What Happens To Your ITC When Goods Become GST-Exempt With New GST Rates

With GST 2.0, many goods that earlier attracted 18% GST are now taxed at 12%, while others have been moved to the exempt category altogether. One of the most pressing questions for businesses is: "What happens to my accumulated Input Tax Credit (ITC) if my goods are now exempt from GST?"

Imagine you stocked up on goods, paying 12% GST on them. You planned to use this ITC to offset the tax on your final sales. But after 22nd September, your product is exempt as per the new GST rates. Now you might be wondering — what happens to the ITC you’ve already accumulated? Can it still be claimed?

This is a critical financial question that can significantly impact your cash flow and profitability. Let’s break down the rules in simple terms and explore how to manage this situation correctly, so your business stays compliant and financially healthy.

Understanding Input Tax Credit (ITC)

First, let's revisit the fundamental rule of ITC. The entire concept of ITC is built on a crucial condition is tied to this benefit: You can only claim ITC on inputs used to make taxable supplies.

If the final product you sell is exempt from GST, you are not collecting any tax from your customers. In such cases, the GST law doesn’t allow you to claim ITC on the goods linked to that product. This is where the concept of ITC reversal comes into play.

Your ITC in a rate change scenario

So, what happens when a product was taxable but becomes exempt? Your inventory and ITC records now straddle two different tax regimes.

Here’s the rule you need to follow:

You can only use the accumulated ITC for sales made up to September 21st, the day before the new exempt status takes effect. Any remaining ITC that pertains to the stock used for exempt supplies from September 22nd onwards must be reversed.

Let's take an example: Imagine you run a trading business,

• You purchased goods worth ₹10,00,000 on 10th September, paying 12% GST (₹1,20,000 ITC).
• You sold 60% of the goods before 21st September (while still taxable).
• Remaining 40% stock is unsold as of 22nd September.

Here’s what happens:

• For the 60% goods sold before 22nd September → You can utilize proportionate ITC (₹72,000).
• For the 40% goods lying in stock as of 22nd September → The proportionate ITC (₹48,000) has to be reversed, since the sales now fall under exempt supply.

Calculating the reversal amount

The tricky part isn't understanding the rule; it's implementing it. How do you accurately calculate the exact amount of ITC that needs to be reversed? It's not as simple as just reversing the entire closing balance.

The ITC to be reversed should be proportionate to the value of inputs held in stock on the day of the transition. This includes:

• Inputs as raw materials.

• Inputs contained in semi-finished goods.

• Inputs contained in finished goods.

Calculating this requires meticulous record-keeping. You need to identify precisely how much of your stock on hand is tied to the accumulated ITC. For a business with a large and varied inventory, this can be a complex and time-consuming task. Getting it wrong can lead to either paying more than you need to or facing penalties for incorrect reversal during an audit.

Step-by-step guide to managing ITC reversal

To navigate this process, follow these steps:

1. Identify all affected stock: On the date of the transition (September 22nd), conduct a thorough inventory count. List all raw materials, work-in-progress, and finished goods that will now be used to create exempt supplies.
2. Value the inputs: For each stock item, determine the value of the inputs and the corresponding ITC you claimed on them. This requires tracing back to your original purchase invoices.
3. Calculate the reversal amount: Sum up the total ITC related to the stock identified in step 1. This is the amount you are required to reverse
4. Record the reversal in your books: You must pass an accounting entry to debit your expenses (increasing your cost) and credit your ITC ledger (reducing your available credit). This ensures your financial statements accurately reflect the new cost structure.

Turn a challenge into a compliance win

Having your product become exempt is great for your customers, but it requires careful management of your accumulated ITC to avoid financial strain on your business. The requirement to reverse ITC on your closing stock is a non-negotiable compliance step.

While the calculation can seem daunting, the right tools can make all the difference. By leveraging TallyPrime’s powerful inventory and GST compliance features, you can automate the process, ensure accuracy, and handle the transition with confidence. Instead of spending days buried in spreadsheets, you can perform the necessary adjustments in a fraction of the time, knowing your business is fully compliant and your financial records are pristine.