Library / Goods and Services Tax: The Professional's Master Guide

17. Apportionment and Reversal of Credit (Sections 17 and 18; Rules 42, 43 and 44)

Credit is meant to relieve tax on taxable business outputs. Where inputs also serve non-business purposes or exempt supplies, only the part relating to taxable business supplies can be kept. This chapter covers the split under section 17, the formulas in rules 42 and 43, the bank option, reversal on exit from the taxable net, sale of capital goods and credit notes.

17.1 Business and non-business use; taxable and exempt supplies

Section 17(1) limits credit to the part attributable to business purposes, and section 17(2) to the part attributable to taxable supplies, including zero-rated supplies (which is why exporters keep full credit). Credit on items used exclusively for exempt or non-business purposes is not taken; credit on items used exclusively for taxable supplies is taken in full. Only the common credit needs a formula.

17.2 What counts as exempt supply value

Under section 17(3) and its Explanation, exempt supply includes supplies on which the recipient pays tax under reverse charge, transactions in securities, sale of land and, subject to paragraph 5(b) of Schedule II, sale of a building. It excludes Schedule III activities, other than sale of land and completed buildings (paragraph 5) and the prescribed paragraph 8(a) transactions (sale of warehoused goods before clearance).

The Explanation to rule 43, which applies to rules 42 and 43, takes land and building at stamp duty value and securities at 1% of sale value. It excludes interest or discount on deposits, loans and advances, except for banks and financial institutions including NBFCs, and also duty credit scrips and certain non-GST duties.

Illustration 101: Working out the value of exempt supplies

Prakash Enterprises Pvt. Ltd., a consulting company in Kolkata, has the following receipts in FY 2026-27 apart from taxable consulting fees.

(a) Sale of a plot of land for Rs. 1,80,00,000; stamp duty value Rs. 2,00,00,000. Included at Rs. 2,00,00,000.

(b) Sale of listed shares for Rs. 50,00,000. Included at 1% = Rs. 50,000.

(d) Rent from a residential flat let to an individual for his own residence, Rs. 12,00,000 (exempt). Included.

Result: E = Rs. 2,00,00,000 + Rs. 50,000 + Rs. 12,00,000 = Rs. 2,12,50,000. A one-off land sale can distort the ratio for the year.

17.3 Rule 42: common credit on inputs and input services

Rule 42 works every month and is trued up once a year. The symbols are as follows.

Symbol	Meaning
T	Total input tax on inputs and input services in the tax period
T1	Used exclusively for non-business purposes
T2	Used exclusively for exempt supplies
T3	Blocked under section 17(5)
C1	T minus (T1 + T2 + T3); credited to the electronic credit ledger
T4	Used exclusively for taxable supplies including zero-rated supplies
C2	C1 minus T4: common credit
D1	(E / F) x C2: part of common credit attributable to exempt supplies (E = exempt supplies, F = total turnover in the State)
D2	5% of C2: deemed attributable to non-business purposes, where common inputs are also used for such purposes
C3	C2 minus (D1 + D2): eligible common credit

D1 and D2 are reversed each month in GSTR-3B, separately for CGST, SGST and IGST. If there is no turnover in a month, the ratio of the last period with turnover is used.

Illustration 102: Monthly computation under rule 42

Green Valley Agro Pvt. Ltd., Nagpur, sells processed foods (taxable at 5%) and fresh vegetables (exempt). Figures for October 2026:

Step 1: Total ITC T = Rs. 5,00,000. Non-business T1 = Rs. 10,000. Exclusively for exempt supplies T2 = Rs. 40,000. Blocked T3 = Rs. 25,000.

Step 2: C1 = Rs. 5,00,000 minus Rs. 75,000 = Rs. 4,25,000.

Step 3: Exclusively for taxable supplies T4 = Rs. 2,85,000. Common credit C2 = Rs. 4,25,000 minus Rs. 2,85,000 = Rs. 1,40,000.

Step 4: Exempt turnover E = Rs. 30,00,000; total turnover F = Rs. 1,20,00,000. E/F = 25%. D1 = 25% x Rs. 1,40,000 = Rs. 35,000.

Step 5: D2 = 5% x Rs. 1,40,000 = Rs. 7,000.

Step 6: C3 = Rs. 1,40,000 minus (Rs. 35,000 + Rs. 7,000) = Rs. 98,000.

Result: Eligible credit for the month = T4 + C3 = Rs. 2,85,000 + Rs. 98,000 = Rs. 3,83,000. Amount reversed in Table 4B(1) = D1 + D2 = Rs. 42,000.

Annual true-up

Under rule 42(2), D1 and D2 are recomputed on annual figures before the due date of the September return after the year end. A short reversal is paid with interest under section 50(1) from 1 April of the next year; an excess reversal is reclaimed.

Illustration 103: Annual true-up with interest

For FY 2025-26, Green Valley Agro's total common credit C2 was Rs. 16,50,000. Monthly D1 reversals added up to Rs. 3,90,000 and D2 to Rs. 82,500.

Step 1: Annual exempt turnover Rs. 3,90,00,000; annual total turnover Rs. 15,00,00,000. E/F = 26%.

Step 2: Final D1 = 26% x Rs. 16,50,000 = Rs. 4,29,000. Final D2 = 5% x Rs. 16,50,000 = Rs. 82,500, equal to the amount reversed.

Step 3: Short reversal = Rs. 4,29,000 minus Rs. 3,90,000 = Rs. 39,000.

Step 4: Paid through DRC-03 on 20 September 2026. Interest from 1 April 2026 to 20 September 2026, both days included = 173 days. Rs. 39,000 x 18% x 173 / 365 = Rs. 3,327.

Result: Pay Rs. 39,000 plus interest Rs. 3,327. Had the annual ratio been lower, the excess reversal would be reclaimed without interest.

17.4 Rule 43: common credit on capital goods

Credit on capital goods used exclusively for non-business or exempt purposes is not taken; credit on those used only for taxable supplies is taken in full. Credit on common capital goods is credited in full, with a useful life of five years from the invoice date, and then:

Tc: aggregate common credit on capital goods whose useful life is still running.
Tm = Tc / 60: common credit attributable to one month.
Tr: total of Tm for all such capital goods.
Te = (E / F) x Tr: credit attributable to exempt supplies, added to output tax liability every month, along with applicable interest, during the useful life.

If capital goods used only for exempt supplies later go into common use, credit is taken after reducing it by 5 percentage points for every quarter or part quarter from the invoice date.

Illustration 104: Rule 43 for two capital goods

Green Valley Agro buys a cold storage unit in April 2026 with common credit Rs. 3,60,000 and a delivery van (goods carriage) with common credit Rs. 1,20,000. Both serve taxable and exempt supplies.

Step 1: Tm for the cold storage = Rs. 3,60,000 / 60 = Rs. 6,000. Tm for the van = Rs. 1,20,000 / 60 = Rs. 2,000.

Step 2: Tr = Rs. 6,000 + Rs. 2,000 = Rs. 8,000.

Step 3: For November 2026, E/F = 20%. Te = 20% x Rs. 8,000 = Rs. 1,600.

Result: Rs. 1,600 is added to output tax for November 2026, and the exercise repeats monthly for 60 months.

17.5 Banking companies and financial institutions: section 17(4)

Section 17(4) lets a banking company or a financial institution, including an NBFC, engaged in accepting deposits or extending loans or advances take 50% of eligible credit on inputs, capital goods and input services every month instead of following section 17(2); the rest lapses. The option cannot be withdrawn during the year, and the restriction does not apply to supplies from other registrations with the same PAN.

Illustration 105: Option under section 17(4)

Coastal Finance Ltd., an NBFC, opts for the 50% route. In October 2026 its eligible credit (after section 17(5)) is Rs. 20,00,000, of which Rs. 2,00,000 relates to cross charges from its own offices in other States under the same PAN.

Step 1: Credit subject to the restriction = Rs. 20,00,000 minus Rs. 2,00,000 = Rs. 18,00,000. 50% = Rs. 9,00,000.

Step 2: Credit on same-PAN supplies Rs. 2,00,000 is allowed in full.

Result: Credit taken = Rs. 11,00,000. The remaining Rs. 9,00,000 lapses.

Judicial view: Credit validly taken and statutory reversal

Eicher Motors Ltd. v. Union of India (Supreme Court, 1999): Under the Modvat scheme, the Court held that credit validly taken on inputs is indefeasible and cannot be taken away by a later rule that lapses the credit.

Collector of Central Excise v. Dai Ichi Karkaria Ltd. (Supreme Court, 1999): Credit validly taken is as good as tax paid, and the manufacturer may use it at any time.

These pre-GST rulings are cited when the department tries to take away credit already taken. They do not help where the GST law itself makes credit subject to later events: reversals under rules 37, 37A, 42, 43 and 44 and section 18(4) are part of the conditions on which credit was given.

17.6 Reversal when supplies become exempt or the person exits: section 18(4) and rule 44

Under section 18(4), a person who opts for composition, or whose supplies become wholly exempt, pays an amount equal to the credit on inputs in stock, inputs in semi-finished and finished goods, and capital goods; the remaining ledger balance lapses. Section 29(5) applies the same idea on cancellation, taking the higher of this credit and the output tax on the goods.

Under rule 44, inputs are valued on the purchase invoices (or prevailing market price if none), and for capital goods the credit for the remaining useful life in months is reversed, taking five years as useful life. The amount is reported in form GST ITC-03 (GSTR-10 on cancellation); on a switch to composition, ITC-03 is due within 60 days from the start of the financial year (rule 3(3)).

Illustration 106: Switch to composition: rule 44

Lakshmi Hardware opts for composition from 1 April 2026. On 31 March 2026 its records show the following credits.

Step 1: Inputs in stock: Rs. 42,000.

Step 2: Inputs contained in semi-finished goods: Rs. 18,000. Inputs contained in finished goods: Rs. 30,000.

Step 3: Capital goods bought on 1 April 2024 with credit Rs. 2,40,000. Used for 24 months; remaining life 36 months. Reversal = Rs. 2,40,000 x 36 / 60 = Rs. 1,44,000.

Result: Payable through ITC-03 = Rs. 42,000 + Rs. 18,000 + Rs. 30,000 + Rs. 1,44,000 = Rs. 2,34,000. Any credit left in the ledger afterwards lapses.

17.7 Sale of capital goods: section 18(6)

When capital goods or plant and machinery on which credit was taken are supplied, the supplier pays the higher of (a) the credit taken, reduced by 5 percentage points for every quarter or part of a quarter from the invoice date (rule 40(2)), and (b) the tax on the transaction value. Refractory bricks, moulds and dies, jigs and fixtures supplied as scrap pay tax on the transaction value alone.

Illustration 107: Sale of used machinery

Verma Plastics bought a moulding machine on 10 May 2024 with IGST credit Rs. 1,80,000. It sells the machine on 15 August 2026.

Step 1: Quarters or part quarters from 10 May 2024 to 15 August 2026: nine full quarters to 9 August 2026 plus one part quarter = 10. Reduction = 10 x 5 = 50 percentage points.

Step 2: Credit less reduction = Rs. 1,80,000 x 50% = Rs. 90,000.

Case A: Sale price Rs. 6,00,000. Tax at 18% = Rs. 1,08,000. Higher of Rs. 90,000 and Rs. 1,08,000 = Rs. 1,08,000. Normal tax invoice.

Case B: Sale price Rs. 3,00,000. Tax at 18% = Rs. 54,000. Higher = Rs. 90,000. Verma Plastics pays Rs. 90,000: Rs. 54,000 as tax shown on the invoice and the balance Rs. 36,000 through GSTR-3B or DRC-03 as its own cost. The buyer can take credit only of the Rs. 54,000 on the invoice.

17.8 Credit notes: section 34(2) and the IMS declaration

The Finance Act, 2025 amended section 34(2) from 1 October 2025: a supplier may reduce output tax on a credit note only if the recipient has reversed the related credit, where it was availed. From the October 2025 tax period, the recipient states in IMS, when accepting a credit note, whether credit is to be reduced and by how much, with a remark for partial or no reversal. A rejected credit note increases the supplier's liability in the next GSTR-3B.

Illustration 108: Credit note with and without reversal

Nisha Polymers, Silvassa, issues a credit note for a volume discount (agreed in the contract and linked to invoices) of Rs. 1,00,000 plus IGST Rs. 18,000 to each of three buyers in November 2026.

(a) Anand Plastics had taken full credit. It accepts the credit note in IMS and reverses Rs. 18,000. Nisha reduces its output tax by Rs. 18,000.

(b) Sunrise Hotels had not taken credit on the original invoice because the goods were used for a blocked purpose. It accepts, answers "No" to reduction and records the reason. Nisha may still reduce its tax by Rs. 18,000, because no credit was availed.

(c) Balaji Traders disputes the discount and rejects the credit note. Nisha's GSTR-3B liability for the next period goes up by Rs. 18,000 until the matter is settled.

Chapter summary

• Credit relating to non-business use or exempt supplies must not be kept; zero-rated supplies are treated as taxable.

• Exempt supply value includes reverse charge supplies, securities at 1%, and land and buildings at stamp duty value, but not most Schedule III items or interest on loans for non-banking entities.

• Rule 42 splits common credit monthly (D1 = E/F x C2; D2 = 5%), with an annual true-up by September and interest on short reversal from 1 April.

• Rule 43 spreads common credit on capital goods over 60 months and reverses Te = E/F x Tr each month.

• Banks and NBFCs may take 50% of credit under section 17(4) instead of the formula.

• On switching to composition or exempt supplies, reverse credit on stock and the unexpired life of capital goods through ITC-03 (rule 44).

• On sale of capital goods, pay the higher of credit less 5 percentage points per quarter and tax on transaction value; on credit notes, the supplier's reduction depends on the recipient's reversal in IMS.