Rule 42 of the CGST Rules, 2017 lays out the method to determine the quantum of input tax credit that is required to be reversed. The said Rule is for cases where a taxpayer is providing partially taxable and partially exempt or nil rated supplies. To summarize, reversal under Rule 42 has to be done under the following circumstances –
- ITC Reversal required under Section 17(1) and (2) of CGST Act, 2017.
- In cases where ITC has been availed for Services falling under Section 17(5).
- In cases where supply of services is covered by clause (b) of paragraph 5 of Schedule II.
The most vital aspect of Rule 42 is sub-clause 2(a) which states that the reversal has to be made before the September of the following financial year with interest leviable as per Section 50(1) for the period starting from first day of April to the date of payment.
To give an illustration, reversal for the FY 2024-2025 should be made before September 2025 as per Rule 42. Thus, Rule 42 mandates that the formula for reversal must be applied monthly and then yearly as well and while doing the yearly reversal, interest has to be paid alongside it.
Section 50(1) states that an 18% interest has to be paid. Therefore, if a taxpayer is executing partly exempted and partly taxable activities, then they are liable to pay interest whenever they would be doing the mandatory reversal after the end of a financial year.
On the other hand, if we dig deep into Section 50 and truly understand the scope of the applicability of interest, we might be able to dig our way out of the mandatory interest under Rule 42(2)(a). In the matter of M/s. Larsen & Toubro Limited v. State of West Bengal & Ors., 2022 (12) TMI 1496, Calcutta High Court held that interest is applicable only if the ITC has been wrongly availed and utilized. A mere availment of ITC without utilization would not result in the applicability of interest. Similarly, the Calcutta High Court reaffirmed the same in the case of Utpal Das v. State of West Bengal & Ors., 2024 (10) TMI 1016, by stating that the non-utilization of wrongly availed ITC will not result in interest upon its reversal.
Thus, it is well settled that the applicability of interest is dependent on the utilization of the amount that is to be reversed in cases of ITC reversal. Applying the same to Rule 42, interest on reversal in cases where a taxpayer is executing partially taxable as well as partially exempt or nil rated supplies, should only be applied if the balance of the credit ledger at any point during the financial year is less than the amount to be reversed.
To illustrate the same with an example, assume a scenario where the ITC to be reversed after applying the formula of Rule 42 comes out to be Rs. 1,00,000/- and the electronic credit ledger was never below this amount at any instance in the financial year for which the reversal is being made, then interest as per the precedents established by the Calcutta High Court will not be applicable.
Therefore, a taxpayer must ensure that when they have to undertake such reversal under Rule 42, they have to maintain the balance in the credit ledger to an extent to ensure that it is not below the amount that they would have to reverse.
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Note: This is a personal opinion of the author, this may not be taken as legal advice.
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Well Explained, very well written
Very insightful and crisp!!