The Finance Bill 2022 proposed an updated Section 38 within the Central Goods and Services Tax (CGST) Act of 2017. This revision aims to strengthen input tax credit (ITC) regulations, addressing the widespread issue of ITC fraud involving fictitious entities and false invoices. The new provisions are also intended to minimize future legal disputes.

Recent legislative updates indicate changes to GST regulations. As of February 1, 2025, manual invoice validation might become necessary, as the phrase 'autogenerated' is removed from CGST Section 38(1), potentially affecting GSTR-2B. Furthermore, a new clause (c) under CGST Section 38(2) empowers the government to specify additional details for ITC statements, increasing compliance requirements.

This article will explain the new Section 38 and its effects on business input tax credit claims.

Previous Provisions of Section 38 for ITC Claims

The former Section 38 of the CGST Act, named ‘Furnishing details of inward supplies,’ outlined procedures for suppliers to submit outward supply information (sales) and for recipients (buyers) to acknowledge these inward supplies (purchases) and claim associated Input Tax Credit.

This section was designed around a two-way communication system, though it was never fully implemented. It mandated sellers to provide details of their outward supplies using forms like GSTR-1, as per Section 37(1). Subsequently, buyers were meant to confirm, adjust, or remove these entries in their GSTR-2 inward supply returns, with feedback sent to the supplier within a specified timeframe.

Ultimately, the provision required recipient taxpayers to match their reported inward supplies with the outward supplies declared by their vendors. Any discrepancies or errors had to be communicated to the supplier. Additionally, any underpaid taxes and associated interest were to be remitted to the government by the designated deadline.

Analyzing the Updated Section 38

The updated Section 38, introduced by the Finance Bill 2022 and titled ‘Communication of details of inward supplies and input tax credit,’ imposes further limitations on input tax credit claims. It also formally discontinues the two-way communication system between sellers and buyers, a process that was not effectively adopted previously.

The objectives of this new section are conveyed through two main subsections:

1. The initial subsection states that information on a taxpayer's outward supplies will be automatically provided in a GSTR-2B statement. This formalizes an existing practice, aligning the law with current CGST Rules.
2. The second subsection details the contents of GSTR-2B, clearly defining when input tax credit can and cannot be claimed by taxpayers (differentiating eligible and ineligible ITC).

This clause outlines several situations leading to ITC ineligibility, such as when a supplier is newly registered under GST, has failed to pay taxes, or has claimed excessive ITC illegally. The subsequent sections of this article will thoroughly analyze each clause of subsection (2), including illustrative examples.

Explaining the Provisions of the Amended Section 38

Subsection (2) of the updated Section 38 can be challenging for taxpayers to interpret. Therefore, we will examine each clause individually.

1. Clause (a) of subsection (2) delineates the specifics of inward supplies and the eligible ITC that a recipient (buyer) can claim via the GSTR-2B statement.
2. Clause (b) is more intricate, detailing inward supplies reported by the supplier in GSTR-2B for which ITC is NOT permitted, effectively defining ineligible ITC. This clause is divided into six distinct parts: a. ITC cannot be claimed on supplies provided by a supplier within a specified timeframe* following their GST registration. b. ITC is disallowed for supplies from a supplier who has failed to remit taxes, and this default has persisted for a designated duration*. c. ITC cannot be claimed for supplies where the supplier's declared tax liability exceeds the actual tax paid within a specified period and by a predetermined limit*. d. ITC is not available for supplies from a supplier who has claimed ITC beyond the amount permitted by clause (a), with the excess determined by a specified limit*. e. ITC cannot be claimed on supplies from a supplier who has not fulfilled their tax payment obligations under Section 49(12), subject to specific prescribed conditions and limitations*. f. ITC is not applicable for supplies from a supplier categorized under other classes of persons as may be designated*.

*Note: The term 'prescribed' signifies that the precise timeframes or categories of individuals have not yet been legally defined. The government retains the authority to establish or amend these parameters.

Section 49(12) grants the government the power to set the maximum portion of output tax liability that certain taxpayers can settle using their electronic credit ledger.

Illustrative ITC Claims Under the Amended Section 38

1. Prior to Section 38 Implementation

The process of ITC claims is currently quite simple.

2. Following Section 38 Implementation

Particulars|Amount|Amount ---:|:---| :--- Total ITC as per books|–|23,40,800 ITC in the GSTR-2B, filed by suppliers|–|21,40,800 Eligible ITC in the GSTR-2B|–|19,58,500 ITC that can be availed before Sec.38 conditions|–|19,58,500 (new clauses in Section 38)|(amounts disallowed)|_(Remaining ITC that can be availed) Supplier is a newly registered business under GST|1,02,000|18,56,500 Supplier has filed their GSTR-1 but not GSTR-3B|45,000|18,11,500 Supplier’s liability in the GSTR-1 is greater than in their GSTR-3B|55,000|17,56,500 Supplier’s ITC in GSTR-3B is greater than in their GSTR-2B|1,15,500|16,41,000 Supplier has received demand notices and defaulted in the payment of taxes (and the default continues)|75,000|15,66,000 Supplier has not fulfilled the conditions of Rule 86B (i.e.paid their entire liability in ITC instead of partly in cash as prescribed)|95,000|14,71,000

Consequently, the eligible ITC, which was Rs.19,58,500 under the previous law, has been lowered to Rs.14,71,000 due to the updated Section 38.

Consequences for ITC Claims After Revised Section 38 Notification

Many taxpayers might wonder why they cannot claim input tax credit if their suppliers are newly registered or have failed to comply. While GST was initially designed to ensure a smooth flow of ITC, this section was enacted for specific reasons, which we will now briefly explain.

Since its inception, input tax credit claims have been exploited for tax evasion and fraud. Annually, the government incurs significant losses from taxpayers who claim ITC using counterfeit invoices, often from shell companies that are later dissolved. To combat this widespread fraud, the government proposed the revised Section 38, introducing three primary changes for taxpayers:

1. Reconciliation processes must now be more frequent, dynamic, and ideally automated to guarantee the accuracy and eligibility of all ITC claims.
2. Taxpayers must ensure they only transact with compliant vendors. Verifying a supplier’s compliance before engagement is crucial, as compliant suppliers directly contribute to higher eligible ITC claims.
3. If a taxpayer fails to reconcile 100% of their input tax credits, or if their supplier is non-compliant (e.g., defaulting on tax payments or claiming excessive ITC), the recipient taxpayer (buyer) will be unable to claim the rightful ITC. This situation will consequently raise their GST cash liability and negatively impact their working capital.

Strategies for Enhancing ITC Claim Efficiency for Taxpayers

To optimize their ITC claim process, taxpayers should implement strong vendor verification and efficient claim procedures. This can be streamlined through three steps, utilizing automation:

1. Configure the Enterprise Resource Planning (ERP) system to accurately record all invoice details and vendor information.
2. Verify vendor compliance rigorously before establishing any business relationship.
3. Perform dynamic matching against the GSTR-2B statement prior to remitting payments to suppliers. If non-compliance is identified, the buyer can choose to defer payments.