ITC Rules for Capital Goods under GST

Businesses use many capital goods for their operations. It is to be noted that tax paid on these capital goods can be availed as input tax credit. This article explains all about ITC rules for capital goods.

Latest Update

1st February 2022
Budget 2022 updates-
1. ITC cannot be claimed if it is restricted in GSTR-2B available under Section 38.
2. Time limit to claim ITC on invoices or debit notes of a financial year is revised to earlier of two dates. Firstly, 30th November of the following year or secondly, the date of filing annual returns.
3. Section 38 is completely revamped as ‘Communication of details of inward supplies and input tax credit’ in line with the Form GSTR-2B. It lays down the manner, time, conditions and restrictions for ITC claims and has removed the two-way communication process in GST return filing on the suspended return in Form GSTR-2. It also states that taxpayers will be provided information of eligible and ineligible ITC for claims.
4. Section 41 is also revamped to remove the references to provisional ITC claims and prescribes self-assessed ITC claims with conditions.
5. Sections 42, 43 and 43A on provisional ITC claim process, matching and reversal are eliminated. 

29th December 2021
CGST Rule 36(4) is amended to remove 5% additional ITC over and above ITC appearing in GSTR-2B. From 1st January 2022, businesses can avail ITC only if it is reported by the supplier in GSTR-1/ IFF and it appears in their GSTR-2B.

21st December 2021
From 1st January 2022, ITC claims will be allowed only if it appears in GSTR-2B. So, the taxpayers can no longer claim 5% provisional ITC under the CGST Rule 36(4) and ensure every ITC value claimed was reflected in GSTR-2B.

What is capital goods?

Capital goods are assets such as buildings, machinery, equipment, vehicles and tools that an organization uses to produce goods or services. For example, a blast furnace used in the iron and steel industry is a capital asset for the steel manufacturer.   

Difference between capital goods & other inputs

Let us take an example. You are making a cake in your oven. You add ingredients such as eggs, water, flour, butter. These are your inputs. The cake is your final product. The oven is the capital good which helps you to make the cake. Inputs are consumed while making the final product and are treated as business expenses as cost of production. 

Capital goods are not consumed when the final product is made. They are not consumed in a single year of production. 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. The business recognises part of the cost each year through accounting techniques as depreciation, amortization and depletion.   

What is credit on capital goods? 

When you purchase anything, you are required to pay GST on it. Later, you can claim input tax credit on the GST paid on your purchases. Similarly, when you are purchasing any machinery for your factory, you will pay the applicable GST rate. This GST paid can be claimed as credit in the same way as inputs. However, if you claim depreciation on the GST paid while purchasing the capital asset, you cannot claim input tax credit.

What is common credit?

Businesses often use the same assets and inputs for both business & personal use. For example, Ms. Anita is a freelance designer and blogger. She has a personal laptop which she also uses for her freelance work. She can claim the input credit of GST paid on purchase of laptop only to the extent it pertains to her freelance business. Ms. Anita has also purchased a special designing software. Since this pertains only to her business, she can claim full ITC on this.

Why is common credit important?

ITC is only available for business purposes. Many traders use the same inputs for both business & personal reasons. A taxpayer cannot claim any tax benefit of personal expenses. Again, goods exempted under GST already enjoy 0% GST. 

ITC cannot be claimed for inputs used in such exempted goods as it will lead to negative taxation. So, ITC on inputs for exempted goods will also be removed. 

The following calculations will help you to calculate the common credit that is attributable to personal supplies & exempted supplies leaving behind only the portion that pertains to taxable sales. Only that amount can be claimed as ITC. The credit that is attributable to personal supplies & exempted supplies must be reversed while filing GSTR-3B.

Types of ITC for capital goods

Let us take each case one by one.

Capital goods used only for personal use or for exempted sales

No ITC is available for personal purchases or for capital goods used in exempted sales. This will be indicated in GSTR-3B and shall not be credited to the electronic credit ledger. 

Example 1: Personal purchases 

Ms. Anita has purchased a fridge. Since this is not required for her business, i.e., a purely personal purchase, she will not be able to claim any ITC on the GST paid for the fridge. 

Example 2: Capital goods used for exempted sales 

Mr. Avinash has purchased a small flour mill in his grocery shop to grind wheat grains to flour. Since he is producing unbranded flour it is exempted from GST. As it is an exempted sales, he cannot claim any ITC on the GST paid for the mill. 

Capital goods used for normal sales

XYZ has purchased machinery to manufacture shoes. Since, shoes are normal taxable supplies, the GST included paid while purchasing machinery will be completely available as ITC. This shall be indicated in GSTR-3B and shall be credited to the electronic credit ledger.

Common credit for partly personal/ exempted and partly normal sales

• The ITC paid for the capital goods will be credited to electronic credit ledger
• Useful life of such capital asset will be taken as 5 years from the date of purchase
• Now the total amount of input tax credited to electronic credit ledger for the whole useful life will be distributed over the useful life

The useful life will be taken as 5 years. If you pay GST on a monthly basis then you will use the following formula:

Calculations for common credit

For exempted supplies

The amount of ITC attributable to exempt supplies out of common capital credit –

Remaining amount after deducting credit for exempt supplies will be allowed as ITC. All the above calculations must be done separately for:

• Central tax
• State Tax
• Union Territory Tax
• Integrated Tax

What happens if one starts using an asset for exempt goods also for taxable goods?

 If a capital asset was earlier used exclusively used for:

• Personal purpose OR
• Selling exempted goods

And now it will is used commonly for:

• Business and personal purpose OR
• Affecting taxable and exempt supplies

Input tax to be credited to electronic credit ledger = Input Tax – 5% of Input tax for every quarter or part thereof from date of invoice.

Let us understand this via an example. Mr. Avinash bought a capital asset for use in exempt supplies only. He paid Rs 1,00,000/- along with GST of Rs 18,000 as input tax on 1st October 2017. On 15th November 2018, he wishes to use the capital asset commonly for both taxable and exempt supplies. 

Now the eligible common input tax credit will be calculated as follows
Input Tax – 5% of Input tax for every quarter or part thereof 
The no. of quarters from 1st October 2017 to 15th November 2018 = 5
i.e., 18,000 – (5% of 18000) * 5 quarters = 18,000 – 4,500 = 13,500 
Now, this is the common credit available to Mr. Avinash. 

He will credit Rs 13,500 to Electronic Credit ledger. Now he will calculate the ITC attributable to exempt supplies as per the formula for exempt supplies. 

Common credit for one month= 13,500÷60=225 assuming his total turnover is Rs.160 lakhs and exempted sales is Rs.40 lakh-

Credit attributable for exempt supplies = (40/160) * 225 = Rs.56.25.

This amount of Rs.56.25 will be reversed in GSTR-3B under the ITC Reversal column.  

Reversal of credit under certain circumstances

In the following circumstances the proportionate ITC will be reversed i.e. added to output tax liability in GSTR-3B:

• Where a normal taxpayer opts to pay tax under composition scheme or goods/services supplied by him become exempt
• In case of supply of capital goods or plant and machinery, on which input tax credit has been taken
• Every registered person whose registration is cancelled

Input tax credit involved in the remaining useful life in months shall be computed on a pro-rata basis, taking the useful life as five years. 

Example:
Capital goods have been in use for 4 years, 6 month and 15 days.
Therefore, the useful remaining life in months = 5 months ignoring a part of the month
Input tax credit taken on such capital goods = C (say 10 lakhs)
Input tax credit attributable to remaining useful life = C *5÷60 = 10,00,000*5÷60 = 83,333 

The above calculation must be done separately for integrated tax and central tax. This amount must be reversed in (i.e. becomes part of output tax liability) and furnished in:

• Where a normal taxpayer opts to pay tax under composition scheme or goods/services supplied by him become exempt - Form GST ITC-03
• Registration is cancelled - Form GSTR-10

This must be accompanied by a certificate from a practicing chartered accountant or cost accountant. In case of sale of capital goods, if the amount determined above is greater than the tax on transaction value of such sale, then the amount determined as above will be added to output tax liability. The details must be furnished in Form GSTR-1.

Capital goods send on job work

ITC will be allowed to the principal manufacturer if a capital asset has been sent to a job worker for job work. 

Condition:

Such goods must be received back within a period of 3 years of being sent out. 

Implications:

If the goods are not sent back within 3 years, it shall be treated as a deemed supply from the date of sending the goods and tax would be payable along with interest for late payment of taxes.

From the above calculations, it is clear that ITC Rules for common credit under GST have been meant to be followed strictly to avoid interest and other recovery mechanisms.

For more information read the below:
Input Tax Credit on Job Work and ITC-04
ITC rules for common credit for inputs under GST