Input Tax Credit Treatment Under GST Rate Rationalization

This article aims to guide businesses on how Input Tax Credit (ITC) will be impacted under the revised GST regime coming into effect from September 22, 2025. The analysis draws directly from the Frequently Asked Questions (FAQs) released by the Press Information Bureau (PIB), which clarify the treatment of ITC in light of the GST rate rationalization approved by the GST Council. The FAQs address common concerns around continuing eligibility of existing ITC, sector-specific restrictions, and compliance requirements under the new structure.

GST ITC: What changes and what doesn’t

1. ITC you’ve already availed stays usable

PIB’s FAQ clarifies that ITC “once duly availed in the e-credit ledger can be used for discharge of any output tax liability” in line with section 49(4) of the CGST Act. In short: valid credits already sitting in your ledger remain fungible against output GST after the new rates kick in.

2. When your output turns 5 percent “without ITC,” you must block/reverse credits

For supplies that are now taxed at 5 percent without ITC (for example, specified hotel accommodation up to INR 7,500 per unit per day and beauty/physical well-being services), businesses:

3. Sector-specific ITC treatments to note (post-rationalization)

• Hotels (≤ INR 7,500 per unit/day): Mandatory 5 percent without ITC; no option to charge 18 percent with ITC for these units. Plan for credit blocking/reversal on related inputs/services.
• Beauty & physical well-being services: Mandatory 5 percent without ITC; apply Section 17(2) reversals for common inputs.
• Multimodal transport of goods:

• • If no leg is by air → 5 percent with restricted ITC (only ITC of input transportation services capped at 5 percent of value; no ITC on other inputs/input services).
  • If any leg is by air → 18 percent with full ITC.

FAQs include worked examples—use them to design billing and vendor-tax setups.

• Leasing/renting a car with operator: Supplier can choose 5 percent with ITC of input services in the same line of business or 18 percent with full ITC. Consider which option optimizes your credit position.
• Job-work (e.g., bus body building): Aligned to 18 percent with ITC; supports full credit flow for manufacturers and job workers.
• Insurance (health & life, individual policies): Output is exempt; reinsurance services to insurers are exempt, while ITC on other inputs/input services tied to the exempt output must be reversed.

4. Inverted duty cases: refunds remain available

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Where the rationalization deepens inversion (e.g., certain medical devices at 5 percent), the FAQs reiterate that refund of accumulated ITC on account of inverted duty structure is available, with process reforms aimed at expedited refunds. (Note: specific restrictions like imitation zari continue as earlier policy choices.)

5. “Special rate” (e.g., 40 percent) and compensation cess merger: rate rationale, not a new ITC regime

India’s GST Council has merged compensation cess on select sin/luxury goods into GST via a higher “special rate” to maintain tax incidence as cess winds down. The PIB FAQ explains the rationale but does not announce a new ITC rule set—thus standard ITC provisions continue to apply unless a specific “without ITC” condition is prescribed. Align contracts/pricing, but don’t assume cess-like restrictions unless notified.

CLICK HERE TO KNOW MORE: India to Remove GST Compensation Cess from Sept. 22, 2025: Details Here

Practical actions for CFOs and tax heads

A) Map your stock keeping unit (SKUs)/services to the new rate-ITC grid

Identify items moving to 5 percent without ITC, those eligible for restricted ITC (multimodal, non-air), and those retaining full ITC (18 percent services, multimodal with air leg, job-work at 18 percent). Update item tax codes, pricing, and margin models accordingly.

B) Automate credit blocking & Section 17(2) reversals

• Configure ERP to block ITC on exclusively used inputs for 5 percent-without-ITC outputs.
• Set Rule 42/43 logic for proportionate reversal on common inputs and capital goods linked to such outputs. Keep calculations and workings auditable.
• Supplies at 5 percent “without ITC”: no credit on direct inputs, proportionate reversal of common credits (Rule 42/43).
• Sector-wise specifics (hotels, beauty, multimodal, insurance, leasing).

C) Re-paper vendor contracts and rate cards

• Transport/logistics: Distinguish multimodal engagements by the air leg criterion; renegotiate pass-through of ITC eligibility and rate (5 percent restricted vs 18 percent full).
• Leasing with operator: Choose between 5 percent limited-ITC vs 18 percent full-ITC based on your input structure.

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D) Manage legacy credits and pricing transitions.

Leverage the PIB clarification that existing availed ITC remains usable against output liabilities post-September 22. Reflect this in working capital forecasts and price adjustments where outputs shift to non-creditable slabs.

E) Plan cash-flow for inverted-duty refunds.

Where inversion persists or deepens (e.g., some health-care supply chains), model refund timelines and set documentation standard operating procedure (SOPs) to benefit from the expedited process intent flagged by the GST Council.

F) Train front-office teams to avoid wrong-rate billing

Misapplying the “option” where none exists (e.g., hotels ≤ INR 7,500; beauty/well-being) or missing restricted-ITC caps in multimodal can cause ineligible ITC and interest exposure.

Red flags & do/don’t checklist

• Don’t claim ITC on inputs exclusively used for 5 percent-without-ITC supplies; do reverse common credits per Section 17(2).
• Do separate multimodal jobs by air-leg to apply the correct rate and ITC entitlement.
• Do retain documentation that supports your ITC position (contracts, invoices showing service category, routing).
• Do continue to use valid ledger ITC against output taxes post-rate change, in line with section 49(4).
• Don’t assume new ITC restrictions merely because a special (higher) rate applies—the PIB note explains rate rationale, not a new ITC block, unless separately prescribed.

Bottom line

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The GST rate overhaul tightens ITC in clearly identified pockets (mandatory 5 percent without ITC, restricted ITC for non-air multimodal, insurer reinsurance exemption impacts), while preserving credit flow elsewhere (18 percent with full ITC; job-work; multimodal with air leg). Your priority is to tag transactions correctly, configure automated reversals, and renegotiate vendor terms so ITC remains compliant and cash-efficient under the new regime.

ALSO READ: Supreme Court Allows ITC on Commercial Buildings Construction

Rule 42/43 compliance checklist for ITC reversals

Identify ITC streams

• Segregate ITC attributable exclusively to taxable supplies (fully eligible).
• Segregate ITC attributable exclusively to exempt/5 percent-without-ITC supplies (fully ineligible).
• Mark common ITC used for both categories (to be apportioned).

Apply Rule 42 (Input services & inputs)

• Compute exempt turnover ÷ total turnover for the tax period.
• Multiply the above ratio by common ITC → reversal amount.
• Post reversal entry in GSTR-3B under “ITC Reversal”.

Apply Rule 43 (Capital goods)

• Identify capital goods used commonly across taxable and exempt outputs.
• Apportion ITC over useful life of 60 months.
• Apply exempt turnover ratio each month → reversal of capital ITC.
• Update working papers to reflect month-on-month reversals.

Blocked credits (Section 17(5))

• Ensure inputs/services marked “without ITC” under notifications are not claimed (e.g., specified hotel accommodation, beauty/well-being services, certain multimodal transport cases).
• Cross-check supplier invoices tagged under restricted ITC categories.

Documentation and audit trail

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• Maintain turnover reconciliation (taxable vs. exempt) with ledger references.
• Retain calculation sheets for Rule 42/43 reversals for minimum 72 months (as per GST retention rules).
• Ensure ERP/accounting system auto-flags restricted ITC categories.

Final controls before filing GSTR-3B

• Verify reversal amounts match Rule 42/43 workings.
• Ensure ITC ledger after reversal tallies with return figures.
• Cross-verify against invoices blocked under “without ITC” category.

Pro tip: Automating Rule 42/43 computations in ERP can reduce disputes, especially in sectors like hospitality, logistics, and services where turnover mix frequently changes.

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