Eligibility of Input Tax Credit (ITC) on Prepaid Expenses

Introduction: –

Section 16 of CGST Act 2017 provides that every registered person shall be entitled to take Input Tax Credit of tax paid on input and input service, subject to such conditions and restrictions as may be prescribed.

Section 16(2) of CGST Act 2017 provides that ITC on Input and service shall be available subject to following conditions: –

• he is in possession of a tax invoice or debit note issued by a supplier registered under this Act, or such other tax paying documents as may be prescribed;
• he has received the goods or services or both.
• subject to the provisions of section 41 or section 43A, the tax charged in respect of such supply has been actually paid to the Government, either in cash or through utilisation of input tax credit admissible in respect of the said supply; and
• he has furnished the return under section 39.

Accordingly, Input tax credit can be claimed only if above conditions are fulfilled.

Background: –

There are many expenses during the year which are to be incurred in future but the amount for the same has already been paid in advance called prepaid expense. Prepaid expenses are initially recorded as assets, because they have future economic benefits, and are expensed at the time when the benefits are realized.

An example of a prepaid expense is insurance, which is frequently paid in advance for multiple future periods; an entity initially records this expenditure as a prepaid expense (an asset), and then charges it to expense over the usage period. Another item commonly found in the prepaid expenses account is prepaid rent.

Issue: –

Whether full ITC can be taken on prepaid expenses as soon as registered person received the tax invoice and payment is also made to the supplier or whether the ITC is required to be reversed on prepaid expense and avail on the actual realisation of economic benefits?

There are two separate views on the above issue. One school of thought says that ITC will be available when tax invoice is received, and payment also made to the supplier. Second school of thought says that ITC on prepaid expense will be available next year because supply has not received in actual.

In this article, an attempt has been made to analyse the above issues.

Analysis: –

As per section 16(2) of CGST Act 2017, input tax credit can be availed when the goods or services are received by the recipient.

Explanation to Section 13(2) of CGST Act, 2017 clarified that the supply shall be deemed to have been made to the extent it is covered by the invoice or, as the case may be, the payment.

Accordingly, when the supply is deemed to have been provided to the extent it is covered by the invoice then it can be construed that the same has also been received by the recipient.

Further, according to matching concept of accounting, expenses which are paid in current accounting period for which associated benefit will arise in next accounting period are recorded as prepaid expense as an asset and booked as an expense in next accounting period. Therefore, according to the matching principle in accrual accounting system expenses are recognized when related benefit will arise regardless the cash outflow.

Under GST law there is no provision which requires carry forward of expense including ITC to next accounting period based on associated benefit.

Conclusion: –

In view of the above discussion, it can be concluded that ITC can be availed based on tax invoice received towards input service and payment also made to the supplier. Hence, Input Tax Credit is not required to be reversed on prepaid expense of input service.

Hope the readers will find the above article useful. In case of any query/information, feel free to write back to us. The author can be reached at [email protected]

The opinion is based on my understanding of law and regulation prevailing as on the date. There is no assurance that the Revenue Authorities will agree to the view expressed above. Further, the views, thoughts, and opinions expressed in this article belong solely to the author, and not necessarily represent or reflect the views of the author’s employer, organization, or other group or individual.