How is ITC passed on through the supply chain?

The passing of Input Tax Credit (ITC) through the supply chain is a fundamental principle under the Goods and Services Tax (GST) regime in India, designed to eliminate tax cascading and promote seamless credit flow from one taxpayer to another in the supply chain.

Under the GST system, each registered taxpayer can claim ITC on the taxes paid on inputs (goods and services), which they use to manufacture or provide goods or services. The ITC is passed on through the supply chain in such a way that the final consumer bears the final tax burden, while businesses in the supply chain merely pass on the tax they have paid on inputs, subject to certain conditions.

1. How ITC is Passed on through the Supply Chain:

The ITC mechanism works on a cascading principle where businesses along the supply chain pass on the benefit of ITC to the next entity in the chain until the goods or services reach the final consumer.

Step-by-step Flow of ITC:

1. Supplier to Manufacturer/Service Provider:
   • A manufacturer or service provider who receives taxable goods or services from a supplier can claim ITC on the tax paid to the supplier on inputs or input services (as long as these goods/services are used for business purposes).
   • The supplier must issue a tax invoice that contains all necessary details (e.g., GSTIN, tax rate, tax amount, and description of goods/services).
   • The ITC claimed by the manufacturer is passed down the supply chain and forms the base for the next buyer.
2. Manufacturer to Distributor/Wholesaler:
   • When a manufacturer sells finished goods to a distributor or wholesaler, the manufacturer charges GST on the sale, and the wholesaler can claim ITC for the tax paid on these goods, subject to the same conditions.
   • This creates a pass-through of credit as the wholesaler can offset the GST they have collected on their own sales using the ITC passed on by the manufacturer.
3. Distributor to Retailer:
   • The distributor or wholesaler selling goods to a retailer passes on the ITC to the retailer.
   • For this, the distributor issues a valid tax invoice, and the retailer can claim the credit on inputs used for making taxable supplies.
4. Retailer to Consumer:
   • The final retailer, who sells the goods or services to the end consumer, collects GST on the sale. However, the retailer has already used the ITC available from earlier stages in the supply chain to offset the GST paid on purchases.
   • The end consumer, being the final point in the supply chain, cannot claim any ITC, and thus bears the full tax burden.

This seamless flow of ITC through the supply chain ensures that businesses are not paying taxes on taxes (cascading effect), and only the value-added component is taxed at each stage of the supply chain.

Key Provisions for Passing ITC:

1. Section 16 of the CGST Act – Eligibility and Conditions for ITC:
   • ITC is available to a registered taxpayer if the goods or services are used for business purposes.
   • The taxpayer must possess a valid tax invoice or debit note and must have received the goods or services.
   • The supplier must have paid the tax to the government (this ensures the chain of credit is maintained).
2. Section 17 of the CGST Act – Apportionment of Credit:
   • Section 17 lays down the rules for apportionment of ITC when a taxpayer is engaged in both taxable and exempt supplies. ITC can only be claimed in proportion to the taxable supplies.
   • If a business is involved in mixed supplies (both taxable and exempt), ITC must be apportioned.
3. Section 37 and 38 – Matching of Invoices:
   • Section 37 requires the supplier to file GST returns (GSTR-1), which will provide details of the invoices issued to the buyer.
   • The buyer can claim ITC based on the details provided in GSTR-2A/2B, which is automatically generated and contains details of the invoices uploaded by the supplier.
4. Section 42 and 43 of CGST Act – Matching of Returns:
   • Section 42 provides for reconciliation of the returns filed by the buyer and the seller. If any discrepancy arises, the ITC claim may be denied until the mismatch is resolved.
5. Rule 36 of GST Rules – Conditions for Availing ITC:
   • This rule specifies that the ITC claimed by the taxpayer must match with the returns filed by the supplier in GSTR-1 and be reflected in GSTR-2A.
6. GST Invoice – The most essential document for passing ITC is a valid GST invoice. For ITC to pass through the chain, the invoices must be correctly uploaded and reported by both the buyer and the seller in the GST portal.

2. Landmark Cases Related to ITC and Its Flow through the Supply Chain:

Case 1: Mohammad Iqbal vs. Union of India (2018)

• In this case, the issue was whether the buyer could claim ITC when the seller had not deposited the GST to the government, even though a valid tax invoice was issued. The Supreme Court ruled that ITC is allowed only when the tax has been paid to the government by the supplier.
• This case reaffirmed that ITC can only be claimed when the tax paid by the supplier flows through the system, maintaining the integrity of the credit chain.

Case 2: Hindustan Coca Cola Beverages Pvt. Ltd. vs. Union of India (2009)

• In this case, the issue involved the reversal of ITC due to the non-payment of tax by the supplier. The Supreme Court held that the buyer, who had received goods and claimed ITC, could not be denied ITC if the supplier failed to remit the tax to the government.
• The ruling clarified that ITC could be passed through the chain even in cases of non-payment by the supplier, but reversal of ITC may be required if the supplier has defaulted.

Case 3: M/s. SKF India Ltd. (2014)

• The Bombay High Court in this case ruled that the credit of input taxes cannot be denied solely on the basis of technicalities in invoices or returns, as long as the goods were actually supplied and used for business purposes.
• This case highlighted the importance of allowing the flow of ITC through the chain provided the goods are used for business purposes, and the tax is ultimately paid to the government.

Case 4: Ravi Kumar Gupta v. State of Haryana (2020)

• The issue in this case was whether ITC can be claimed on goods used for both taxable and exempt purposes. The Haryana GST Tribunal ruled that businesses engaged in mixed supplies must apportion the ITC based on the ratio of taxable to exempt supplies.
• This case helped clarify the mechanism for apportionment of ITC when goods are used for multiple purposes (taxable, exempt, or non-business).

3. Conclusion:

In summary, ITC is passed through the supply chain under the GST regime in a seamless manner, ensuring that businesses only pay taxes on the value added at each stage of production or service provision. The primary provisions governing the flow of ITC are found in Section 16, Section 17, and Section 37 of the CGST Act, which outline the eligibility conditions, the mechanism for claiming ITC, and the necessary matching of invoices between buyers and sellers.

While there have been a few important court cases regarding ITC, they mainly focus on issues like the validity of invoices, reversal of ITC due to non-payment of taxes by the supplier, and the apportionment of credit in cases of mixed supplies. The legal framework ensures that ITC is passed down the supply chain smoothly, ensuring the ultimate consumer bears the final tax burden while avoiding tax cascading.