Input Service Distributor – Mandatory from 1st April 2025

The concept of the Input Service Distributor (ISD) has been in existence since the service tax era beginning in 2005. Although it was not widely adopted due to compliance costs and remained optional, this concept was reintroduced with the advent of GST in 2017. Initially, the provisions under GST were optional. However, the Finance Act 2024 has now made these provisions mandatory. This article will delve into the implications of this change in detail.

50^th GST Council Meeting:

GST Council in its 50^th meeting held on 11^th July 2023 recommended the following:

“The Council has recommended to clarify through a circular that Input Services Distributor (ISD) mechanism is not mandatory for distribution of input tax credit of common input services procured from third parties to the distinct persons as per the present provisions of GST law, and also to clarify issues regarding taxability of internally generated services provided by one distinct person to another distinct person. The Council has also recommended that amendment may be made in GST law to make ISD mechanism mandatory prospectively for distribution of input tax credit of such common input services procured from third parties.”

The CBIC issued a Circular subsequent to the 50^th GST Council meeting vide Circular No. 199/11/2023 GST dated 17^th July 2023 which clarifies various issues which can be stand till 31.03.2025. The issue clarified with regards to ISD is as below:

Issue:

Whether HO can avail the input tax credit (hereinafter referred to as ‘ITC’) in respect of common input services procured from a third party but attributable to both HO and BOs or exclusively to one or more BOs, issue tax invoices under section 31 to the said BOs for the said input services and the BOs can then avail the ITC for the same or whether is it mandatory for the HO to follow the Input Service Distributor (hereinafter referred to as ‘ISD’) mechanism for distribution of ITC in respect of common input services procured by them from a third party but attributable to both HO and BOs or exclusively to one or more BOs?

Clarification:

It is clarified that in respect of common input services procured by the HO from a third party but attributable to both HO and BOs or exclusively to one or more BOs, HO has an option to distribute ITC in respect of such common input services by following ISD mechanism laid down in Section 20 of CGST Act read with rule 39 of the Central Goods and Services Tax Rules, 2017 (hereinafter referred to as ‘the CGST Rules’). However, as per the present provisions of the CGST Act and CGST Rules, it is not mandatory for the HO to distribute such input tax credit by ISD mechanism. HO can also issue tax invoices under section 31 of CGST Act to the concerned BOs in respect of common input services procured from a third party by HO but attributable to the said BOs and the BOs can then avail ITC on the same subject to the provisions of section 16 and 17 of CGST Act.

In case, the HO distributes or wishes to distribute ITC to BOs in respect of such common input services through the ISD mechanism as per the provisions of section 20 of CGST Act read with rule 39 of the CGST Rules, HO is required to get itself registered mandatorily as an ISD in accordance with Section 24(viii) of the CGST Act.

Further, such distribution of the ITC in respect a common input services procured from a third party can be made by the HO to a BO through ISD mechanism only if the said input services are attributable to the said BO or have actually been provided to the said BO. Similarly, the HO can issue tax invoices under section 31 of CGST Act to the concerned BOs, in respect of any input services, procured by HO from a third party for on or behalf of a BO, only if the said services have actually been provided to the concerned BOs.

The position as per this circular can be taken till 31.03.2025. The definition of the Input Service Distributor as it stood before the amendment brought in by Finance Act 2024 was:

S.2(61) of the CGST Act 2017

“Input Service Distributor” means an office of the supplier of goods or services or both which receives tax invoices issued under section 31 towards the receipt of input services and issues prescribed document for the purposes of distributing the credit of central tax, state tax, integrated tax or union territory tax paid on the said services to a supplier of taxable goods or services or both having the same permanent account number as that of the said office.”

Amended definition vide Notification no. 16/2024 CT dated 06.08.2024 w.e.f.  01.04.2025

“Input Service Distributor” means an office of the supplier of goods or services or both which receives tax invoices towards the receipt of input services, including invoices in respect of services liable to tax under sub-section (3) or sub-section (4) of section 9, for or on behalf of distinct persons referred to in section 25, and liable to distribute the input tax credit in respect of such invoices in the manner provided in section 20.”

The amended definition now includes services received where the tax has to be paid under reverse charge. Invoices received in respect of services where tax is to be paid under reverse charge under section 9(3) & 9(4) are also liable to be distributed through ISD mechanism if it received on behalf of the distinct person.

Section 20 of the CGST act also has been amended vide Notification no. 16/2024 CT dated 06.08.2024 w.e.f.  01.04.2025.

As per sub section (2) of the section 20 till 31.03.2025 it is important to note it includes the words “Input Service Distributor may distribute the credit”. The amended Subsection (2) w.e.f. replaces it as “Input Service Distributor shall distribute the credit”. The change from “may” to “shall” makes the provisions of ISD mandatory with effect from 01.04.2025.

The amended definition of input service distributor in S.2(61) mentions any service received on behalf of the “distinct person” referred to in section 25. Who is this distinct person as per section 25?

Sub section (4) of section 25 defines distinct person as “A person who has obtained or is required to obtain more than one registration, whether in one State or Union Territory or more than one State or Union Territory shall, in respect of each such registration, be treated as distinct persons for the purposes of this Act.”

It is also very important to note that as per section 24 clause (viii) of the CGST Act 2017, makes it mandatory to register as input service distributor. The provisions are:

“S.24. Notwithstanding anything contained in sub-section (1) of section 22, the following categories of persons shall be required to be registered under this Act,

(viii) Input Service Distributor, whether or not separately registered under this Act;”

Key features of ISD

• Mandatory registration as ISD (S.20(1))
• ISD to distribute credit which is covered under RCM (S. 2(61))
• Distribution of credit to its distinct entity
• Applicable only for input services

Procedure for distribution of ITC by ISD (Rule 39)

• Distribution of the credit in the same month and details thereof to be furnished in GSTR 6 (39(1)(a))
• ITC distributed cannot exceed the available credit (39(1)(b))
• Credit attributable to specific recipients being distributed solely to that recipient (39(1)(c))
• Credit to be distributed to more than one recipient shall be distributed pro-rata based on turnover in the relevant period (39(1)(d) & 39(1)(e))

Meaning of relevant period (explanation to Rule 39)

Scenario 1:

If the recipient of credit has turnover in their states or union territories in the financial year preceding the year during which credit is to be distributed.

Relevant period for distribution of ITC – the said financial year

Scenario 2:

If some or all recipients of the credit do not have any turnover in their states or union territory in the financial year preceding the year during which the credit is to be distributed.

Relevant period for distribution of ITC – the last quarter for which details of such turnover of all recipients are available, previous to the months during which credit is to be distributed

Meaning of turnover in the State / Union Territory S.2(112)

Means the aggregate value of all taxable supplies (excluding the value of inward supplies on which tax is payable under reverse charge) and exempt supplies, exports of goods or services but excludes taxes.

Whether ineligible credit also to be distributed?

The ISD shall separately distribute the ineligible input tax credit (ineligible under the provisions of sub-section (5) of section 17 or otherwise) and the amount of eligible input tax. Credit [Rule 39(1)(g)]. The ISD shall distribute the ineligible and eligible credits separately.

Type of taxes distributed by ISD

Credit distributed within the State

• IGST to be distributed as IGST
• CGST / SGST / UTGST to be distributed as CGST / SGST / UTGST

Credit distributed outside the State

• IGST to be distributed as IGST
• CGST / SGST / UTGST to be distributed as IGST

Manner of distribution of ITC by ISD

• ISD shall issue ISD invoice to distribute the credit (R.54(1))
• ISD shall issue ISD credit note for reduction in the input tax credit (R.54(1))
• Any additional amount of ITC on account of debit note shall also be distributed
• The supplier of services can issue tax invoice to ISD directly and then ISD can distribute through ISD invoice to respective distinct persons (Rule 54(1)) or
• For common services, where supplier of such services issues tax invoices to the registered person having same PAN and state code as ISD, shall issue normal tax invoice to ISD and then transfer the credit to respective distinct persons (Rule 54(1A)).
• The input tax credit on account of Central tax, State tax, Union Territory tax and Integrated tax shall be distributed separately [Rule 39(1)(h)]

Is ISD registration required in all the states for a registered taxable person?

Need not be required unless the company needs to distribute GST credits on input services. The ISD registration is required only in the cases where the office receives the tax invoices on behalf of its distinct persons.

When normal GSTIN registration is obtained in one state, is there any need to obtain ISD in the same State or GSTIN?

Yes, GSTIN and ISD registrations are mutually exclusive in a given state. ISD registration is required separately as GSTIN registration does not permit distribution of credit. The distribution of the credit is permitted only through ISD mechanism.

Compliances for ISD:

• ISD to file monthly returns in form GSTR 6 by 13th of the subsequent month
• To issue ISD invoice as per Rule 54(1)
• The credit will appear in GSTR 2A / 2B
• ISD not required to file Annual return
• The amount of credit distributed shall not exceed the amount of credit available for distribution (Rule 39(1)(b))

What happens if any excess credit is distributed?

21 of the CGST Act 

“Excess credit distributed in contravention of the provisions of law shall be recovered from such recipients along with interest, and the provisions of section 73 or section 74 or section 74A, as the case may be, shall, mutatis mutandis, apply for determination of amount to be recovered.”

Why we cannot cross charge instead of distributing as ISD:

• A cross charge is possible only if there is a supply to a distinct person. Without supply, the recipient cannot avail credit due to the condition of receipt of services in section 16(2) not met.
• Cross charge is basically charging the common expenses incurred by HO in lieu of service supplied by the said HO to its branches without consideration.
• ISD is basically tax invoices received on behalf of the distinct person and since no supply is involved between the distinct person, it cannot be cross charged.

What are the consequences of not registering as an ISD:

• Late fees (S.47)
• Penalty (S.125)
• ITC to be reversed with interest & penalty

It is possible that the office of the supplier of goods or services can decide to forego the provisions of ISD and reverse the proportionate ITC not applicable to them, which will not eventually give the exchequer the desired results, but still there is a possibility, the officers may levy a penalty for non-registration as section 24, where it mandates compulsory registration. Though there is no loss to the revenue, but the procedure as mandated by law is not followed and there can be a penalty levied under section 125.

Challenges ahead:

• Configuring new ISD branch / branches within IT infrastructure
• Implementing systems for ITC distribution invoice issuance
• Establishing appropriate accounting procedures to maintain books
• Communicating ISD registration numbers to vendors
• Ensuring vendors issue invoices to the correct legal entities.

Conclusion:

ISD will open a new area of litigation, which will give both the taxpayers and department to argue certain expenses to be eligible for ISD or otherwise. There can always be a case where a taxpayer may interpret a certain expense to be exclusively for its own purpose, but department may interpret that the benefits of such costs may be received by its distinct persons and hence liable to distribution under ISD. Time will unfold the unknown.