Adjustment of Tax Liability or Refund through GST Credit Note

Under the CGST Act, a supplier of goods or services or both is mandatorily required to issue a tax invoice. However, in the ordinary course of trade or commerce, situations may arise after issuance of the tax invoice which necessitate correction of the originally declared taxable value or tax charged. Such situations may include:

• The supplier having erroneously declared a value higher than the actual value of the goods or services supplied;
• The supplier having charged tax at a higher rate than what is applicable to the goods or services supplied;
• Receipt of a lesser quantity of goods by the recipient than what was mentioned in the tax invoice;
• Deficiency in quality of goods or services supplied, leading to partial or full reimbursement of the invoice value;
• Any other similar circumstances warranting adjustment of the invoice value or tax.

To regularize such situations, the law permits the supplier to issue a credit note to the recipient. Upon issuance of the credit note in accordance with Section 34 of the CGST Act and subject to prescribed conditions, the corresponding tax liability of the supplier stands reduced.

In this regard, Section 34(1) of the CGST Act provides that

“Where one or more tax invoices have been issued for supply of any goods or services or both and the taxable value or tax charged in that tax invoice is found to exceed the taxable value or tax payable in respect of such supply, or where the goods supplied are returned by the recipient, or where goods or services or both supplied are found to be deficient, the registered person, who has supplied such goods or services or both, may issue to the recipient one or more credit notes for supplies made in a financial year containing such particulars as may be prescribed.”

Adjustment of Tax Liability for Credit Notes – Time Limit

A registered person issuing a credit note in respect of a supply of goods or services or both is required to declare the details of such credit note in the return for the tax period in which the credit note is issued. However, such declaration must be made not later than the 30th of November following the end of the financial year in which the original supply was made, or the date of furnishing of the relevant annual return, whichever is earlier.

Accordingly, reduction of output tax liability is not permissible in cases where the credit note is issued or declared beyond the prescribed time limit.

In this regard, Section 34(2) of the CGST Act provides that

“(2) Any registered person who issues a credit note in relation to a supply of goods or services or both shall declare the details of such credit note in the return for the month during which such credit note has been issued but not later than the thirtieth day of November following the end of the financial year in which such supply was made, or the date of furnishing of the relevant annual return, whichever is earlier, and the tax liability shall be adjusted in such manner as may be prescribed:

Provided that no reduction in output tax liability of the supplier shall be permitted, if the–

(i) input tax credit as is attributable to such a credit note, if availed, has not been reversed by the recipient, where such recipient is a registered person; or

(ii) incidence of tax on such supply has been passed on to any other person, in other cases.

 The output tax liability of the supplier stands reduced upon issuance of the credit note and successful matching thereof. The details of the credit note relating to outward supplies, as furnished by the supplier for a tax period, are required to be matched in the manner prescribed, namely:

(a) with the corresponding reduction in the claim of input tax credit by the recipient in his valid return for the same tax period or any subsequent tax period; and

(b) to ensure that there is no duplication of claims for reduction in the supplier’s output tax liability.

If the reduction in GST liability claimed by the supplier through a credit note matches with the reduction of input tax credit reversed by the recipient, such reduction will be finally accepted and informed to the supplier. However, the supplier will not be allowed to reduce GST liability if it is found that the tax and interest burden has already been passed on to someone else (principle of unjust enrichment).

If the supplier claims more reduction in output tax liability than the ITC reversed by the recipient, or if the recipient does not declare the related credit note in his GST return, the difference will be treated as a discrepancy and both the supplier and the recipient will be informed.

In case the supplier claims reduction twice for the same credit note, such duplication will be informed only to the supplier.

If a discrepancy is communicated and the recipient does not correct it in his valid GST return for that month, the disputed amount will be added back to the supplier’s GST liability in the next month’s return.

If the reduction in GST liability is found to be due to duplicate claims, the wrongly reduced amount will be added back to the supplier’s GST liability in the same month in which such duplication is communicated.

Illustrative Example – Adjustment of Tax Liability through Credit Note

Facts

• Supplier: M/s ABC Traders (registered under GST)
• Recipient: M/s XYZ Enterprises (registered under GST)
• Original Supply:
  • Date of invoice: 06.2022
  • Taxable value: ₹10,00,000
  • GST @18%: ₹1,80,000
  • Total invoice value: ₹11,80,000
• Financial Year of Supply: 2022–23

Issuance of Credit Note:

Due to quality issues, goods worth ₹2,00,000 were returned by the recipient.

• Credit Note issued on: 08.2023
• Taxable value of credit note: ₹2,00,000
• GST @18%: ₹36,000

The credit note is declared by the supplier in GSTR-1 and GSTR-3B for August 2023.

Since the credit note is declared before 30.11.2023 (i.e., 30th November following the end of FY 2022–23) and before filing of the annual return, the time limit under Section 34(2) is complied with.

Matching with Recipient’s ITC

• M/s XYZ Enterprises had availed ITC of ₹1,80,000 on the original invoice.
• Upon receipt of the credit note, the recipient reverses ITC of ₹36,000 in GSTR-3B for September 2023.

The reduction in output tax liability of ₹36,000 claimed by the supplier matches with the corresponding reversal of ITC by the recipient.

Final Acceptance

As the matching is successful and there is:

• no duplication of claim, and
• no unjust enrichment (tax incidence not passed on),

the reduction in output tax liability of ₹36,000 is finally accepted and communicated to the supplier.

Scenario of Discrepancy

Assume that the recipient fails to reverse ITC of ₹36,000 in his return.

• The discrepancy is communicated to both the supplier and the recipient.
• If the recipient does not rectify the discrepancy in his valid return for the month in which such discrepancy is communicated,

Note-  ₹36,000 shall be added back to the output tax liability of the supplier in the return for the month immediately succeeding the month of communication.

Scenario of Duplication

If M/s ABC Traders wrongly claims reduction of ₹36,000 twice on account of the same credit note:

• The duplication is communicated only to the supplier.
• The duplicated amount of ₹36,000 shall be added back to the supplier’s output tax liability in the return for the month in which such duplication is communicated.

Time-barred Credit Note (No Tax Adjustment)

If the credit note had been issued or declared after 30.11.2023, the supplier would not be permitted to reduce output tax liability, even though the credit note is otherwise valid for commercial purposes.

Key Legal Takeaway

Reduction of output tax liability through a credit note is permissible only when:

• issued and declared within the statutory time limit,
• matching with ITC reversal by the recipient is successful, and
• there is no unjust enrichment or duplication.

Circular No. 136/06/2020-GST dated 03.04.2020

It has now been brought to the notice of the Board that taxpayers are facing difficulties in complying with certain provisions of the CGST Act, 2017, which were not specifically addressed earlier and therefore require further clarification. In this context, Circular No. 136/06/2020-GST dated 03.04.2020 was issued to explain various relief measures provided by the Government to assist taxpayers in meeting their compliance obligations under the CGST Act.

The issue, inter alia, concerning the cancellation of contracts at a later stage, issuance of credit notes, and adjustment or refund of tax liability, has been addressed in the said circular, and may be read as follows:

Question-1: An advance is received by a supplier for a Service contract which subsequently got cancelled. The supplier has issued the INVOICE before supply of service and paid the GST thereon. Whether he can claim refund of tax paid or is he required to adjust his tax liability in his returns?

 In case GST is paid by the supplier on advances received for a future event which got cancelled subsequently and for which invoice is issued before supply of service, the supplier is required to issue a “credit note” in terms of section 34 of the CGST Act. He shall declare the details of such credit notes in the return for the month during which such credit note has been issued. The tax liability shall be adjusted in the return subject to conditions of section 34 of the CGST Act. There is no need to file a separate refund claim.

However, in cases where there is no output liability against which a credit note can be adjusted, registered persons may proceed to file a claim under “Excess payment of tax, if any” through FORM GST RFD-01.

Question-2: An advance is received by a supplier for a Service contract which got cancelled subsequently. The supplier has issued RECEIPT VOUCHER and paid the GST on such advance received. Whether he can claim refund of tax paid on advance or he is required to adjust his tax liability in his returns?

In case GST is paid by the supplier on advances received for an event which got cancelled subsequently and for which no invoice has been issued in terms of section 31 (2) of the CGST Act, he is required to issue a “refund voucher” in terms of section 31 (3) (e) of the CGST Act read with rule 51 of the CGST Rules.

The taxpayer can apply for refund of GST paid on such advances by filing FORM GST RFD-01 under the category “Refund of excess payment of tax”.

Question-3: Goods supplied by a supplier under cover of a tax invoice are returned by the recipient. Whether he can claim refund of tax paid or is he required to adjust his tax liability in his returns?

 In such a case where the goods supplied by a supplier are returned by the recipient and where tax invoice had been issued, the supplier is required to issue a “credit note” in terms of section 34 of the CGST Act. He shall declare the details of such credit notes in the return for the month during which such credit note has been issued. The tax liability shall be adjusted in the return subject to conditions of section 34 of the CGST Act. There is no need to file a separate refund claim in such a case.

However, in cases where there is no output liability against which a credit note can be adjusted, registered persons may proceed to file a claim under “Excess payment of tax, if any” through FORM GST RFD-01.

Remark: It is pertinent to note that sub-section (1) of Section 54 of the CGST Act provides that any person may claim a refund of any tax, along with interest, if applicable, or any other amount paid by him. Such a claim must be made by filing an application before the expiry of two years from the relevant date, in the form and manner prescribed under the rules. Therefore, in each case, the refund application should be made specifically under Section 54(1) of the CGST Act.

Refund by unregistered persons in terms of clause (e) of sub-section (8) of Section 54 of CGST Act.

Instances have been brought to notice where unregistered buyers had entered into agreements or contracts with builders for the supply of construction services, such as flats or buildings, and had paid consideration for such services—either fully or partially—along with the applicable tax. Subsequently, these buyers were compelled to cancel the contracts or agreements due to non-completion, delay in construction, or other reasons.

In several such cases, the period for issuance of a credit note under Section 34 of the Central Goods and Services Tax Act, 2017 (CGST Act) may have already expired. In such circumstances, the supplier may refund the amount to the buyer after deducting the tax already collected from the buyer.

A similar situation may arise in the case of long-term insurance policies, where the premium for the entire policy term is paid upfront along with the applicable GST, and the policy is subsequently required to be terminated prematurely for any reason. In some instances, the period for issuing a credit note under Section 34 of the CGST Act may have already expired. Consequently, the insurance company may refund only the proportionate premium, net of GST.

In this regard, the department has received various representations requesting the provision of a facility for unregistered buyers/recipients to claim a refund of the tax amount borne by them in cases where:

1. A contract or agreement for the supply of construction services for flats or buildings is cancelled; or

2. A long-term insurance policy is terminated prematurely.

The Board, in exercise of the powers conferred by Section 168(1) of the CGST Act, has issued Circular No. 188/20/2022-GST, dated 27th December 2022.

The Circular, while considering the provisions of Section 54(1) of the CGST Act and in terms of clause (e) of sub-section (8) of Section 54, clarifies that in cases where an unregistered person has borne the incidence of tax and has not passed it on to any other person, the refund shall be paid to him directly, instead of being credited to the Consumer Welfare Fund (CWF).

To enable such unregistered persons to file a refund application under sub-section (1) of Section 54 in cases where a contract or agreement for the supply of construction services has been cancelled, or a long-term insurance policy has been terminated, a new functionality has been made available on the Common Portal. This functionality allows unregistered persons to obtain temporary registration and apply for a refund under the category “Refund for Unregistered Person.”

Further, sub-rule (2) of Rule 89 of the CGST Rules, 2017 has been amended, and Statement 8 has been inserted in FORM GST RFD-01 vide Notification No. 26/2022-Central Tax, dated 26.12.2022, to specify the documents required to be furnished along with the refund application by unregistered persons and the statement to be uploaded with such application.

1. Filing of refund application

An unregistered person who intends to file a refund application under sub-section (1) of Section 54 of the CGST Act, in cases where a contract or agreement for the supply of construction services has been cancelled, or a long-term insurance policy has been terminated, shall first obtain temporary registration on the Common Portal using their Permanent Account Number (PAN).

While registering, the unregistered person shall select the same State/UT where the supplier—whose invoice forms the basis for the refund claim—is registered. Thereafter, the unregistered person must undergo Aadhaar authentication in accordance with Rule 10B of the CGST Rules.

Further, the unregistered person is required to enter bank account details for receipt of the refund. The bank account must be in the name of the applicant and linked to the same PAN used for temporary registration.

2. Refund Application

The refund application shall be filed in FORM GST RFD-01 on the Common Portal under the category “Refund for Unregistered Person.” The applicant shall upload Statement 8 (in PDF format) along with all requisite documents as specified under sub-rule (2) of Rule 89 of the CGST Rules.

3. Amount of refund claimed

The refund amount claimed shall not exceed the total tax declared on the invoices for which the refund is being sought. Additionally, the applicant must upload the certificate issued by the supplier in accordance with clause (kb) of sub-rule (2) of Rule 89 of the CGST Rules.

The applicant may also upload any other supporting documents to establish that they have paid and borne the incidence of tax and that the said amount is eligible for refund.

4. Separate refund applications

Separate refund applications must be filed in respect of invoices issued by different suppliers. Further, where the suppliers—whose invoices form the basis for the refund claim—are registered in different States/UTs, the applicant shall obtain temporary registration in each of the concerned States/UTs where such suppliers are registered.

5. Refund application only when time period to credit note has expired

Where the time period for issuance of a credit note under Section 34 of the CGST Act has not expired at the time of cancellation or termination of a contract/agreement for the supply of services, the concerned supplier may issue a credit note to the unregistered person. In such cases, the supplier would also be able to refund the amount of tax collected from the unregistered person, and therefore, there would be no need for the unregistered person to file a separate refund claim.

Accordingly, refund claims by unregistered persons are required only in cases where, at the time of cancellation or termination of the contract/agreement for supply of services, the time period for issuance of a credit note under Section 34 of the CGST Act has already expired.

6. Relevant date for filing of refund:

As per sub-section (1) of Section 54 of the CGST Act, a time period of two years from the relevant date is prescribed for filing a refund application. Further, in cases of refund claimed by a person other than the supplier, the relevant date is defined, under clause (g) of Explanation (2) to Section 54, as the date of receipt of goods or services or both by such person.

However, in situations where the supplier and the unregistered person (recipient) have entered into a long-term contract/agreement for supply—such as construction of flats or long-term insurance policies—with advance or instalment payments, if the contract is cancelled or terminated before completion of the service, there may be no date of receipt of service for the portion of the supply not rendered.

Therefore, in such cases, it has been decided that, for the purpose of determining the relevant date under clause (g) of Explanation (2) to Section 54, the date of issuance of the letter of cancellation of the contract/agreement by the supplier shall be considered as the date of receipt of the services by the applicant.

7. Minimum refund amount

Sub-section (14) of Section 54 of the CGST Act provides that no refund under sub-section (5) or sub-section (6) shall be paid to an applicant if the amount is less than ₹1,000. Accordingly, refund claims shall not be filed if the amount of refund is less than ₹1,000.

8. Refund sanction order

The Proper Officer shall process the refund claim filed by the unregistered person in a manner similar to other RFD-01 claims. The Proper Officer shall scrutinize the application to ensure the completeness and eligibility of the refund claim to their satisfaction and issue the refund sanction order in FORM GST RFD-06 accordingly.

Further, the Proper Officer shall upload a detailed speaking order along with the refund sanction order in FORM GST RFD-06.

In cases where the amount refunded by the supplier to the unregistered person, on cancellation or termination of a contract/agreement for the supply of services, is less than the amount originally paid by the unregistered person, only the proportionate tax corresponding to the amount actually refunded shall be eligible for refund to the unregistered person. Example: Suppose an unregistered person paid ₹1,00,000 to a supplier for a construction service, which included ₹18,000 as GST. If the contract is later cancelled and the supplier refunds only ₹60,000, then only the proportionate GST, i.e., ₹10,800 (₹60,000 ÷ ₹1,00,000 × ₹18,000), shall be eligible for refund to the unregistered person.

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Disclaimer: Nothing contained in this document is to be construed as a legal opinion or view of either of the author whatsoever and the content is to be used strictly for informational and educational purposes. While due care has been taken in preparing this article, certain mistakes and omissions may creep in. the author does not accept any liability for any loss or damage of any kind arising out of any inaccurate or incomplete information in this document nor for any actions taken in reliance thereon.