The Government has notified the Finance Act, 2024 on February 15, 2024, to implement the financial proposals of the Central Government for the fiscal year 2024-2025. This Act introduces significant amendments to the GST Law in India, particularly concerning the Input Service Distributor (ISD) mechanism. These changes align with the recommendations of the GST Council from its recent meetings. This article explores the necessity of these amendments and their implications on the definition of ISD and the mechanism for distributing Input Tax Credit (ITC).
What is an ISD?
An Input Service Distributor (ISD) refers to an office of a supplier of goods or services (or both) that receives tax invoices towards the receipt of input services. The ISD then distributes the credit of central tax, State tax, integrated tax, or Union territory tax paid on these services to other suppliers of taxable goods or services (or both) having the same Permanent Account Number (PAN).
The Finance Bill 2024 amends this definition to include invoices for services liable to tax under sub-section (3) or sub-section (4) of section 9 of the Central Goods and Services Tax (CGST) Act, 2017, and mandates distribution of the input tax credit (ITC) for or on behalf of distinct persons referred to in section 25 of the Act.
Amended Definition (Finance Bill 2024):
“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.”)
Need for the Amendment
Before the amendment, the GST Law was unclear on whether the ISD mechanism was compulsory for distributing ITC from third-party invoices, such as those from auditors or ERP services, which generally benefit the entire company. This lack of clarity led to confusion, with some entities opting to distribute ITC via the Cross Charge route rather than through the ISD mechanism. Consequently, the industry was following mixed practices for the distribution of common credit, either through the ISD mechanism or via the Cross Charge mechanism through tax invoices raised on the respective locations receiving the credit. The ISD mechanism involves a separate registration, typically in the name of the Head Office (HO), in addition to the normal registration required by the company.
The GST Council addressed this ambiguity in its 50th meeting on July 11, 2023, recommending a circular to clarify that the ISD mechanism was not mandatory for distributing ITC from common input services procured from third parties. This clarification was issued through Circular No. 199/11/2023-GST on July 17, 2023. Subsequently, in its 52nd meeting on October 7, 2023, the GST Council proposed amendments to make the ISD mechanism mandatory prospectively for distributing ITC from such common input services.
Amendments by the Finance Bill 2024
1. Amendment to the Definition of ISD in Section 2(61) of the CGST Act, 2017:
The amended definition now reads: “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.”
2. Amendment to the Manner of Distribution of Credit by ISD in Section 20:
The revised section 20 states: “(1) Any 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, shall be required to be registered as Input Service Distributor under clause (viii) of section 24 and shall distribute the input tax credit in respect of such invoices.
(2) The Input Service Distributor shall distribute the credit of central tax or integrated tax charged on invoices received by him, including the credit of central or integrated tax in respect of services subject to levy of tax under sub-section (3) or sub-section (4) of section 9 paid by a distinct person registered in the same State as the said Input Service Distributor, in such manner, within such time and subject to such restrictions and conditions as may be prescribed.
(3) The credit of central tax shall be distributed as central tax or integrated tax and integrated tax as integrated tax or central tax, by way of issue of a document containing the amount of input tax credit, in such manner as may be prescribed.”
Effect of the Amendments
Mandatory ISD Mechanism: The new definition mandates the ISD mechanism, making it compulsory for distributing ITC. This change will apply prospectively from a date appointed by the Central Government via notification in the Official Gazette.
Inclusion of RCM Services: ITC on Reverse Charge Mechanism (RCM) invoices, where tax is first paid by a distinct person registered in the same state as the ISD, must also be distributed by the ISD. This includes services like Goods Transport Agency (GTA) and legal services covered under RCM.
Detailed Procedures to be Prescribed: The revised section 20 does not detail the ITC distribution process by ISD, which will now be covered under amended Rule 39 of the CGST Rules. This amendment will include provisions for the computation of distribution ratios, aligning with the GST Council’s recommendations.
Distribution to Distinct Persons: The proposed definition covers distinct persons referred to in section 25 of the CGST Act, which includes other registrations of the same person in different states/UTs, expanding the scope beyond the same Permanent Account Number (PAN).
In addition to the aforementioned considerations, it’s essential to address the need for clarification regarding the treatment of entirely common inward service supplies. There is a concern whether these supplies will have to be cross-charged or distributed under the ISD mechanism. Presently, it is crucial to demonstrate that the inward supply of service at the Head Office (HO) was “for and on behalf of distinct persons” to determine the mandatory distribution of Input Tax Credit (ITC). For instance, this could include insurance premiums for specific distinct persons in other states or stock audits for specific distinct persons. However, there is uncertainty regarding whether general common administrative input services can be covered under the ISD mechanism, given the language adopted, which appears to create an artificial distinction. As a result, completely common inward service supplies may need to be cross-charged rather than distributed under ISD, posing a challenge that requires further clarification.
Conclusion
The proposed amendments outlined in the Finance Bill 2024 introduce significant revisions to the ISD mechanism, aiming to enhance clarity, broaden responsibilities, and necessitate additional rule adaptations. Stakeholders should anticipate these changes, considering their potential mandatory enforcement. Adapting to the new regulations will require substantial adjustments in accounting and IT infrastructures, especially for businesses running across multiple states. As these amendments come into effect, organizations must devise strategic plans to seamlessly incorporate the revised ISD framework.
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