Rule 42: inputs and input services
Credit that relates only to taxable or zero-rated supplies (T4) is kept in full. Credit that relates only to exempt supplies (T2) or to non-business use (T1), and credit blocked by s.17(5) (T3), is not available. What is left, C2, is common credit and is split by turnover:
- C1 = T − (T1 + T2 + T3); C2 = C1 − T4
- D1 = (E ÷ F) × C2, credit attributable to exempt supplies
- D2 = 5% of C2, only where common inputs are also used for non-business purposes
- C3 = C2 − (D1 + D2), the common credit you keep
D1 and D2 are added to output tax every month. If there was no turnover in the month, use E and F of the last period that had turnover. By s.17(3), exempt supply includes reverse-charge supplies, transactions in securities and sale of land and buildings, but excludes the other Schedule III items (from 1 October 2023). Rule 45 values securities at 1% of the sale value and land or buildings at stamp duty value. Interest on deposits and loans is left out of E, except for banks and financial institutions that earn it as a business. Source: Rule 42, CBIC tax repository.
Annual true-up under Rule 42(2)
After the year ends, D1 and D2 are worked out again on the full year's E, F and C2. If the final figure is higher than what you reversed month by month, the shortfall is added to output tax in a return no later than September's, with interest under s.50(1) at 18% from 1 April of the next year until you pay. If you reversed too much, take the excess back as credit in the same window. No interest is payable to you. The September GSTR-3B is due on 20 October (22 or 24 October under QRMP). For most ITC, 30 November is the outer limit under s.16(4). Do not wait for it for Rule 42 reclaims.
Rule 43: capital goods
Capital goods used only for exempt or non-business purposes get no credit. Those used only for taxable supplies get full credit. For common capital goods, the full credit A is taken on purchase, with a useful life of five years from the invoice date. Each month, Tm = A ÷ 60 for every common capital good still in its life. Tr is the total of those Tm. Te = (E ÷ F) × Tr is added to output tax for that month. A good that moves from exempt use to common use gets its credit after cutting 5 percentage points for every quarter or part of a quarter it was used. Source: Rule 43, CBIC tax repository.
Where it goes in GSTR-3B
Since the revised GSTR-3B (Notification 14/2022-CT and Circular 170/02/2022-GST), reversals under Rules 38, 42 and 43 and s.17(5) go in Table 4(B)(1) and are permanent. Table 4(B)(2) is for reversals you can reclaim later, such as Rule 37 non-payment. Reclaim excess Rule 42 reversal through 4(A)(5) and also show it in 4(D)(1). With the Invoice Management System, the full 2B credit flows into 4(A). Your Rule 42/43 reversal must still be entered by hand, because the portal does not know your exempt turnover.
Common questions
Is the 5% D2 reversal compulsory for every business?
No. D2 applies only where common inputs or input services are used partly for non-business purposes, such as a guest house used by directors or a shared vehicle. If nothing is used for non-business, D2 is nil. Credit used exclusively for non-business goes to T1 instead.
Do exports or supplies to SEZ count as exempt supplies?
No. Zero-rated supplies are taxable supplies for Rule 42. Their credit goes in T4, and their value stays in F but not in E.
Is interest due if I reversed too little during the year?
Yes. Rule 42(2)(a) adds the shortfall to output tax with interest at the s.50(1) rate (18%) from 1 April of the next year until payment. An excess reversal is reclaimed without interest, no later than the September return.
Should Rule 42 be applied separately for each GSTIN?
Yes. Turnover F is the turnover of the State or Union territory, so each registration works out its own D1, D2 and Te. Head-office input service distribution under Rule 39 comes before this.