While the introduction of GST has been the biggest reform in post-independence India, what has been of special interest in the GST Indian economy is the input credit mechanism under GST.
To put things in a nutshell, input credit implies that you can reduce the tax already paid on purchase while paying taxes on sales. This has ushered a new era in the GST Indian economy.
This article will cover what input tax credit is, the method of calculating it and the process to claim it.
Input Tax Credit, What Is It?
The reduction of taxes that are paid for inputs from taxes that are be paid for output is referred to as Input Tax Credit. The GST charged during the supply of any services or goods is called the Input Tax Credit. This is the most prominent feature that makes the GST Indian economy stand out.
It’s not that it’s an entirely new concept. It did exist before the GST indirect taxes regime but now its scope has been widened.
Earlier, claiming input tax for central sales tax, luxury tax, entry tax, and taxes of any other kind was not possible. Moreover, service providers and manufacturers were barred from claiming the central excise duty.
Before the implementation of GST, any cross-credit service tax against VAT/excise or vice-versa was disallowed. However, under GST, there shall not be any bar on setting off the input tax credit as all taxes will be subsumed into the GST.
Each state can have separate rules and regulations and input tax credit shall not be applied on all types of inputs. The input tax credit can also be of interest to one who has bought goods for resale.
Being the very foundation of the GST program, the tax credit is of special interest to registered persons. The rules governing it are stringent and specific in nature.
To cite an example, let’s assume that you happen to be a manufacturer and the tax you have to pay on the final product is Rs.600. The purchase tax to be paid is Rs.150. The input credit to be claimed by you is Rs.150 and the tax you finally pay is Rs.450.
How Do We Calculate Input Tax Credit?
Let us cite an example to clarify the calculation of input tax.
Let’s assume that the product sold by you has a tax of 18% levied on it. Input goods or services are used by you while running the business. The 18% tax to be paid by you is to be adjusted with the taxes you’ve already paid for the purchase of input goods for your product. The tax added by the manufacturers is therefore solely for the addition of value and is not on the value of the final product.
If we take an example of steel utensils, supposing that the manufacturer had purchased raw materials, steel for Rs.500 to manufacture a frying pan. Along with this, he had also bought more raw material items for Rs.100. Assuming that GST for steel is at 18% while that for the other raw material items is 28%, the manufacturer has been charged a tax of Rs.28 on other raw material items and another tax of Rs.90 on steel used by him as input. Hence, the total tax paid is Rs.118.
Now, let’s assume that after taking into consideration the costs involved in the manufacture of the frying pan, the manufacturer decides to sell it at Rs.800+GST ensuring a decent profit.
Assuming that the frying pan has a GST of 18% on it, the tax levied on it will, therefore, be Rs.144. As such, the manufacturer shall have to fix the price of the frying pan, in other words, invoice it at Rs.944.
So, Rs.144 is being collected as GST on the sale by the manufacturer from the distributor. Rs.118 had been paid by the manufacturer as GST for the purchase of raw materials as input. So, the manufacturer is able to bag a credit of Rs.118 he had already paid as GST for the input items out of the Rs.144 of GST. Hence, the manufacturer has to pay only the difference of Rs.26 as tax to the government.
How Do We Claim Input Tax Credit?
The following conditions need to be fulfilled by a to be able to claim an input tax credit under the GST scheme:
- Only if the services and goods are used for business can you claim Input Tax Credit.
- You need to be a registered tax person.
- You can claim input tax credit on zero-rated supplies and exports.
- As prescribed in the Model GST Law, the Input Tax Credit can be credited provisionally in the electronic credit ledger.
- In the event of sale, merger or transfer of ownership of a business, the Input Tax Credit shall be moved on to the new business entity.
- An Input Tax Credit can be claimed only in the event of an actual transaction of goods and services.
- Tax invoice, debit note, and supplementary invoices are needed as supporting documents for claiming the Input Tax Credit.
- Cash ledger or electronic credit may be used for payment of input tax.
- It is mandatory to file all tax returns like GST-1,2,3,6 and 7.
How Does Input Tax Credit Work?
Let’s suppose that Mr.A, the seller sells some items to Mr.B. Mr.B, being the buyer by using his purchase invoices is may claim the purchase credit.
This is how it works:
- All the tax invoice details are uploaded by Mr.A as issued in GSTR-1
- Details once uploaded get updated in GSTR-2A. These details also appear when Mr.B fills in the GSTR-2 returns which are actually only the details of his purchase.
- Now, Mr.B makes an acknowledgment of the sale and the purchase tax is then transferred to Mr.B’s electronic credit. This can be used by him later to adjust output tax liability in the future and make himself eligible for a return.
The Input Tax Credit is the most talked about feature in the GST program. It enables traders to reap the benefits of a reduction of taxes paid on inputs from taxes that need to be paid on output. While the feature did exist earlier, its scope has been widened. It is today a major incentive for traders who have gained due to reduced taxes. The intention was to boost the economy. We have explained the process of Input Tax Credit calculation in detail. The examples given should help in further clarifying the concept which can be a tad confusing.