Summary: GST Rules 42 and 43 govern the reversal of Input Tax Credit (ITC) on inputs/input services and capital goods, respectively, when a registered person makes exempt supplies. Crucially, the definition of “exempt supplies” for the purpose of ITC reversal includes nil-rated, non-taxable, specific exempted supplies (like interest on loans), transactions in securities, and the sale of land/building, but explicitly excludes Zero-Rated Supplies (ZRS), such as exports or supplies to SEZ units. ZRS are treated as equivalent to taxable supplies, regardless of whether the underlying goods/services are otherwise exempt or nil-rated, and regardless of whether the supply is made with or without a Letter of Undertaking (LUT). Therefore, under GST, there is no ITC reversal required under Rules 42 and 43 for any common credit attributable to ZRS. Reversal is calculated only by taking the portion of common ITC proportional to the value of exempt supplies (excluding ZRS) against the total turnover in the state.
1. Coverage of this article:
In this article, I am covering the applicability of Rule-42 of GST Act in case of Zero rated supplies which explains the reversal of Input Tax Credit (ITC) of inputs and input services if a registered person is engaged in making exempt supplies.
2. Rule-43:
It explains the reversal of ITC of capital goods if a registered person is engaged in making exempt supplies.
3. Meaning of exempt supplies (Sec 2(47)):
Exempt supplies includes
a. Nil rated supplies which attracts nil rate of tax
b. Non-taxable supplies
c. Supplies which is specifically exempted by a notification like Interest on loan.
4. Meaning of exempt supplies for reversal of ITC:
Exempt supplies includes
a. Nil rated supplies which attracts nil rate of tax
b. Non-taxable supplies
c. Supplies which is specifically exempted by a notification like Interest on loan
d. Supplies on which recipient is liable to pay tax under RCM
e. Transaction in securities
f. Sale of land and building
Zero rated supplies is not covered under this definition.
5. Zero rated supplies:
If a registered person is engaged in making supplies outside India (export sales) or sale to an SEZ, it will be treated as a ZRS.
a. Supplies outside India with LUT:
| S No. | Particulars | Is it ZRS or not ? | GST on Sale |
| 1 | Taxable supplies o/s India | Yes | No |
| 2 | Exempt supplies o/s India | Yes | No |
| 3 | Nil rated supplies o/s India | Yes | No |
| 4 | Non Taxable supplies o/s India | Yes | No |
b. Supplies outside India without LUT:
| S No. | Particulars | Is it ZRS or not ? | GST on Sale |
| 1 | Taxable supplies o/s India | Yes | Yes |
| 2 | Exempt supplies o/s India | Yes | No |
| 3 | Nil rated supplies o/s India | Yes | No |
| 4 | Non Taxable supplies o/s India | Yes | No |
c. Supplies to SEZ with LUT:
| S No. | Particulars | Is it ZRS or not ? | GST on Sale |
| 1 | Taxable supplies to SEZ | Yes | No |
| 2 | Exempt supplies to SEZ | Yes | No |
| 3 | Nil rated supplies to SEZ | Yes | No |
| 4 | Non Taxable supplies to SEZ | Yes | No |
d. Supplies to SEZ without LUT:
| S No. | Particulars | Is it ZRS or not ? | GST on Sale |
| 1 | Taxable supplies to SEZ | Yes | Yes |
| 2 | Exempt supplies to SEZ | Yes | No |
| 3 | Nil rated supplies to SEZ | Yes | No |
| 4 | Non Taxable supplies to SEZ | Yes | No |
-
- In all of the above cases, there will be no reversal of ITC as per Rule- 42 & 43.
- ZRS are treated as taxable supplies. Even if exempt goods or services supplied outside India or sold to an SEZ, there will no reversal of ITC.
6. Turnover in a state:
This means the total turnover of a registered person (GSTIN wise) during the month includes
a. Taxable supplies
b. Exempt supplies
c. Zero rated supplies
d. Supplies between deemed distinct persons
e. Sale of assets
f. Supplies on which the recipient is liable to pay tax under RCM
excluding the amount of GST.
7. Comparison chart for Rule-42:
| S No | Nature of supplies | Considered in “Exempt supplies” | Considered in “Turnover in the state” |
| 1 | Taxable supplies to SEZ | No | Yes |
| 2 | Exempt supplies to SEZ | No | Yes |
| 3 | Nil rated supplies to SEZ | No | Yes |
| 4 | Non Taxable supplies to SEZ | No | Yes |
| 5 | Taxable supplies o/s India | No | Yes |
| 6 | Exempt supplies o/s India | No | Yes |
| 7 | Nil rated supplies o/s India | No | Yes |
| 8 | Non Taxable supplies o/s India | No | Yes |
No reversal of ITC under Rule: 42 & 43 in case of ZRS.
8. Practical scenario:
a. Input details with the number of cases for better understanding of the readers:
| S No | Particulars | IGST Amount |
| 1 | Input & Input services exclusively used in taxable supplies | 1,00,000 |
| 2 | Input & Input services exclusively used in exempt supplies | 50,000 |
| 3 | Input & Input services exclusively used in export supplies | 30,000 |
| 4 | Input & Input services exclusively used in SEZ supplies | 70,000 |
| 5 | Input & Input services falls u/s 17(5): Blocked credit | 80,000 |
| 6 | Input & Input services used in both supplies | 2,50,000 |
We will take only those invoices that matched with the GSTR-2B. This means considering only the invoices that are reflecting both in our GSTR-2B & in our books.
** Do not consider ITC figures of all invoices merely because they are reflecting in our GSTR-2B or recorded in our books.
*** Reversal under this rule will be calculated separately for CGST, SGST & IGST. In my case, I am considering only IGST.
b. Turnover details with the number of cases for better understanding of the readers:
| S No | Particulars | Sales Amount |
| 1 | Taxable supplies within India | 10,00,000 |
| 2 | Exempt supplies within India | 5,00,000 |
| 3 | Export supplies | 3,00,000 |
| 4 | SEZ supplies | 7,00,000 |
| 5 | Sale of securities of Rs. 80,00,000 | 80,000 |
c. Exempt supplies for reversal purpose is 5,80,000
d. Total turnover is 25,80,000
e. Common ITC is 2,50,000
| S No | Particulars | IGST Amt | Eligibility |
| 1 | Input & Input services exclusively used in taxable supplies | 1,00,000 | Full ITC allowed |
| 2 | Input & Input services exclusively used in exempt supplies | 50,000 | ITC not allowed |
| 3 | Input & Input services exclusively used in export supplies | 30,000 | Full ITC allowed |
| 4 | Input & Input services exclusively used in SEZ supplies | 70,000 | Full ITC allowed |
| 5 | Input & Input services falls u/s 17(5): Blocked credit | 80,000 | ITC not allowed |
| 6 | Input & Input services used in both supplies | 2,50,000 | Common ITC |
f. ITC figure which is used in exempt supplies:
-> -> -> Common ITC * Exempt supplies
Turnover in a state
>>> 2,50,000 * 5,80,000 = 56,202
25,80,000
g. ITC used in exempt supplies is 56,202
h. ITC used in taxable supplies is 1,93,798
i. Total amount of reversal as per Rule 42 is 1,06,202
j. Amount of blocked credit is 80,000
k. ITC will be credited in credit ledger of Rs 3,93,798
9. In above example, we have reversed the ITC only for exempt supplies not for the ZRS. In numerator, exempt supplies will be considered that should be excluding ZRS.
10. Refer the article: Rule-42 of GST: Reversal of ITC of Input & Input Services in case of exempt supplies
*****
If you have any queries, you can reach the author by email at caashishsingla878@gmail.com or by phone at 9896478194.
Disclaimer: The views and opinions expressed in this article are those of the author. This article is intended for general information purposes only and does not constitute professional advice. Readers are strongly advised to consult a qualified professional for guidance specific to their individual situation before making any financial, legal, or tax-related decisions. The author shall not be held liable for any loss or damage of any kind incurred as a result of the use of this information or for any actions taken based on the content of this article.
Author Bio
