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June 3, 2020

Know when you can avail ITC on Capital Goods and When you Cannot under GST Law

by Rubina Dsouza in GST

Know when you can avail ITC on Capital Goods and When you Cannot under GST Law

What exactly are capital goods?

In simple words, capital goods are basically assets which are capitalised in the books of accounts which aid in the production of goods and services (e.g. plant and machinery, building, equipment, etc). Capital goods are not consumed when the final product is made. Therefore, they cannot be entirely deducted as business expenses in the year of their purchase. Instead, they are depreciated over the course of their useful lives.

As per CGST Act, ‘capital goods’ means goods, the value of which is capitalised in the books of account of the person claiming the input tax credit and which are used or intended to be used in the course or furtherance of business.

Useful Life of the Capital Goods is 5 years according to GST Rules

Illustration

For instance, Mr A has purchased a machinery of Rs 20 lakhs for production purposes. Let us assume GST paid on the purchase of machinery was Rs 2 lakh. This Rs 2 lakh paid is the ITC on the capital good of plant and machinery.

The issue arises as to how this ITC can be availed. Now the machine which is purchased is used for the production of two types of goods:-

  1. Exempt Goods
  2. Taxable Goods

We already are aware that no ITC is available on any inputs which are utilised for producing exempted goods. Let us understand what portion of the common ITC can be availed and how can the same be done.

Manner of Apportionment of Credit on Capital Goods (CG) and Reversal thereof:

Computation of reversal of ITC on capital goods is covered under Rule 43.

The first step is to find out if the ITC falls under the following criteria:

  1. The capital goods that have been used exclusively for non-business purposes or for making exempt outward supplies. OR
  2. The capital goods that have been used exclusively for making supplies other than exempt supplies (including zero rated supplies

In case the ITC on CG falls under the (1) category above, then credit will not be allowed in respect of the same. 

In case the ITC on CG falls under (2) category above, then credit will be allowed and taken to Electronic Credit Ledger. 

ITC on Capital goods which are used for providing both category (1) and (2) supply will although be included in the Electronic Credit Ledger it has to be reversed proportionately. The useful life of the capital goods has been taken as 5 years (which means 60 months), but our filing period relates to the supplies made/received in a particular month, so we will first find the ITC attributable to a month by dividing the credit by 60 (i.e. 60months/5years). The ITC attributable to a month will be divided proportionately between taxable and non-taxable supply on the basis of turnover for the month and the proportionate amount of non-taxable ITC will be reversed.

It might sound complicated, but don’t worry you will understand the same after referring the example below.

Illustration:-

CGGST PaidSuch CG is used forIs ITC available
A18,000Exempted SupplyNo
B27,000Block CreditNo
C36,000Nil Rated SupplyNo
D45,000Personal PurposeNo
E54,000Taxable SupplyYes
F63,000Zero Rated SupplyYes
G72,000Taxable Supply + Personal Purpose + Zero Rated Supply + Exempted SupplyCommon credit (partly allowed)
H81,000Taxable Supply + Personal Purpose + Zero Rated Supply + Exempted SupplyCommon credit (partly allowed)

Turnover for the month is Rs 50 lakhs which is bifurcated as below:-

  1. Taxable supply = Rs 10 lakhs
  2. Zero rated supply = Rs 20 lakhs
  3. Personal Use = Rs 2 lakhs
  4. Exempted supply = Rs 18 lakhs

Computation of ITC that can be availed:-

 Rs.
ITC on E54,000
ITC on F63,000
ITC on G (common credit)72,000
ITC on H (common credit)81,000
Transfer to electronic credit ledger2,70,000
Reversal of Common Credit (see working below)(1020)
Actual ITC2,68,980

Common Credit for a month = (72000 + 81000)/60 (i.e., 5years=60 months) = Rs 2550 (attributable to taxable, personal and exempted supply)

Common Credit for a month which is attributable to personal and exempted supply = 2550 * 20 lakhs / 50 lakhs = Rs 1020

CASE-1

Cases where Capital Goods purchased was initially used for exempted supply only but later was also used for taxable supply

Rule 43 which provides the mechanism of reversal of ITC with respect to capital goods has been amended recently.

Before the recent amendment, provided the computing the reduced ITC amount at the rate of 5 percentage points for every quarter or part thereof for the period capital good was used for effecting exempt supply from the gross ITC amount reflected on the invoice. Such reduced ITC was then required to be divided by entire useful life (in months) in order to derive the ITC pertaining to a particular tax period. This leads to certain absurdity in terms of calculating the amount of reversal for a tax period which resulted in revenue leakage.

In order to curb the revenue leakage, the Government has brought out the amendment, which prescribes that ITC pertaining to the period for which the capital goods were initially used for effecting exempt supply shall be added to the output tax liability instead of reducing it from gross ITC. Also, the entire ITC amount reflected on the invoice is required to be availed in the electronic credit ledger in the month in which ITC amount has been added to output tax liability and ITC pertaining to particular period is to be arrived by dividing the gross ITC with useful life.

Illustration:-

For instance, Mr ‘X’ purchased a machine on 10.07.17 for Rs 10 lakhs + GST @ 12 % which was used for exempted supply.

On 01.10.19 this machine was used for providing exempted as well as taxable supply.

Turnover for Oct 19 was Rs 30 lakhs (Rs 10 lakhs for exempted supply and Rs 20 lakhs for taxable supply)

How will ITC be computed in this case?

ITC to be availed on 01.10.191,20,000
Period for which the machine was exclusively used for exempted supply [10.07.17 to 30.09.19] 9 quarters (part of a quarter will be considered as a whole quarter) 
ITC amount to be added to output tax liability [9 quarters * 5% = 45%]54,000
Reversal of ITC Credit per month 1,20,000/60 months * 10lakhs / 30 lakhs667

So what has this amendment changed?

Basically this amendment was introduced to remove the concept of Common credit. If we see the above same e.g. without the amendment that for the sake of Reversal of ITC the amount would have been (120000-54000)= 66000

I.e., 66000/60months*10lakhs/30lakhs=367

With the virtue of this amendment the Government is now able to increase the Tax revenue and thereby curb the operating income of the taxpayer by increase in way of collecting Reversal of ITC per month.

Cases where Capital Goods purchased was initially used for taxable supply only but later was also used for exempted supply

Rule 43 before amendment provides for reduction of ITC attributable to the period when capital good was exclusively used for rendering the taxable supply, from the total amount of ITC mentioned on the invoice for deriving the value of common credit which is to be reversed in a tax period basis the exempt turnover ratio.

This provision was also leading to the short reversal of ITC, consequently, Government brought the like amendment for above mentioned scenario and has done away with the requirement of reduction of ITC from gross ITC amount to derive the common credit. Hence, the ITC for a particular tax period is required to be computed by taking the entire amount reflected on the invoice.

For instance, Mr ‘X’ purchased a machine on 10.07.18 for Rs 10 lakhs + GST @ 18% which was used for taxable supply.

On 05.11.19 this machine was used for providing exempted as well as taxable supply.

Turnover for Nov 19 was Rs 10 lakhs (Rs 3 lakhs for exempted supply and Rs 7 lakhs for taxable supply)

How will ITC be computed in this case?

ITC Availed1,80,000
Period for which the machine was exclusively used for taxable supply [10.07.18 to 04.11.19] = 6 quarters (part of a quarter will be considered as a whole quarter) 
Credit attributable to period of taxable supply  [6 quarters * 5% = 30%]54000
Reversal ITC every month 1,80,000/60 * 3lakhs / 10 lakhs(900)

Special Circumstances Enabling Availing of Credit

There are 2 circumstances falling under this category:-

  1. Registered person switching from Composition levy to regular scheme
  2. Registered persons under exempt supply becomes taxable

Credit entitled on capital goods to be reduced by 5% per quarter or part thereof from date of invoice on the day immediately preceding the date on which he becomes liable to tax under regular scheme or exempt supply becomes taxable.

ITC is to be availed within 1 year from the date of issue of invoice by supplier.

Special Circumstances Leading to Reversal of Credit or Payment of Tax

SituationReversal of Credit or Payment of Tax
1. Registered person who has availed ITC switching to composition levy
2.Cancellation of registration
3.Supplies from registered person getting wholly exempt from tax
Amount reversed is equivalent to ITC on CG on the day immediately preceding the date of switchover/exemption/cancellation of registration.

Amount to be reversed on pro rata basis pertaining to the remaining useful life (in months)

Here’s hoping that ITC of capital goods which is generally considered as complicated was made easy for you.

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