Businesses utilise various capital goods for which input tax credit is available under GST registration. Capital goods include assets like buildings, machinery, equipment, vehicles, and tools that organisations use in the production of goods or services. For instance, a blast furnace used in the iron and steel industry is considered a capital asset for the steel manufacturer. In this blog, we shall focus on the aspect of ITC rules for capital goods under GST.
Understanding Capital Goods
Let us first understand the meaning of capital goods before going into ITC rules for capital goods under GST. Capital goods refer to assets essential for production, encompassing buildings, machinery, etc. utilised by organisations to manufacture goods or provide services.
In the process of creating a product, various inputs, such as eggs, water, flour, and butter, are combined, with the oven serving as the capital good. While inputs are consumed during production, constituting business expenses, capital goods differ in that they endure beyond a single year and are not fully deducted in the year of purchase. Instead, they undergo depreciation, amortisation, or depletion over their useful lives.
Upon purchasing any item, including machinery for a factory, Goods and Services Tax is levied. Subsequently, businesses can claim input tax credit on the GST paid for their purchases. However, if depreciation is claimed on the GST associated with acquiring a capital asset, input tax credit cannot be asserted. Let us now explore about ITC rules for capital goods under GST.
Understanding Common Credit in GST
Before going into the ITC rules for capital goods under GST, let us understand its meaning. Common credit refers to the scenario where businesses use the same assets and inputs for both personal and business purposes. For instance, individuals engaged in freelance work, like might utilise personal assets, such as laptops, for professional activities. However, the eligibility for input tax credit on such common assets is limited to the extent that they are utilised for business purposes.
The importance of common credit lies in ensuring that ITC is availed only for legitimate business purposes. This distinction is crucial, especially when individuals use the same inputs for both personal and business reasons. Claiming tax benefits for personal expenses is not permissible, and goods exempted under GST, already subject to 0% GST, further emphasise the limitations on ITC.
Calculation and Reversal of Common Credit
Under ITC rules for capital goods under GST, to determine the common credit attributable to personal and exempted supplies, specific calculations are necessary. These calculations aid in isolating the portion related to taxable sales, which is the only amount eligible for ITC. Any credit linked to personal and exempted supplies must be reversed during the filing of GSTR-3B to comply with regulatory requirements.
ITC Limitations for Personal and Exempted Use in GST
One of the important ITC rules for capital goods under GST. Is that when it comes to personal purchases, Input Tax Credit is not available. For example, if an individual acquires a fridge for personal use without any business purpose, she cannot claim any ITC on the Goods and Services Tax paid for the fridge. This non-business-related purchase is excluded from ITC eligibility and is clearly indicated in the GSTR-3B, ensuring it is not credited to the electronic credit ledger.
Similarly, ITC rules for capital goods under GST dictate that when capital goods are employed in activities leading to exempted sales, no ITC can be claimed. Take Mr. B’s case, who purchased a flour mill for his grocery shop to produce unbranded flour, exempted from GST. As the sales are exempted, he cannot avail any ITC on the GST paid for the mill. This restriction is documented in the GSTR-3B to prevent crediting such amounts to the electronic credit ledger.
Contrastingly, the same ITC rules for capital goods under GST state that when capital goods are utilised for normal taxable supplies, as in the case of XYZ purchasing machinery for manufacturing shoes, the GST paid on the machinery is fully available as ITC. This eligibility for ITC is explicitly noted in the GSTR-3B, and the corresponding credit is appropriately added to the electronic credit ledger.
Distribution of Common Credit for Partially Personal/Exempted and Partially Normal Sales
When capital goods are used for a combination of personal, exempted, and normal sales, the Input Tax Credit paid for these assets will be credited to the electronic credit ledger. The useful life of such capital assets is considered to be 5 years from the date of purchase.
Distribution Over the Useful Life
The total amount of input tax credited to the electronic credit ledger for the entire useful life will be distributed over the 5-year period.
Calculations for Common Credit
The formula used here is:
For exempted supplies, the remaining amount after deducting credit for exempt supplies will be allowed as ITC. All these calculations must be performed separately for:
· Central Tax
· State Tax
· Union Territory Tax
· Integrated Tax
This meticulous breakdown ensures a clear delineation of the credit associated with each tax component, taking into account the diverse nature of the supplies, be they exempt, personal, or for normal sales.
Reversal of Credit Under Specified Circumstances
In specific situations, the proportionate Input Tax Credit will be reversed, meaning it will be added to the output tax liability in GSTR-3B. These circumstances include:
1. Composition Scheme Opted or Supplies Becoming Exempt:
When a normal taxpayer chooses to pay tax under the composition scheme or when the goods/services supplied by them become exempt, a proportionate amount of ITC will be reversed.
2. Supply of Capital Goods or Plant and Machinery:
In the case of the supply of capital goods or plant and machinery on which input tax credit has been claimed, a corresponding proportion of the ITC will be reversed.
3. Cancellation of Registration:
If the registration of a registered person is cancelled, the proportionate ITC will be reversed.
Pro-Rata Computation for Remaining Useful Life:
· The input tax credit involved in the remaining useful life, calculated in months, will be computed on a pro-rata basis.
· The useful life considered for this calculation is assumed to be five years.
This methodology ensures that the reversal of ITC is fair and reflects the remaining value of the credit in relation to the remaining useful life of the capital goods or plant and machinery.
Final Thoughts
ITC rules for capital goods under GST play a crucial role in ensuring fair taxation. Businesses can claim ITC for assets used in taxable supplies, subject to specific conditions. However, limitations exist for personal use and exempted sales. The distribution of common credit over the useful life of assets, typically five years, adds a systematic approach to credit allocation. In certain scenarios, such as opting for the composition scheme or registration cancellation, proportionate ITC reversal is mandated. These ITC rules for capital goods under GST aim to streamline tax credits, promoting transparency and adherence to GST guidelines in the utilisation of capital goods.
