ITC (Input Tax Credit)

In this article, we will be discussing in detail ITC, How it works.

What is an Input tax credit?

The input tax credit is a mechanism that was introduced with GST back in 2017, which provided a framework for how cascading effect of tax (Paying tax on tax) can be removed. It is a procedure by which any entity which comes under the GST Act will be eligible for the input tax credit. Businesses can claim a refund for the GST they already paid to the government while making purchases, and the tax already paid by the business is adjusted from the tax collected from customers and thus, the business has to pay only the margin amount. Thus, it eliminated cascading effect of tax. When the GST was introduced, the input tax credit was new in India, and nothing such ever existed during the pre-GST regime.

In this article, you will know about ITC, its working process elaborated with an example.

How does Input tax credit (ITC) work?

When a business buys something and pays GST with it, it is eligible for an Input tax return. Then, the business may adjust it with the tax is collected from the customers or just apply for a refund if his goods/services are tax-exempt or nil-rated. This may lead to input tax credit accumulation with the government, which it is eligible to pay.

For example:- Let us consider a supply chain of biscuits.

(a) When a biscuit is to be made, its journey begins with purchasing of raw materials by the manufacturer (like sugar and wheat), and GST is to be paid at the time of buying by the buyer itself. After the sales take place to the distributor, the raw material seller, at the time of paying GST collected to the government can claim for input tax return.

(b) Once the biscuits are prepared, they are packaged and ready to be sold to the distributors, GST will be levied once again (as the packaging is the value added to the ready product hence liable to charge GST on it) by the manufacturer and paid by the purchasing party (the distributor). After the sales take place to the distributor, the manufacturer at the time of paying GST collected to the government can claim for input tax return.

(c) When the distributor sells the goods to the wholesaler, the tax has to be paid by the wholesaler. After the sales take place to the wholesaler, the distributor at the time of paying GST collected to the government can claim for input tax return.

(d) Finally, when the wholesaler sells the goods to the retailers, the retailer will levy GST once again, which will be paid by the customer. Here, the wholesaler is eligible for input tax returns.

(e) After the sales take place to the final consumer, the retailer, at the time of paying GST collected to the government can claim for input tax return.

Note:- When anyone in the supply chain pays tax at the time of purchasing the goods, they are eligible for the input tax credit, which means they would be paying tax just once, at the time of sales. In the end, the retailer will collect tax from the consumer, and thus making GST a consumption-based tax.

Steps involved in a journey of biscuit

Steps	Description	TAX
Step-1	Purchasing of raw materials for making biscuit	YES
Step-2	Selling of goods by the factory to the distributor	YES
Step-3	The distributor sells goods to the wholesaler	YES
Step-4	The wholesaler will sell it to the retailer	YES
Step-5	The retailer sells it to the final consumer	YES

As shown in the above example, GST will be levied in every step of the supply chain. But it does not mean you have to pay tax again and again (Cascading effect). Every person in the supply chain can claim for the Input tax credit, which will be calculated by subtracting tax paid from all sources from tax collected from all the sales. After reading this article, you will have learned how GST works and how the input tax credit works in the GST regime.

Disclaimer: This article is intended for general consumption only. The information in the article was accurate at the time of publication, but it is subject to change due to changes in government rules and regulations. The contents of the blog may not be copied unless prior permission is obtained.

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