Rule 86B of GST: Restricting the use of ITC

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.

---

Table of content

Understanding Rule 86B of CGST: Restrictions on Input Tax Credit Utilization

Practical Examples to Illustrate Rule 86B

Applicability of Rule 86B

Key Restrictions Imposed by Rule 86B

Restrictions Imposed by the Rule 86B

Objectives Behind Implementing Rule 86B

Utilisation of ITC before GST Rule 86B

Exceptions to Rule 86B

Consequences of Non-Compliance with Rule 86B

Impact of Rule 86B on Different Types of Businesses

Effect of Rule 86B on different types of Businesses

Bottom line

Most Asked Questions

---

Understanding Rule 86B of CGST: Restrictions on Input Tax Credit Utilization

The Central Goods and Services Tax (CGST) Act introduced Rule 86B through Notification No. 94/2020 dated December 22, 2020, effective from January 1, 2021. This rule aims to curb tax evasion and the misuse of Input Tax Credit (ITC) by imposing restrictions on its utilization. Let’s delve deeper into the intricacies of Rule 86B.

Practical Examples to Illustrate Rule 86B

To illustrate how Rule 86B operates:

• Example: A taxpayer, Mr. A, makes sales valued at ₹1 crore with a tax rate of 12%. According to Rule 86B, Mr. A can discharge up to ₹1,18,800 (99% of ₹12,000) through ITC and must pay ₹12,000 in cash.

Applicability of Rule 86B

Rule 86B applies to registered persons under the GST regime whose taxable value of supplies (excluding exempt and zero-rated supplies) exceeds ₹50 lakh in a particular month. It is crucial for businesses to assess their taxable turnover monthly before filing GST returns to determine if they fall under this rule. 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)

Key Restrictions Imposed by Rule 86B

Under Rule 86B, applicable registered persons cannot utilize ITC exceeding 99% of their total output tax liability. In simpler terms, businesses with a monthly taxable turnover above ₹50 lakh are required to pay at least 1% of their output tax liability in cash. This restriction effectively limits the usage of ITC accumulated through purchases.

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.

Objectives Behind Implementing Rule 86B

The introduction of Rule 86B is primarily aimed at combating tax evasion and fraudulent practices within the GST framework. By imposing restrictions on the utilization of Input Tax Credit (ITC), the government seeks to address the growing concern over fake invoicing schemes that allow unscrupulous businesses to claim ITC without legitimate transactions.

The rule mandates that registered persons with a taxable turnover exceeding ₹50 lakh in a month must pay at least 1% of their output tax liability in cash, thereby reducing reliance on potentially fraudulent ITC claims. This measure not only strengthens compliance but also promotes a fairer tax environment by ensuring that only genuine transactions contribute to tax credits.

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 Rule 86B

While Rule 86B applies broadly, certain exceptions allow specific taxpayers to bypass these restrictions:

1. High Income Tax Payments: If a registered person or their key stakeholders (proprietor/karta/managing director/partners) have paid income tax exceeding ₹1 lakh in each of the preceding two financial years, they are exempt from this rule.

   
   

2. Refund Recipients: Registered persons who received a refund greater than ₹1 lakh in the previous financial year due to exports under LUT or an inverted tax structure are also exempt.

   
   

3. Excess Cash Payments: If a registered person has discharged their output tax liability by electronic cash ledger for an amount exceeding 1% cumulatively during the current financial year, they may be exempt.

   
   

4. Government Bodies: Statutory bodies such as government departments, public sector undertakings, local authorities, and statutory authorities are not subject to the restrictions imposed by Rule 86B.

   
   

5. Discretionary Powers of Commissioner: The Commissioner or authorized officials can remove restrictions on a case-by-case basis after due verification.

Consequences of Non-Compliance with Rule 86B

Failing to comply with Rule 86B can lead to penalties and increased scrutiny from tax authorities. Businesses must ensure they adhere to these regulations to avoid potential legal issues.

Impact of Rule 86B on Different Types of Businesses

This rule primarily impacts large businesses with high turnovers. Small businesses with a monthly taxable turnover below ₹50 lakh are not affected by these restrictions. While Rule 86B may increase cash outflow for some large businesses, it plays a vital role in plugging loopholes and ensuring a more robust and transparent tax system.

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.

FAQ

Q1. When did Rule 86B come into effect?

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

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

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?

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?

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?

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.

Q6. When did Rule 86B come into effect?

 Rule 86B became effective on January 1, 2021.

Q7. What is the restriction listed under Rule 86B?

The rule restricts the usage of input tax credits (ITC) in the electronic credit ledger to 99% of the total ITC for payment of output tax. The remaining 1% must be paid in cash.

Q8. Who falls under the ambit of this new rule?

Any registered business whose taxable supply exceeds ₹50 lakh in a month falls under Rule 86B.

Q9. Are there any exceptions to this rule?

Yes, exceptions include businesses paying high income tax, those receiving refunds above ₹1 lakh, and certain government bodies.