Businesses frequently utilize various capital assets in their operations. It is important to note that the tax paid on these capital goods can be claimed as Input Tax Credit (ITC). This article provides a comprehensive overview of the ITC rules applicable to capital assets under the Goods and Services Tax regime in India. Budget 2022 brought several updates to ITC claims. Firstly, ITC cannot be claimed if it is restricted in GSTR-2B under Section 38. Secondly, the time limit for claiming ITC on invoices or debit notes for a financial year has been revised to the earlier of two dates: November 30th of the following year, or the date of filing annual returns. Thirdly, Section 38 has been fully revamped as ‘Communication of details of inward supplies and input tax credit’ to align with Form GSTR-2B. This section now outlines the manner, timing, conditions, and restrictions for ITC claims, removing the two-way communication process previously associated with Form GSTR-2. It also specifies that taxpayers will receive information regarding eligible and ineligible ITC. Fourthly, Section 41 has been updated to remove references to provisional ITC claims and now prescribes conditions for self-assessed ITC claims. Lastly, Sections 42, 43, and 43A, which covered provisional ITC claim processes, matching, and reversal, have been eliminated. Furthermore, as of January 1st, 2022, CGST Rule 36(4) was amended to remove the provision for claiming an additional 5% ITC over what appears in GSTR-2B. Consequently, businesses can only claim ITC if it is reported by the supplier in GSTR-1/IFF and is reflected in their GSTR-2B. This means taxpayers can no longer claim the 5% provisional ITC under CGST Rule 36(4) and must ensure all claimed ITC values are reflected in GSTR-2B.

Defining Capital Goods

Capital goods are assets such as infrastructure, machinery, equipment, vehicles, and tools that an organization uses to produce goods or deliver services. For instance, a blast furnace employed in the iron and steel sector is considered a capital asset for the steel manufacturer.

Distinguishing Capital Goods from Other Inputs

Consider an example: when baking a cake in an oven, ingredients like eggs, water, flour, and butter are your inputs, and the cake is your final product. The oven, in this scenario, is the capital good that facilitates cake production.

Inputs are consumed during the creation of the final product and are recognized as business expenses impacting the cost of production. Capital goods, conversely, are not consumed during the production of a single final product. Their utility extends beyond a single year of production. Therefore, their entire cost cannot be fully deducted as a business expense in the year of purchase. Instead, their cost is allocated over their useful lives through accounting methods such as depreciation, amortization, and depletion, allowing the business to recognize a portion of the cost annually.

Understanding Credit on Capital Goods

When you acquire any item, you are obligated to pay GST. Subsequently, you can claim input tax credit on the GST paid for your purchases. Similarly, when you buy machinery for your factory, you will pay the applicable GST rate. This GST amount can be claimed as credit in the same manner as inputs. However, if you claim depreciation on the GST component paid during the purchase of the capital asset, you are not eligible to claim input tax credit on that same amount.

What is Common Credit?

Businesses often utilize the same assets and inputs for both commercial and personal use. For example, if a freelance designer and blogger uses her personal laptop for her professional work, she can claim input credit of GST paid on the laptop purchase only to the extent it relates to her freelance business. If she also buys specialized design software exclusively for her business, she can claim full ITC on that particular purchase.

Importance of Common Credit

ITC is exclusively available for business-related purposes. Many taxpayers use the same inputs for both business and personal reasons. Tax benefits cannot be claimed for personal expenses. Furthermore, goods exempted under GST already benefit from a 0% GST rate. Therefore, ITC cannot be claimed for inputs used in producing such exempted goods, as this would result in a form of negative taxation. Consequently, ITC on inputs utilized for exempted goods must also be removed.

The subsequent calculations aid in determining the common credit that is attributable to personal and exempted supplies, leaving only the portion relevant to taxable sales. Only this eligible amount can be claimed as ITC. The credit linked to personal and exempted supplies must be reversed when filing GSTR-3B.

Categories of ITC for Capital Goods

Let us examine each scenario.

Capital Goods Used Exclusively for Personal or Exempted Sales

No ITC is available for personal purchases or for capital goods utilized solely for making exempted sales. This will be reported in GSTR-3B and will not be credited to the electronic credit ledger.

Example 1: Personal Purchases Ms. Anita acquired a refrigerator for personal use. Since this purchase is not required for her business, she cannot claim any ITC on the GST paid for the appliance.

Example 2: Capital Goods for Exempted Sales Mr. Avinash purchased a small flour mill for his grocery shop to grind wheat grains into flour. As he produces unbranded flour, it is exempt from GST. Since this constitutes an exempted supply, he cannot claim any ITC on the GST paid for the mill.

Capital Goods Used for Taxable Sales

XYZ Limited purchased machinery for manufacturing shoes. Since shoes are considered normal taxable supplies, the GST paid during the machinery purchase will be entirely available as ITC. This will be declared in GSTR-3B and credited to the electronic credit ledger.

Common Credit for Partially Personal/Exempted and Partially Taxable Sales

The ITC paid for the capital goods will be credited to the electronic credit ledger.
The useful life of such a capital asset will be assumed to be 5 years from the date of purchase.
The total amount of input tax credited to the electronic credit ledger for the entire useful life will then be distributed over this period. The useful life is considered to be 5 years. If GST is paid on a monthly basis, the following formula will be used: ITC for 1 month = Total ITC for Capital Goods ÷ 60 months (5 years * 12 months)

Calculations for Common Credit

For Exempted Supplies

The amount of ITC attributable to exempt supplies from the common capital credit is calculated as follows: Credit for exempt supplies per month = (Value of exempted supplies ÷ Total turnover) × Common credit for one month The remaining amount after deducting the credit for exempt supplies will be allowed as ITC.

All the calculations mentioned above must be performed separately for:

Central Tax
State Tax
Union Territory Tax
Integrated Tax

What if an Asset Used for Exempt Goods is Later Also Used for Taxable Goods?

If a capital asset was previously used exclusively for:

Personal purposes, OR
Selling exempted goods

And it is now used commonly for:

Business and personal purposes, OR
Effecting taxable and exempt supplies

The input tax to be credited to the electronic credit ledger is calculated as: Input Tax – 5% of Input tax for every quarter or part thereof from the date of the invoice.

Let’s illustrate with an example. Mr. Avinash purchased a capital asset solely for use in exempt supplies. He paid Rs 1,00,000, along with GST of Rs 18,000 as input tax, on October 1st, 2017. On November 15th, 2018, he decides to use the capital asset for both taxable and exempt supplies. The eligible common input tax credit will be calculated as follows: Input Tax – (5% of Input tax) × Number of quarters. The number of quarters from October 1st, 2017, to November 15th, 2018, is 5. Therefore, 18,000 – (5% of 18,000) × 5 quarters = 18,000 – 4,500 = 13,500. This amount, Rs 13,500, represents the common credit available to Mr. Avinash. He will credit Rs 13,500 to the Electronic Credit Ledger. Now, he will determine the ITC attributable to exempt supplies using the formula for exempt supplies. Assuming his total turnover is Rs 160 lakhs and exempted sales are Rs 40 lakhs, the common credit for one month is 13,500 ÷ 60 = 225. Credit attributable for exempt supplies = (40 / 160) × 225 = Rs 56.25. This amount of Rs 56.25 will be reversed in GSTR-3B under the ITC Reversal column.

Reversal of Credit Under Specific Circumstances

In the following situations, the proportionate ITC will be reversed, meaning it will be added to the output tax liability in GSTR-3B:

When a normal taxpayer opts to pay tax under the composition scheme, or the goods/services supplied by them become exempt.
In the case of supplying capital goods or plant and machinery on which input tax credit has already been claimed.
For every registered person whose registration is cancelled.

The input tax credit associated with the remaining useful life, calculated in months, will be computed on a pro-rata basis, considering a useful life of five years.

Example: A capital good has been in use for 4 years, 6 months, and 15 days. Therefore, the remaining useful life in months is 5 months (ignoring any part of a month). If the input tax credit taken on such capital goods is C (e.g., Rs 10 lakhs), the input tax credit attributable to the remaining useful life = C × 5 ÷ 60 = 10,00,000 × 5 ÷ 60 = 83,333.

This calculation must be performed separately for Integrated Tax and Central Tax. This amount must be reversed (i.e., it becomes part of the output tax liability) and reported in:

Form GST ITC-03, if a normal taxpayer opts for the composition scheme or their goods/services become exempt.
Form GSTR-10, if registration is cancelled. This must be supported by a certificate from a practicing chartered accountant or cost accountant.

In the event of selling capital goods, if the amount determined as above is greater than the tax on the transaction value of such sale, then the higher amount determined will be added to the output tax liability. The details must be reported in Form GSTR-1.

Capital Goods Sent for Job Work

ITC will be permitted to the principal manufacturer if a capital asset has been dispatched to a job worker for job work, provided certain conditions are met.

Condition: Such goods must be returned within a period of 3 years from the date they were sent out.

Implications: If the goods are not received back within 3 years, the transaction will be treated as a deemed supply from the date of dispatch, and tax will be payable along with interest for delayed payment of taxes.

Based on these calculations, it is evident that ITC rules for common credit under GST must be meticulously followed to avoid interest and other recovery measures.

For additional information, consider reading:

Understanding Input Tax Credit Regulations for Capital Assets under GST