Apportionment of ITC

By Adv. Sanjay Dwivedi

ITC relating to non-business activities and exempted supplies is

required to be apportioned and reversed. This is first part of the
article describing apportionment of credits of inputs and input
services. The 2nd part will discuss Credit of Capital Goods.

Credit is allowed on the inward supplies so that the same value doesn’t suffer tax
multiple times. Barring few exceptions, credit is allowed on everything that is
used for the business. But, there is a cardinal principle of the credit system viz. –
it is allowed on the inward supplies only when tax is payable on the output. If I
purchase a table lamp and use it at my home, I won’t be allowed credit. Here, the
table lamp was not used for any business which could result into a taxable
outward supply. Zero rated supplies are the only exception to this principle. Zero
rated supplies refer to following

(a) export of goods or services or both; or

(b) supply of goods or services or both to a Special Economic Zone

developer or a Special Economic Zone unit.

Credit remains available on zero rated supplies even if the supply is made
without payment of tax.

The Ground Rules:

Following observations emerging out of section 16 and 17 of the CGST Act, 2017
would be relevant to this discussion:

Credit is available on almost all inward supplies, but

i. Credit is allowed only when the inward supply is for use “in the
course or furtherance of business”; and

ii. Even where the inward supply is used for business, the Credit is not
allowed if the outward supply is exempted, nil rated, or non-taxable.

iii. Zero-rated supplies are exception to the previous observation. In

other words ITC relating to ‘zero rated supplies’ remain available
even if the supplies were otherwise exempted.

iv. Credit on certain supplies are ‘blocked’ i.e. the recipient is not
entitled to avail credit on such supplies. The list is contained in
Section 17 (5).
The Problem:

Thus, before availing credit on any inward supply we are required to first
determine whether it is blocked, is it for business use and is it not for exempted
outward supplies? Problem arises when the same inward supply is used for
business as well as non-business purposes; or when it is common to taxable as
well as exempted outward supply. Section 17 of the CGST Act, 2017 says that:

When input/ input service is used The amount of credit shall be

restricted to

Partly for purpose of any business so much of the input tax as is

and partly for other purposes attributable to the purposes of his
business.
Partly for effecting taxable (including so much of the input tax as is as is
zero rated) supplies, and partly for attributable to
exempt supplies - taxable supplies; and
- zero-rated supplies.

How to implement it – An Overview

Rule 42 and 43 of the CGST Rules, 2017 provides the step-by-step method to
implement the above mandate of section 17. While the rule 42 applies to the
credits against inputs and input services, the rule 43 applies to the Capital
Goods. The rule provide mechanism to determine and payback (i.e. reverse) the
credits taken on non-business and exempted supplies.

The rule 42 is quite mathematical in nature. It uses some symbols as T, T1, T2,
C, D1, D2 etc. It would be easier to understand the scheme of the rule if we
divide it into two broad steps:

1. The first goal is to determine the amount of credit that is common (to
taxable, exempted, business, non-business). To do this:

 Identify the credits that are clearly not available (i.e. the inward
supplies used for non-business purposes, exempted outward
supplies and blocked credits). Such identification should be done
at invoice level. The balance amount goes to the e-Credit Ledger.

 Now, identify the credits that are fully available (those used
exclusively for taxable outward supplies and zero-rated
supplies). Again, these are to be identified at invoice level. If we
keep this credit aside, the balance amount is the common credit.
 2. The rule then provides method to apportion the common credit to
exempted supplies and non-business purposes. Through this step we
arrive at the amount required to be reversed.

Step-by-Step Implementation Process:

Let’s go into the detailed steps involved in rule 42. Remember, this relates to
‘inputs’ and ‘input services’. It does not relate to Capital Goods.

1. Identifying the credits that are clearly not available: List out all the
invoices for inward supplies. Take following steps at invoice level.

Step Details Symbol

a. Find out the total amount of tax involved T

(total of eligible as well as ineligible credits).

Less: b. Out of above T, determine the tax T1

attributable to those intended to be used
exclusively for the purposes other than
business

Less: c. Out of above T, determine the tax T2

attributable to those intended to be used
exclusively for effecting exempt supplies

Less: d. Identify the ‘blocked credits’ [i.e. on which T3

credit is not available under sec 17 (5)]

Balance e. This is the ITC to be credited to the e-Credit C1

Ledger

C1 = T- (T1+T2+T3)

2. Identifying the credits that are fully available: Against each invoice:

f. Identify the invoices whose items are intended T4

to be used exclusively for effecting

 supplies other than exempted; and

 zero rated supplies

Full amount of this credit (T4) is available.

3. The above amounts [‘T1’, ‘T2’, ‘T3’ and ‘T4’] are required to be determined
at invoice level. We are also required to declare it in FORM GSTR-2. (Off
course presently GSTR-2 filing is not enabled].

4. Common Credit will be calculated as C2 = C1- T4. This common credit is

to be divided into three parts:

o Credit attributable to exempted supplies. This amount is required

to be reversed.

o Credit attributable to non-business purposes. This amount is also

required to be reversed.

o The remaining credit, which would relate to other supplies (taxable

and zero rated). This would remain available.

5. The ITC attributable to exempt supplies is determined on the basis of

turnover of the exempt supplies. The calculation would be as under:

Credit relating 'E' - aggregate value of exempt supplies

x Common
to exempted =
Credits ( C2)
supplies (‘D1’) 'F' - total turnover in the State

For example, if 10% of the total supplies are exempted then 10% of the
common credit is apportioned to the exempted supplies.

We may note that Central Excise duty is still leviable on certain products.
The duty amount will not be included in the figure ‘E’ or ‘F’ above.
Similarly, the state Excise Duty and Sales Tax or Purchase Tax (wherever
leviable) will not form part of ‘E’ and ‘F’ above. Thus, these duties and
taxes would neither be covered in the numerator nor in the denominator.
It needs to be stressed that only duty & tax has been excluded. The value
of such supplies will have to be included.

6. The next question to be answered is – how much credit will be attributed

to non-business purposes. The rule says that the amount will be 5% of the
common credit. It is to be denoted as ‘D2’.

Credit attributable to non-business purposes (D2) = 5% of C2

7. The balance amount is the credit available to the tax payer. It is denoted
as ‘C3’. Mathematically, C3 = C2 - (D1+D2)
 ‘C3’ represents the credit (out of the common credits) attributable to
business and non-exempt supplies. It also includes the component relevant
to zero rated supplies.

The entire process can be diagramatically presented as under:

‘T’ – Total Input Tax on Inputs & Input Services

Less T1 – exclusively for non-business purposes

Less T2 – exclusively for exempt supplies

Less T3 – Blocked Credits u/sec 17 (5)

C1 Balance Credit = T-(T1+T2+T3) C1 - Credited to the “e-Credit Ledger”

T4 – Exclusively
'T1', 'T2', 'T3' and 'T4' shall be
for C2=C1-T4
determined and declared at the Common
a. Other than Credit
invoice level in GSTR-2;
exempted;
b. Exports/ SEZ

Credit relating 'E' - aggregate value of exempt supplies D2:

to exempted ‘D1’= x C2 Relating to
supplies 'F' - total turnover in the State non-
business =
5% of C2

Out of the Common Credits

Available Credit ‘C3’ = Common Credits (C2) – (D1+D2)

Note:

 The amount of D1 and D2 is the amount required to be paid. It is added to

the output tax liability of the tax payer.

 The amount 'C3' is to be computed separately for ITC of CGST, SGST,

UTGST and IGST.