ITC reversal calculator — Rule 42 and Rule 43
If any part of your output is exempt — and interest income counts, which surprises most people — a proportionate slice of your common input tax credit has to be reversed every month. This works out C1, C2, D1, D2 and C3 for inputs and input services, and Tm, Tr and Te for capital goods, in the order the rules actually prescribe.
Rule 42 — inputs and input services
Figures for the tax period. Enter tax amounts, not invoice values.
Turnover for the period
Rule 43 — capital goods
How Rule 42 actually works
Section 17(1) and 17(2) say the same thing in two directions: credit is available only to the extent inputs are used for business, and only to the extent they are used for taxable supplies. Rule 42 is the machinery that turns that principle into a monthly number. It works by elimination — strip out everything that can be attributed exclusively somewhere, and apportion what is left.
| Step | What it is |
|---|---|
| T | Total input tax on inputs and input services for the period |
| T1 | Exclusively for non-business purposes — not creditable |
| T2 | Exclusively for exempt supplies — not creditable |
| T3 | Blocked under section 17(5) — not creditable |
| C1 = T − (T1 + T2 + T3) | Credited to the electronic credit ledger |
| T4 | Exclusively for taxable supplies, including zero-rated — fully creditable |
| C2 = C1 − T4 | The common credit. Everything that cannot be attributed either way |
| D1 = (E ÷ F) × C2 | Attributable to exempt supplies — reverse |
| D2 = 5% of C2 | Deemed non-business use — reverse. Flat, regardless of actual use |
| C3 = C2 − (D1 + D2) | Eligible common credit. This stays with you |
D1 and D2 are added to the output tax liability for the month. They are not deducted from the credit ledger directly — the mechanics matter if you are reconciling the ledger against the return.
The annual recomputation — Rule 42(2)
The monthly figures are provisional. After the financial year ends, the whole calculation is redone using the year's aggregate figures, and the result is compared with the sum of the twelve monthly reversals.
If the annual figure is higher, the shortfall is added to output tax liability and carries interest at 18% per annum from 1 April of the succeeding year. If it is lower, the excess is claimed back as credit — with no interest in your favour. The deadline for both is the return for September following the end of the financial year.
The asymmetry is deliberate and it is worth planning around: under-reversing costs you interest, over-reversing costs you the time value of the money for up to a year and a half.
Rule 43 — why capital goods are different
Capital goods credit is not reversed in one hit, because the asset is used across years. The common credit Tc is spread over sixty months, giving Tm for each month. The Tm figures for every common capital good aggregate to Tr, and the reversal for the month is:
Te = (E ÷ F) × Tr
Te is added to output tax liability along with interest. That is a real difference from Rule 42, where interest only arises on the annual true-up. Rule 43 charges it monthly, expressly.
Two further points. A capital good that starts life exclusively for exempt supplies and later moves to common use enters the Tc pool at its value reduced by 5% per quarter or part quarter since the invoice date. And the sixty-month clock runs from the date of the invoice, not the date the asset was put to use.
Where this goes wrong in practice
Three failure modes account for most of the reversals we see raised on scrutiny. Businesses that never computed D2 at all, because they had no non-business use and assumed the 5% was conditional on having some — it is not. Businesses that treated exports as exempt rather than zero-rated, and reversed credit they were entitled to keep. And businesses that computed the monthly figures correctly and then never did the Rule 42(2) annual recomputation, which is where the interest exposure sits.
Common questions
When do I have to reverse input tax credit under Rule 42?
Whenever input tax credit relates to inputs or input services used partly for taxable supplies and partly for exempt supplies or non-business purposes. If every rupee of your output is taxable and everything you buy is for the business, Rule 42 does not touch you. The moment there is an exempt supply — interest income, an exempt commodity, a sale of land or completed building — a proportionate reversal arises on the common credit.
What is the difference between D1 and D2?
D1 is the reversal attributable to exempt supplies, computed as the exempt turnover over total turnover, applied to the common credit C2. D2 is a flat 5% of C2, deemed to be attributable to non-business use, and it applies whether or not you actually have any non-business use. Both are added to your output tax liability for the month; the balance C3 stays available to you.
Is interest payable on a Rule 42 reversal?
On the monthly reversal, no — you add D1 and D2 to the output tax liability of that month and discharge it in the ordinary course. Interest arises on the annual recomputation under Rule 42(2): if the figure computed for the year exceeds the sum of the monthly reversals, the shortfall must be paid with interest at 18% from 1 April of the following year. If it is lower, you claim the excess back as credit, without interest.
How is capital goods reversal under Rule 43 different?
Capital goods credit is not reversed in one go. The common capital goods credit Tc is spread over sixty months — a useful life of five years — as Tm. The Tm figures for all common capital goods aggregate to Tr, and the reversal for the month, Te, is the exempt-to-total turnover ratio applied to Tr. Te is added to output tax liability along with interest at 18%, which is expressly provided for in Rule 43 and is a genuine difference from Rule 42.
What counts as exempt turnover for this?
Exempt supplies as defined in section 2(47) — nil-rated, wholly exempt and non-taxable supplies — plus, by the explanation to Rule 42, certain items that are not obviously exempt: interest on deposits, loans and advances, and the value of transactions in securities computed at 1%. Interest income is the one that catches people out. A trading business with surplus in a fixed deposit has exempt turnover whether it thinks so or not.
Does Rule 42 apply if I only have a small amount of exempt income?
Legally yes — there is no de minimis threshold. Practically, where the exempt turnover is a very small fraction of the total, the D1 reversal is small, but D2 at 5% of the common credit is not proportionate to it and can be the larger of the two. It is worth computing rather than assuming it is immaterial.
Have a professional check this
Send us what the tool showed you. We will tell you what the position actually is, and what it would cost to deal with, before you commit to anything.
If you have never done this
Send us a year of GSTR-3B and your purchase register. We will compute the Rule 42 and 43 position for each month, do the annual recomputation, and tell you whether you are under-reversed and by how much — before a notice asks the same question.
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