Input tax credit

Also called: ITC · Topic: Taxation: Direct and Indirect Taxes, GST and Global Tax Issues · NCERT: Class 12, Ch 5 "Government Budget and the Economy"

Meaning

Input tax credit (ITC) is the credit a registered business gets for the GST it already paid on its purchases (inputs) at the previous stage of supply. It sets this credit off (subtracts it) against the GST it must pay on its own sales at the next stage.

• Formula: GST payable = Output tax − Input tax credit. Output tax is the GST charged on the business's own sales.
• Why it matters: ITC turns GST into a tax on value addition only. Value addition is the extra value each business adds to the product. Without ITC, tax would be charged on tax at every stage, which is cascading, and final prices would be higher.

Explanation

How the credit chain works

• Every seller in the chain collects GST on its sale. It then subtracts the GST it already paid when it bought its inputs.
• Only the tax on the new value it added reaches the government.
• Worked example at 18%:

Stage	Sale price	Output tax (18%)	ITC	Net GST paid
Manufacturer	₹100	₹18	₹0	₹18
Wholesaler	₹150	₹27	₹18	₹9 (18% of ₹50 value added)
Retailer	₹200	₹36	₹27	₹9 (18% of ₹50 value added)
Total to government				₹36 = 18% of ₹200

• The government gets exactly 18% of the final price of ₹200. The tax falls on the final consumer and is collected in small parts at each stage.
• Without ITC, tax cascades:
• The wholesaler would pay 18% on the full ₹150, and that ₹150 already contains the manufacturer's ₹18 of tax.
• So tax is charged on tax → costs rise at every stage → the final price is higher than ₹236.

ITC across states (IGST) and the order of use

• Inter-state example: a Tamil Nadu seller sells ₹1,000 of goods at 18% to a buyer in Uttar Pradesh.
• The seller pays ₹180 IGST (integrated GST, which the Centre levies on inter-state sales) to the Centre.
• The UP buyer uses this ₹180 as input credit when it pays its own tax in UP.

• The Centre then moves the state's share to UP, the consuming state. ITC is what makes the destination-based design work.

• Utilisation order (which credit is used first):

• IGST credit goes first: against IGST, then CGST, then SGST.
• CGST credit and SGST credit are used after that.
• CGST credit cannot pay SGST, and SGST credit cannot pay CGST. This keeps the Centre's money and the state's money separate.

When the credit is lost or gets stuck

• Blocked credits under Sec. 17(5): some purchases give no ITC, such as food, personal cars and personal consumption. These are final consumption, not business inputs.
• Composition scheme: small taxpayers who pay a flat rate on turnover (total sales) get no ITC. They also cannot pass any credit on to their buyers.
• Exempt and nil-rated supplies: no GST is charged on the sale, and no ITC is allowed on inputs. The input tax stays hidden inside the price.
• Items outside GST: the five petroleum products (crude oil, petrol, diesel, ATF and natural gas) are inside the GST law, but the Council has not yet notified a date to tax them. Electricity is also outside GST. So there is no ITC on fuel and power:
• A transport firm pays GST on its trucks but gets no credit for the tax on diesel.

• That tax becomes part of its cost → cascading remains in the system.

• Inverted duty structure: the tax on inputs is higher than the tax on the final product.

• Output tax is too small to use up all the credit → unused credit piles up with the business → its working capital (money needed for daily running) gets blocked.

In India

• Legal base: the 101st Constitutional Amendment Act, 2016 (assent 8 September 2016) made GST possible. GST was launched on 1 July 2017. ITC works under the CGST, SGST, UTGST and IGST Acts, and blocked credits are listed in Sec. 17(5).
• GST Council (Art. 279A) recommends the rates. Those rates decide whether the credit chain runs smoothly or gets inverted.
• Inverted duty after GST 2.0:
• The 56th GST Council meeting (3 September 2025) replaced four main slabs with two main rates: 5% (merit rate) and 18% (standard rate). It also added a 40% special rate for sin and luxury goods [2][4].
• The new rates came into force on 22 September 2025 [2][3].

• The rate cuts may make some inverted duty gaps worse. A refund mechanism covers such cases, and process changes are meant to speed up refunds [3].

• Technology that supports ITC:

• GSTN portal (www.gst.gov.in): registration, returns and payments are all done online.

• E-invoicing: each invoice is checked online and given an Invoice Reference Number (IRN), and returns are then filled in automatically. The turnover threshold was cut to ₹5 crore from August 2023.

• Scale: there were over 1.51 crore active GST registrations as of 30 April 2025 [5]. Gross GST collection hit a record ₹22.08 lakh crore in 2024-25 [5]. The need to claim ITC pushes businesses to buy from registered sellers, which helps formalisation (more businesses coming into the tax net).

Don't confuse with

• Zero-rated vs exempt/nil-rated supply: all three carry no GST on the sale. But zero-rated supplies (exports, supplies to SEZs) keep ITC, claimed as a refund or by exporting under a Letter of Undertaking (LUT). Exempt and nil-rated supplies lose ITC.
• Composition scheme: a composition dealer pays a flat rate on turnover (for example 1% for traders and manufacturers up to ₹1.5 crore). It gets no ITC and cannot pass on credit. A normal taxpayer pays output tax minus ITC.
• Reverse charge mechanism (RCM): RCM changes who pays the GST: the recipient pays instead of the supplier. ITC changes how much is paid, by subtracting tax already paid on inputs.
• Cascading effect: this is the problem, "tax on tax". ITC is the cure.

Prelims Hooks

• GST payable = Output tax − Input tax credit. With full ITC, total tax equals the GST rate × the final price (18% of ₹200 = ₹36).
• Order of use: IGST credit first (against IGST → CGST → SGST). CGST credit cannot pay SGST, and SGST credit cannot pay CGST.
• Blocked credits under Sec. 17(5): food, personal cars and personal consumption. Trap: GST paid on them is not creditable.
• Zero-rated (exports, SEZ supplies) keeps ITC. Exempt and nil-rated supplies do not.
• Composition dealers get no ITC and cannot make inter-state supplies.
• No ITC on the five petroleum products or electricity, because they are not taxed under GST. The petroleum products are within the GST law, but no date has been notified.

Mains Points

• The credit chain is incomplete:
• Petroleum and electricity are outside GST → no ITC on fuel and power → cascading continues in transport and manufacturing.

• Bringing them in needs Centre-state agreement on sharing revenue, which tests cooperative federalism.

• Simpler rates vs smooth credit:

• The 2025 move to 5%/18%/40% reduces classification disputes and lowers prices for consumers [2].

• But it can widen inverted duty gaps. Credit then piles up, MSMEs' working capital gets blocked, and faster refunds become critical [3].

• ITC as a tool for formalisation:

• Buyers can claim credit only on purchases from registered sellers → small firms have a reason to register → the tax base widens (1.51 crore registrations by 30 April 2025) [5].
• But composition dealers cannot pass on credit, so registered buyers may avoid them. This hurts the smallest firms.

Related concepts

• Goods and Services Tax
• Destination-based taxation
• CGST, SGST and IGST
• Reverse charge mechanism
• Composition scheme
• Zero-rated supply
• E-way bill
• E-invoicing
• Revenue neutral rate

Read more

• GST architecture: dual, destination-based, credit-linked