Whether ITC is to be Reversed in Case of Writing off The Value of Inventory

Introduction

While paying taxes to our Government, businesses can use the credit of GST paid on the purchases like raw materials/services used for manufacturing or selling products. It is known as an Input Tax Credit (ITC). If the input tax credit is wrongly claimed, then it should be reversed by making payment to that extent next month.

In certain situations, even if the primary conditions for claiming ITC is satisfied, ITC claimed must be reversed. Reversal of ITC means the credit of inputs utilised earlier would now be added to the output tax liability, effectively nullifying the credit claimed earlier. Depending upon when such reversal is done, payment of interest may also be required.

Analysis of the GST implication where inventory is written off

Central Goods and Service Tax Act, 2017 (CGST Act, 2017) provides for specific conditions wherein a registered person cannot avail ITC on various goods and services. One of these situations includes where goods are “written off” dealt by Section 17(5)(h), which is reproduced herein below:

“Notwithstanding anything contained in the sub-section (1) of section 16 and subsection (1) of section 18, the input tax credit shall not be available in respect of following, namely:-or the purposes of this Act, the expression “supply” includes––
(h)  goods lost, stolen, destroyed, written off or disposed of by way of gift or free samples.”

Before jumping to the conclusion to reverse ITC in case of goods are written off, we need to understand the meaning and scope of the word “written off”, since the same is not defined anywhere under the said Act. We will refer to the general and accounting meaning of written off.

Inventory write-off refers to the accounting process of reducing the value of inventory that has lost all of its value. The inventory may lose its values due to damage, deterioration, loss from theft, damage in transit, changes in market demands, misplacement etc. However, if inventory still has some fair market value, but its fair market value is found to bee less than its book value, it will be written down instead of written off. When the market price of the inventory falls below its cost, accounting rules require that a company write down or reduces the reported value of the inventory on the financial statement to the market value.

Since the term used in the provision is written off, which indicates the full actual written off the inventory.  It may also be observed that the credit need not be reversed, when a provision is made to write off the inventory value, either partially or fully. Further, as per clause (h) of subsection (5) of section 17 states that goods are written off, not value written down. The liability to forego the credit would arise, only when the goods are entirely written off and not the value.

In Excise regime, as amended from time to time, it had been provided explicitly for the reversal in case writing off the inputs, capital goods, full write off partially writing off as well as for the provision made. Hence the scope was expanded to cover situations of partial write off and creating provision to write off.

Under GST, the requirement to reverse ITC arises only in case of actual write off. No ITC reversal is required where the value of the goods have been partially written down, and provision to write off is made.

In conclusion, businesses can claim Input Tax Credit (ITC) on GST paid for purchases used in their manufacturing or selling activities. However, if ITC is wrongly claimed or certain conditions are not met, the ITC must be reversed. Reversal of ITC means adding the credit back to the output tax liability. In the case of goods being written off, the term "written off" refers to the complete elimination of the inventory's value, not just a reduction in value. Provision for partial write-off or value write-down does not require ITC reversal under GST.

Discover the implications of inventory write-offs and the reversal of Input Tax Credit (ITC) under GST. For more related Information, Inquire us at: info@manishanilgupta.com

Disclaimer:This content is purely for knowledge and educational purposes. It contains only general information and references to legal content. It is not legal advice, and should not be treated as such