INPUT TAX CREDIT AND SET OFF-ELIGIBILITY, REVERSE TAX CREDIT, PROPORTIONATE TAX CREDIT

The concept of taking credit of input taxes and setting off the same against Output tax payable forms the backbone of the Value Added Tax system.

1. What is Input Tax?
   
   Taxes paid under the VAT Act in respect of purchases made by a dealer is called as Input Tax. Some States have included tax paid under the State Entry Taxes or Entry of Motor Vehicles Tax also as part of Input Taxes.
   
   

2. How is credit of Input Tax taken?
   
   Credit of Input taxes is taken by reducing the input tax suffered on purchases from the Output tax payable.

To illustrate, let us take an example of a dealer who has the following transaction in a month:

3. Who can take Input Tax credit?
   
   A dealer registered under the VAT Act can only take Input tax credit. This means that an unregistered dealer or a Composition dealer ( except in certain circumstances) cannot reduce the input tax paid from the output tax payable.
   
   

4. What is the basis of claiming Input Tax credit?
   
   
   The Tax invoice of the registered Vendor from whom goods were purchased, forms the primary basis for claiming Input Tax credit.
   
   

7. Are there any circumstances when Input tax credit cannot be taken by a registered dealer?
   
   In the following circumstances, Input credit is not allowed, and if already set off, has to be reversed in the month in which the event takes place:
   
   

   1. When the dealer does not have a proper Tax Invoice
      

   2. When Inputs purchased are used wholly or partly for manufacture and/sale of Tax free (or exempt) goods.
      

   3. When goods purchased are given as Free samples or gifts.
      

   4. When goods purchased or stolen or destroyed by fire etc.
      

   5. When goods in respect of which input credit has been taken, are still lying in stock at the time of discontinuation/closure of business.
      

   6. When goods purchased are returned back after availing credit and a credit note is received from the Vendor.
      

   7. When goods such as Motor Vehicle and its accessories, Air Conditioners and related equipments, Furniture, Fixtures (including electrical fixtures) and purchased by a dealer who is not engaged in the buying and selling of such goods.
      
      
      

8. What are the circumstances when Input tax credit is allowed partially?
   
   When goods are purchased for manufacture and/dispatch to another State otherwise than by way of Sale (ie., by way of Consignment or Branch Transfers) the input tax on the purchases shall be reduced by 4% and only the excess over 4% is eligible for set off against other taxable dispatches. In Maharashtra certain inputs such as Fuel also give rise to partial input tax credit.
   
   
   

9. What are the taxes which are not eligible for being taken credit of?
   
   As already mentioned taxes under the respective VAT Acts are eligible for Input tax credit on fulfillment of conditions. Thus CST paid on interstate purchases cannot be reduced from output tax payable. Entry taxes can be claimed credit as per certain State VAT Acts. No other taxes, unless explicitly allowed in the VAT Act is eligible for credit or set off. 
   
   
   

10. What are the goods that are entitled for Input tax credit?
    
    All goods used for business and fulfilling the above conditions are eligible for Input tax credit. This includes Capital Goods as well, and taxes embedded on the stocks lying as on 31st March 2005. However the Maharastra Act is silent on grant of input credit on purchase of Capital Goods while the West Bengal Act has prohibited Input tax credit on Capital goods.
    
    
    

11. Is the set off of Input tax credit immediate?
    
    In almost all cases, the set off is immediate. However, in case of Capital Goods the White paper as well as some State VAT Acts have provided for a 36 month period over which the credit is to be taken. Also for taxes paid on Opening Stock as on 1.4.05, credit is available only after 3 months of filing the Statement of Stocks and is available for set off up to 31.12.05.
    
    
    

12. Should the inputs and Outputs matched on a One-to-One basis for set off purposes?
    
    No, there is no One-to-One matching and inputs need not be identified with the output. However one has to bear in mind the circumstances when Input Credit is not allowed, or is to be reversed, and to this extent it is necessary to have track of the Input-Output chain.
    
    

13. What happens if the Input tax credit exceeds the Output tax payable?
    
    In such cases, the excess is adjusted against CST dues if any and then against Interest and Penalty under the VAT Act and/or the CST Act. Any excess after such adjustment is carried forward to the second year and if the excess remains even at the end of the second financial year, then at the option of the dealer, either Refund or further carry-over is permitted.

STATE-WISE ANALYSIS

WHITE PAPER:

Concept of VAT and Set-off / Input Tax Credit
2.2 The essence of VAT is in providing set-off for the tax paid earlier, and this is given effect through the concept of input tax credit/rebate. This input tax credit in relation to any period means setting off the amount of input tax by a registered dealer against the amount of his output tax. The Value Added Tax (VAT) is based on the value addition to the goods, and the related VAT liability of the dealer is calculated by deducting input tax credit from tax collected on sales during the payment period (say, a month).

Coverage of Set-Off / Input Tax Credit
2.3 This input tax credit will be given for both manufacturers and traders for purchase of inputs/supplies meant for both sale within the State as well as to other States, irrespective of when these will be utilised/sold. This also reduces immediate tax liability. Even for stock transfer/consignment sale of goods out of the State, input tax paid in excess of 4% will be eligible for tax credit.

Inputs Procured from Other States
2.6 Tax paid on inputs procured from other States through inter-State sale and stock transfer will not be eligible for credit. However, a decision has been taken for duly phasing out of inter-State sales tax or Central sales tax. As a preparation for that, a comprehensive inter-State tax information exchange system is also being set up.

DELHI [Sec 8, 9, 10: Rule 6, 7]
Circumstances when Input Tax Credit is not allowed, or having been taken earlier, needs to be reversed:

• When the dealer does not hold a Tax Invoice for the purchase or goods are not purchased from a registered dealer.
  

• When goods are used exclusively for manufacture, processing or packaging of Tax-free goods under the I Schedule.
  

• When the dealer purchases non-creditable goods in Schedule VII.
  

• When goods purchased are used to incorporate in a building owned by the dealer.
  

• When goods are used for taxable as well as non-taxable purposes, the extent of input taxes relatable to non-taxable purposes shall not be eligible, or shall be reversed.
  

• When the goods purchased are destroyed or lost
  

• When goods are branch transferred or consigned outside the State, otherwise as a sale, input tax credit shall not be allowed to the extent of 4%, or shall be reversed.
  

• When goods are neither sold nor resold in Delhi, or are not sold in the course of interstate trade or exports, the credit taken in respect of such transactions shall be reversed.
  

• When the dealer returns the goods purchased against a Credit note from the Vendor, the input tax already taken credit shall be reversed. 
  

• When goods are purchased from a Composition Dealer.
  

• When goods are purchased from a dealer included in Schedule V.

MAHARASHTRA (SEC 48 raw RULE 52-24)

"When tax invoice in not available, or when goods are purchased from an unregistered dealer, no credit is allowed."

• When tax invoice is not available or when goods are purchased from an unregistered dealer. 
  

• Tax paid on earlier purchase under this Act is eligible for set off
  

• Where payment of sales tax is exempted in part or full, only the amount paid is eligible for credit.
  

• Credit of tax shall not exceed the tax actually paid except when the claimant dealer has paid purchase tax.
  

• Tax paid on Fuel purchased upto 4% cannot be set off and only excess over 4% available for set off.
  

• Where tax free goods are packed in packing materials, 4% tax on the purchase of packing materials need to be reversed.
  

• Where tax free goods are manufactured, 4% tax on the inputs (not being Capital goods or Fuel) need to be reversed.
  

• Where goods are dispatched outside the State otherwise than by Sale, 4% tax on inputs (not being capital goods or fuel) used therein is to be reversed. 
  

• Where a Works Contract dealer has opted for Composition Scheme, 16/25th part of the input tax otherwise available for set off will be allowed, with the balance being disallowed.
  

• Where the above reduction makes it difficult to identify the purchases that were eventually used for sale, FIFO method will be used.
  

• Input tax credit taken in respect of goods lying in stock at the time of discontinuation of business or closure, shall be reversed and refunded.
  

• Set off is not available in respect of Motor Vehicles, parts or accessories thereof used as Capital Assets except when the dealer is in the business of leasing out the Vehicles.
  

• When Motor Spirit is sold otherwise than by Interstate/Export sale/Branch Transfer.
  

• When crude oil is purchased by an Oil refinery.
  

• When job workers principally engaged in labour work purchase capital goods and consumables, the tax therein is not eligible for set off.
  

• When dealers holding “Entitlement” certificates purchase raw materials, tax thereon is not available for set off.
  

• Purchaser of goods of incorporeal nature other than export incentives in all forms, are not eligible for input tax credit.
  

• Purchase of Software packages by dealers in Software is not eligible for input tax credit.
  
  It is specifically provided in Sec 48 that tax paid under the Maharashtra Tax on Entry of Motor Vehicles into the Local Areas Act, 1987, be granted to the dealer purchasing or importing motor vehicles; and tax paid under the Maharashtra Tax on Entry of Goods into the Local Areas Act, 2002, be granted to the dealer. 

WEST BENGAL [SEC 22, Rule 19, 20, 23]

Circumstances when Input Tax Credit is not allowed, or having been taken earlier, needs to be reversed:

• The Tax portion is not clearly mentioned on the Tax Invoice, or the tax amount is not clearly mentioned therein.
  

• The Original Tax invoice is not available..
  

• Where the goods lying in stock become tax-free from any given date, the input tax therein cannot be claimed as credit.
  

• When goods are resold, or the goods manufactured are moved out of WB otherwise than by way of sale, input tax to the extent of 4% cannot be set off.
  

• No input tax credit can be taken on purchases made from outside WB.
  

• When goods are used to manufacture partly taxable and party tax-free goods, the input tax shall be reduced in proportion to their respective turnover. 
  

• Input Tax embedded on stocks lying at the time of closure of business/cancellation of registration shall be reversed or refunded.
  

• No input tax credit shall be available to a registered dealer for tax paid or payable at the time of purchase of goods if such goods are lost or destroyed or damaged beyond repair because of any theft, fire, or natural calamity and cannot eventually be sold 
  

• Tax on purchase of ACs, Automobiles, Crude oil, food and beverages, personal consumption items and others as may be prescribed shall not be entitled for Input Tax credit.
  

• Tax paid on purchases made from composition dealers including Works Contractors opting for Composition tax.
  

• Goods that are not sold/resold in West Bengal, or sold interstate or exported or used for Works contract
  

• Goods purchased have been destroyed/lost/stolen without being used.
  

• When a capital good on which credit is being taken on instalment basis is disposed off otherwise than by way of sale within 36 months, the credit so far taken shall be reversed or refunded

PUNJAB [ SEC 2, 13: RULE 19]

Circumstances when Input Tax Credit is not allowed, or having been taken earlier, need to be reversed:

• When proper Tax invoice is not maintained.
  

• Goods used for personal consumption or as gifts.
  

• Goods used for manufacture or sale of Schedule A goods-ie. Exempted goods.
  

• Credit note for output tax received from seller of goods on purchases in respect of which input tax credit is claimed.
  

• Goods are subsequently not used in accordance with the conditions prescribed for availing input tax credit such as:

1. Partly used for tax free output.
   

2. Used for dispatches or manufacture of goods to be dispatched outside the State otherwise than by way of sale in which case 4% of the input tax is to be reversed.
   

3. When goods are sent out on job work etc., the corresponding Input credit may be debited and may be restored back, when the goods enter the dealer’s premises again after job work. 
   

• Having availed the credit, and also the refund in relation to exports, the dealer is required to reverse the credit
  

• Having availed the credit, but at the time of closure of business has stocks lying with him, shall be required to reverse the credit to the extent of tax embedded in such stocks.
  

• 4% of the input tax paid on Furnace oil, transformer oil, mineral turpentine oil, water methanol mixture, naptha and lubricants used for manufacturing taxable goods or for captive power generation will be disallowed and only the excess can be taken credit of.
  

• Purchase of weigh bridge except when installed inside a manufacturing premises in the manufacturing process of taxable goods.
  

• Goods used in generation, distribution and transmission of electrical energy, if not used for captive consumption.
  

• Purchase of Civil structures, immoveable properties and goods
  

• In the following instances, credit of tax paid on inputs cannot be taken if the dealer is not in such business:
  

  • Purchase of automobiles and parts thereof 
    

  • Purchase of Petroleum products
    

  • Purchase of Air-conditioners and ancillaries
    

  • Purchase of office equipments and building materials.
    

  • Purchase of furniture and fixtures including electrical fixtures and fittings
    

  • Provision of food, beverage and tobacco products

• Where proper books are not maintained and the assessee purchases goods partly for taxable sales and deals in taxable, tax-free, interstate as well as branch transfers, the following formula is applied to determine the input tax credit:

• If there is a branch transfer out of the State, then the above formula should be further reduced by:

SUMMARY:

The White Paper has only laid down the broad contours of the system of Input Tax credit. This appears to have been followed largely by all States. Special provisions are found in each state to tackle different situations. It may be noted that certain States have made rules in respect of certain situations explicit while other States have not so done. It should be noted however, that basic issues of set off, though not explicit in some State VAT Acts, are to be read as implicit in the overall VAT scheme.