GST on Capital Goods: Know About ITC, Conditions, and Compliance Essentials

Top Stories GST on Capital Goods: Know About ITC, Conditions, and Compliance Essentials Section 16(3) of the CGST Act lets taxpayers choose between ITC or depreciation on GST for capital goods, optimizing tax benefits By Kavi Priya – On January 26, 2025 10:12 am – 4 mins read Capital goods play an important role in business operations, especially in taxation under the Goods and Services Tax ( GST ). The CGST Act provides taxpayers with two options for handling the GST paid on capital goods.

Section 16(3) allows taxpayers to decide between capitalizing GST for depreciation under the Income Tax Act or claiming Input Tax Credit ( ITC ) under GST provisions. The choice depends on the taxpayer’s financial strategy, operational needs, and compliance considerations. Defining Capital Goods Under GST Capital goods, as defined in Section 2(19) of the CGST Act, refer to assets whose value is capitalized in the books of accounts and are used in the course of business to produce taxable supplies. Common examples include machinery, equipment, tools, and vehicles essential for production. Unlike consumables, these assets are used repeatedly and remain within the business. Complete Supreme Court Judgment on GST from 2017 to 2024 with Free E-Book Access, Click here GST Treatment for Capital Goods When capital goods are purchased, the GST paid on them presents taxpayers with two choices: capitalize it for depreciation under the Income Tax Act or avail of ITC. Each option has distinct implications for taxation and financial planning.

Capitalizing GST for Depreciation Under this approach, the GST paid is included in the capitalized value of the asset in the books of accounts. This inclusion allows depreciation to be claimed on the full cost (including GST) under Section 32 of the Income Tax Act. For example, if machinery costs Rs. 10,00,000 with GST of Rs. 1,80,000, the total value capitalized is Rs. 11,80,000. This option is advantageous for businesses with substantial taxable income under the Income Tax Act. It is particularly relevant for exporters who cannot claim GST refunds on capital goods since the goods remain in India while only the output is exported. Availing ITC on GST Paid Alternatively, taxpayers can claim the GST paid on capital goods as ITC.

In this case, only the base cost of the asset (excluding GST) is capitalized. Using the same example, the machinery would be capitalized at Rs. 10,00,000, while the GST of Rs. 1,80,000 would be recorded as ITC and used to offset GST liabilities. This method is ideal for businesses with significant GST liabilities or exporters opting for payment of IGST on exports to claim refunds under Section 54 of the CGST Act. Complete Supreme Court Judgment on GST from 2017 to 2024 with Free E-Book Access, Click here Considerations for Exporters Exporters face unique challenges with ITC on capital goods since these assets remain within India, making their GST component ineligible for direct refunds.

To optimize benefits, exporters can utilize the ITC for IGST payments on exports. After using the ITC, they can claim a refund for the IGST paid on export. For example, if an exporter purchases machinery costing Rs. 1,00,00,000 with GST of Rs. 28,00,000, they can utilize Rs. 20,00,000 from the ITC for IGST payments on exported goods and claim a refund for the same. The remaining Rs. 8,00,000 ITC is retained for future use. ITC Utilization Scenarios The use of ITC depends on how the capital goods are employed: Exclusive Business Use: When capital goods are used solely for taxable supplies, the entire GST paid is eligible for ITC.

Mixed Use: If capital goods are used for both business and personal purposes, ITC is calculated proportionately. The GST paid is divided over the asset’s useful life, typically 60 months (five years), and claimed monthly. For Exempt Supplies: ITC cannot be claimed if the capital goods are used exclusively for exempt supplies. For example, a flour mill producing unbranded flour exempt from GST cannot claim ITC on its machinery. Change in Usage: If capital goods initially used for exempt supplies are later utilized for taxable supplies, ITC can be recalculated based on the remaining useful life of the asset. Complete Supreme Court Judgment on GST from 2017 to 2024 with Free E-Book Access, Click here Reversal of ITC Certain scenarios necessitate the reversal of ITC: Switching to Composition Scheme: When a regular taxpayer opts for the composition scheme, any ITC claimed on capital goods must be reversed.

Cancellation of GST Registration: Businesses canceling their GST registration must reverse ITC on unutilized capital goods. Sale of Capital Goods: If capital goods are sold, ITC reversal is calculated based on the asset’s remaining useful life. A capital asset costing Rs. 1,00,000 with Rs. 18,000 GST was purchased on October 1, 2017. If the asset is used for exempt supplies for 5 quarters and later shifts to taxable use, ITC reversal for the 5 quarters equals: 18,000×5%×5 = Rs. 4,50018,000 \times 5\% \times 5 = Rs. 4,50018,000×5%×5 = Rs. 4,500

The remaining Rs. 13,500 is available for ITC. Compliance Requirements Taxpayers must adhere to specific compliance obligations when dealing with ITC on capital goods. For instance, when canceling GST registration, Form GSTR-10 must be filed to account for any ITC liabilities. Any change in the purpose of asset usage, such as a shift from exempt to taxable supplies, must be reflected in GST filings. Strategic Tax Planning The decision to capitalize GST for depreciation or claim ITC depends on the taxpayer’s financial goals. Businesses with high-income tax liabilities may prefer capitalizing GST and those with substantial GST liabilities benefit from claiming ITC. Exporters, in particular, should focus on utilizing ITC for IGST payments and claiming refunds to enhance cash flow. Conclusion Section 16(3) of the CGST Act offers flexibility in managing GST on capital goods, allowing businesses to optimize their tax strategy. By carefully evaluating their financial position and tax liabilities, taxpayers can choose the most beneficial option, ensuring compliance and maximizing efficiency in their operations.

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