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What is Input Tax Credit or ITC | GST India


what is input tax credit

Before GST was rolled out, the indirect taxation in India was very outdated. It had a cascading nature which used to increase the cost of the final product to more than desirable levels. However, in July 2017, GST brought with it Input Tax Credit or ITC. This helped replace the existing redundant taxation system with a better one.

Input tax credit mainly means that when a manufacturer pays the tax on his output, he can deduct the tax he previously paid on the input he purchased. Let's understand it more.

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Good question!

By cascading, what I mean is that as and when taxes were applied to a product, they used to keep adding up. This resulted in the final product becoming more expensive than it should have been.

Let's try and understand it with a very basic example.

Suppose I am a businessman and I make special types of erasers and sell them to customers. Now to make the erasers I require a type of rubber as raw material. Suppose I Buy Rs 100 worth of raw material and pay 10% tax on that transaction which is Rs 10.

So my Cost Price becomes Rs 110. I produce my erasers spending Rs 90 on manufacturing. So total Cost price for my eraser for me becomes Rs 200. If I wish to sell it at 10% profit, then its Marked price will become Rs 220.

However, this will not be the final price as I would have to add Tax to this price as well since I would have to pay this tax to the government. If the tax rate is 10%, then the final price for the customer will become Rs 242.

So you see, taxes keep adding up and the final price increases a lot.

SO DOES Input Tax Credit HELP?

Surely it does! 

Let us understand it using the same example as above.

So as in the above example, My Marked price, after including my Profit margin, is Rs 220.

Now, in the previous tax regime, I needed to add tax before reaching final Marked Price. 
However, since now the government has offered me Input Tax Credit under the GST system, I CAN DEDUCT THE TAX I HAVE ALREADY PAID ON THE INPUT FROM THE TAX I NEED TO PAY FOR MY OUTPUT.

Here, my input is the raw material I bought and paid the tax of 10%. So now, when I calculate the amount of tax I need to pay on selling my final product (OUTPUT), I can deduct the tax I have already paid.

So the output rate is 10%. Which means I am expected to pay 10% of Rs 220 = Rs 22.

But since I have already paid Rs 10 as tax while buying the raw material, I can subtract this from my output tax.

So the ACTUAL OUTPUT TAX payable by me is 22 - 10 = Rs 12.

Hence the Final Marked Price becomes 220 + 12 = Rs 232.

So as you can very well see, the final price gets reduced by Rs 10. Means the price of the product is reduced without affecting my profit margin.


Yes, I know.

Although this is a very basic example, and there might be some other variable involved depending on different products and industries, but the main concept remains the same. 

One can see some reduction in prices of products and services where this is applicable.

One example where ITC is applicable is Star Hotel Restaurants. These restaurants charge GST at 18% but since they have the provision of ITC, you may see some reduction in rates.

Also, when GST launched, ITC was also applicable to regular AC and non AC restaurants. However, a recent decision by the GST council has removed ITC benefits from these restaurants and reduced the GST rates applicable to them. 

New GST Rates for Restaurants in India.

I hope this article helped you understand the basic concept of Input Tax Credit. If you have anything to add, feel free to share in the comments below. Any suggestions or improvements are most welcome.

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