Can ITC be claimed on exempt supplies?

In the context of Indirect Taxation in India, ITC refers to Input Tax Credit, which allows businesses to offset the tax paid on inputs (goods or services) against the tax they collect on their output (sales). This is a critical aspect of the Goods and Services Tax (GST) regime in India, introduced in 2017.

1. Can ITC be claimed on exempt supplies?

No, Input Tax Credit (ITC) cannot be claimed on exempt supplies under the GST regime. Exempt supplies are those goods or services which are not subject to GST, or are subject to nil or 0% tax rates. As a result, any tax paid on purchases related to these exempt supplies cannot be used to offset the tax liability on the sale of taxable goods or services.

Provision under GST Law (Section 17): The provisions regarding ITC on exempt supplies are governed by Section 17 of the Central Goods and Services Tax Act, 2017 (CGST Act). It states that ITC is not available on inputs or input services used to make exempt supplies.

Section 17(2) of the CGST Act:
- It clearly provides that ITC is not available for the supply of goods or services that are exempt from GST.
- If a business makes both taxable and exempt supplies, it must calculate the proportion of credit it is eligible to claim, and this is governed by Section 17(3) of the CGST Act, which relates to apportionment of credit.

Section 17(2) of CGST Act:

“A registered person shall not be entitled to take credit under section 16 (of the CGST Act) on any supply of goods or services or both to the extent they are used for making exempt supplies.”

2. Treatment of ITC on Exempt Supplies:

Full ITC cannot be claimed on goods or services used to make exempt supplies.
For businesses making mixed supplies (both taxable and exempt supplies), they are required to apportion the ITC between the taxable and exempt supplies. This is done based on the proportion of taxable and exempt turnover, and the apportionment method is outlined in the GST Rules (Rule 42 and Rule 43).
The Input Tax Credit (Apportionment) Rules (Rules 42 and 43) help determine the proportion of credit available when a taxpayer has both taxable and exempt supplies. The unclaimed ITC on exempt supplies is transferred to a ‘credit ledger’ and cannot be used to offset tax liability.

3. Section 17(3):

This section refers to the restricted ITC available to a taxpayer who deals with both taxable and exempt supplies (mixed supply). Here, businesses must maintain proper documentation and records of both taxable and exempt supplies to correctly calculate the available ITC.

4. GST and Exempt Supplies – Practical Example:

If a business makes taxable sales (subject to 18% GST) but also engages in the sale of exempt services (like educational services, healthcare services, or services related to agriculture), it cannot claim ITC for the tax paid on purchases used for the exempt supply portion of its business. Only the ITC related to taxable supplies can be used.

5. Landmark Cases Related to ITC and Exempt Supplies:

While there aren’t many landmark cases specifically related to ITC on exempt supplies, there are several important cases and rulings by the Authority for Advance Rulings (AAR) that deal with the eligibility and restrictions on claiming ITC, especially in cases where businesses make both taxable and exempt supplies.

Case 1: M/s. Indian Oil Corporation Ltd. (2018)

This case dealt with the issue of whether a company could claim ITC on input services used to make exempt supplies (in this case, the sale of petroleum products). The ruling emphasized that if the goods or services are exempt from GST, ITC on them cannot be claimed under Section 17 of the CGST Act.

Case 2: M/s. Bharti Airtel Ltd. (2020)

This case involved whether Airtel could claim ITC for input services used in the provision of exempt services (such as telecommunications to charitable organizations). The ruling clarified that Airtel could not claim ITC on those services used exclusively for exempt supplies under the GST provisions.

Case 3: Commissioner of GST v. M/s. Sony India Pvt. Ltd. (2020)

This ruling dealt with the apportionment of Input Tax Credit (ITC) in the case where the taxpayer made both taxable and exempt supplies. The case reinforced the principle that businesses making mixed supplies need to apportion the ITC between the taxable and exempt portions.

6. Conclusion:

In summary, under the GST regime, ITC cannot be claimed for goods or services used to make exempt supplies. The provisions governing this are in Section 17(2) and Section 17(3) of the CGST Act. Businesses that make both taxable and exempt supplies are required to apportion the credit they are entitled to claim, and the unutilized ITC for exempt supplies cannot be offset against taxable liabilities.

This approach ensures that businesses are not able to claim credit for taxes paid on inputs that are used in exempted or non-taxable supplies, maintaining the integrity of the tax system and avoiding tax cascading.