CGST Rules: Chapter 5 – Input Tax Credit: A Comprehensive Guide

Introduction

Chapter 5 of the Central Goods and Services Tax (CGST) Rules, 2017, forms the bedrock of the Input Tax Credit (ITC) mechanism under the Goods and Services Tax (GST) regime in India. ITC is the mechanism that allows registered businesses to reduce their output tax liability by the amount of GST they have already paid on their purchases of goods or services or both, which are used in the course or furtherance of their business. This chapter meticulously details the conditions, procedures, and limitations associated with availing ITC, ensuring transparency and preventing the cascading effect of taxes, which was a significant drawback of the pre-GST tax regime. A thorough understanding of these rules is paramount for every GST-registered taxpayer to optimize their tax liabilities and maintain compliance.

Understanding Chapter 5 of CGST Rules – Input Tax Credit

Chapter 5 of the CGST Rules, 2017 provides a comprehensive framework for the availment and reversal of Input Tax Credit under GST. ITC enables registered businesses to offset their output tax liability by claiming credit for the tax paid on inputs used in the course of business. A thorough understanding of these rules is essential for maintaining compliance and optimizing tax liabilities.

1. Conditions for Claiming Input Tax Credit (Rule 36)

Rule 36 is the cornerstone of ITC eligibility, outlining the fundamental prerequisites that a registered person must fulfill to claim ITC on their inward supplies. Non-compliance with any of these conditions can lead to the denial of ITC.

• Possession of Tax Invoice or Debit Note or Other Prescribed Documents: The most crucial condition is that the registered person must possess a valid tax invoice issued by the supplier, which contains all the mandatory particulars as prescribed under the GST law. Alternatively, a debit note issued by the supplier under section 34 of the CGST Act can also serve as a valid document for claiming ITC. Additionally, the rules may prescribe other documents, such as a bill of entry for imported goods, as valid for claiming ITC.
  
  Example: M/s ABC Traders purchases raw materials from M/s XYZ Suppliers. To claim ITC on the GST paid on these raw materials, ABC Traders must have a valid tax invoice issued by XYZ Suppliers, containing details like the GSTIN of both parties, invoice number and date, description of goods, quantity, value, rate of GST, and the amount of GST charged. If there was a subsequent increase in the price, a debit note issued by XYZ Suppliers would also be a valid document for claiming ITC on the additional tax paid.
• Receipt of Goods or Services or Both: The registered person must have actually received the goods or services or both. This implies that the supply must have been physically completed. In the case of goods, this condition is also deemed to be satisfied when the goods are delivered to a third person on the direction of the registered person (also known as bill-to-ship-to transactions). For services, the service must have been rendered to the registered person.
  
  Example (Goods): If M/s PQR Manufacturers orders machinery from M/s LMN Ltd., PQR Manufacturers can claim ITC only after the machinery has been received at their factory. If, upon PQR’s instruction, LMN Ltd. directly ships the machinery to a job worker’s premises, PQR Manufacturers are still considered to have received the goods and can claim ITC.
  
  Example (Services): If M/s STU Consultants hires the services of a marketing agency, they can claim ITC on the GST paid only after the marketing services have been provided as per the agreement.
• Payment of Tax by the Supplier: This is a critical condition to prevent fraudulent ITC claims. The supplier who has charged GST on the invoice must have actually paid the tax amount to the government. While it might be challenging for the recipient to directly verify this, the government’s emphasis on invoice matching through GSTR-2B aims to address this. If the supplier has not paid the tax, the recipient might face issues with their ITC claim, potentially leading to demands for reversal.
  
  Example: If M/s UVW Retailers receives a tax invoice from M/s OPQ Wholesalers and claims ITC, but it is later found that OPQ Wholesalers have not deposited the tax collected from UVW Retailers with the government, UVW Retailers might be asked to reverse the ITC claimed.
• Furnishing of Return: The registered person claiming the ITC must have furnished their return under section 39 of the CGST Act, which is typically the monthly return in FORM GSTR-3B. This condition ensures that only compliant taxpayers are eligible to avail ITC. If a taxpayer has defaulted in filing their returns, they might be restricted from claiming ITC for the relevant period.
  
  Example: If M/s GHI Enterprises has not filed their GSTR-3B for the month of October, they will not be able to claim the ITC pertaining to the purchases made in October in their subsequent returns until the October GSTR-3B is filed.
• Invoice Details Matched with GSTR-2B (Rule 36(4)): As highlighted in the recent updates, Rule 36(4) now mandates that the ITC can be availed only to the extent that the details of the invoices or debit notes related to the supply are furnished by the suppliers in their outward returns (GSTR-1/IFF) and are communicated to the recipient in FORM GSTR-2B. There is no longer any provision for claiming provisional ITC beyond what is reflected in GSTR-2B.
  
  Example: If M/s JKL Importers has purchased goods and received a valid tax invoice, but the supplier has only uploaded 80% of the invoices for that month by the due date of filing GSTR-1, then M/s JKL Importers can only claim ITC on those invoices that appear in their GSTR-2B. They cannot claim ITC on the remaining 20% of invoices until the supplier uploads them in their subsequent GSTR-1 filing and they appear in the updated GSTR-2B.

2. Manner of Reversal of Input Tax Credit (Rule 37)

Rule 37 deals with a specific scenario where ITC, once legitimately claimed, needs to be reversed. This primarily occurs when the recipient of goods or services fails to make payment to the supplier within a stipulated timeframe.

• The 180-Day Rule: If a registered person has availed ITC on any inward supply of goods or services or both, but fails to pay the supplier the value of such supply along with the tax payable thereon within a period of one hundred and eighty days from the date of issue of the invoice, then the ITC availed must be reversed.
• Reversal Mechanism: The recipient is required to reverse the input tax credit availed on the unpaid invoice along with interest at the prescribed rate (currently 18%) from the date of availing the credit until the date of reversal. This reversal is to be done while filing the return for the month immediately following the expiry of the 180-day period.
• Re-availment of Credit: Once the recipient makes the payment to the supplier (including the tax amount), they are entitled to re-avail the reversed input tax credit. This re-availment can be done in any subsequent return filed after the payment is made.
  
  Example: M/s DEF Ltd. purchased goods worth ₹50,000 plus GST of ₹9,000 from M/s GHI Suppliers on March 1st, 2025, and availed the ITC of ₹9,000 in their March GSTR-3B. However, they fail to make the payment to GHI Suppliers within 180 days from March 1st, 2025 (i.e., by August 28th, 2025). In this case, DEF Ltd. will have to reverse the ITC of ₹9,000 along with the applicable interest in their GSTR-3B for the month of September 2025. If DEF Ltd. makes the payment to GHI Suppliers in October 2025, they can re-avail the reversed ITC of ₹9,000 in their GSTR-3B for October 2025.

3. Reversal of Input Tax Credit on Non-Payment of Consideration (Rule 37A)

Rule 37A addresses a situation where, despite the recipient having made the payment to the supplier, the supplier fails to pay the corresponding tax to the government. This rule was introduced to ensure that ITC is available only when the tax has actually reached the government’s coffers.

• Supplier’s Non-Payment: If a recipient has availed ITC on a supply, and the supplier has not paid the tax on that supply as evidenced by the non-reflection of the supply in the recipient’s GSTR-2B or any other discrepancy, the recipient might be required to reverse the provisionally availed ITC.
• Communication and Action: The tax authorities may communicate such discrepancies to the recipient. The recipient would then be expected to follow up with the supplier to ensure the tax is paid. If the supplier fails to pay the tax by a specified date (often linked to the due date for filing the annual return by the supplier), the recipient might be asked to reverse the ITC.
• Re-availment upon Supplier’s Payment: If the supplier subsequently pays the tax, the recipient would be eligible to re-avail the reversed ITC.
  
  Example: M/s KLM Traders purchased services from M/s NOP Services and paid the invoice along with GST. KLM Traders availed the ITC based on the invoice. However, when KLM Traders checks their GSTR-2B, the invoice from NOP Services is not reflected, indicating that NOP Services might not have paid the tax. The tax authorities might notify KLM Traders about this discrepancy. If NOP Services fails to pay the tax by the stipulated deadline, KLM Traders might be asked to reverse the ITC. Once NOP Services pays the tax and it reflects in KLM Traders’ GSTR-2B, KLM Traders can re-avail the ITC.

4. Matching, Reversal and Reclaim of Input Tax Credit (Rule 38)

Rule 38 outlines the crucial process of matching input tax credit details to identify discrepancies and ensure the integrity of the ITC chain.

• Matching Process: The GST system compares the details of inward supplies declared by the recipient in their GSTR-3B with the details of outward supplies furnished by their suppliers in GSTR-1. This matching is done based on parameters like GSTIN of the supplier and recipient, invoice number, invoice date, taxable value, and tax amount.
• Identification of Mismatches: When the system identifies discrepancies between the details furnished by the recipient and the supplier, these mismatches are communicated to both parties through the GST portal.
• Reversal of Credit on Mismatch: If a discrepancy is not rectified by the supplier within a specified period, the recipient might be required to reverse the input tax credit claimed on the mismatched invoice. The tax authorities may also initiate recovery proceedings in such cases.
• Reclaim of Reversed Credit: If the supplier subsequently rectifies the discrepancy in their GSTR-1 and files a corrected return, and the corrected details are reflected in the recipient’s GSTR-2B, the recipient can reclaim the input tax credit that was earlier reversed.
  
  Example: M/s QRS Retailers claimed ITC on an invoice from M/s TUV Wholesalers. However, the invoice number was incorrectly entered by TUV Wholesalers in their GSTR-1. This mismatch is identified by the GST system and communicated to both QRS Retailers and TUV Wholesalers. If TUV Wholesalers fail to correct the invoice number within the stipulated time, QRS Retailers might be asked to reverse the ITC. Once TUV Wholesalers rectifies the error and files a revised GSTR-1, and the corrected invoice appears in QRS Retailers’ GSTR-2B, QRS Retailers can then reclaim the reversed ITC.

5. Claim of Credit by a Banking Company or a Financial Institution (Rule 39)

Rule 39 provides specific guidelines for banking companies and financial institutions, including non-banking financial companies (NBFCs), as they often provide both taxable and exempt supplies, making the determination of eligible ITC complex.

• Partial Exemption Scenario: Banking companies and financial institutions often provide services that are either wholly or partially exempt from GST. In such cases, they are eligible to avail only a portion of the input tax credit that is attributable to their taxable supplies.
• Fifty Percent Restriction: Notwithstanding anything contained in these rules, a banking company or a financial institution, including a non-banking financial company, engaged in supplying services by way of extending deposits, loans or advances shall be allowed a credit of fifty per cent. of the input tax on inputs, capital goods and input services. The remaining fifty per cent. credit shall lapse.
• Full Credit in Certain Cases: However, this restriction does not apply to the tax paid on inputs and input services that are used in making taxable supplies (including zero-rated supplies). In such cases, the banking company or financial institution can avail the full input tax credit.
  
  Example: XYZ Bank incurs GST on various inputs, capital goods, and input services. Since a significant portion of their services (like interest on loans) is exempt from GST, they are generally allowed to claim only 50% of the ITC on these inputs. However, if XYZ Bank uses specific input services solely for providing a taxable service, such as credit card fees, they can claim the full ITC on those specific input services.

6. Procedure for Distribution of Input Tax Credit by Input Service Distributor (ISD) (Rule 39A – now Rule 39)

Rule 39 (formerly Rule 39A) outlines the procedure for an Input Service Distributor (ISD) to distribute the input tax credit to its various branches or units that have the same Permanent Account Number (PAN) but are registered in different states.

• Concept of ISD: An Input Service Distributor (ISD) is essentially a head office or a registered office of a business that receives invoices for input services used by its various branches or units. Instead of each branch claiming ITC separately, the ISD collects all these invoices and distributes the credit to the respective branches.
• Conditions for Distribution: The ISD must have the same PAN as the recipient units to whom the credit is being distributed. The credit can only be distributed against a valid ISD invoice, which should contain specific details as prescribed under the rules.
• Manner of Distribution: The input tax credit available for distribution in a month must be distributed in the same month. The distribution is done in the ratio of the turnover of each recipient unit during the relevant period to the aggregate turnover of all recipient units to whom the input service credit is attributable. The “relevant period” is generally the last financial year. If some recipient units were not operational in the last financial year, the last quarter’s available turnover details may be considered.
  
  Example: ABC Ltd. has its head office in Delhi (registered as an ISD) and branches in Mumbai and Bangalore. The head office receives an invoice for advertising services that are used by all three locations. The total GST paid on this invoice is ₹30,000. The turnover of the Delhi HO in the previous financial year was ₹50 lakh, Mumbai branch ₹30 lakh, and Bangalore branch ₹20 lakh, making the total turnover ₹1 crore. The ITC will be distributed as follows:
  
  Delhi HO: (₹50 lakh / ₹1 crore) * ₹30,000 = ₹15,000
  Mumbai Branch: (₹30 lakh / ₹1 crore) * ₹30,000 = ₹9,000
  Bangalore Branch: (₹20 lakh / ₹1 crore) * ₹30,000 = ₹6,000
  The ISD (Delhi HO) will issue ISD invoices to its Mumbai and Bangalore branches for ₹9,000 and ₹6,000 respectively, allowing them to claim this ITC in their respective GST returns. The Delhi HO will retain the ITC of ₹15,000.

7. Manner of Claiming Credit in Special Circumstances (Rule 40)

Rule 40 addresses specific scenarios where a registered person becomes eligible to claim ITC under particular circumstances.

• New Registration within 30 Days of Liability: If a person applies for GST registration within thirty days from the date they became liable to registration and are granted registration, they are entitled to claim ITC on inputs held in stock, inputs contained in semi-finished or finished goods held in stock, and capital goods held in stock on the day immediately preceding the date from which they became liable to pay tax.
  
  Example: XYZ Sole Proprietorship’s turnover exceeded the threshold limit for GST registration on March 15th, 2025. They applied for registration on April 5th, 2025, and were granted registration on April 15th, 2025. XYZ Sole Proprietorship can claim ITC on the inputs, semi-finished goods, finished goods, and capital goods they had in stock as of March 14th, 2025, provided they possess valid invoices for these purchases (not older than one year for inputs and five years for capital goods). They need to file FORM GST ITC-01 to claim this credit.
• Voluntary Registration: A person taking voluntary registration is also eligible to claim ITC on the stock and capital goods held on the day immediately preceding the date of registration.
• Switching from Composition Scheme to Regular Scheme: A registered person who opts out of the composition scheme and chooses to pay tax under the regular scheme is also entitled to claim ITC on the stock and capital goods held on the day immediately preceding the date of switchover.
• Exempt Supply Becoming Taxable: When an exempt supply of goods or services becomes taxable, the person making such supplies can claim ITC on the inputs held in stock and inputs contained in semi-finished or finished goods held in stock relatable to such exempt supply, on the day such supply becomes taxable.
• Conditions and Time Limits: There are specific conditions and time limits for claiming ITC under these special circumstances. For instance, FORM GST ITC-01 needs to be filed within 30 days of the date of registration or the date of opting for the regular scheme. Invoices for inputs generally should not be older than one year from the date of registration, while for capital goods, the invoices should not be older than five years. If the ITC claimed is more than ₹2 lakh, a certificate from a chartered accountant or a cost accountant is also required.

8. Manner of Determining Input Tax Credit in Respect of Inputs or Input Services and Reversal Thereof (Rule 42)

Rule 42 provides a detailed methodology for determining the eligible ITC when inputs or input services are used partly for business purposes and partly for non-business purposes, or partly for making taxable supplies (including zero-rated supplies) and partly for making exempt supplies.

• Common Credit: When inputs or input services are used for both taxable and exempt supplies or for business and non-business purposes, the ITC related to these common inputs/services is termed as the “common credit.”
• Steps for Calculation: Rule 42 outlines the process for calculating the eligible and ineligible ITC:
  • Total Input Tax (T): First, determine the total ITC availed on all inputs and input services in a tax period.
  • Ineligible Credit (A): Identify the input tax credit that is directly attributable to non-business purposes (T1), exclusively used for making exempt supplies (T2), and those for which credit is specifically blocked under section 17(5) of the CGST Act (T3). These are directly ineligible and are not part of the common credit.
  • Credit for Taxable Supplies (C1): Identify the ITC directly attributable to taxable supplies (including zero-rated supplies) (T4). This is fully eligible.
  • Common Credit (C): Calculate C = T – (T1 + T2 + T3 + T4). This common credit needs to be further apportioned.
  • Credit Attributable to Exempt Supplies (D1): Calculate D1 = (Value of exempt supplies (E) / Total turnover (F)) * C.
  • Credit Attributable to Non-Business Purposes (D2): If any portion of the common inputs/services is used for non-business purposes, the proportionate ITC needs to be reversed.
  • Eligible Common Credit (C2): Determine C2 = C – (D1 + D2).
  • Total Eligible ITC: Sum C1 and C2.
  • Reversal of Ineligible Credit: Reverse ineligible ITC, which includes T1, T2, T3, and D1.
• Example: M/s UVW Manufacturers has a total input tax credit of ₹50,000 for the month. Out of this:
  
  ₹5,000 is directly attributable to non-business use (T1).
  ₹10,000 is exclusively used for making exempt supplies (T2).
  ₹2,000 is blocked credit under section 17(5) (T3).
  ₹15,000 is directly attributable to taxable supplies (T4).
  The value of exempt supplies (E) for the month is ₹20,000, and the total turnover (F) is ₹1,00,000.
  Common Credit (C) = ₹50,000 – (₹5,000+₹10,000+₹2,000+₹15,000) = ₹18,000.
  Credit Attributable to Exempt Supplies (D1) = (₹20,000/₹1,00,000) * ₹18,000 = ₹3,600.
  Assuming no common inputs/services were used for non-business purposes, D2 = 0.
  Eligible Common Credit (C2) = ₹18,000 – ₹3,600 – ₹0 = ₹14,400.
  Total Eligible ITC = C1 + C2 = ₹15,000 + ₹14,400 = ₹29,400.
  ITC to be reversed = T1 + T2 + T3 + D1 = ₹5,000 + ₹10,000 + ₹2,000 + ₹3,600 = ₹20,600.

9. Manner of Determining Input Tax Credit in Respect of Capital Goods and Reversal Thereof (Rule 43)

Rule 43 provides a similar methodology as Rule 42, but specifically for determining the input tax credit in respect of capital goods that are used partly for business and partly for non-business purposes, or partly for making taxable and partly for making exempt supplies.

• Capital Goods and Common Credit: When capital goods are used for both taxable and exempt supplies, the input tax credit availed on such capital goods is considered as “common credit.”
• Monthly Credit: The total ITC on a capital good is not taken as credit in one go if it’s used for both taxable and exempt supplies. Instead, a notional credit equal to the tax involved is credited to the electronic credit ledger over a period of five years (60 months). So, the monthly credit for a capital good is calculated as (Total ITC on capital good) / 60.
• Steps for Calculation: Determine total ITC on capital goods (Tc); identify credits exclusively for non-business purposes (A) and for exempt supplies (B), and those exclusively for taxable supplies (C). The common credit is allocated monthly as Tmc = (ITC on the capital good) / 60. Then, calculate the credit attributable to exempt supplies (Te) = (Value of exempt supplies (E) / Total turnover (F)) * Tmc. The aggregate Te for all capital goods is the ITC to be reversed for the tax period.
  
  Example: M/s RST Ltd. purchased a machine for ₹10,00,000 plus GST of ₹1,80,000. Total ITC on the machine = ₹1,80,000.
  Monthly credit (Tmc) = ₹1,80,000 / 60 = ₹3,000.
  In a particular month, the value of exempt supplies (E) is ₹50,000, and the total turnover (F) is ₹2,50,000.
  Credit attributable to exempt supplies (Te) for that month = (₹50,000 / ₹2,50,000) * ₹3,000 = ₹600.
  Therefore, in that month, RST Ltd. will have to reverse ₹600 of the ITC related to this machine, and the remaining ₹2,400 (₹3,000 – ₹600) will be considered as eligible ITC for that month.

Conclusion

Chapter 5 of the CGST Rules provides a comprehensive framework for the availment and reversal of Input Tax Credit under GST. A thorough understanding of these rules, along with the latest amendments and clarifications, is indispensable for businesses to manage their tax obligations effectively and optimize their working capital. The conditions for claiming ITC under Rule 36, the reversal mechanisms under Rules 37 and 37A, the matching and reconciliation requirements of Rule 38, and the specific provisions for sectors like banking and the distribution of credit through ISDs under Rule 39, along with the detailed apportionment rules for inputs/input services and capital goods under Rules 42 and 43, collectively ensure a structured and transparent approach to ITC. Businesses must prioritize compliance with these rules to avoid potential penalties and ensure the smooth flow of input tax credit, which is fundamental to the success of the GST regime. Regularly staying updated with the evolving GST landscape through official notifications and expert consultations is highly recommended for all GST-registered taxpayers.

Disclaimer: This detailed article provides a general overview of Chapter 5 of the CGST Rules related to Input Tax Credit. The application of these rules can be complex and may vary based on specific facts and circumstances. For precise interpretations and guidance on your specific business scenario, it is strongly recommended to consult with a qualified tax professional and refer to the official notifications, circulars, and the CGST Act and Rules as issued by the Government of India.