Input Service Distribution or ISD in not a new concept in India, its familiarity dates back to the Service Tax Era. The Service Tax law upheld the principle that credits relating to any input service can be utilised to discharge output tax only on the supply (service or manufactured goods) that utilised such input services. When companies received services such as audit, tax consultancy, secretarial services, HR related services etc, the input credit could not be attributed to any specific supply as they were commonly used for the company as a whole. These services were commonly called the Head Office expenses, could not be attributed to one specific location/ supply and companies ended up accumulating such credit without understanding how to utilise the same.
Service tax worked under PAN based registration model and unlike the current GST regime, there was no concept of distinct person wherein registration is to be obtained in each state where the company is operates. Further, Cross charge invoice could not be raised to transfer the common credits as it was void ab initio due to absence of distinct parties to contract. Further, the Service Tax Law also stipulated that “Service to Self” is not taxable leaving no room to transfer credit through an internal invoice.
In light of the above, the Government had come up with a rescue mechanism by introducing the concept of ISD vide Cenvat Credit Rules, 2004. The ISD mechanism provided a rationale for utilisation of common credits and helped companies evacuate its common credits accumulated at the Head Office. It is glaringly evident from the above that the concept of ISD was introduced for the convenience of the taxpayer to avoid credit loss and was not persuaded to be mandatory. This means the taxpayer could either opt in for the ISD compliance for effective credit utilisation or alternatively decide to bear the credit loss by not registering for ISD. Thus, the ISD mechanism was optional under the erstwhile Service Tax Law.
When the same concept of ISD got transitioned into the GST law, it did not behold the underlying principles that existed in the old regime – the concept of ISD reincarnated with the same body but a different soul. When GST was introduced, the ISD law was silent about being optional or mandatory and seemed to have been merely drafted as a modified replication of the service tax regulations. However, with the introduction of the concept of distinct person under GST, the spirit of ISD regulation did not remain the same.
Before the ISD mechanism was made mandatory, many companies chose to not opt for ISD registration. Companies where the non-distribution of common credits dint seem consequential chose to lose such credits. Also, many companies chose the route of “cross charge” or “internally generated invoices” to avoid common credit accumulation at head office. This created an irregularity in following the ISD provisions across assesses and there was no clarity on which is the right method the company should follow to utilise the common credits.
Further, the concept of distinct persons requires every company to take GST registration in each of the state where it is operational and discharge tax accordingly. This means the taxpayer should ensure he reports the right amount of output and input transactions into the respective GST registration where it belongs. This also means that the common services cannot be simply absorbed into a single registration where the Head Office is located and should be distributed to all registrations proportionately. Failure to distribute common service credits appropriately can result in revenue disparities, where states housing head offices (often the states of metro cities such as Bangalore, Chennai, Mumbai etc) may experience excess input credit set off leading to revenue losses, while other states gain undue revenue. This implies that to enable equitable revenue distribution, the ISD provisions had to be made mandatory. Now the Notification 16/2024-CT dated 06-Aug-2024 has been issued mandating ISD provisions effective 01-Apr-2025. Currently, as the ISD provisions are not mandatory the taxpayer enjoys certain lenience which will cease from 01-Apr-2025. Let us understand what are the additional burden on the taxpayer going forward:
1. Companies with multiple GSTIN will have to mandatorily take the ISD registration and dedicate extra time and resource necessary for the related compliance. Additional efforts would be required for reconciling GSTR 6A along with the existing GSTR 2A.
2. Cross Charge or internally generated invoices cannot be used for transferring common credits, only an ISD invoice shall distribute common credits in the stipulated proportion.
3. Even if the company believes that forgoing the common credits is beneficial than the effort of ISD compliance, they may not have the option to not take the ISD registration. As ISD is mandatory for companies with common credit, penalty under section 122 and 125 of the CGST Act, 2017 may be levied during the GST Audits
4. Under the erstwhile law, in case of inadvertent error in compliance with the ISD regulations, the assessee had the shelter of “revenue neutrality to government”. But the same may not be available as every GSTIN is a distinct person and the input credits belonging to one state cannot be justified for utilization in another.
5. The GST Audits by the department would now have an additional check to find out if any of the expense could be common in nature. There maybe additional notices which randomly picks some input credits claimed by the company and requires to prove that they are not common credits subject to ISD provisions.
Although it cannot be denied that ISD is the way forward for ensuring optimum regularisation of utilisation of common credits, it can also true that ISD under GST is more for the convenience of tax collector than for the taxpayer. It is now essential for the companies to take suitable proactive measures to understand the ISD implication on its business and ensure preparedness in terms of process, resource and ERP set up. It would be interesting to watch how the mandatory ISD implementation unfolds and the new challenges/ difficulties that would require to be addressed by the authorities.
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