GST Return Filing for Partially Exempt Businesses: How TaxBuddy Segregates Taxable and Exempt Turnover
- Rashmita Choudhary
- Jan 10
- 8 min read
Updated: Feb 9
Partially exempt businesses under GST deal with both taxable and exempt supplies, making return filing more complex than standard compliance. Incorrect segregation of turnover directly impacts Input Tax Credit eligibility and can lead to excess reversals, interest, or scrutiny. GST law requires a clear distinction between taxable, exempt, zero-rated, and non-taxable supplies while filing returns. Accurate classification and proportionate ITC reversal are essential to remain compliant with Section 17 of the CGST Act and Rules 42 and 43. Platforms like TaxBuddy simplify this process by automating turnover segregation and ITC calculations based on actual transaction data.
Table of Contents
Understanding GST for Partially Exempt Businesses
Partially exempt businesses under GST supply a mix of taxable and exempt goods or services within the same registration. While GST registration remains mandatory once threshold limits are crossed, Input Tax Credit cannot be fully claimed when exempt supplies exist. The law requires restricting ITC to the portion attributable to taxable and zero-rated supplies. This framework is governed by Section 17 of the CGST Act and implemented through Rules 42 and 43. Businesses commonly affected include healthcare providers with pharmacy sales, educational institutions offering taxable services, real estate developers, banks, NBFCs, and traders dealing in exempt goods alongside taxable products.
What Counts as Taxable, Exempt, and Zero-Rated Turnover Under GST
Taxable turnover includes supplies chargeable to GST at applicable rates such as 5%, 12%, 18%, or 28%. Exempt turnover includes nil-rated supplies, supplies wholly exempt under notifications, and non-taxable supplies such as alcoholic liquor for human consumption. Zero-rated supplies, primarily exports and supplies to SEZ units or developers, are treated as taxable for ITC purposes despite a 0% tax rate. Exempt turnover also includes the value of land and building transactions based on stamp duty value and a notional value of securities calculated at 1% of the sale value, even though GST is not levied on them.
ITC Restriction Rules for Partially Exempt Businesses Under GST
Section 17(2) mandates that ITC must be restricted to the portion attributable to taxable and zero-rated supplies. ITC relating exclusively to exempt supplies is fully ineligible. ITC relating exclusively to taxable supplies is fully eligible. Common ITC, which cannot be directly attributed, must be proportionately reversed. This rule ensures that GST credit benefits are not availed on exempt or non-taxable activities. Non-compliance can lead to interest liabilities, reversals, and notices during audits or assessments.
Common ITC Reversal Calculation Under Rule 42 for Services and Inputs
Rule 42 prescribes a formula-based method to reverse common ITC. Businesses must first segregate exclusive credits, then identify common eligible credits. The proportionate reversal is calculated using the ratio of exempt turnover to total turnover. The formula applies monthly or quarterly, depending on the return cycle. A final adjustment is mandatory in the September return following the end of the financial year, based on actual annual turnover figures. Any shortfall attracts interest, while excess reversal may be reclaimed.
Capital Goods ITC Reversal Rules Under Rule 43
For capital goods used for both taxable and exempt supplies, ITC is not reversed upfront. Instead, the credit is spread over 60 months. Each month, a portion of ITC is attributed to exempt supplies using the exempt-to-total turnover ratio. This ensures long-term assets such as machinery, equipment, or property are fairly apportioned. Except for specific real estate cases, no annual reconciliation is required for capital goods once monthly reversals are correctly applied.
Treatment of Schedule III Activities in Exempt Turnover
Schedule III activities are neither treated as a supply of goods nor a supply of services. Examples include employee salaries, services by a court or tribunal, and functions performed by MPs or MLAs. These activities are generally excluded from exempt turnover for ITC reversal purposes. However, the value of land and building transactions listed under Schedule III must still be included in exempt turnover calculations. From 1 October 2023, duty-free shop supplies are also included for reversal purposes, tightening compliance for affected businesses.
GST Return Filing Requirements for Partially Exempt Businesses
Partially exempt businesses must file GSTR-1 and GSTR-3B regularly if registered under GST. Exempt turnover must be disclosed separately in outward supply details. ITC reversals must be reported in Table 4(B) of GSTR-3B. NIL returns are allowed only when there are no supplies at all. Annual return GSTR-9 is not mandatory for businesses with aggregate turnover up to ₹2 crore from FY 2024-25 onwards, reducing compliance burden for smaller entities.
How TaxBuddy Segregates Taxable and Exempt Turnover Accurately
TaxBuddy uses invoice-level classification to distinguish taxable, exempt, zero-rated, and non-taxable supplies. Uploaded invoices are mapped using HSN and SAC codes, enabling automated turnover segregation. The system applies Rule 42 and Rule 43 formulas accurately, reflects ITC reversals directly in GSTR-3B, and flags mismatches before filing. This structured approach reduces manual errors and ensures consistency across monthly and annual filings.
Handling Special Scenarios Like Real Estate, Banking, and Multi-Project Businesses
Real estate projects require ITC apportionment based on carpet area and project-wise segregation. Banks and NBFCs may opt for a flat 50% ITC reversal instead of detailed calculations under Section 17(4). Businesses operating multiple projects or locations must reasonably allocate common inputs across units. In such scenarios, accurate record-keeping and system-driven allocation are essential to avoid excess reversals or departmental disputes.
Latest GST Updates Affecting Partially Exempt Businesses in 2025
From FY 2024-25 onwards, one of the most significant compliance reliefs for small and mid-sized businesses is the exemption from filing GSTR-9 for taxpayers with aggregate turnover up to ₹2 crore. This change reduces the annual compliance burden for partially exempt businesses that already manage complex monthly ITC reversals and turnover segregation. Although the annual return is no longer mandatory for this category, monthly or quarterly filings such as GSTR-1 and GSTR-3B continue to remain compulsory, along with accurate reporting of exempt turnover and ITC reversals.
Another important development relates to clarifications around Schedule III transactions. Certain activities that were earlier treated ambiguously are now clearly considered for ITC reversal purposes. Transactions involving land and buildings are explicitly included in exempt turnover calculations, even though they are neither a supply of goods nor services. Additionally, duty-free shop supplies, effective from October 2023, are required to be considered while computing exempt turnover for ITC reversal. These clarifications have increased the scope of transactions impacting proportionate ITC reversal for partially exempt businesses.
While the fundamental framework of ITC segregation under Section 17 and Rules 42 and 43 remains unchanged, enforcement has become more data-driven. Enhanced reconciliation systems, tighter return matching, and improved backend analytics are enabling tax authorities to identify inconsistencies between outward supplies, exempt disclosures, and ITC claims more efficiently. Mismatches that earlier went unnoticed are now more likely to trigger scrutiny, notices, or audit queries.
As a result, accurate classification of taxable, exempt, zero-rated, and non-taxable supplies has become more critical than ever. Businesses relying on estimates or manual segregation face higher compliance risk in the current environment. Consistent reporting, proper documentation, and timely ITC reversals are essential to ensure GST filings remain aligned with the updated compliance landscape in 2025.
Conclusion
GST compliance for partially exempt businesses depends heavily on correct turnover classification and proportionate ITC reversal. Errors in segregation can compound over time and lead to interest and litigation. System-driven compliance and structured reconciliation reduce these risks and ensure returns remain aligned with statutory provisions. For anyone looking for assistance in tax filing, downloading the TaxBuddy mobile app offers a simplified, secure, and hassle-free experience.
FAQs
Q. Does TaxBuddy offer both self-filing and expert-assisted plans for ITR filing, or only expert-assisted options?
TaxBuddy offers both self-filing and expert-assisted plans. The self-filing option is suitable for straightforward tax situations where income sources and deductions are simple and well-documented. Expert-assisted plans are designed for cases involving multiple income streams, capital gains, foreign assets, GST-linked income, or prior notices. This flexibility allows taxpayers to choose the level of assistance based on complexity rather than forcing a single filing approach.
Q. Which is the best site to file ITR?
The best site to file an income tax return is one that ensures accuracy of calculations, secure handling of financial data, and reliable post-filing support. While the official income tax portal allows direct filing, many taxpayers prefer platforms that provide validation checks, guided workflows, and error alerts. A good filing platform should also help with revisions, responses to notices, and reconciliation issues after submission.
Q. Where to file an income tax return?
Income tax returns can be filed directly on the official income tax e-filing portal of the Government of India. Alternatively, authorised tax filing platforms can be used to prepare and submit returns on behalf of the taxpayer. These platforms typically integrate tax computation, document upload, validation, and e-verification in one workflow, reducing manual errors and missed disclosures.
Q. Is ITC reversal mandatory every month for partially exempt businesses?
Yes, for partially exempt businesses, provisional ITC reversal is mandatory for each tax period in which common inputs or input services are used. The reversal must be calculated monthly or quarterly based on the exempt-to-total turnover ratio. This ensures that ineligible credit is not carried forward. A final reconciliation is then required after the end of the financial year using actual turnover figures.
Q. Are exports treated as exempt supplies for ITC reversal?
No, exports are classified as zero-rated supplies under GST and are treated as taxable supplies for ITC purposes. This means ITC attributable to exports is fully eligible and should not be reversed. Zero-rated supplies are excluded from the exempt turnover while calculating ITC reversal ratios under Rule 42 and Rule 43.
Q. Is alcohol considered exempt turnover for GST reversal?
Yes, alcoholic liquor for human consumption is a non-taxable supply under GST. Even though GST is not levied on alcohol, its turnover must be included in the exempt turnover for the purpose of ITC reversal. Businesses dealing in alcohol alongside taxable supplies must proportionately reverse ITC on common inputs and services.
Q. Are Schedule III activities always excluded from reversal calculations?
Most Schedule III activities are excluded from ITC reversal calculations because they are neither a supply of goods nor services. Examples include employee salaries and services by courts or tribunals. However, land and building transactions listed under Schedule III must be included in the exempt turnover for ITC reversal. Certain notified inclusions, such as duty-free shop supplies from October 2023, also impact reversal calculations.
Q. Is interest applicable for delayed ITC reversal?
Yes, interest is applicable if ITC reversals are short-paid or delayed. If a business fails to reverse ineligible ITC on time or reverses a lower amount than required, interest is calculated from the due date of return filing until the date of payment. This makes timely and accurate reversal critical to avoid additional financial exposure.
Q. Can ITC reversed earlier be reclaimed later?
Yes, if provisional ITC reversal during the year exceeds the actual amount required based on annual turnover, the excess reversed credit can be reclaimed. This adjustment is made in the return filed for September, following the end of the financial year. Proper reconciliation is essential to ensure eligible credit is not permanently lost.
Q. Are capital goods ITC reversals permanent?
No, ITC on capital goods is not permanently reversed upfront. Instead, the credit is spread over a period of 60 months. Each month, a portion of ITC attributable to exempt supplies is reversed based on the turnover ratio. This ensures that long-term assets are fairly apportioned based on actual usage over time.
Q. Do partially exempt businesses need to file GSTR-9?
Partially exempt businesses are required to file GSTR-9 only if their aggregate turnover exceeds ₹2 crore. From FY 2024–25 onwards, businesses with a turnover of up to ₹2 crore are exempt from filing GSTR-9. However, regular monthly or quarterly returns such as GSTR-1 and GSTR-3B remain mandatory.
Q. Does automation reduce GST notices?
Yes, automation significantly reduces GST notices by minimising mismatches between outward supplies, ITC claims, and reversal disclosures. Automated classification, system-driven calculations, and return-level validations help ensure consistency across filings. This reduces common triggers for scrutiny, such as incorrect ITC claims, turnover mismatches, and reporting errors.
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