The Input Tax Credit (ITC) mechanism, which is a part of the Goods and Services Tax (GST) has redefined the indirect tax system in India. ITC allows businesses to offset taxes paid on inputs, input services, and capital goods (assets that a business uses for its operations or production) against their output tax liabilities. It helps them reduce their overall tax burden. 

However, the process of claiming ITC on capital goods, particularly the possibility of obtaining refunds for unutilized ITC, creates a lot of issues for businesses. This article covers the details of ITC on capital goods, exploring eligibility criteria, legal provisions, refund policies, and more.

Understanding Capital Goods under GST

Under GST, capital goods are defined as goods that are used or intended to be used in business activities, that are capitalized in the books of accounts of an enterprise. Capital goods are meant for long-term use. 

Unlike inputs or input services, capital goods have a longer economic life and are not consumed immediately in the production process. Some examples of capital goods include equipment, machinery, plant, or vehicles, used for business purposes. 

ITC Eligibility Criteria & Conditions for Capital Goods

For businesses to claim ITC on capital goods, certain conditions must be met:

• Registered Taxpayers: Only businesses that are GST-registered taxpayers are eligible for availing ITC on their capital goods. 
• Exclusive Use for Taxable Supplies: ITC is fully available if the capital goods are used only for taxable supplies. If a business uses it for both i) taxable ii) exempt supplies, it needs to claim it in proportion to the turnover ratio.
• Capitalization in the Books of Accounts: The business should be capitalizing its capital goods in the financial records. 
• Depreciation on Tax Component: ITC cannot be claimed if the tax component of the capital goods has been included in the depreciation claimed under the Income Tax Act. This ensures that businesses do not receive double benefits.
• Personal Use or Exempt Sales: No ITC is available for capital goods used solely for personal purposes or for making exempt supplies. Businesses cannot claim ITC on goods (except for machinery & plant) used for building immovable property as well. The ITC which is not eligible should be mentioned in GSTR-3B and not put into the credit ledger of the business. 

Additionally, businesses should ensure that they’re claiming ITC as per the due date. Proper documentation, like accurate bookkeeping and tax invoices, is needed to avail ITC. You can take the help of professional taxation services to understand the eligibility of your business. 

Legal Framework Governing ITC on Capital Goods

The eligibility and utilization of ITC on capital goods are governed primarily by Sections 16 and 17 of the CGST Act among many others:

• Section 16: Provides details about the eligibility as well as the conditions for claiming ITC and highlights that a registered individual has the right to take credit of input tax charged on any supply of goods or services, like capital goods, used for business purposes.
• Section 17(5): This section of the act lists the circumstances under which ITC is blocked, which means that you cannot claim ITC under GST. such as goods used for personal consumption or exempt supplies.
• Proportional ITC: For goods used partially for business and partially for other purposes, ITC is allowed only to the extent of the taxable supply.

Provisions under the IGST Act for Zero-Rated Supplies

Section 16 of the IGST Act provides special provisions for zero-rated supplies, such as exports and supplies to Special Economic Zones (SEZs). 

Businesses making zero-rated supplies can claim ITC even if their output tax liability is zero. However, refunds for ITC on capital goods are typically excluded under current rules, causing liquidity challenges for exporters and SEZ suppliers.

Refund of Unutilized ITC on Capital Goods

Refund of unutilized ITC is generally permitted for inputs and input services. However, ITC accumulated on account of capital goods is typically excluded from refund eligibility, as per the provisions of Rule 89(4). This is because rule 89(4) of the CGST Rules excludes capital goods from the definition of “Net ITC.” 

As a result, businesses cannot claim refunds for ITC accumulated due to the purchase of capital goods, even when such goods are used exclusively for zero-rated supplies.

Implications for Businesses

1. Zero-Rated Supplies: Exporters and SEZ suppliers are particularly affected, as they are unable to recover substantial ITC tied up in capital goods. This affects their financial planning and cash flow. 
2. High Capital Expenditure: Industries like manufacturing, power generation, and logistics, which require huge amounts of investment in machinery and equipment, face increased financial strain because of blocked ITC.

Conclusion

The GST framework is transformative but it has certain limitations that impact the business community, particularly regarding ITC on capital goods. The current provisions restricting refunds for unutilized ITC on capital goods create financial challenges, especially for exporters and industries with significant capital expenditure. The solution is here to strategically plan the cash flows to survive and maintain business efficiency. 

For this, you can get in touch with us. At GJM & Co, we help you with everything related to Financing, Taxation, Business Formation, Payroll Management, Bookkeeping and Accounting Services, and more. Call us or email us at info@gjmco.com.