New Section 38 of the CGST Act Governing Input Tax Credit Claims (Proposed by Finance Bill 2022)

The Finance Bill 2022 introduced a new section in the Central Goods and Services Tax (CGST) Act, 2017 by way of substituting the existing Section 38. The revised Section 38 was proposed in a bid to further tighten input tax credit (ITC) claims, owing to the extent of ITC fraud that takes place by way of fake entities and fake invoices. The provisions of this section will also help avoid any matters of litigations in the court of law.

Latest updates

Union Budget 2025- 1st Feb 2025

• Manual validation of invoices may now be required as GSTR-2B may no longer be fully system-generated as CGST Section 38(1) is being amended to omit the expression "autogenerated".
• New clause (c) under CGST Section 38(2) allows the government to specify additional ITC statement details, increasing compliance requirements.

Let’s decode the new Section 38 and find out how it will impact the ITC claims of a business.

How does the existing Section 38 govern ITC claims?

The existing Section 38 of the CGST Act is titled ‘Furnishing details of inward supplies’. It governed the furnishing of details of outward supplies (i.e. sales) by a supplier, followed by the recipient (buyer) accepting such inward supplies (i.e. purchases) and claiming ITC on the same. 

The existing section was based on a two-way communication methodology, though the process was never followed. It involves the seller furnishing their details of outward supplies under Section 37(1), for instance, the GSTR-1. The buyer is then required to accept/modify/delete these supplies in their inward supplies return (i.e. the GSTR-2), which is then communicated back to the supplier within the prescribed period.

Finally, the section says that the recipient taxpayer must reconcile the inward supplies reported by them with the outward supplies reported by their supplier. If any error or omission is observed, the same should be communicated to the supplier. Further, any tax and interest in respect of any short payment should be paid to the government within the prescribed due date.

Understanding the revised Section 38

The revised Section 38, proposed by the Finance Bill 2022, is titled ‘Communication of details of inward supplies and input tax credit’. It restricts input tax credit claims in more ways than one and eliminates the two-way communication process between the seller and the buyer (although it was never followed).

The intention of the new section is communicated by way of two subsections:

• The first subsection prescribes that the details of outward supplies furnished by a taxpayer’s suppliers will be made available in an auto-generated statement, i.e. the GSTR-2B. (It is to be noted that this process is already being followed, the change in law will now support the existing CGST Rules that are in place.)
• The second subsection prescribes the contents of the GSTR-2B. In simple words, it tells taxpayers the cases in which input tax credit may be availed and may not be availed (eligible and ineligible ITC). 

Some of the restrictions in this clause that involve ITC ineligibility are in cases where the supplier has recently registered under the GST law, defaulted in paying their taxes or availed additional ITC unlawfully, to name a few. We will decode each of the clauses in subsection (2), with an example, in the next part of our article.

Decoding the clauses of the revised Section 38 

The revised Section 38 subsection (2) is a slightly complicated one for taxpayers to understand. So, let’s tackle this section clause-by-clause.

1. Clause (a) of subsection (2) specifies the details of inward supplies and available ITC for the recipient (buyer) to claim in the GSTR-2B statement. In other words, eligible ITC.

2. Clause (b) is more complicated. It consists of the details of inward supplies furnished by the supplier in the GSTR-2B, in respect of which ITC may NOT be availed. In other words, ineligible ITC. This clause comprises six parts:

• First part: ITC may not be availed on supplies furnished by a supplier within the prescribed period* after the supplier’s registration under the GST law.
• Second part: ITC may not be availed on supplies furnished by a supplier who has not paid their taxes, and where such default has continued for a prescribed period*.
• Third part:  ITC cannot be claimed on such supplies on which the supplier has tax liability higher than the tax actually paid during the said period and by such limit prescribed*.
• Fourth part: ITC may not be availed on supplies furnished by a supplier where the supplier has claimed ITC more than what was allowed as per clause (a). In this part, too, it says that the excess is determined by the limit prescribed*.
• Fifth part: ITC may not be availed on supplies furnished by a supplier who has failed to pay their tax liability as per Section 49(12), subject to the conditions and restrictions prescribed*.
• Sixth part: ITC may not be availed on supplies furnished by a supplier where the supplier belongs to such other class of persons as may be prescribed*.

*Please note that the word “prescribed” here means that the actual time limit/class of persons has not yet been specified in the law as on date. The government has the power to specify or change these limits.

#Section 49(12) empowers the government to prescribe the maximum proportion of output tax liability that may be paid by a specified taxpayer through the electronic credit ledger.

Example of ITC claims under the revised Section 38

1. Before implementation of Section 38

The process of ITC claims is currently quite simple.

2. After implementation of Section 38

Hence, out of Rs.19,58,500 ITC that could be availed as per the existing law, the eligible ITC has been reduced to Rs.14,71,000 as per the revised Section 38.

Impact on ITC claims after the revised Section 38 got notified

Most taxpayers may be confused about why they cannot claim input tax credit because their suppliers are newly registered or have defaulted. When GST was introduced, it promised taxpayers the seamless flow of input tax credit. Let us tell you in brief exactly why this section was introduced.

Input tax credit claims have been a source of tax evasion and fraud ever since the incorporation of GST. Each year, the government loses hundreds or even thousands of crores due to fraudulent taxpayers who avail input tax credit based on fake invoices. These invoices are generated by businesses set up just for this purpose and are then shut down. Hence, the government proposed the revised Section 38 to end all ITC-related fraud that mainly changed three things for taxpayers.

• Their reconciliation processes became more frequent, more dynamic and preferably automated to ensure their ITC claims are always 100% eligible and accurate.
• Taxpayers need to ensure that they ONLY deal with compliant vendors. Again, automated GST solutions in the market enable a taxpayer to check their supplier’s compliance BEFORE they onboard them. A compliant supplier translates to higher ITC claims.
• If a taxpayer does not match 100% of their input tax credits or, even worse, the supplier is non-compliant (i.e. they default in paying taxes or claim excess ITC). The recipient taxpayer (buyer) cannot claim the ITC that is lawfully due to them. This will only increase their GST cash liability and hit their working capital.

How can taxpayers make their ITC claim process more efficient?

Taxpayers would need to ensure a robust mechanism of vendor checks and an efficient ITC claim process.This can be achieved in just three steps with automation-

• Configure the ERP to capture all invoice details and vendor information.
• Check vendor compliance before onboarding.
• Undertake a dynamic matching with the GSTR-2B BEFORE making payments to the suppliers. If suppliers are non-compliant, the buyer has the option to withhold payments.