Input tax credit (ITC) reversal under Rule 42/43 ensures businesses claim only eligible credits. In India, many businesses mix taxable and exempt supplies. In such cases, the credit must be partially reversed. Let’s see how to calculate and comply with ITC reversal rules.
What is ITC Reversal Under Rule 42/43:
“Reversal of ITC” refers to returning claimed Input Tax Credit (ITC) when original conditions for claiming ITC aren’t fully met. Under Rule 42 and Rule 43 of the CGST Rules, 2017, reversal is required when supplies are partly taxable and partly exempt, or when capital goods are partly used for exempt or non-business purposes.
Rule 42 deals with “inputs and input services,” while Rule 43 covers “capital goods.” In short: if your business uses inputs or capital goods partly for exempt supplies (or non-business use), then you may need to reverse a portion of your initially claimed ITC.
When Does Reversal Become Necessary:
You must reverse ITC under Rule 42/43 in following situations:
- When goods or services (or both) are used partly to make taxable or zero-rated supplies; and partly for exempt or non-taxable supplies.
- When inputs or capital goods are partly used for personal or non-business purposes (not related to outward supply).
- When supplies are exempt (or non-taxable), but ITC was claimed assuming taxable supply — necessitating reversal.
Note: Exports or supplies to SEZs (zero-rated supplies) are treated as taxable for ITC-reversal purposes — so common credits used for such supplies typically do not require reversal.
How to compute ITC reversal (common credit method):
When ITC cannot be directly attributed to either taxable or exempt supplies, businesses must calculate “common credit” and reverse the share related to exempt/non-business use. Here is a simplified step-by-step for Rule 42 (inputs & services):
- From total ITC (T), subtract:
- ITC on inputs used exclusively for exempt supplies or non-business use (T2 and T1)
- Blocked credits under Section 17(5) (T3)
- The remaining credit is common credit (C2).
- Reverse the portion of C2 based on the ratio of exempt supplies (E) to total turnover (F):
- Reversal (D1) = (E ÷ F) × C2
For example, if total ITC is ₹2.5 lakh and exempt supplies are 5.8 lakh out of total turnover of 25.8 lakh, proportionate reversal is required. Under Rule 43 (capital goods), similar allocation is required over the useful life of assets (generally 5 years). Credits must be reversed quarterly/annually depending on exempt vs taxable usage.
Why ITC Reversal Matters — Compliance & Practical Impact
Firstly, compliance with Rule 42/43 ensures businesses don’t over-claim ITC — which otherwise could attract demands or disallowance by tax authorities. In a recent 2025 judgment, the Calcutta High Court held that authorities must follow the statutory formula under Rule 42/43 — arbitrary disallowance without formulaic reversal is unsustainable.
Secondly, incorrect reversal (or failure to reverse) may result in penalties or interest under the law. Over-claiming ITC inadvertently (e.g., on exempt supplies or non-business usage) can raise compliance risk during audits. Thirdly, for businesses with mixed supply profiles — taxable and exempt — consistent monthly reversal under Rule 42/43 can improve transparency and avoid surprises at year-end. It enforces accurate tracking of exempt vs taxable turnover.
Conclusion:
Understanding and applying ITC reversal under Rule 42/43 is essential for GST compliance in India. By correctly identifying exempt or non-business usage, calculating common credit, and reversing the appropriate portion of ITC, businesses can avoid legal issues and interest liabilities. Explore more GST & tax-compliance insights now!
– Ketaki Dandekar (Team Arthology)
Read more about Reversal of ITC here – https://cleartax.in/itc-reversal-gst