GST Input Tax Credit Changes Will Hurt Corporate Cash Flow
Matching of input tax credit under the Goods and Services Tax became more complex and burdensome for taxpayers on Jan. 1, as recent changes to the law came into effect.
A crucial amendment has been introduced under Section 16 of the Central Goods and Services Tax Act, 2017, which mandates the filing of return by the supplier, and communication thereof of such filing to the recipient, to avail the credit. While this sounds simple enough, in the absence of a proper credit-matching facility on the GST portal, the recipient taxpayer has been made to suffer nightmares to faultlessly perform the matching exercise.
At the time of GST implementation in 2017, the new indirect tax came with the promise of automatic matching of credit on the GST portal. Alas, that was never implemented.
On the contrary, the government introduced a series of amendments in the law to ensure that the reconciliation which the portal failed to do, is done by taxpayers themselves, using whatever tool at their disposal.
The ITC Muddle
Among these amendments, a crucial one which compelled taxpayers to start matching credit manually was the introduction of Rule 36(4) in Central Goods and Services Tax Rules, 2017 – which restricted ITC in respect of unmatched invoices to a specified percentage of matched invoices. It was notified in October 2019. Subsequently, the ITC permitted to be claimed on unmatched invoices was reduced, from 20% of matched invoices, to 5%.
Even while this curb on claiming ITC has been challenged in court, on grounds that the Rule 36(4) is unconstitutional as it is not backed by a substantive provision in law, most taxpayers have been following it to avoid negative consequences such as denial of credit and the interest and penalties that follow.
In November 2020, the government introduced a new form GSTR-2B on the GST portal, containing details of ITC based on the invoices reported by suppliers in their outward supply statement in GSTR-1.
This was introduced as a static statement to be available a day after the due date of furnishing GSTR-1. The government also added a detailed advisory on how to match the credit using GSTR-2B while keeping the option of GSTR-2A (which is the dynamic statement) intact on the portal. Post introduction of GSTR-2B, taxpayers have been receiving demand notices for ITC taken in GSTR-3B that exceeds the amount in GSTR-2B.
The 2022 ITC Twist
On Jan. 1, an amendment to Section 16 of the CGST Act came into effect. It gives legislative backing to Rule 36(4) thereby countering the argument of unconstitutionality. It also clarifies which Form (GSTR-2A or GSTR-2B) is to be used for the matching exercise.
The amended is a powerful tool for tax authorities to deny ITC if invoice is not reported by the supplier in its GSTR-1. Rule 36(4) is also amended to allow only the matched credit to the recipient and the earlier provision which allows certain percentage of unmatched credit also stands removed.
Consequences For Taxpayers
The following points are critical to note:
With effect from Jan. 1, 2022, unless the respective supplier has filed his returns on time, the taxpayer has no ability to claim ITC [as opposed to the past position where either it was legally debatable or some ITC was available under Rule 36(4)].
GSTR-2B is a static document which is generated one day after the due date of filing of GSTR-1 (i.e., on the 12th of every month). Hence, a taxpayer’s eligible credit gets decided and locked on the 12th while the actual credit availment and the consequent tax payment is required to be made on the 20th (i.e., the due date of filing GSTR-3B). Hence, any late filing by the supplier between 13th and 20th will not reflect in GSTR-2B to the taxpayer in that month but it will go to the subsequent month’s GSTR-2B.
Even if taxpayers are able to match GSTR-3B with GSTR-2B for the month, there is still a possibility that the supplier may end up not paying GST. There is no mechanism for a recipient to ascertain whether the tax has been paid by the supplier. This could result in a scenario where the department chases the unsuspecting recipient for recovery of tax who in turns chases after the actual tax evader, i.e., the supplier.
In case the department denies the credit to the recipient and recovers unpaid tax from the supplier, there is no mechanism for the recipient to avail credit of such tax.
The rampant blockage of ITC by the tax authorities because of mismatch issues will only see an increase now. It is also sometimes seen that the ITC blocked amount is higher than the mismatched amount. This could therefore also lead to cash flow issues where taxpayers could be forced to pay GST in cash despite having ITC.
The tax authorities have already been rejecting export refunds of ITC which has remained mismatched. This amendment will now give more teeth to such rejections.
The amendment will significantly affect a taxpayer’s ability to avail credit based on invoices received in its books and will also negatively affect cash flows due to the introduction of GSTR-2B under Rule 36(4) wherever there is a delayed filing of returns by the vendor.
If GST amount is paid to the vendor without a corresponding entry in GSTR-2B and subsequently the vendor does not report the invoice in its outward returns, the credit taken by the recipient will have to be reversed leading to a bottom-line loss. If credit is not reversed for any reason, taxpayers are likely to receive demand notices from the tax authorities for reversal of credit, interest, and penalty thereon.
Under the earlier VAT laws, courts have, on occasion, taken a lenient view in favour of a bonafide buyer on disallowance of credit by the department due to non-payment by the supplier. However, GST is a different law, and the ever-changing provisions of GST are yet to go through the grind of legal scrutiny which may take some time.
In the meantime, how do taxpayers safeguard themselves from the denial of credit, interest, and penal consequences?
Clearly, taxpayers are required to put an immediate focus on monthly reconciliation of ITC with GSTR-2B. Considering the volumes involved and the kind of errors that have been seen in carrying out such reconciliation, this is not going to be an easy exercise.
There is a need for extensive automation whereby such reconciliation is automated, and errors are reduced.
Steps such as not paying GST till reflected in GSTR-2B, immediate action against defaulting suppliers, contractual changes to recover GST amount at a later stage, maintaining a vendor rating for vendors through automation etc. are some of the key steps that taxpayers need to start thinking about.
At the same time, there is a need to balance between the potential loss of ITC and business urgencies forcing taxpayers to make payments without waiting for filing of returns.
Ritesh Kanodia is Partner, and Smruti Amin is Senior Associate, at Dhruva Advisors LLP.
The views expressed here are those of the authors and do not necessarily represent the views of BloombergQuint or its editorial team.