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GST & Compliance
Input Tax Credit (ITC)
The GST paid on business purchases that can be subtracted from the GST liability on sales.
Input Tax Credit (ITC) is one of the most powerful features of the GST system in India. It allows you to reduce the GST you owe on your sales (output tax) by the GST you have already paid on your purchases (input tax). This eliminates the cascading effect of "tax on tax" that existed before GST.
Understanding ITC with a Simple Example
Let's say you're a furniture manufacturer:
- You buy timber worth ₹10,000 + 18% GST = ₹11,800 total (GST paid = ₹1,800)
- You manufacture furniture and sell it for ₹25,000 + 18% GST = ₹29,500 total (GST collected = ₹4,500)
Without ITC: You would pay full ₹4,500 to the government
With ITC: You only pay ₹4,500 - ₹1,800 = ₹2,700 to the government
The ₹1,800 you paid when buying timber gets "credited" to your account. You're only taxed on the value you added to the product (your labor, margin, overhead).
Eligibility for Claiming ITC
You can claim ITC on:
- Raw Materials: Steel, plastic, fabric – anything that becomes part of your final product
- Capital Goods: Machinery, equipment, computers used in business
- Input Services: Transportation charges, job work charges, legal/CA fees, electricity bills
- Office Supplies: Furniture, stationery, software licenses
- Maintenance & Repairs: Machine servicing, factory building repairs
When You CANNOT Claim ITC
ITC is blocked on:
- Personal Use Items: Goods or services used for personal consumption, not business
- Food & Beverages: Restaurant bills, outdoor catering (except for manufacturing units providing free food to workers)
- Motor Vehicles: Cars, bikes (unless used for specific business activities like making further taxable supplies of vehicles, transportation of goods, or passenger transportation)
- Employee Benefits: Health services, life insurance, travel benefits (with some exceptions)
- Membership Fees: Club memberships, health & fitness centers
- Composition Scheme Purchases: If you buy from a composition dealer, they don't charge GST, so no ITC
- Non-GST Supplies: Alcohol, petroleum products (until notified)
Conditions for Claiming ITC
To claim ITC, you MUST satisfy these conditions:
- 1.Possession of Tax Invoice: The supplier must issue a valid GST invoice mentioning GST amount separately
- 2. Goods/Services Actually Received: You cannot claim ITC on a purchase that hasn't been delivered yet
- 3. Tax Paid to Government: Your supplier must have deposited the GST they collected from you (system auto-verifies this via GSTR-2B)
- 4. Return Filed: You must file your GST returns (GSTR-3B) to claim ITC
- 5. Used for Business Purpose: The purchased item must be used in the course or furtherance of business
Real Factory Examples of ITC
Example 1: Auto Parts Manufacturer (Full ITC Recovery)
- Purchased aluminum sheets: ₹2,00,000 + GST ₹36,000 (18%) = ₹2,36,000
- Purchased machine oil & lubricants: ₹20,000 + GST ₹3,600 (18%) = ₹23,600
- Paid electricity bill: ₹50,000 + GST ₹9,000 (18%) = ₹59,000
- Total Input GST Paid: ₹36,000 + ₹3,600 + ₹9,000 = ₹48,600
- Sold auto parts: ₹6,00,000 + GST ₹1,08,000 (18%) = ₹7,08,000
- Output GST Collected: ₹1,08,000
- GST to Pay After ITC: ₹1,08,000 - ₹48,600 = ₹59,400
- Benefit: Saved ₹48,600 by claiming ITC
Example 2: Textile Manufacturer (Mixed Inputs)
- Purchased fabric: ₹3,00,000 + GST ₹15,000 (5%) = ₹3,15,000 → ITC of ₹15,000 can be claimed
- Purchased office chairs: ₹40,000 + GST ₹7,200 (18%) = ₹47,200 → ITC of ₹7,200 can be claimed (business use)
- Staff lunch from restaurant: ₹5,000 + GST ₹250 (5%) = ₹5,250 → ITC of ₹250 CANNOT be claimed (blocked category)
- Total Claimable ITC: ₹15,000 + ₹7,200 = ₹22,200 (₹250 forfeited)
Example 3: Electronics Assembler (Capital Goods ITC)
- Purchased SMT machine: ₹15,00,000 + GST ₹2,70,000 (18%) = ₹17,70,000
- Full ITC of ₹2,70,000 can be claimed immediately (unlike the old system where capital goods ITC was spread over years)
- This reduces the effective cost of the machine from ₹17.7L to ₹15L
ITC Reversal – When You Must Pay Back ITC
Sometimes, ITC claimed earlier must be reversed (paid back). Common scenarios:
- Goods Lost or Stolen: If raw materials are destroyed by fire or theft, ITC must be reversed
- Payment Not Made in 180 Days: If you don't pay your supplier within 180 days of invoice, ITC is reversed (restored once payment is made)
- Used for Non-Business Purpose: If a business asset is used personally, proportionate ITC must be reversed
- Exempted Supplies: If you use inputs for making exempt supplies (like agricultural products, healthcare), ITC must be reversed
Common ITC Mistakes in Indian MSMEs
- Not Reconciling with GSTR-2B: Many claim ITC without checking if supplier has filed their return. If supplier hasn't reported your purchase, your ITC gets blocked
- Claiming ITC on Photocopies: Original tax invoice is mandatory; some businesses claim ITC on Xerox copies
- Claiming ITC on Advance Payment: ITC can only be claimed after receiving goods/services, not at payment stage
- Missing September Deadline: ITC for a financial year can be claimed until 30th September of the next year. After that, it lapses
- Not Maintaining Separate Accounts: If you make both taxable and exempt supplies, you must calculate ITC proportionally. Many don't maintain this
Best Practices for ITC Management
- Monthly Reconciliation: Match your purchase register with GSTR-2B every month to identify missing or wrong GSTINs
- Verify Supplier GSTIN: Before making a purchase, verify that the supplier's GSTIN is active on the GST portal
- Proper Invoice Storage: Maintain all original tax invoices for at least 6 years (digital or physical)
- Track Blocked ITC Separately: Maintain a separate register for expenses where ITC is blocked (staff welfare, vehicle purchases)
- Immediate Claiming: Don't wait until year-end. Claim ITC monthly to improve cash flow
How ERP Systems Automate ITC
Modern ERPs like Karygar make ITC management effortless:
- Auto-Calculate ITC: System automatically checks if purchase is eligible for ITC based on HSN code and category
- GSTR-2B Reconciliation: Import GSTR-2B from GST portal and auto-match with purchase entries. Highlights mismatches instantly
- ITC Ledger: Real-time view of total ITC available, used, and lapsed. Alerts if ITC is about to expire (September deadline)
- Reversal Tracking: Auto-calculates ITC reversal for blocked categories or Rule 42/43 compliance
- E-Invoice Integration: Auto-fetch ITC details from e-invoices, eliminating manual data entry errors
- Supplier Compliance Check: Flag purchases where supplier hasn't filed returns, preventing blocked ITC scenario
ITC and Profitability
ITC directly improves your cash flow and profitability:
- If you claim ₹50,000 ITC monthly, that's ₹6 lakh annual cash savings
- Proper ITC management can reduce your effective GST liability by 40-60%
- Missed ITC = money left on the table. Once the September deadline passes, it's gone forever
See Input Tax Credit (ITC) in Action
Don't just read about Input Tax Credit (ITC). See how Karygar automates this process to reduce manual work and errors on your factory floor.