All About Rule 86B Under GST: Restriction on ITC Utilisation In Electronic Credit Ledger

How was ITC utilization allowed before Rule 86B?

Before Rule 86B was introduced,  Input Tax Credit  (ITC) could be utilized freely against the output tax liability. Businesses could use the available ITC balance to pay GST on their sales without any restrictions. There was no specific limit on how much ITC could be used in one go. This allowed businesses to offset their tax liability by using the full ITC available in their electronic credit ledger. The only condition was that the credit claimed was valid, i.e., it should match the invoices, and the supplier should have filed  GST returns . If these conditions were met, ITC could be used without restrictions.

Also Check-Out Insights on –  Transitioning To GST

Applicability of Rule 86B under GST

Rule 86B does not apply to every GST registered person. It mainly targets cases where the taxable value of outward supplies in a month crosses a specific limit.

In simple words, Rule 86B applies when:

• The taxable value of outward supplies in a month is more than fifty lakh rupees
• While checking this limit, exempt supplies and zero rated supplies are not counted
• The check is done month by month before filing the return for that month

If in a particular month your taxable outward supplies are less than fifty lakh rupees, Rule 86B does not apply for that month, even if your annual turnover is very high.

If in another month the taxable value crosses fifty lakh rupees, you must apply the one percent cash payment rule on the tax liability for that month, subject to the exceptions given in the rule.

Detailed List of Exemptions Under Rule 86B

Rule 86B allows certain exceptions, as mentioned below:

1. If the individuals listed below paid more than Rs. 1 lakh in income tax pursuant to the Income Tax Act, 1961
2. • The registered person
   • Proprietor, Managing Director, or Karta of the Registered Person
   • Any partners, full-time directors, or any other individual as the case may be.
2. If the registered person has previously obtained a refund for export under LUT or because of an  inverted tax structure  totalling more than Rs. 1 lakh.
3. If the registered person in question has paid all of his output tax liability through an electronic cash ledger that cumulatively exceeds 1% of the outstanding output tax liabilities up to the relevant month in the current fiscal year.
4. If the registered individual in question is any of the following:
5. • Government department
   • Public sector initiative
   • Local authority
   • Statutory Authority

Also, Get Familiar With –  Reverse Charge Mechanism in GST

When can the department relax the Rule 86B restriction

Rule 86B is designed to curb fake input tax credit, but the law also recognises that genuine businesses may face hardship in some cases.

The commissioner or an authorised officer can relax the restriction in suitable cases. In simple terms:

• The registered person can apply to the jurisdictional officer, explaining why the one percent cash payment rule is causing genuine difficulty
• The officer can look at past compliance behaviour, filing track record and pattern of tax payments
• If the officer is satisfied that the risk of fake credit is low and the business is genuine, the restriction can be removed, fully or partly, subject to conditions mentioned in the order

Effect of Rule 86B on Firms and Working Capital

After examining Rule 86B, it is clear that the above rule only applies to large taxpayers. Small and micro businesses are not affected by this rule.

The aim of implementing this rule is to prevent the issuance of fake invoices that claim fraudulent input tax credits to discharge liabilities. It also prevents scammers from claiming high turnovers when they have none.

Further clarification from the CBIC states that 1% is to be computed on the tax liability in a month and the turnover of the particular month.

Illustration

Let’s use the following example to understand it better:

A taxpayer named Mr A sold products for Rs. 1 crore at a 12% tax rate. According to this rule, he can fulfil his obligation in this situation up to 99% through ITC and pay Rs. 12,000 in cash.

Compliance Strategies & Cash Flow Implications

Rule 86B is not a very high percentage restriction, but it directly affects cash flow planning, especially for ITC rich businesses.

Cash-flow impact

1. Minimum cash outgo every applicable month
2. • Businesses cannot rely on ITC alone to meet 100% of tax liability if Rule 86B applies.
   • Even heavily credit positive entities must arrange at least 1% of output tax liability in cash.
2. Extra working capital requirement
3. • ITC sitting in the electronic credit ledger cannot be used for anything else.
   • Rule 86B effectively pushes the business to keep a buffer cash balance in its GST cash ledger or bank account.
3. Effect on pricing and vendor terms
4. • If cash gets tight, businesses may delay vendor payments or look for advances from customers.
   • CAs should factor this into working capital forecasts and pricing discussions, especially in sectors with thin margins and high GST.

Practical compliance strategies

To handle Rule 86B smartly, consider these steps:

1. Monthly monitoring of taxable turnover
2. • Track taxable supplies (excluding exempt and zero rated) every month.
   • If values are moving close to ₹50 lakh, plan for the possibility that Rule 86B may apply in that month.
2. Check if client fits into any exemption
3. • Before arranging extra cash, see whether your client:
   • • Has paid sufficient income tax in previous years, or
     • Has received significant refunds (exports/inverted duty), or
     • Falls into a category for which the rule is not applicable.
3. Pre plan cash requirement
4. • Take projected output tax liability and calculate 1% of that amount.
   • Ensure that this minimum cash portion is built into monthly cash flow budgets.
4. Use ITC efficiently for remaining liability
5. • Beyond the 1% cash rule, continue to apply ITC to the fullest allowed extent.
   • Keep ITC reconciliations tight (GSTR 3B vs GSTR 2B and books) so that you do not lose usable credit due to mismatches.
5. Discuss business model changes if Rule 86B hits regularly
6. • If the client is repeatedly impacted by Rule 86B and is still under cash stress, review:
   • • Payment terms with customers and vendors
     • Inventory cycles
     • Whether they can restructure some parts of the business to ease working capital pressure

Role of a CA and accounting software

A CA should:

• Build Rule 86B checks into monthly GST review routines.
• Use accounting / GST software that:
• • Shows monthly taxable turnover clearly,
  • Calculates projected tax liability, and
  • Highlights months where Rule 86B might apply.

This way, the client is not surprised at the time of filing GSTR 3B and can plan cash in advance instead of rushing to arrange funds at the last moment.

Compliance checklist for businesses under Rule 86B

To avoid last minute issues while filing GSTR 3B, businesses can follow a simple month wise checklist.

Step one: Check taxable supplies for the month
Calculate the taxable value of outward supplies for the month, excluding exempt and zero rated supplies, and see whether it is more than fifty lakh rupees.

Step two: Compute output tax liability
Prepare a monthly summary of outward tax, taking into account all taxable supplies and any credit notes or debit notes.

Step three: Test Rule 86B applicability
If taxable supplies for the month are more than fifty lakh rupees, treat Rule 86B as applicable, subject to the exceptions. If they are below this limit, Rule 86B does not apply for that month.

Step four: Check if any exception is available
Review whether any of the following conditions are satisfied:

• Income tax of more than one lakh rupees has been paid in each of the last two years by the registered person or by key persons such as proprietor, karta, managing director or partner
• A refund of more than one lakh rupees was received in the previous year on account of exports or inverted duty structure
• Cumulative tax paid in cash in the current financial year already exceeds one percent of total output tax liability
• The registered person is a government department, public sector undertaking, local authority or statutory body

If any one of these conditions is met, the restriction under Rule 86B does not apply for that month.

Step five: Decide the minimum cash payment
If Rule 86B applies and no exception is available, calculate one percent of the output tax liability for that month. This is the minimum amount that must be paid in cash through the electronic cash ledger.

Step six: Maintain working papers
Keep a simple monthly working paper showing:

• Turnover used for the fifty lakh test
• Whether any exception applies
• How the one percent cash amount was computed

These records will help during audits and departmental enquiries.

Common mistakes to avoid under Rule 86B

Many businesses run into trouble under Rule 86B because of small practical mistakes. Some frequent errors are:

• Checking the fifty lakh limit on total turnover including exempt and zero rated supplies instead of only taxable supplies
• Treating the fifty lakh limit as a yearly test and not checking it separately for each month
• Forgetting that cash payments made in earlier months can help satisfy the one percent condition and may give an exception
• Ignoring the effect of large credit notes or debit notes while computing taxable value and tax liability for the month
• Not keeping a clear breakup of domestic taxable supplies, exempt supplies and exports in internal reports

By avoiding these mistakes, businesses can reduce the risk of notices, interest demands and disruption to working capital.