There are distinct provisions beneath the GST regime to calculate input tax credit (ITC) on capital goods under GST, availability, and non-availability of the input tax credit, and ITC reversal calculation as well. Businesses use many capital items on which input tax credit is available. The input tax credit is the most crucial function of the GST era. Input tax has been proved to be the most vital characteristic in the generation of GST. It has modified the system of taxation that has been enforcing or imposed on goods and services. So here we will discuss ITC rules on capital goods in GST in a more detailed way.

Section (19) of the CGST Act defines “capital goods” as goods, the cost of which is capitalized in the books of account of the person claiming the input tax credit and which can be used or intended to be used in the path or furtherance of business.

Goods will remain as capital goods in case the following situations are satisfied or meet:

(a) The price of such items is capitalized in bookkeeping activities of the person claiming the input tax credit.

(b) Such items are significantly meant to be used within the course or furtherance of business.

This post is for the portion of an input tax credit of GST paid on buying such capital goods/items.

What are Capital Goods under GST?

Capital goods are assets that have equipment, motors, buildings, machinery, and gear that an organization uses in order to produce goods or services. For example, a blast furnace that is used in the iron and steel industry is considered a capital asset for the steel manufacturer.

Difference Between Capital Goods and Inputs

In order to understand the difference between capital goods/items and inputs, let us take an example here.

Say, you are preparing a cake in the oven. then, you will have the requirements of some ingredients such as flour, eggs, water, base, and butter, and etc. So, if we talk about the capital goods under Goods or Services Tax, the ingredients are referred to as your inputs, while the cake is your final product. The oven is the capital good through you to make the cake.

Inputs are fed on even as making the final product and are dealt with as business expenses as the cost of production. However, capital goods are consumed whilst the final product is prepared. These are not consumed in a single year of production. Therefore, these cannot be entirely deducted as business costs in the year of their purchase. Instead, they are depreciated over the course of their useful lives. The business considered a part of the value every year via accounting strategies as depreciation, amortization, and depletion.

Input Tax Credit Or ITC Rules on Capital Goods In GST

When you purchase an item, you are required to pay GST on the purchase of that particular item. Later, you could declare input tax credit on the GST paid in your purchases. Similarly, whilst you are purchasing any machinery for your factory, you will pay the relevant GST rate. This GST paid can be claimed as a credit in the same way as inputs.

However, if you claim depreciation on the GST paid while shopping the capital asset, you cannot claim input tax credit.

What is Common Credit?

Businesses regularly use the identical belongings and inputs for both commercial enterprise & private use.

For instance, Sonia is a freelance fashion designer as well as runs her own fashion blog. She has a laptop, which she also makes use of for her freelance work in blogging. She can claim the input credit of GST paid on the purchase of laptop, but only to the extent that it pertains to her freelance enterprise for commercial purpose only.

Also, Sonia purchased a special designing software for use in her laptop. Since this pertains most effective to her business, therefore, she can claim a full ITC on this.

Importance of Common Credit

ITC is most effectively available for commercial purposes only. Several traders, usually prefer using the same inputs for both business and personal reasons. A taxpayer does not have any right to claim any tax benefit of personal expenses. Additionally, goods/items that are exempt under GST already revel in 0% GST. ITC cannot be claimed for inputs that are utilized in such exempted goods as it will only lead to negative taxation. Hence, ITC on inputs for goods that are exempted can also be removed.

The calculations which were shown you in the later parts of this article will help you to calculate the common credit that is attributed to personal supplies and exempted elements leaving behind most effectively the components that pertain to taxable sales. However, only that amount can be claimed as ITC.

The credit that is attributed to personal components and exempted components need to be reversed in GSTR-2.

Types of ITC Rules for Capital Goods In Gst

Capital goods are usually categorised into the following types:

1. Capital goods used for only personal or for exempted sales
2. And also used for normal taxable sales
3. Used for partly personal/exempted or partly for normal sales

1. Capital or raw Goods used for Personal Use or for Exempted Sales Only

There is no ITC available for personal purchases or for capital goods used in exempted sales. This will be indicated in FORM GSTR-2 and shall not be credited to the electronic credit ledger.

(a) Personal Purchases

For instance, James had recently purchased a refrigerator for his home. Since this is not required for his business, i.e., a purely personal purchase, he will, therefore, no longer be able to claim any ITC on the GST paid for the refrigerator.

(b) Capital Goods used for Exempted Sales

Venkatesh had purchased a small flour mill to grind wheat grains into flour in his grocery store. Since he is producing unbranded flour, it is thus, exempted from GST. As it is an exempted sales, he cannot claim any ITC on the GST paid for the small flour mill.

2. Capital Goods used for Normal Sales

For instance, a local company recently purchased machinery for the purpose of manufacturing footwear. Since footwear is normal taxable supplies, the GST included paid whilst purchasing the equipment can be completely available as ITC. Also, this is to be indicated in FORM GSTR-2 and shall be credited to the electronic credit ledger.

3. Common Credit for Partly Personal or Exempted and Partly Normal Sales

• The ITC paid for the capital goods will be credited to electronic credit ledger.

• The useful life of such capital assets might be taken as 5 years from the date of purchase.

• Now, the total quantity of input tax credited to electronic credit ledger for the whole useful life will be distributed over the useful life.

The useful life shall be taken for a total of 5 years.

If you GST is paid monthly, then you will have to use the formula given as under:

Input Tax Credit (for 1 month) = Input Tax Credit to Electronic Credit Ledger / 60 (5 years x 12 months)

If your turnover is less than Rs. 1.5 crores, then you will be required to pay GST on a quarterly basis. The ITC may be calculated with the help of the formula given as under:

Input Tax Credit (for 1 quarter) = Input Tax Credit to Electronic Credit Ledger / 20 (5 years x 4 quarters)

Calculations for Common Credit

(a) For exempted supplies

For the amount of ITC on account of exempt supplies out of common capital credit, the formula is given below:

Credit attributable to exempt supplies = Value of exempt supplies / Total Turnover x Credit for a tax period

Only the remaining amount after deducting credit for exempt supplies shall be allowed as ITC.

All the above calculations need to be executed separately for:

• Central tax
• State Tax
• Union Territory Tax
• Integrated Tax

(b) A person uses an asset for exempted goods as well as for taxable goods

This is applicable if a capital asset was previously used for any of the following:

• Personal cause
• Selling exempted goods

And now it shall be used commonly for:

• Business and personal reason
• Effecting taxable and exempt supplies

The input tax to be credited to the electronic credit ledger = Input Tax – 5% of Input tax for every quarter or part thereof from the date of invoice.

Let us take another example to understand this better.

Venkatesh had purchased a capital asset for use in exempt supplies only. He paid Rs. 1,00,000 in conjunction with the GST of Rs. 18,000 as input tax on 1st October 2017. Now, on 15 November 2018, he wishes to use the capital asset commonly for both taxable and exempt resources.

So, the eligible common input tax credit will be calculated using the formula as follows:

Input tax to be credited to electronic credit ledger = Input Tax – 5% of Input tax for each quarter or part thereof from the date of invoice

Here, the number of quarters starting from 01-10-2017 to 15-11-2018 = 5

= 18,000 – (5% of 18000) x 5 quarters

= 18,000 – 4,500

= 13,500

Thus, this is the common credit that is available to Venkatesh. This means that he will credit Rs. 13,500 to Electronic Credit ledger.

Again, he is going to calculate the ITC that is attributable to exempted supplies with the help of the above formula. The result is:

Common credit for 1 month = 13,500 / 60 = 225

Now, assuming that his total turnover is Rs. 160 lakhs and exempted sales is Rs. 40 lakhs, we are going to use the formula given as follows:

Credit attributable for exempt supplies = Value of exempt supplies / Total turnover x Common credit for the month

The amount, which is 56.25, will be reversed in GSTR-2 under Table 11 ITC Reversal.

Reversal of Credit Under Certain Circumstances

The proportionate ITC can be reversed i.e., added to the output tax liability in GSTR-2 under the following circumstances:

• Where a normal taxpayer chooses to pay tax under the GST Composition Scheme, or goods/services supplied by him become exempt.

• In case of supply of capital goods/items or plant and machinery, on which input tax credit has been taken.

• Every registered person whose registration is cancelled.

The input tax credit involved in the remaining useful life in months shall be computed on pro-rata basis, taking the useful life as 5 years.

For instance:

Capital goods/items have been in use for 4 years, 6 month and 15 days.

Therefore, the useful remaining life in months = 5 months, ignoring a part of the month.

Input tax credit taken on such capital goods = C (assuming Rs. 10 lakhs)

Input tax credit attributable to the remaining useful life = C x 5 / 60

= Rs. 10,00,000 x 5 / 60

= Rs. 83,333

The above calculation have to be performed one by one for integrated tax and central tax.

This amount should be reversed in (i.e., becomes part of output tax liability) and furnished in:

• Where a normal taxpayer chooses to pay tax under the GST Composition Scheme or goods/services supplied by him turns out to be exempt. Here, he/she is required to file FORM GST ITC-03.

• Registration is cancelled. Here, he/she is required to file FORM GSTR-10.

This must be accompanied by using a certificate from either a practising Chartered Accountant (CA) or Cost Accountant.

In case of sale of capital goods/items, if the amount determined above is greater than the tax on transaction value of such sale, then the amount determined as above shall be added to the output tax liability. Also, the details must be furnished in FORM GSTR-1.

Capital Goods/Items Sent on Job-Work

ITC shall be allowed to the principal manufacturer/producer if a capital asset has been sent to a job worker for job-work.

The following is the condition that needs to be fulfilled:

Such goods should be obtained back within a length of 3 years of being sent out.

The implications include:

If the goods/items are not sent back within 3 years, then it will be treated as a deemed supply from the date of sending the goods/items and tax would be payable along with interest for late payment of taxes.

Thus, from the above calculations, it is clear that ITC Rules for Common Credit under GST have been intended to be followed strictly in order to avoid interest and other recovery mechanisms.