ITC Reversal Under Rule 42 and Rule 43, Explained

A business that makes both taxable and exempt supplies cannot keep all the tax it pays on shared costs. ITC reversal under Rule 42 and 43 of the CGST Rules is the arithmetic that splits that common credit: Rule 42 for inputs and input services, Rule 43 for capital goods. This guide walks through each formula term by term, works a numeric example for both, and shows where the reversal goes in the return.

Why common credit has to be split

Section 17(1) and 17(2) of the CGST Act allow input tax credit only to the extent that goods and services are used for business and for taxable supplies, including zero-rated supplies. Credit attributable to exempt supplies and to non-business use is not available. When a cost can be traced to one kind of supply, that is simple. When it cannot — rent, electricity, audit fees, a shared machine — the law needs a formula, and Rules 42 and 43 are that formula. For the general conditions that apply before any of this, see what is input tax credit and input tax credit rules explained.

Three kinds of credit

Every invoice of the month falls into one of three buckets before any formula is applied.

Getting the tagging right at purchase entry does most of the work. The formula only ever touches the common bucket.

Rule 42: inputs and input services

The rule builds the common credit step by step, for each tax period:

• T — total input tax on inputs and input services for the period.
• T1 — credit on items used exclusively for non-business purposes.
• T2 — credit on items used exclusively for exempt supplies.
• T3 — credit blocked under section 17(5).
• C1 = T − (T1 + T2 + T3) — credit credited to the electronic credit ledger.
• T4 — credit on items used exclusively for taxable supplies, including zero-rated.
• C2 = C1 − T4 — the common credit.
• D1 = (E ÷ F) × C2 — the share of common credit attributable to exempt supplies, where E is the value of exempt supplies and F the total turnover in the state for the period.
• D2 = 5% of C2 — the share attributable to non-business use, applied only where the common pool is used partly for non-business purposes.
• C3 = C2 − (D1 + D2) — the common credit that remains eligible.

D1 and D2 are reversed, that is, added to output tax liability. The rule computes all of this separately for central tax, state or union territory tax and integrated tax. If there was no turnover in the period, E and F are taken from the last period in which there was turnover.

Rule 42 worked example

A trader in one state sells taxable goods and also exempt goods. For the month, exempt turnover is ₹20,00,000 and total turnover is ₹1,00,00,000, so E ÷ F is 20%. Part of the common pool is also used for non-business purposes.

Of ₹1,00,000 paid, ₹20,000 is never claimed (T1 + T2 + T3), ₹12,500 is reversed (D1 + D2), and ₹67,500 stays as credit.

The annual true-up under Rule 42

The monthly figures are provisional, because a single month's turnover mix can be unrepresentative. After the year closes, D1 and D2 are recomputed for the whole financial year, using the year's E and F. The final figure must be worked out by the due date of the return for September of the following financial year.

• If the annual reversal is higher than the sum of monthly reversals, the excess is added to output tax liability, with interest from the first day of the following financial year until it is paid.
• If it is lower, the difference can be claimed back as credit.

The annual figures also have to agree with what is reported in the GSTR-9 annual return, so keep the working papers.

Rule 43: capital goods

Capital goods are used over several years, so Rule 43 spreads their common credit rather than splitting it all at once. The sorting is the same as for inputs: capital goods used only for non-business or exempt purposes get no credit; those used only for taxable supplies get full credit. For common capital goods:

• Tc — the common credit on capital goods, credited to the electronic credit ledger.
• Tm = Tc ÷ 60 — the credit attributable to one month, taking the useful life as five years (60 months) from the invoice date.
• Te = (E ÷ F) × Tm — the part of that month's credit attributable to exempt supplies, added to output tax liability.

Te is worked out every month for the useful life, separately for each tax head. Capital goods first used only for exempt supplies and later moved to common use can have credit claimed, reduced for the time already used; the rule sets out the method. More on when capital goods credit is available in ITC on capital goods.

Rule 43 worked example

The same trader buys a packing machine, used for both taxable and exempt goods, with GST of ₹6,00,000 on the invoice. The month's E ÷ F is again 20%.

If the ratio stays at 20% for all 60 months, the total reversal is ₹1,20,000 and ₹4,80,000 of the credit is kept. In practice the ratio moves each month, and so does Te.

Reporting the reversal in GSTR-3B

Reversals under Rules 42 and 43, together with blocked credit under section 17(5), are reported in table 4(B)(1) of GSTR-3B for the month; other reversals go in 4(B)(2). Report the full eligible credit in 4(A) and the reversal in 4(B), so that net ITC in 4(C) matches your books. The annual Rule 42 difference is reported the same way in the month you settle it. See the GSTR-3B filing guide for the table layout.

Other ITC reversals, briefly

Rules 42 and 43 are about how credit is used. Other reversals are about something else going wrong:

• Blocked credits — items listed in section 17(5), such as most motor vehicles, food and personal consumption, are never eligible. See blocked credits under section 17(5).
• Unpaid suppliers — credit is reversed if the supplier is not paid within 180 days of the invoice. See the 180-day payment rule.
• Supplier has not paid the tax — reversal when the supplier has not filed their return or paid the tax on the supply. See Rule 37A ITC reversal.

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