Understanding ITC on Capital Goods in GST: Rules, Reversal, and Examples

The Input Tax Credit (ITC) mechanism is a fundamental part of the Goods and Services Tax (GST) framework in India. It allows businesses to claim credit for taxes paid on inputs, including capital goods, thereby reducing overall tax liability.

For businesses investing in capital goods such as machinery, equipment, or vehicles, understanding ITC on capital goods is crucial for efficient tax planning and compliance. This article explains the rules, conditions, reversals, and practical examples related to ITC on capital goods.

What are Capital Goods Under GST?

According to Section 2(19) of the CGST Act, capital goods are defined as:

Goods, the value of which is capitalized in the books of accounts of the person claiming the input tax credit and which are used or intended to be used in the course or furtherance of business.ere

Simply put, capital goods are assets purchased by a business for long-term use in its operations, such as:

Machinery & equipment
Tools & appliances
Vehicles (for specific business purposes)
Furniture & fixtures
IT hardware (computers, servers, etc.)
Plant & building (excluding land and residential property)

ITC Eligibility on Capital Goods

Under GST, ITC can be claimed on capital goods if the following conditions are met:

The goods must be used for business purposes and not for personal use.
ITC is not available on capital goods used exclusively for exempt supplies or non-business purposes.
ITC is not available on motor vehicles, unless they are used for specific business activities like transportation, training, or passenger services.
The capital goods should be purchased from a registered supplier.
ITC cannot be claimed if depreciation is claimed on the GST portion of the capital goods.

ITC Reversal on Capital Goods

While ITC on capital goods is generally allowed, there are cases where it needs to be reversed, either partially or fully:

1. If Used for Both Taxable and Exempt Supplies

If a capital good is used for both taxable and exempt supplies, ITC must be reversed proportionally based on the exempt turnover.

Formula for Reversal:

Reversal Amount = (Exempt Turnover ÷ Total Turnover) × ITC on Capital Goods

This reversal is spread over 5 years (60 months) from the date of purchase.

2. If Capital Goods are Sold Before 5 Years

If capital goods are sold before 5 years of purchase, ITC reversal is calculated based on 5% per quarter of use.

Example:

A business purchases a machine worth ₹10 lakh, paying ₹1.8 lakh GST.
If the machine is sold after 2 years, the remaining ITC for 3 years must be reversed.
ITC to be reversed = (1.8 lakh × 5% × 12 quarters) = ₹1.08 lakh

3. If ITC Was Wrongly Claimed

If ITC was claimed but the capital good was later used for non-business purposes or exempt supplies, ITC reversal must be done with interest at 18% p.a.

4. If Business Shifts to Exempt Supply

If a business that earlier sold taxable goods switches to exempt goods, ITC on capital goods must be reversed proportionally for the remaining period.

ITC on capital goods under GST with example

Example 1: ITC Allowed

A manufacturing company purchases a CNC machine worth ₹5 lakh with ₹90,000 GST. Since the machine is used for business, the company can claim ₹90,000 as ITC, reducing GST liability.

Example 2: ITC Reversal Required

A restaurant purchases a commercial oven for ₹2 lakh with ₹36,000 GST. Later, the restaurant starts selling alcohol (exempt supply). Since alcohol is outside GST, the ITC on the oven must be reversed proportionally.

Example 3: No ITC Allowed

A consulting firm purchases a car for office use. Since motor vehicles are blocked credits, ITC cannot be claimed unless the firm is in the transportation or leasing business.

Blocked Credits on Capital Goods (Where ITC is Not Allowed)

Under Section 17(5) of the CGST Act, ITC cannot be claimed on certain capital goods, including:

Motor vehicles (except for specific businesses like logistics, car rentals, or driving schools)
Aircrafts and vessels (unless used for business purposes like air transport services)
Goods used for personal consumption
Capital goods used for non-business purposes

Steps to Claim ITC on Capital Goods

Ensure the purchase is from a registered GST supplier.
Obtain a valid tax invoice with GST details.
Enter the details in GSTR-3B return.
Match the ITC with GSTR-2B auto-populated credit.
Use ITC to offset GST liability before making tax payments.

Conclusion

Understanding ITC on capital goods can significantly reduce tax burdens and improve cash flow for businesses. However, businesses must be mindful of ITC reversals, exemptions, and compliance rules to avoid penalties and legal issues.