGST credits between CGST and SGST after satisfying the IGST liability. Businesses that may have overlooked this in prior months can adjust their strategy in subsequent periods to establish and maintain balanced credit ledgers.