Rule 86B Explained: How ITC Utilization is Limited Under GST

Overview

To combat false input tax credit (ITC) claims, Rule 86B was added to the Goods and Services Tax (GST) framework. This rule requires a portion of the tax to be paid in cash and limits the use of ITC for discharging GST liability in specific situations. It is applicable to companies whose monthly taxable revenue exceeds Ôé╣50 lakh and went into effect on January 1, 2021.

The Purpose of Rule 86B

Preventing fraudulent ITC claims and discouraging tax evasion are the main objectives of Rule 86B. Numerous dishonest taxpayers were discovered using fictitious invoices without real business transactions to claim ITC, which cost the government money.

Essential Elements of Rule 86B

1. Limitations on the Use of ITC

• A taxpayer's output tax bill cannot be mitigated by more than 99% of their ITC if their monthly taxable turnover exceeds Ôé╣50 lakh.
• At least one percent of their tax liability must be paid in cash.

2. Rule 86B Applicability

• Only when the monthly taxable turnover surpasses Ôé╣50 lakh (excluding exempt and zero-rated goods) does this regulation come into play.
• All firms registered under GST are subject to it, with the exception of those exempt from some requirements.

3. Rule 86B Exemptions

• The limitation is not applicable if:
  • Over the past two fiscal years, the taxpayer has paid over Ôé╣1 lakh in income tax.
  • In the previous fiscal year, the taxpayer obtained a refund of almost Ôé╣1 lakh from the GST on exports or inverted tariff structure.
  • The taxpayer is a statutory body, PSU, local government agency, or department.
  • Over 1% of the entire output tax burden has already been paid in cash by the taxpayer during the current fiscal year.

4. Effect on Companies

• Companies with substantial ITC accumulation and real transactions may experience cash flow issues.
• Financial difficulties may arise for startups and capital-intensive enterprises that depend on ITC for working capital.
• Because firms must make sure they match the exemption criteria in order to avoid cash payments, compliance obligations have increased.

Practical Examples

Example 1: Rule 86B Is Relevant

• The production GST liability for ABC Ltd. in January 2025 is Ôé╣10 lakh.
• It intends to use the Ôé╣12 lakh available ITC to cover the full amount of its tax obligation.
• Rule 86B is applicable since the taxable turnover exceeds Ôé╣50 lakh.
• ABC Ltd. can use ITC for the remaining amount, but it must pay at least 1% (Ôé╣10,000) in cash.

Example 2: Rule 86B Does Not Apply

• For January 2025, the production GST liability of XYZ Ltd. is Ôé╣8 lakh.
• In the preceding fiscal year, it paid Ôé╣2 lakh in income tax.
• XYZ Ltd. can use 100% ITC to offset its tax burden because it satisfies the exemption requirements.

Advantages of Rule 86B

• Lowers ITC fraud: stops fraudulent invoice transactions.
• Assures the collection of tax revenue: demands that a certain amount of GST be paid in cash.
• Encourages adherence: encourages taxpayers to pay income taxes and keep accurate records.

Obstacles and Remarks

• Cash flow problems for companies who pay taxes using the ITC.
• Even if they have valid ITC applications, genuine taxpayers are impacted.
• Increased burden of compliance, requiring companies to monitor exemptions and turnover.

Conclusion

One significant GST anti-tax evasion mechanism is Rule 86B. For compliant taxpayers, it causes cash flow issues even though it reduces false ITC claims. To prevent needless cash payments, businesses must carefully assess if they meet the exemption requirements.