Rule 42 of the CGST Rules requires reversal of input tax credit on inputs and input services that are used commonly for taxable and exempt (or non-business) supplies. The exempt-attributable portion (D1) and a 5% deemed non-business portion (D2) are added back to output tax liability each month and recomputed annually.
When Rule 42 applies
Rule 42 applies where a registered person uses inputs or input services partly for taxable supplies (including zero-rated) and partly for exempt supplies or for non-business purposes. Credit that is exclusively for taxable supplies is fully available; credit exclusively for exempt or personal use is fully blocked. The difficulty is the common credit, which Rule 42 apportions.
"Exempt supply" for this purpose includes nil-rated, wholly exempt and non-taxable supplies, and certain items like the sale of land/building and securities, computed per the Explanation to Rule 42/43.
The formula step by step
| Symbol | Meaning |
|---|---|
| T | Total input tax on inputs and input services in the period |
| T1 | Input tax exclusively for non-business purposes |
| T2 | Input tax exclusively for exempt supplies |
| T3 | Blocked credit under Section 17(5) |
| C1 | T − (T1 + T2 + T3) |
| T4 | Input tax exclusively for taxable + zero-rated supplies |
| C2 | Common credit = C1 − T4 |
| D1 | Exempt-attributable reversal = C2 × (E ÷ F) |
| D2 | Deemed non-business reversal = 5% of C2 |
| C3 | Eligible common credit = C2 − (D1 + D2) |
Here E = aggregate exempt turnover and F = total turnover in the State for the period. D1 and D2 are added to output tax liability.
Worked example
Common credit C2 = Rs.1,00,000. Exempt turnover E = Rs.20,00,000; total turnover F = Rs.1,00,00,000.
- D1 = 1,00,000 × (20,00,000 ÷ 1,00,00,000) = Rs.20,000
- D2 = 5% × 1,00,000 = Rs.5,000
- Eligible common credit C3 = 1,00,000 − 25,000 = Rs.75,000
D1 + D2 = Rs.25,000 is reversed (added to output liability) for the month.
Annual recomputation and Rule 43
The monthly reversals are recomputed for the whole financial year by 30 September of the following year (along the GSTR-9 timeline). If the annual reversal exceeds the sum of monthly reversals, the difference is paid with interest; if lower, the excess is reclaimed. Rule 43 applies the same logic to capital goods, spreading the credit over 60 months (useful life of five years).
Key takeaways
- Rule 42 apportions common ITC between taxable and exempt/non-business use.
- D1 = C2 × exempt/total turnover; D2 = 5% of C2.
- Zero-rated supplies are taxable turnover, not exempt.
- Recompute annually by 30 September; Rule 43 covers capital goods over 60 months.