Summary: Rule 86B of the CGST Rules restricts utilisation of Input Tax Credit (ITC) beyond 99% of output tax liability where taxable supplies, excluding exempt and zero-rated supplies, exceed Rs. 50 lakh in a month. However, the restriction is subject to specified exceptions. These include payment of income tax exceeding Rs. 1 lakh by prescribed key persons in each of the relevant two financial years, receipt of refunds exceeding Rs. 1 lakh in the preceding financial year for zero-rated supplies without payment of tax or inverted duty structure, cumulative cash discharge exceeding 1% of output tax liability during the current financial year, specified Government and statutory entities, and the goods-specific carve-out under Rule 31D. The Commissioner or an authorised officer may also remove the restriction after appropriate verification and safeguards. Therefore, applicability of Rule 86B should be determined only after examining the monthly taxable-supply threshold and all available exceptions.
- Rule 86B: Restriction on 99% ITC Utilisation
- The Six Exceptions at a Glance
- Practical Illustrations
- Illustration 1 – Basic Applicability
- Illustration 2 – Income Tax Exception
- Illustration 3 – Refund-Based Exception
- Illustration 4 – Cumulative Cash Payment Exception
- Commissioner's Discretion to Remove Rule 86B Restriction
- Practical Takeaway
Rule 86B: Restriction on 99% ITC Utilisation
Rule 86B of the CGST Rules, 2017 restricts a registered person from using Input Tax Credit (ITC) to discharge more than 99% of output tax liability, where taxable supply (excluding exempt and zero-rated supply) exceeds Rs. 50 lakh in a month. This means at least 1% of the output tax must be paid in cash, even where sufficient ITC balance is available.
The rule was inserted vide Notification No. 94/2020–Central Tax, dated 22nd December 2020, effective from 1st January 2021, primarily to curb fake invoicing and fraudulent ITC claims.
However, Rule 86B is not a blanket restriction. The provisos to the rule carve out six specific exceptions where the 1% cash payment requirement does not apply, summarised below.
The Six Exceptions at a Glance
| No. | Exception | Conditions |
|---|---|---|
| 1 | Income Tax Exception | Proprietor, karta, MD, any two partners, whole-time directors, or members of managing committee/board of trustees have paid more than Rs. 1 lakh income tax in each of the last two financial years (Section 139(1) due date expired). |
| 2 | Refund under Section 54(3)(i) | Refund of more than Rs. 1 lakh received in the preceding financial year on account of unutilised ITC for zero-rated supplies made without payment of tax. |
| 3 | Refund under Section 54(3)(ii) | Refund of more than Rs. 1 lakh received in the preceding financial year on account of unutilised ITC due to inverted duty structure. |
| 4 | 1% Cumulative Cash Payment | Output tax liability already discharged in cash in excess of 1% of total output tax liability, applied cumulatively up to the relevant month in the current financial year. |
| 5 | Entity Exception | Applicable to Government Department, Public Sector Undertaking, Local Authority, or Statutory Body. |
| 6 | Rule 31D Carve-Out | A registered person other than a manufacturer is exempt in respect of goods specified under Rule 31D, where tax has been paid by the supplier on retail sale price basis. |
Practical Illustrations
The following illustrations show how the exceptions apply in practice:
Illustration 1 – Basic Applicability
ABC Pvt. Ltd. has a taxable turnover of Rs. 80 lakh in a month and has sufficient ITC balance to discharge its entire output tax liability. Since turnover exceeds Rs. 50 lakh, Rule 86B applies, and ABC Pvt. Ltd. must pay at least 1% of its output tax liability in cash, even though ITC is available to cover the full amount.
Illustration 2 – Income Tax Exception
In XYZ & Co., a partnership firm, two partners have each paid income tax of Rs. 1.2 lakh in FY 2023-24 and Rs. 1.5 lakh in FY 2024-25 (both due dates under Section 139(1) having expired). Since this satisfies the condition of more than Rs. 1 lakh income tax paid by any two partners in each of the last two financial years, Rule 86B does not apply to XYZ & Co., regardless of its monthly turnover.
Illustration 3 – Refund-Based Exception
PQR Exports, an exporter of goods under LUT (zero-rated supply without payment of tax), received a refund of Rs. 1.5 lakh of unutilised ITC in the preceding financial year under Section 54(3)(i). PQR Exports is therefore exempt from the 1% cash payment requirement in the current financial year.
Illustration 4 – Cumulative Cash Payment Exception
LMN Industries, from April to August of the current financial year, has already paid Rs. 3.2 lakh in cash against a cumulative output tax liability of Rs. 280 lakh (which is more than 1%). Even though LMN Industries has ITC available in September, since it has already paid more than 1% in cash cumulatively during the year, Rule 86B does not apply for the month of September.
Commissioner’s Discretion to Remove Rule 86B Restriction
The Commissioner, or an officer authorised by him, may remove the 1% cash payment restriction after such verification and safeguards as deemed fit.
Practical Takeaway
Rule 86B is a restriction on ITC utilisation, not a blanket 1% cash payment rule for every large taxpayer. Before applying it, always check:
– Rs. 50 lakh monthly turnover threshold
– Cumulative cash payment history
– Refunds received under Section 54(3)
– Income-tax payment history of key persons,
– Entity/goods-specific carve-outs above.
