GST Rule Change from April 1, 2025: ISD Mandatory for Claiming Input Tax Credit

As of April 1, 2025, the Goods and Services Tax (GST) framework in India is set to undergo a pivotal transformation with the mandatory implementation of the Input Service Distributor (ISD) mechanism for claiming input tax credit (ITC). This change, notified by the Central Board of Indirect Taxes and Customs (CBIC) through Notification No. 16/2024-Central Tax dated August 6, 2024, aims to streamline the process of distributing ITC among various branches of a company, replacing the previous cross-charge mechanism. This article delves into the details of this rule change, its implications for Indian businesses, and practical steps for compliance, ensuring a comprehensive understanding for professionals and business owners alike.

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The Finance Act 2024 amended the CGST Act to implement the ISD system, allowing businesses operating in multiple states to centralize invoices for common input services (domestic or imported) at a single branch or headquarters5. This ensures the fair distribution of input tax credit (ITC) among branches using these shared services5. Proper ITC utilization reduces a business’s overall tax liability5.

Understanding Input Service Distributor (ISD).

An Input Service Distributor (ISD) is defined under Section 2(61) of the Central Goods and Services Tax (CGST) Act, 2017, as an office of a supplier of goods or services that receives tax invoices for input services and distributes the available ITC to other branch offices of the same business. These branches must be registered under the same Permanent Account Number (PAN) but can have different Goods and Services Tax Identification Numbers (GSTINs). The ISD mechanism, previously optional, is now mandatory effective from April 1, 2025, following amendments made by the Finance Act, 2024, and notified under the aforementioned notification.

The ISD process involves the head office or a central office receiving invoices for shared services, such as software maintenance, security services, or communication charges, and then distributing the ITC to consuming branches based on their turnover or usage. This ensures a proportional and transparent allocation, aligning with the GST Council’s efforts to enhance compliance and reduce discrepancies.

The Previous System: Cross-Charging.

Before this rule change, companies often used a cross-charge mechanism where one branch would bill another for shared services. For instance, if the head office in Delhi incurred expenses for POS machines used by branches in Mumbai, Chennai, Kolkata, and Gujarat, it would issue invoices to each branch, and each branch would claim ITC individually. While this method was flexible, it led to complexities, including potential misreporting, audit risks, and delays in ITC claiming, especially for businesses with numerous branches across states.

The New Rule: Mandatory ISD from April 1, 2025.

The new rule, effective from April 1, 2025, eliminates the cross-charge option and mandates registration as ISD for businesses meeting certain criteria. Key aspects include:

• Registration Requirement: Companies with multiple GST registrations across different states, particularly those procuring input services centrally but utilizing them across branches, must register as ISD.
• Filing Returns: ISDs are required to file monthly returns in Form GSTR-6, detailing the ITC received and its distribution to various units.
• Timely Distribution: ITC must be distributed within the same month it is received, ensuring no delays in credit flow.
• Allocation to All Consuming Offices: Even unregistered or exempt branches must receive their share of ITC if they consume the services, based on a turnover ratio if multiple locations are involved.
• Elimination of Cross-Charging: The cross-charge mechanism is no longer allowed, simplifying the process but requiring a shift in operational practices.

This change is part of broader amendments to Sections 2 and 20 of the CGST Act, 2017, as proposed by the Finance Act, 2024, and notified to come into effect from April 1, 2025, as per Notification No. 16/2024-Central Tax.

Why This Change is Happening.

The shift to mandatory ISD is driven by the need to enhance transparency, reduce compliance errors, and align with the GST Council’s goal of creating an IT-driven, user-friendly tax structure. The cross-charge system often led to discrepancies in ITC claiming, especially for service-based organizations like IT firms, consulting businesses, and manufacturing companies with pan-India operations. By standardizing the process through ISD, the government aims to minimize audit risks, ensure seamless credit flow, and simplify reconciliation for taxpayers.

Who Does This Affect?

The rule change primarily impacts businesses with the following characteristics:

• Multi-State Operations: Companies with GST registrations in multiple states, such as retail chains, IT firms, and manufacturing units.
• Centralized Procurement: Organizations that procure input services centrally (e.g., software licenses, security services) but utilize them across branches.
• Service-Based Firms: Consulting businesses, legal firms, and other service providers with shared service costs.
• Large Enterprises: Corporations with significant turnover and multiple branches, where ITC distribution is a critical financial process.

Small businesses, while less likely to be affected due to fewer branches, may still face challenges if they expand or share services across states, potentially increasing compliance costs. This unexpected impact on smaller firms could strain their operational budgets, especially given the need for system upgrades and training.

How to Comply with the New Rule.

To prepare for the mandatory ISD implementation, businesses should take the following steps:

1. Register as ISD: Ensure registration is completed before April 1, 2025, using the GST portal at GST Portal.
2. Upgrade Systems: Update accounting and ERP systems to handle ISD invoicing, ITC distribution, and GSTR-6 filings, ensuring compatibility with GST regulations.
3. Train Teams: Educate finance and compliance teams on the ISD process, including return filing and allocation rules, to minimize errors.
4. Review Strategies: Modify ITC allocation strategies to align with ISD requirements, such as turnover-based distribution for multiple locations.
5. Monitor Updates: Stay informed about any further GST updates and compliance regulations through official channels like CBIC Website.

Penalties for Non-Compliance.

Failure to comply with the new rule can have serious consequences:

• ITC Denial: Branches may be denied ITC if the head office fails to distribute it through ISD, affecting cash flow and tax liabilities.
• Penalties: A minimum penalty of Rs. 10,000 applies, with potential increases based on the extent of non-compliance, as outlined in TaxScan Article.
• Legal Risks: Repeated non-compliance could lead to audits, additional scrutiny, and legal proceedings, impacting business reputation and operations.

Practical Examples.

To illustrate, consider the following scenarios:

Example 1: Old System (Cross-Charge).

• Company: ABC Pvt Ltd, head office in Hyderabad, branches in Mumbai, Bangalore, and Chennai.
• Service: Annual software maintenance expense incurred by the head office for all branches.
• Process: The head office bills each branch for their share, and each branch claims ITC individually, leading to potential delays and errors in reporting.

Example 2: New System (ISD).

• Company: Same as above, now registered as ISD.
• Process: The head office receives the invoice, distributes ITC via ISD invoices based on branch turnover, and files GSTR-6 monthly, ensuring timely and transparent credit flow without cross-charging.

Comparison of Old and New Systems.

Frequently Asked Questions (FAQs).

1. What is ISD under GST?
   ISD is an office that receives tax invoices for input services and distributes ITC to branches with the same PAN but different GSTINs.
2. Who needs to register as ISD?
   Businesses with multiple GST registrations across states and centralized service procurement must register.
3. What happens if I don’t comply by April 1, 2025?
   Non-compliance can lead to ITC denial for branches and penalties starting at Rs. 10,000.
4. How is ITC distributed under ISD?
   ITC is distributed based on turnover or usage, with monthly filings in GSTR-6.
5. Can small businesses be affected?
   Yes, especially if they expand or share services across states, potentially increasing compliance costs.

Conclusion

The mandatory ISD rule from April 1, 2025, marks a significant shift in GST compliance for Indian businesses, particularly those with multi-state operations. By understanding the changes, preparing for compliance, and leveraging the streamlined process, companies can navigate this transition effectively, ensuring financial efficiency and regulatory adherence. For further resources, refer to the GST Compliance Calendar and ISD Course.

C.K. Gupta

Hello, I am C.K. Gupta Founder of Taxgst.in, a seasoned finance professional with a Master of Commerce degree and over 20 years of experience in accounting and finance. My extensive career has been dedicated to mastering the intricacies of financial management, tax consultancy, and strategic planning. Throughout my professional journey, I have honed my skills in financial analysis, tax planning, and compliance, ensuring that all practices adhere to the latest financial regulations. My expertise also extends to auditing, where I focus on maintaining accuracy and integrity in financial reporting. I am passionate about using my knowledge to provide insightful and reliable financial advice, helping businesses optimize their financial strategies and achieve their economic goals. At Taxgst.in, I aim to share valuable insights that assist our readers in navigating the complex world of taxes and finance with ease.