What is Input Tax Credit (ITC) under GST?

One of the positive features of GST is that it helps to avoid the undesirable cost cascading effect (or tax on tax) that existed previously. Now, in the case of GST, there is the mechanism of Input Tax Credit (ITC) which helps to eliminate the cost cascading effect of the pre-GST tax regime. Under GST, there is not cost cascading effect because of two facts. First, most of the taxes are merged under a single tax, and second, the input tax credit.

What is Input Tax Credit?

The meaning of ITC can be easily understood when we take the words ‘input’ and ‘tax credit’. Inputs are materials or services that a manufacturer purchase in order to manufacture his product or services which is his output.

Tax credit means the tax a producer was able to reduce while paying his tax on output.

Input tax credit means that when a manufacturer pays the tax on his output, he can deduct the tax he previously paid on the input he purchased. Here, while paying the tax on his output, he can deduct or take credit for the tax he paid while purchasing inputs.

Example:

An example will make things much clear. Suppose that a readymade garment firm buys polyester (input) from a supplier (of input) at Rs 100 and a CGST of Rs 10 is also has to be paid (CGST rate of 10%). The price of polyester input will be Rs 110.

Now the garment manufacturer sells the product at Rs 200 plus tax (means his value addition is Rs 100). Imagine that the GST rate of readymade shirt is 12%. Here, the manufacturer must pay a tax of Rs 24. But he has previously paid a tax of Rs 10 while purchasing the input of polyester. Hence, he can claim this Rs 10 and has to pay only the remaining Rs 14 (of the total Rs 24). The Rs 10 that the manufacturer claimed is the input tax credit.

How the ITC under the GST avoids the cost-cascading effect?

Now, look at the pre-GST situation. Here, the price paid by the readymade manufacturer is Rs 110 and his value addition is Rs 100. Totally this will come to Rs 210. In the absence of proper input tax credit (between Union Excise Duties and State VAT), the readymade manufacturer will charge 12% of Rs 210 as tax for the shirt. Hence, the price will be Rs 210; plus Rs 25.2 = Rs 235.2. This is higher than the GST price of Rs 224.

Thus, it is the input tax credit that makes the GST efficient and constructive. Providing ITC is a big administrative and technological work under the GST platform. The larger the number of input suppliers, the more important will be the ICT mechanism. Suppliers and manufacturers have Electronic Credit Ledgers and Electronic Cash Ledgers to smoothly undertake the ITC.  

ITC can be claimed by a manufacturer, supplier, agent, e-commerce operator, aggregators or any of the persons mentioned and registered under GST on the tax paid on purchases of inputs.

How input tax can be claimed?

Claiming of ITC is to be made in the proper way. According to the GST rules, taxes paid on inputs cannot be deducted or credited between CGST and SGST. This means that input tax paid on CGST can be availed to pay SGCST. Similarly, an input tax paid on SGST cannot be used to pay CGST. Following are the rules for claiming the ITC.

Table: calming the ITC under GST

 

Input tax credit from

Possible adjustment to pay for:

CGST

SGST

IGST

CGST

1st

NA

2nd

SGST

NA

1st

2nd

IGST

2nd

3rd

1st

How Input Tax Credit can be used?

Here, the table show that credit of CGST cannot be used for payment of SGST and credit of SGST cannot be utilised for payment of CGST. Input Tax Credit from CGST, SGST and IGST can be used to pay the other taxes only in a prescribed manner.

(i) When ITC is received from CGST

  • First preference is to pay CGST.
  • The remaining amount can be used to pay IGST.
  • ITC from CGST can not be used to pay SGST.

(ii) When ITC is received from SGST

  • First preference is to pay SGST.
  • The remaining amount can be used to pay IGST.
  • ITC from SGST can not be used to pay CGST.

(iii) When ITC is received from IGST

  • First preference is for teh payment of IGST.
  • Second preference is to pay CGST.
  • If remaining, it an be used for the the payment of SGST.

Implication of the ITC is that only value additions at various stages will be taxed. This effectively rules out cost cascading effect of taxation. Thus, the input tax credit (ITC) is the backbone of the GST regime and is one of the core concepts of the GST framework.

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