Input Tax Credit (ITC) is a crucial aspect of the Goods and Services Tax (GST) system in many countries, allowing businesses to claim a credit for the tax paid on purchases made for their business. Input Tax Credit is the credit that businesses can claim for taxes paid on inputs used in the production of goods and services. However, there are special rules for calculating input tax credit reversals, input tax credit availability, non-availability, and input tax credit for capital goods under GST. In this article, we will dive into the concept of ITC for capital goods. Claiming the correct ITC can be challenging, since there are many rules and regulations you need to follow.
Consider using a robust GST Accounting Software to claim Input Tax Credit, so that you can keep up with the compliance required to claim ITC correctly.
Businesses require both capital goods and raw materials to produce the goods and services they sell. Capital goods refer to the machinery, equipment and assets used to produce goods and services. Raw materials are the primary products that go through the manufacturing process and get converted into finished products.
For example, let’s say ‘Company A’ manufactures wooden furniture. To do so, they will require machines to cut, shape and polish the wood. The use of these machines will not end with the production of one piece of furniture. They will be used for many years. Thus, these are long term capital goods. On the other hand, the wood used to make the furniture is a raw material. This wood is transformed into furniture through the use of the machinery.
Another way to think about capital goods is that there is no material change in them once the manufacturing process is complete. But there is a material change in raw materials, and you cannot bring the raw materials back to the state they were in before going through the manufacturing process.
Under Section 2 (19) of the GST Act, “capital goods” are goods that have been capitalised in the books of accounts of the person who is claiming Input Tax Credit.
When you purchase any goods or services, you need to pay the applicable GST rate on them. However, if you are a GST registered taxpayer, you can claim back the GST amount as Input Tax Credit. The same applies to when you purchase capital goods for business purposes. But, capital goods are subject to depreciation over time, as per rates prescribed under the Income Tax Act. They also have a predetermined useful life as per the same Act.
To claim ITC, you must claim depreciation only on the taxable value of the capital goods you have purchased i.e value excluding the GST paid. If you have claimed depreciation on the total value you have paid for the capital goods i.e value including the GST paid, then you cannot claim Input Tax Credit.
For example, let’s say you purchased a new computer for business use. That computer will be classified as capital goods. The taxable value of the computer is ₹50,000, and the applicable rate of GST is 18%, which is ₹9,000. Hence, the total amount you have paid for the computer is ₹59,000. Computers, under the Income Tax Act, can be depreciated at the rate of 40%, over a period of 5 years (their useful life). To be eligible for ITC, you must claim depreciation only on the value before GST i.e. ₹50,000. If you claim depreciation on the entire amount of ₹59,000, then you cannot claim ITC.
When a taxpayer purchases capital goods for both business and personal use, they can claim Input Tax Credit only to the extent that the capital goods are used only for business purposes.
Let’s say you are a freelancer selling copywriting services to clients. You have purchased a computer, which you use not only to do your copywriting work, but also for personal entertainment, like occasional gaming, watching movies etc. You can claim ITC for the GST paid when you purchased the computer, but only to the extent that the computer is being used for your copywriting business.
Let’s say you purchased a subscription to a software that helps you do your copywriting work better and faster. Since you are using that software only for business purposes, you can claim full ITC for the tax you pay each month on the subscription price of the software.
However, if you purchase a computer game, or a subscription to a movie streaming service, both of which are purely for personal use, then you cannot claim any ITC on either of them.To know more, read our guide to ITC on Common Credit.
The Conditions for claiming ITC on Capital goods are as follows:
There are three types of ITC for Capital goods. These are:
The input tax credit is not available for personal or exempted sales of capital goods. For instance, if Mr Kapoor buys a fridge for his house, it is a personal purchase; hence, ITC cannot be claimed. Similarly, if he purchases a small flour mill for his grocery shop, he is producing unbranded flour, which is exempted from GST, and thus he cannot claim an ITC for the same.
Mr Manoj has purchased machinery for manufacturing shoes, and the GST he pays while buying the machinery will be available to be claimed as ITC since the machinery comes under normal taxable supply.
Capital goods used partly for personal or exempted sales and partly for normal taxable sales are eligible for claiming ITC.
The ITC that is paid for the capital goods is transacted through the e-ledger. The shelf life of such assets will be marked as five years from the date of purchase. The total amount of input tax transacted to the e-ledger will be distributed over the entire marked shelf life.
Considering five years as the shelf life and the GST is paid monthly, the following formula can be used to calculate the ITC per month:
ITC per month= Input tax credited to the e-ledger divided by 60 (5×12)
The amount of ITC from common capital credit that can be attributed to exempt supplies is:
Credit attributed to exempted supply= (Value of exempted supplies divided by the total sales) multiplied by Common Credit for a tax period
After subtracting credit for exempt materials, the remaining sum will be eligible for ITC. These calculations should be carried out separately for CGST, SGST, IGST, and UTGST.
If a capital asset was previously used for personal intent or for selling things that are exempt and now it will be used for both personal and professional purposes or affecting both exempt and taxable supplies, Input tax that needs to be added to the electronic credit ledger is calculated as follows:
Input tax to be credited= 5% of input tax for every quarter or part from the date of invoice subtracted from the Input tax.
Cases, when ITC will not be applicable on Capital Goods, are:
A transaction with Consideration: In this case, GST will be due at the corresponding rate, tax invoices must be prepared, and the transaction should be recorded on the GSTR 1 Form.
Transaction without consideration: The same situation as in the previous situation applies here if the supply of goods is unintentionally lost, stolen, destroyed, written off, or otherwise disposed of. In such circumstances, it won’t be regarded as the supply of goods, and no GST will be charged.
The following circumstances require that input tax credits obtained on capital items be reversed:
Suppose a capital asset has been given to an employee for use in the course of business. In that case, the major manufacturer may be eligible for an input tax credit if the item is returned within three years of the date it was given to the employee. If the assets are not returned within three years, they will be considered to have been supplied, and tax, as well as interest for late payments of taxes, would be due.
Thus, capital goods that aid a company’s expansion are eligible for the input tax credit. ITC contributes to reducing the expense of corporate development, which benefits the economy as a whole.
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