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Rule 86B of GST: Restricting the use of ITC

Updated: Oct 6, 2023

The central government has added a new rule in the CGST Rules 2017 termed Rule 86B vide Notification No. 94/2020 – Central Tax, dated December 22, 2020, with the aim to curb fake invoice transactions. This rule restricts the use of ITC (Input Tax Credit) that is available in the electronic credit ledger on the payment of output tax up to 99 percent. This implies that businesses are now required to pay 1 percent of their output tax liability (OTL) in cash.

Understanding Rule 86B with an example

Let's understand the GST rule 86B with example -

A businessman makes a sale of goods valued at Rs 2 crore, and the tax rate on the goods is 14 percent. So as per rule 86B notification, the person is liable to discharge up to 99 percent of his tax liability through ITC and must pay Rs 28000 in cash.

Applicability of Rule 86B

Rule 86B is attached with a non-obstante clause. This implies that this rule overrides all other rules of GST from the date of its enforcement, i.e. 1st January 2021. This rule is applied under the following conditions -

  • The rule applies to GST-registered businesses whose goods in a month have more than 50 lakhs taxable value.

  • The taxable turnover will be exclusive of exempt and zero-rated supply.

  • A person should check the value of their goods each month while filing their GST returns.

  • The taxable turnover can be calculated as - Taxable turnover = Total turnover of the person - (Zero rated + exempted turnover)

Restrictions Imposed by the Rule 86B

The restrictions imposed according to the rule 86B notification are as follows -

  • It limits the use of Input tax credits or ITC in the electronic credit ledger for discharging the OTL.

  • If the registered person has a turnover of more than 50 lakhs in a month, they can only pay 99 percent of their OTL with their ITC.

  • The remaining one percent of the output tax is to be paid in the form of cash.

Utilisation of ITC before GST Rule 86B

Input tax credits, or ITC, is a crucial part of the GST filing process and has saved businesspersons from taxation's cascading effect. This credit which was stored in the electronic credit ledgers has been used by the business for the payment of OTL. Earlier, businesses were able to utilise ITC for the payment of taxes fully. Ever since Rule 86B came into effect, the usage of ITC balance towards the payment of output tax liability has been limited and this needs to be kept in mind while tax planning.

Exceptions to the Rule 86B

Rule 86B of CGST rules comes with some exceptions, which are as follows -

1. Any person mentioned in the list below, who has paid an annual income tax greater than one lakhs rupees under the IT Act of 1961 is exempted from this rule -

  • A registered person

  • Karta of HUF

  • Managing director of the business of the registered person

  • Whole-time directors or any partners (in the case of the firm)

  • Proprietor

2 .If a registered person received a refund of one lakh rupees or more in the last financial year, then this refund of unused ITC received towards export under the letter of undertaking or because of an inverted tax structure, will not be accounted for under Rule 86B.

3. When a registered person in question has paid his OTL using the electronic cash ledger of an amount that is more than 1 percent collectively of the entire OTL on the person in the given month in a given financial year.

4. The person is exempted from any tax if they hold any of the following offices -

  • Local authority

  • PSU

  • Statutory authority

  • Government department

Effect of Rule 86B on different types of Businesses

Rule 86B will have the following impact on businesses -

  • This new rule will have no impact on small-scale and micro businesses as it has a limit of 50 lakhs which applies only to large taxpayers.

  • The rule will reduce the unethical business practices such as creating counterfeit invoices that are later used for creating counterfeit input tax credits. They then use these fake ITCs to discharge their output tax liabilities.

  • This will also prevent fraudsters from displaying false high turnovers, which would lead to higher financial credibility.

  • The restrictions in the rule will also increase the compliance burden on the taxpayers.

Bottom line

The central government brought rule 86B to cut down on tax evasion and stop fake invoicing. However, it has created some problems for the genuine taxpaying large scale businesses that have come under the ambit of this law. These businesses generally run on very low margins of profits due to various industrial practices and are new in the trade. And if a business is taxed under this new rule, they need to get some expert advice on filing GST returns so that they know exactly how much they need to pay in taxes and how much tax exemptions they are eligible for.

Frequently Asked Questions

Q.1 When did Rule 86B come into effect?

Ans. Rule 86B of CGST rules came into effect on 1st January 2021.

Q2. What is the restriction listed under rule 86B?

Ans. Rule 86B restricts the usage of input tax credits (ITC) in the electronic digital ledger to 99 percent of the total ITC for payment of output tax. And the rest, one percent of the tax liability, must be paid in cash.

Q3. Who falls under the ambit of this new rule?

Ans. Any businessman whose taxable supply, excluding zero rate and exempt supply, is more than 50 lakhs for a particular month falls under the ambit of rule 86B.

Q4. Will this limit of one percent cash payments specified under rule 86B include reverse charge payments?

Ans. The reverse charge payment is not included under output taxes. So this is not included in the one percent cash payment, which only applies to output tax liability.

Q5. Can genuine taxpayers exempt themselves from the mandatory 1 percent cash payment?

Ans. Any authorised officer or a commission can remove the restrictions imposed by Rule 86B after proper verification of a company's accounts. Therefore, a genuine taxpayer should draft their representation and present it to the department, hoping to surpass the restriction of making 1 percent tax payments via cash.