ITC reversal when switching from regular to Composition scheme

[Guest]

My neighbour owns a general stores(provision stores kirana stores) shop and doesn't maintain any sales record .He only maintains purchase bills.

So what he does is he adds 10/8% margin on purchase value and compute rate wise sales and accordingly pay GST

As if purchases made during a month are sold during that month itself i.e. GST calculations are made under an assumption(due to lack of records) of zero inventory at the end of the day.

My question is NOW he wants to opt for composition scheme and as per the act he has to reverse ITC taken on inputs held in stock on the day prior to switching to composition scheme.

But per our GST calculations all sales are made out of current stock i.e. one which is acquired on or after 1st April 2020. So he should not be liable for ITC reversal

Please help

[KASTURI SETHI]

As per Section 18(4) of CGST Act, you are required to reverse the credit which is contained in the inputs, semi-finished goods, finished goods and capital goods held on 31.3.20. No other option. The stock (goods) which you will acquire on 1.4.20 or after 1.4.20 is not in picture and has no correlation with the stock held on 31.3.20. You should use maximum ITC before 31.3.20 and if still balance of credit remains that will lapse. When you switch from regular to composition scheme w.e.f. 1.4.20, outward supply is 'equal' to exempt supply. You can neither carry forward the balance of credit lying at your credit in Electronic Credit Ledger as on 31.3.20 nor you can use it. It would lapse.

The whole procedure of switching from regular to composition Scheme is laid down under Section 18(4) of CGST Act which is as follows:-

(4) Where any registered person who has availed of input tax credit opts to pay tax under section 10 or, where the goods or services or both supplied by him become wholly exempt, he shall pay an amount, by way of debit in the electronic credit ledger or electronic cash ledger, equivalent to the credit of input tax in respect of inputs held in stock and inputs contained in semi-finished or finished goods held in stock and on capital goods, reduced by such percentage points as may be prescribed, on the day immediately preceding the date of exercising of such option or, as the case may be, the date of such exemption :

Provided that after payment of such amount, the balance of input tax credit, if any, lying in his electronic credit ledger shall lapse.

[Guest]

Thank you sir for your reply and you are right.I understand your point of view.

But my counter (if required in any assessment) will be-

1.ITC is to be reversed because we have taken credit of purchases and now same stock we will be sold albeit by breaking the tax credit chain

2.But in my case even though we have taken the credit we have also shown the maximum possible sales against that set of purchases i.e. by adding 8/10% of gross margin.

3.Ideally if proper records would have been kept then in some months the net liability would have been zero or negative(carry forward) but due to our peculiar issue our sales is always more than our purchase and in every month we pay GST in cash

So on paper as per the GST calculations for any month the purchases on which credit was availed were sold off during that month itself.

So no question of reversal,right?

[KASTURI SETHI]

"But per our GST calculations all sales are made out of current stock i.e. one which is acquired on or after 1st April 2020." What do you mean by this ?

1.ITC is to be reversed because we have taken credit of purchases and now same stock we will be sold albeit by breaking the tax credit chain

Both versions are contradictory. Pl. clarify.

[KASTURI SETHI]

W.r.t. your query at serial no. 2 above (para nos. 2 & 3), I have not gone through your record and not aware of the facts. So my further views are based on hypothetical situation. Even then I express as under:-

If the rates of tax on inwards supply and outward supply (both) are same and no ITC has been availed on input service and capital goods and no export is involved, ITC has been availed on inputs only, the value addition portion must come from cash ( Electronic Cash Ledger).

What appears to me there is a huge gap between the rate of tax inward supply and outward supply. Rate of tax on outward supply is much higher and rate of tax on inward supply is very very low. This is only on factor and there are other factors to examine the correctness value addition.

I want more data to examine the correctness. Can you post here If I ask for ?

[Guest]

First of all thank you very much for showing deep interest in my queries

Sir,

The points 1,2 and 3 in MY reply to the original post/query were not separate cases but were part of a hypothetical answer/counter argument if the department were to raise any demand for ITC reversal on stock held in hand as on 31/03/2020.

About the contradiction I would like to clarify that-

In the first part of my counter argument I am trying to explain the essence/intent of government for introducing the provisions of section 18(4) i.e. if any person switches from regular to composition scheme and he does hold stock in hand as on the last day of being in regular scheme then because he now has gone out of the tax credit chain(by opting in composition scheme) he must reverse the ITC availed on stock in hand.

The intent of law in demanding reversal of credit is absolutely logical.

However in our case what is happening is as follows:

Let's say during the month of March 2020(Regular scheme) my purchase summary is as follows-

Purchase Taxable Rate Net Amt Tax Amt

0% 100000 0

5% 300000 15000

12% 1000000 120000

18% 50000 9000

Total 1450000 144000

Now please bear in mind the fact that the kirana store owner doesn't maintain any sales record.So,the sales for the month are computed by adding 10%GP to purchases

Accordingly.the sales summary for March 2020(Regular Scheme) will be as follows:

Sales Taxable Rate Net Amt Tax Amt

0% 110000(100000*110%) 0

5% 330000(300000*110%) 16500

12% 1100000 132000

18% 55000 9900

Total 1595000 158400

GST Payable for the month of March 2020:158400-144000=14400

Stock in hand(as per the calculations above):0

Hence ITC to be reversed through ITC-03 on 1st April or within 60 days:0

Hope I am clear Sir?If not please suggest any other mode of communication.

Regards,

Abhishek

[KASTURI SETHI]

Rate of tax on purchase is on lower side (average) and rate of tax on sale is on higher side (average). The assessee may not be availing OTC on input service and on capital goods. So you have nothing to reverse on 31.3.20. Overall payment of tax through cash is far more than through Electronic Credit Ledger. This is plus point for you.

[Guest]

So Sir in conclusion -should I ask the kirana store owner to switch to composition scheme without reversing any credit.

Also,I had a query w.r.t. the composition scheme-

As per section 10(2)(b)

[Guest]

In continuation........

As per section 10(2)(b) of CGST Act to be eligible for opting into composition scheme the person must not be engaged in making any supply of goods which is not leviable to tax under this act.

Now I have read the analysis of above provision on 2 to 3 websites and even got a reply from the CBIC MITRA HELPDESK wherein they have said that the above provision would also cover exempt supplies(Pulses, Dals, Rice, Other food grains commonly sold in the Kirana Stores).

But I think the exempt supplies are also leviable to Tax under the act (but subject to 0% tax) and hence the Kirana Store Owner is eligible for composition scheme.

Also,if he is eligible then he should pay tax @ 1% on what portion of turnover? Should he also pay @1% on exempt supplies like rice,foodgrains,pulses etc.

[KASTURI SETHI]

Q. So Sir in conclusion -should I ask the kirana store owner to switch to composition scheme without reversing any credit.

A. That person will not have any amount of ITC in Electronic Credit Ledger as on 31.3.2020 so where the question of reversal arises ? Secondly, that shop keeper may have physical stock of goods on which ITC has been availed. Tax has to paid in cash on that stock. Thereafter, that person will be eligible for switching to Composition Scheme w.e.f. 1.4.20.

[KASTURI SETHI]

In continuation of my ar serial no.6 above, tax structure remains the same it is only value addition which makes the difference. For example; Suppose you purchase biscuit packet @ ₹ 10/- and pays tax @5% on it and when you sell the same @₹ 11/- (Re one value addition) rate of tax will be charged i.e. @5%. Thus tax on value addition portion is to be paid in cash. I hope you are aware of ingredients of 'Value Addition'.

[Guest]

Replying to Sr.No.9

Sir, although the shopkeeper has/will have physical stock on 31.03.2020 with him but as per the calculations shown in Sr.No.5 he has already shown the maximum possible sales(adding GP @ 10%) from the purchases for that month and paid the appropriate tax on them. So, as per my arguments in serial number 2 and further explanations in serial number 5 there should NOT be any reversal of credit EITHER through cash or credit ledger because as per the logic of section 18(4) ITC is to be reversed on stock held in hand only when the sales are made out of that stock. And, for April 2020 like the calculations in Sr.No.5 the sales will be shown as made only out of the purchases for April and not the stock in hand as on 31.03.2020.The reality may be different but we don’t have any sales record hence it is shown as if the sales were made out of current period purchases only.

[KASTURI SETHI]

I do not agree with you. You cannot go beyond GST law. There is no escape route in this scenario. There is something wrong in value addition. You should consult an CMA to arrive at correct value addition.

You are taking plea again and again that record has not been maintained except purchase bills. This is a minus point for any assessee. Non-maintenance of records is also an offence and it attracts penalty various Sections of CGST Act.

[Guest]

Ok sir agreed.

But could you please elaborate on 'value addition' and its relevance in my specific case where I would be required to pay tax through CASH LEDGER on the stock held in hand on 31.03.2020.

Thanks in advance.

[KASTURI SETHI]

The ingredients of value addition are :

(i) Profit

(ii) Expense on rent of shop (if any)

(iii) Salary of employees in shop

(iv) Electricity bill/expenses

(v) Water bill

(vi) Misc. expenses.

All these should form part of value addition. Expenses are on actual basis + profit.

[Chhatra Jain]

Res Sh Kasturi sir,

You have extensively explained the matter.

I my opinion ideal situation would be for kirana store owner to dispose pf all the stock on 31.03.20 . As there would be no physical stock left as on 01.04.20 so there would not be requirement of reversal of ITC. Otherwise reversal of ITC on the stock left on the tansirion day at the end of the period. As he has availed ITC on all purchases he needs to reverse on the balance stock on 01-04- 20 though as per his accounts practices all material has been sold and no stock is left.

So sir whatever is envisaged by me that he should physically dispose of all the stock is not a right proposition to avoid hassels during transition.

[KASTURI SETHI]

Sh.Chhatra Jain Ji,

Yes, Sir. I agree with you. This is the best recourse and fool-proof. Only difficulty is that the dealer will have to manage and managing is much easier than facing the rigours of litigation. What is avoidable should be avoided i.e. SCN.

AI Summary

Kirana Store Owner Debates Input Tax Credit Reversal Before Switching to GST Composition Scheme; Section 18(4) Discussed A discussion on a forum revolves around a kirana store owner intending to switch from the regular GST scheme to the Composition Scheme. The main issue is whether the owner needs to reverse the Input Tax Credit (ITC) on stock held as of March 31, 2020. A participant explains that under Section 18(4) of the CGST Act, ITC must be reversed on stock held before switching. The store owner argues that all sales are made from current stock, suggesting no reversal is needed. Another participant emphasizes the importance of maintaining proper records and suggests disposing of all stock by March 31 to avoid complications. The discussion also covers the eligibility for the Composition Scheme and the tax implications on exempt supplies.