A Critical study of the issues involved in Accounting for GST & Reversal of GST u/s 16(2) of the GST Act on non-payment of invoice within 180 days

It is the cardinal principle of law that no one can make either profit or losses from the revenue which he collects on behalf of the government. Tax is revenue neutral for a business and so is the GST. The transaction of GST is between the Revenue and the end-user only and the rest of the intermediaries working in between these two persons are just like pure agents of the government in the sense that these  intermediaries just facilitate the flow of GST from the and-use consumers to the government. Therefore these transactions by the intermediaries are only in their fiduciary capacity and the GST revenue does not belong to them.

Under the Goods and Services Act 2017 there are certain provisions which place some restrictions on the free flow of credit between the consumer and the Revenue. These restrictions have been levied to protect the revenue of its due revenue. One such restriction has been provided under Section 16(2)(d) 2nd and 3rd Proviso. According to this section:-

(a) If a recipient fails to pay to the supplier of goods or services or both, other than the supplies on which tax is payable on reverse charge basis, the amount towards the value of supply along with tax payable thereon within a period of one hundred and eighty days from the date of issue of invoice by the supplier, an amount equal to the input tax credit availed by the recipient shall be added to his output tax liability, along with interest thereon, in such manner as may be prescribed:

(b) However the recipient shall be entitled to avail of the credit of input tax on payment made by him of the amount towards the value of supply of goods or services or both along with tax payable thereon.

This restriction is creating innumerable impediments to the receiver of supply. For example: There may a default credit-period permitted to the receiver which is more than 180 days in some industry or business. In this case GST of all those invoices which are overdue by more than 180 day will have to be paid back and reavail the said GST when these invoices are actually paid. The Tax Policy of the Revenue thus overrides the Credit Policy of the business enterprises.

But this is not a new policy. This is a legacy restriction which has been borrowed from the Service Tax Regime as explained below.

Sec 4(7) of  the Cenvat  Credit Rules 2004 provides as under:

“Sec 4(7):- The Cenvat  credit in respect of input service shall be allowed, on or after the day on which the invoice, bill or, as the case may be, challan referred to in rule 9 is received:

Provided that in respect of input service where whole or part of the service tax is liable to be paid by the recipient of service, credit of service tax payable by the service recipient shall be allowed after such service tax is paid:”

“Provided further that in case the payment of the value of input service and the service tax paid or payable as indicated in the invoice, bill or, as the case may be, challan referred to in rule 9 is not made within three months of the date of the invoice, bill or, as the case may be, challan, the manufacturer or the service provider who has taken credit on such input service, shall pay an amount equal to the Cenvat credit availed on such input service, except an amount equal to the Cenvat credit of the tax that is paid by the manufacturer or the service provider as recipient of service, and in case the said payment is made, the manufacturer or output service provider, as the case may be, shall be entitled to take the credit of the amount equivalent to the Cenvat credit paid earlier subject to the other provisions of these rules”

Ostensibly this restriction in the GST Law has been placed to protect the revenue from fraud by adopting the modus operandi of raising only invoices without actual transport of material. Whatever may be the reason the fact as on today is  that under Section 16(2)(d) of the GST Act, :-

If the  recipient fails to pay to the supplier the amount towards the value of supply along with tax payable thereon within a period of one hundred and eighty days as above stated then he will have to pay,  an amount equal to the input tax credit availed by him, as his output liability.

The payment of GST so availed without payment of the supply and GST lead to lot of readjustments u/s 145A of the Income Tax Act 1961 and in consequence thereof many more issues follow. Section 145A envisage Inclusive Method of Accounting  whereas according to Ind AS-2 business enterprises are mandated to follow  Exclusive Method of Accounting and if the accounts are prepared following the Exclusive Method of Accounting, readjustments will necessarily be required to convert the figures from Exclusive to Inclusive method as mandated by section 145A. Though these adjustments are not required to be incorporated in the books of account still a reconciliation will have to be prepared to explain that the profit/loss has not been affected while recasting the figures from one method to other method while filing the Return of Income.   

Method of accounting As per Ind AS-2 ICAI

According to the Ind AS-2 the costs of purchase of inventories comprise the purchase price, import duties and other taxes (other than those subsequently recoverable by the entity from the taxing authorities), and transport, handling and other costs directly attributable to the acquisition of finished goods, materials and services. Trade discounts, rebates and other similar items are deducted in determining the costs of purchase.

Method of accounting-Guidance Note of ICAI

As per the guidelines issued by institute of Chartered Accountants’ of India, a businessman can have either “inclusive method or exclusive method” for accounting entries with regard to Taxes

In the “Inclusive Method”, the purchase of raw material debited in the books of accounts is inclusive of the corresponding GST element and therefore the closing stock should be valued inclusive of GST element. On the other hand,  in the Exclusive Method the cost of raw material debited in the purchase account is net of GST element. In this system, the assessee keeps a separate account for accounting for the GST payable and the GST credit available to it. In this method of accounting,  the closing stock has to be valued exclusive of GST element.

Therefore any increase in the value of closing stock  in one year would result in certain additions in the relevant Accounting Year. However, as this closing stock would become the opening stock for the next succeeding Accounting Year, this addition to the income would result in similar reduction of income in the said succeeding Accounting Year. Therefore, if an overall view is taken, any adjustments of this nature ultimately would not amount to any net increase or decrease of the profit when considered for a few number of years taken together.

Method of accounting As per the Income Tax Act 1961

According to section 145(1) Income chargeable under the head “Profits and gains of business or profession” or “Income from other sources” shall, subject to the provisions of sub-section (2), be computed in accordance with either cash or mercantile system of accounting regularly employed by the assessee.

 Method of accounting in certain cases.

Section 145A further provides that for the purpose of determining the income chargeable under the head “Profits and gains of business or profession”,––

(i) the valuation of inventory shall be made at lower of actual cost or net realisable value computed in accordance with the Income Computation and Disclosure Standards notified under sub-section (2) of section 145;

(ii) the valuation of purchase and sale of goods or services and of inventory shall be adjusted to include the amount of any tax, duty, cess or fee (by whatever name called) actually paid or incurred by the assessee to bring the goods or services to the place of its location and condition as on the date of valuation;

The Revenue later notified Income Computation and Disclosure Standard pursuant to section 145A. (Vide notification no. 87/2016 dated 29-9-2016 w.e.f. Assessment Year 2017-18)

ICDS II relates to Valuation of Inventories.

Cost of Inventories

(a) Inventories shall be valued at cost, or net realisable value, whichever is lower.

(b) Cost of inventories shall comprise of all costs of purchase, costs of services, costs of conversion and other costs incurred in bringing the inventories to their present location and condition.

Costs of Purchase

The costs of purchase shall consist of purchase price including duties and taxes, freight inwards and other expenditure directly attributable to the acquisition. Trade discounts, rebates and other similar items shall be deducted in determining the costs of purchase.

It is therefore, mandatory to value the closing stock, sales, purchases, opening stock by including the corresponding GST elements. However, it is seen that if the purchase, sales, opening stock and closing all are considered inclusive of the GST element, it would be the adjustment to the opening stock and closing stock only, which would affect the income of an assessee. This is so because the GST credited in the sales would be set off by the GST element debited in the purchase account.

Moreover it is not necessary to change the method of valuation of purchase, sale and inventory regularly employed in the books of account. The adjustments provided in this section can be made while computing the income for the purpose of preparing the return of income. These adjustments are as follows:

(a) Any tax, duty, cess or fee actually paid or incurred on inputs should be added to the cost of inputs (raw materials, stores etc.) if not already added in the books of account.

(b) Any tax, duty, cess or fee actually paid or incurred on sale of goods should be added to the sales, if not already added in the books of account.

(c) Any tax, duty, cess or fee actually paid or incurred on the inventory (finished goods, work-in-progress, raw materials etc.) should be added to the inventories, if not already added while valuing the inventory in the accounts.

Incidentally under the GST Law “aggregate turnover” has been defined as being the aggregate value of all taxable supplies (excluding the value of inward supplies on which tax is payable by a person on reverse charge basis), exempt supplies, exports of goods or services or both and inter-State supplies of persons having the same Permanent Account Number, to be computed on all India basis but excludes central tax, State tax, Union territory tax, integrated tax and cess;

Thus there is a conflict between Accounting Standard & Guidelines of ICAI and the accounting treatment as adopted by section 145 and 145A. and GST Act 2017.

Goods and Service Tax Act 2017

It may be stated that the GST mechanism  is a procedure whereby  businessmen can utilise credit for input tax payable against the GST payable on sales. GST credit taken on input is of the nature of set off available against the GST payable on the final products. GST paid on inputs may be debited to a separate account, e.g. GST credit receivable account. As and when the GST credit is actually utilised against payment of GST on final products appropriate accounting entries will be required to adjust the GST paid out of GST credit receivable account” to the account maintained for payment/ provision for GST on final product.

Methods of Accounting:

(1) Exclusive Method of Accounting

In this case, the purchase cost of the inputs would be net of input GST. Therefore, the inputs consumed and the inventory of inputs would be valued on the basis of purchase cost net of input GST. This method is hereinafter referred to as “exclusive method”.

(2) Inclusive Method of Accounting

In this method ,  the cost of inputs may be recorded at the total amount paid to the supplier inclusive of input GST.  To the extent the GST credit is utilised for payment of excise duty on final products, the amount could be credited to a separate account, i.e. GST credit availed account. Out of the GST credit availed account, the amount of GST credit availed in respect of consumption of inputs would be reduced from the total cost of inputs consumed. This method is referred to as “inclusive method”.

Important: The purpose of section 145A is to reflect the figures on “Inclusive Method” only. It may be pointed out that the “Inclusive Method” is not permitted by AS-2 or the guidelines of the ICAI.

Section 145A starts with non obstante clause which has been made mandatory for all business enterprises.  In view of the above, the adjustments under section 145A will have to be made in all cases where ‘exclusive  method’ is followed.

It is now well settled that if any adjustment is required to be made by a statute, effect to the same should be given irrespective of any consequences on the computation of income for tax purposes. However Adjustment for the same should be made in such a manner that no double deduction is claimed for the same expenditure. Similarly, adjustment should be made for any item of income to ensure that the same item is not treated as income twice.

Alpanil Industries Versus A.C.I.T., Circle-6, Ahmedabad Dated.- September 11, 2009

The order of the ITAT AHMEDABAD is worth reading for understanding the full gamut of what is Inclusive and Exclusive Method of accounting, the provision for Excise Duty and VAT on finished goods lying in godown and the tax effect of adjustments as required by section 145A.

Excise Duty & GST

There is no dispute that the Excise is incurred the moment the goods are manufactured. Therefore, the Excise Duty incurred will become part of the value of the finished goods the moment the finished goods are manufactured. The fact that the Excise Duty is payable only when the finished goods are taken from the factory, will not postpone the incurrence of the liability to pay the Excise Duty. Therefore, in view of section 145A(b) the Excise Duty incurred in respect of the finished goods as shown in the stock will form part of the value of the finished goods. It is a settled law that the liability of the Excise Duty is an expenditure allowable to the assessee under section 37 of the Act. Section 43B lays down that certain expenses are to be allowed only on actual payment. This section put an embargo about the deductibility of certain expenditure which are otherwise allowable under this Act. In view of the provision of Section 43B(a) any sum payable by the assessee by way of Excise Duty shall be allowed irrespective of the previous year in which the liability to pay such sum was incurred only in the previous year in which such sum is actually paid. Proviso to section 43B relaxes these provisions and permits an assessee to make the payment on or before the due date of furnishing of the Income Tax Return under section 139(1) of the Act.

Excise Duty incurred on the finished goods manufactured by the assessee and laying in the stock should form part of the value of the closing stock of the finished goods but at

the same time the assessee is allowed deduction in respect of the liability so incurred provided the assessee has made the payment for the said Excise duty before the due date of filing of the Income Tax Return for the impugned Assessment Year

Goods & Services Tax

However the liability for GST on finished goods lying in godown is different because the taxable event under GST law is the “Supply/Sale” of the products and the  incidence of it arises the moment the goods are supplied or sold. As such the liability for GST on finished goods lying in godown need not be provided.

The GST paid on purchases cannot be included in the cost of purchases where the tax paid on inputs is available for set-off against the tax payable on sales or is refundable, it is in the nature of taxes recoverable from taxing  authorities. The Accounting Standard (AS) 2 “Valuation of Inventories” deals with “cost of inventories” and “cost of purchases”. As per the said AS-2, the cost of purchases cannot include duties and the taxes which are subsequently recoverable from the taxing authorities. Hence the input tax which is refundable, should not be included in the cost of purchases.

GST, to the extent it is refundable, will not form part of the cost of the inventory. The inventory of inputs is to be valued at net of the input tax which is refundable. If the inputs are obtained from the dealers who are exempt from the GST, the actual cost of purchase should be considered as a part of cost of inventory.

A dealer may purchase certain common inputs which can be used for manufacturing goods which are declared tax free as well as taxable goods. In such case, the dealer should estimate inputs expected to be used for making tax free goods and for making taxable goods. The dealer should recognize GST credit only in respect of those inputs which are used for making taxable goods and no GST credit should be recognized in respect of inputs used for making tax free goods. Similar accounting treatment should be given in the case of stock transfer/ consignment sale of goods out of the State where GST credit is available only to the extent of a certain portion of input tax paid.

GST is collected from the customers on behalf of the GST authorities and, therefore, its collection from the customers is not an economic benefit for the enterprise. It does not result in any increase in the equity of the enterprise. Accordingly, it should not be recognized as an income of the enterprise. Similarly, the payment of GST should not be treated as an expense in the financial statements of the enterprise. Therefore, it should be credited to an appropriate account, say. ‘GST Payable Account’. In case the GST has not been charged separately but has made a composite charge, it should segregate the portion of sales which is attributable to tax and should credit the same to ‘GST Payable Account’ at periodic intervals. The amount of GST payable adjusted against the GST Credit Receivable (Capital Goods) Account and amounts paid in cash will be debited to this account. The credit balance in GST Payable Account at the year-end should be shown on the ‘Liabilities’ side of the balance sheet under the head ‘Current Liabilities’. It is important to note that where the assessee is enjoying tax holiday under the relevant state law as a result of which the liability to pay is deferred for a period of more than one year then it should be reflected as a long term liability.

Sec. 145A begins with a non obstante clause, and therefore, to give effect to Sec. 145A, if there is a change in the closing stock as on the year end, there must necessarily be a corresponding adjustment made in the opening stock for that year. Further the change in the closing stock as at the year-end  there too necessarily be a corresponding adjustment made in the opening stock of the next year.

The Institute of Chartered Accountants of India in its guidelines explained that following of either inclusive method of accounting or exclusive method of accounting will not have any effect on the profit disclosed by the profit and loss account. The only effect of following inclusive method will be that the GST liability will appear in the balance sheet which will be added back to the income of the assessee in view of the provisions of section 43B to the extent not paid by the assessee before the due date of furnishing of return of income under section 139(1) of the Act..

The adjustments envisaged by section 145A will not have any impact on the trading account of the assessee. In other words both under exclusive method of accounting and inclusive method of accounting, the gross profit in the trading account will remain the same.

The same is illustrated for a Trading Concern and a Manufacturing Concern as follows:

(I) In case of a Trading Concern

Exclusive Method of Accounting

Particulars Units Rate Amount
To Opening Stock of  Finished Goods 1000 33 33000
Less: ITC in the Op Stock 3000
(Rate of GST 10%) 30000
To Purchases 3000 30 90000
120000
To Gross Profit 30000
150000
Particulars Units Rate Amount
By Sales 2000 45 90000
By Closing stock of Finished Goods 2000 30 60000
150000

In case of a Trading Concern the inventory is only of Finished Goods. There is no inventory of Raw Materials

Inclusive  Method of Accounting

Particulars Units Rate Amount
To Opening Stock of  Finished Goods 1000 33 33000
To Purchases 3000 33 99000
(Rate of GST 10%) 132000
(-) GST availed on cost of goods Sales 6000
126000
To GST paid on Sales 9000
To Gross Profit 30000
165000
Particulars Units Rate Amount
By Sales 2000 49.50 99000
By Closing stock of Finished Goods 2000 33.00 66000
165000

Working Notes:

Cost of Goods Sold
Opening Stock 33000
(+) Purchases 99000
(-) Less Closing Stock -66000
Cost of Goods sold including GST 66000
GST included in the Cost of goods sold 6000
Cost of Goods sold excluding GST 60000
Sales
Sales including GST 99000
(-) GST included in sales 9000
Sales excluding GST 90000

Reconcillation between both the methods of Accounting

Increase in Opening Stock on inclusion of GST 3000
Increase in Purchases on inclusion of GST 9000
Increase in Sales on inclusion of GST 9000
Increase in Closing Stock on inclusion of GST 6000
GST Paid on Sales 9000
GST credit availed on cost of goods sold 6000
21000 21000

As we can see there is no difference in the Gross Profit in both the methods of accounting

Computation of Total Income u/s 145A

Profit as per Profit & Loss Account-Exclusive Method 30000
Add: Adjustments required under section 145A
Increase in sales on inclusion of GST 9000
Increase in Closing Stock on inclusion of GST 6000
45000
Less: Adjustments required under section 145A
GST paid on Sales 9000
Increase in Op. Stock on inclusion of GST
GST Credit Receivable Input A/C 9000
(-)GST availed on cost of goods sold 6000 3000
Taxable Profit 30000

Here also we can see that even after making the adjustments as required by section 145A, the Taxable Profit remains the same under both system of accounting.

(II) In case of Manufacturing Concern

The following information is considered in the case of a manufacturing concern:-

Opening Stock of Raw Material 500 10
Purchases of Raw Material 3000 10
Sales 2500 15
Manufacturing Expenses 3000
Closing Stock of Raw Material 500
Closing Stock of Finished Goods 500
Rate of GST on purchases and sales 4%
Exclusive Method of Accounting
Particulars Units Rate Amount
To Opening Stock 500 10 5000
To Purchases 3000 10 30000
3500 10 35000
Less: Closing Stock of Raw Materials 500 10 5000
3000 10 30000
Manufacturing Expenses 3000
To Cost of production 3000 11 33000
To Gross Profit 10000
43000

Particulars Units Rate Amount
By Sales 2500 15 37500
By Closing stock of Finished Goods( at Cost of production) 500 11 5500
43000

Inclusive Method of Accounting

Particulars Units Rate Amount
To Opening Stock -Raw Materials 500 10.40 5200
To Purchases 3000 10.40 31200
(Rate of GST 4%) 3500 10.40 36400
Less: Closing Stock of Raw Materials 500 10.40 5200
Raw Material consumed 3000 10.40 31200
Less:  GST on Raw Material consumed 1200
Raw Material consumed 3000 10.00 30000
Manufacturing Expenses 3000
Cost of production 3000 11.00 33000
Less:  GST on finished good Sold 1500
Less:  GST on finished good inventory 200
To Gross Profit 10000
44700
Particulars Units Rate Amount
By Sales (Rs. 15+4%) 2500 15.60 39000
By Closing stock of Finished Goods (at cost of production Rs.11 + 4% GST) 500 11.40 5700
44700

Reconcillation between both the methods of Accounting

  Increase in Profit Decrease in Profit
Increase in Opening Stock-Raw Material on inclusion of GST 200
Increase in Purchases on inclusion of GST 1200
GST credit availed on cost of goods sold 1200
Increase in Closing  Stock Raw Material on inclusion of GST 200
Increase on account of GST included in finished goods on account of inclusion of GST in the raw material value 200
Increase in GST on closing stock of finished goods on account of inclusion of GST in the raw material value 200
Increase on account of Sales on inclusion of GST 1500
GST Paid on Sales 1500
3100 3100

Computation of Total Income

Profit as per Profit & Loss Account-Exclusive Method 10000
Add: Adjustments required under section 145A
Increase in sales on inclusion of GST 1500
Increase in Closing Stock -Raw Materials on inclusion of GST 200
Increase in Closing Stock-Finished Goods  on inclusion of GST 200
11900
Less: Adjustments required under section 145A
GST included in closing stock of finished goods 200
Increase in Op. Stock on inclusion of GST 200
GST included in  purchase 1200
GST paid on sales 1500
(-)GST availed on cost of goods sold 1200 300
Taxable Profit 10000

In this case also there is no change in the gross profit under both the systems of accounting.

It will be seen from the above that the gross profit is the same under both the inclusive and the exclusive methods accounting. Further, the closing stock of raw materials includes the appropriate GST. But the GST is not includible in the closing stock of finished goods since the incidence of GST arises only on sale. However, GST on raw material included in the finished goods has been included in the value of closing stock of finished goods.

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3 Comments

    1. CA Lalit Munoyat says:

      The content is about the method of accounting as per AS-2 and Sec 145A and reconciliation of profit under AS-2 and Sec 145A. The Heading of the article is “A Critical study of issues involved in Accounting for GST. Further when GST Invoices are not paid in 180 days then you have to make adjustments to the values of opening & closing stock as per Sec 145A. How these adjustment should be made without affecting the profit, has been explained in the article. Read it fully. Go through the Tables at the end of the article and you will come to know of the content and the title.

      In any case can you please suggest a better title for the article. I will change it.
      Thanks

  1. Ashok Gupta says:

    Very good article.Lot of information and clarifications. Can you give your opinion or section of GST rule in insurance claims. One insured purchased machinery in 2018 and paid GST and also take input credit. In 2020 this machine becomes total loss and a new machinery is purchased. Again GST on new machinery is paid and input credit is taken. How such transactions are dealt in GST. Please reply.

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