ITC in Special Circumstances: Special Rules for Preserving Input Tax Credit

Summary: Section 18 of the Central Goods and Services Tax Act, 2017 provides a special framework for preserving, transferring and reversing Input Tax Credit (ITC) when a taxpayer’s circumstances change. It covers situations where a person becomes liable for registration, obtains voluntary registration, moves from the composition scheme to the regular GST regime, or begins making taxable supplies after previously making exempt supplies. The provision also addresses business reorganisations such as sales, mergers, demergers, amalgamations, leases and transfers, permitting transfer of unutilised ITC where the prescribed conditions are satisfied. Rules 40 and 41 of the CGST Rules prescribe important procedural requirements, including FORM GST ITC-01 and FORM GST ITC-02, while Rule 44 deals with reversal in specified circumstances. Recent litigation has highlighted another dimension of Section 18: whether GST portal restrictions can prevent transfer of credit between registrations in different States following amalgamation. In Umicore Autocat India Private Limited v. Union of India, the Bombay High Court permitted transfer of relevant CGST and IGST credit despite a portal restriction, and the Gujarat High Court subsequently addressed a similar issue in Emerson Process Management (India) Pvt. Ltd. v. Union of India. Section 18 consequently operates as a balancing mechanism, preserving legitimate credit where business or tax circumstances change while imposing time limits, reductions, documentation requirements and reversal obligations to protect the integrity of the GST credit system.

Introduction

Input Tax Credit (ITC) is one of the core features of the Goods and Services Tax (GST) regime. It enables a registered person to claim credit for eligible tax paid on inward supplies and use that credit against output tax liability, thereby reducing the cascading effect of taxation.

However, businesses do not always operate under the same tax status. A person may become liable for GST registration after already purchasing inputs, voluntarily obtain registration, move from the composition scheme to the regular GST regime, or begin making taxable supplies after previously dealing with exempt supplies. Business structures may also change through mergers, amalgamations, demergers, sales or transfers.

These situations raise a practical question: what happens to the ITC already embedded in the business when its tax position changes?

Section 18 of the Central Goods and Services Tax Act, 2017 (CGST Act) addresses this question by providing for the availability of credit in special circumstances. The provision creates specific mechanisms for claiming, transferring and reversing ITC, subject to statutory conditions and procedural safeguards.

Section 18 is therefore important not merely because it permits additional credit in specified situations, but because it seeks to maintain continuity in the GST credit chain while preventing unjustified claims.

When ITC Becomes Available in Special Circumstances

Section 18(1) identifies four principal situations in which eligible ITC can arise because of a change in the taxpayer’s circumstances.

First, where a person becomes liable to registration and applies within the prescribed period, ITC may be claimed on eligible inputs held in stock and inputs contained in semi-finished or finished goods immediately before the date from which the person becomes liable to pay tax.

Second, a person who obtains voluntary registration under Section 25(3) may claim ITC on eligible inputs and inputs contained in semi-finished or finished goods held in stock immediately before registration.

Third, where a registered person ceases to pay tax under the composition scheme and becomes liable to pay tax under the regular provisions, ITC may be claimed on eligible inputs, stock and capital goods, subject to the prescribed reduction applicable to capital goods.

Fourth, where an exempt supply becomes taxable, ITC may be claimed in respect of eligible inputs and capital goods relating to that supply, subject to the statutory conditions.

These provisions recognise that a taxpayer should not necessarily lose legitimate credit merely because the tax treatment of the business has changed.

From Composition Scheme to Regular GST

The transition from the composition scheme to the regular GST regime demonstrates why special ITC provisions are necessary.

A composition taxpayer generally operates outside the ordinary ITC mechanism. When the taxpayer becomes liable to pay tax under the regular scheme, Section 18(1)(c) permits credit relating to eligible inputs, stock and capital goods.

However, the law does not permit unrestricted credit on capital goods. Rule 40 provides that ITC on capital goods covered by Section 18(1)(c) and (d) must be reduced by five percentage points for every quarter or part thereof from the date of the relevant invoice or document.

This reduction reflects the fact that the taxpayer may already have used the capital goods before entering the regular GST regime. The provision therefore attempts to balance preservation of legitimate credit with protection against an excessive credit claim.

When an Exempt Supply Becomes Taxable

Section 18(1)(d) addresses the reverse situation: a supply that was previously exempt becomes taxable. Where this occurs, eligible ITC may be claimed on inputs held in stock, inputs contained in semi-finished or finished goods and capital goods exclusively used for the exempt supply, subject to the prescribed conditions and reduction.

The provision becomes particularly relevant when the tax treatment of goods or services changes through legislative amendments or notifications. Without a transition mechanism, tax paid on inputs during the exempt period could remain embedded in the cost of the business even after the corresponding outward supply becomes taxable.

Section 18 consequently helps align the availability of ITC with the taxpayer’s changed tax liability.

Time Limit and Compliance Conditions

The special credit mechanism is not unlimited. Section 18(2) provides that credit under Section 18(1) cannot be claimed after the expiry of one year from the date of issue of the relevant tax invoice.

Rule 40 further prescribes the procedure for claiming such credit. A taxpayer eligible under Section 18(1) is required to furnish FORM GST ITC-01 electronically within the prescribed period. The rule also contains certification requirements where the aggregate credit claimed crosses the prescribed threshold.

Therefore, entitlement to special ITC depends on more than simply satisfying the substantive conditions of Section 18. Businesses must also identify the correct transition date, verify invoices, determine eligible stock and capital goods, apply the required reductions and comply with the prescribed procedural requirements.

ITC During Merger, Demerger and Other Business Transfers

One of the most commercially significant provisions is Section 18(3).

Where there is a change in the constitution of a registered person because of a sale, merger, demerger, amalgamation, lease or transfer of business, and the transaction contains specific provisions for transfer of liabilities, the unutilised ITC in the electronic credit ledger may be transferred to the relevant business in the prescribed manner.

Rule 41 gives effect to this mechanism through FORM GST ITC-02. In cases of demerger, the credit is apportioned according to the prescribed ratio based on the value of assets of the new units. The transfer also requires the prescribed documentation and professional certification concerning the transfer of liabilities.

This makes ITC an important consideration in corporate restructuring. A merger or demerger is therefore not merely a corporate-law transaction; its GST consequences must also be considered when determining the value and continuity of the business being transferred.

The Contemporary Issue: Transfer of ITC Across States

The operation of Section 18(3) has recently generated an important question: can unutilised ITC be transferred where the transferor and transferee registrations involved in an amalgamation are located in different States?

The Bombay High Court considered this issue in Umicore Autocat India Private Limited v. Union of India, decided on 10 July 2025. The transferor company was registered in Goa and the transferee company in Maharashtra. When the taxpayer attempted to transfer ITC through FORM GST ITC-02, the GST portal prevented the transaction by displaying a restriction that the transferor and transferee should be in the same State/Union Territory.

The Bombay High Court examined Section 18(3) and Rule 41 and held that these provisions did not expressly impose such a restriction. The Court permitted transfer of the relevant IGST and CGST credit, while the petitioner gave up its claim concerning SGST. The Court emphasised the purpose of ITC as maintaining a continuous chain of set-off and observed that a technical restriction on the portal could not, by itself, defeat a statutory entitlement.

The decision raised an important administrative question: can the technological design of the GST portal create a restriction that is not found in the substantive law?

The Gujarat High Court’s 2026 Decision

The issue was considered again in Emerson Process Management (India) Pvt. Ltd. v. Union of India, decided by the Gujarat High Court on 5 March 2026.

In that case, following amalgamation, the petitioner attempted to transfer unutilised ITC through FORM GST ITC-02. The portal again prevented the transfer because the transferor and transferee were located in different States.

The Gujarat High Court followed the reasoning in Umicore Autocat and held that neither Section 18(3) nor Rule 41 prohibited ITC transfer merely because the entities were located in different States. The Court held that the authorities could not introduce a restriction into FORM GST ITC-02 that was absent from the statutory provisions. It consequently permitted the relevant CGST and IGST credit to be transferred manually until an appropriate technological mechanism was provided.

The decision is significant because it demonstrates the importance of keeping substantive tax law and digital tax administration aligned.

At the same time, this issue should be approached cautiously. The judicial position on cross-State transfer of ITC following amalgamation has been the subject of further proceedings, and the High Court decisions should therefore not be described as the final word on the issue.

When ITC Must Be Reversed

Section 18 also operates in the opposite direction.

Where a registered person who has availed ITC opts for the composition scheme, or where the person’s supplies become wholly exempt, Section 18(4) requires reversal of the prescribed amount relating to inputs, stock and capital goods. The remaining balance in the electronic credit ledger, if any, lapses.

Similarly, Section 18(6) deals with the supply of capital goods or plant and machinery on which ITC has been availed. The prescribed tax adjustment prevents a taxpayer from retaining the full benefit of ITC while disposing of the capital asset without the corresponding statutory adjustment.

This demonstrates that Section 18 is not simply a credit-preservation provision. It establishes a balanced framework: credit can become available when a taxpayer enters a regime where ITC is permitted, but credit may also have to be reversed when the taxpayer moves into a regime where the corresponding entitlement no longer exists.

Critical Analysis

The central strength of Section 18 lies in its attempt to preserve continuity without creating an unrestricted credit entitlement.

If legitimate ITC disappeared whenever a taxpayer changed registration status, taxability or business structure, the economic burden of GST could increase despite the underlying transactions remaining connected with taxable business activity. Section 18 addresses this problem by allowing credit in defined circumstances.

At the same time, the one-year invoice limitation, reduction applicable to capital goods, documentation requirements and reversal provisions act as safeguards against excessive claims.

The recent Umicore and Emerson decisions add another dimension to the discussion. They show that the effectiveness of a statutory ITC entitlement can depend on whether the GST technology is capable of implementing that entitlement. A taxpayer may satisfy the substantive requirements of the law yet face a procedural barrier because of the portal’s configuration.

This makes Section 18 relevant not only to tax computation but also to corporate restructuring, compliance management and digital tax administration.

Conclusion

Section 18 of the CGST Act provides an important mechanism for dealing with changes in a taxpayer’s GST circumstances. It covers transitions into registration, voluntary registration, movement from composition taxation to the regular regime, conversion of exempt supplies into taxable supplies and restructuring through merger, demerger, amalgamation, sale or transfer of business.

Its objective is not to grant unrestricted ITC, but to preserve legitimate credit while maintaining appropriate safeguards. Rules 40 and 41 provide the procedural framework for claiming and transferring credit, while the reversal provisions ensure that credit is appropriately adjusted when the taxpayer’s circumstances change.

The recent decisions in Umicore Autocat and Emerson Process Management further demonstrate that the operation of ITC provisions must be considered alongside the technological framework through which GST is administered.

Ultimately, the effectiveness of Section 18 depends on a combination of substantive eligibility, accurate documentation and procedural compliance. For businesses, preserving legitimate ITC therefore requires not only understanding the statutory entitlement but also acting within the prescribed timelines and maintaining records capable of establishing that entitlement.

Section 18 thus serves an important purpose within GST: preserving continuity in the input tax credit chain while ensuring that the credit remains connected to genuine and legally recognised business activity.

References

Statutes and Rules

• Central Goods and Services Tax Act, 2017, Section 18 – Availability of credit in special circumstances.
• Central Goods and Services Tax Rules, 2017, Rule 40 – Manner of claiming credit in special circumstances.
• Central Goods and Services Tax Rules, 2017, Rule 41 – Transfer of credit on sale, merger, demerger, amalgamation, lease or transfer of business.
• Central Goods and Services Tax Rules, 2017, Rule 44 – Manner of reversal of credit under special circumstances.

Circular

• Central Board of Indirect Taxes and Customs, Circular No. 133/03/2020-GST, dated 23 March 2020, Clarification in respect of apportionment of input tax credit (ITC) in cases of business reorganisation under Section 18(3) of CGST Act read with Rule 41(1) of CGST Rules.

Judicial Decisions

• Umicore Autocat India Private Limited v. Union of India, W.P. No. 463 of 2024, Bombay High Court at Goa, decided on 10 July 2025.
• Emerson Process Management (India) Pvt. Ltd. v. Union of India, SCA No. 7006 of 2024, Gujarat High Court, decided on 5 March 2026.