In a move aimed at improving compliance and curbing tax evasion under the Goods and Services Tax (GST) framework, the Central Board of Indirect Taxes and Customs (CBIC) is planning to introduce a mechanism to track reverse charge liability of businesses. The new system is designed to prevent businesses from availing excess input tax credit (ITC) that they are not entitled to. According to official sources, this initiative is expected to streamline the process of claiming ITC and ensure that only legitimate credits are claimed.

The Role of Reverse Charge Mechanism (RCM) in GST Compliance

Under the GST framework, certain transactions fall under the reverse charge mechanism (RCM), wherein the liability to pay tax shifts from the supplier to the recipient of goods or services. This is particularly relevant for sectors where suppliers may be unregistered or part of the unorganised sector. Additionally, RCM also covers cases involving the import of services from suppliers located outside India.

The recipient, after paying the tax under RCM, is entitled to claim ITC, which can offset future tax liabilities. However, discrepancies have arisen in the system, with some businesses claiming ITC without actually paying the tax under RCM, leading to tax evasion. In other cases, businesses have claimed disproportionately higher ITC than what they are eligible for.

The New ITC Ledger: A Solution to Monitor RCM Transactions

To address these issues, the CBIC, in collaboration with the Goods and Services Tax Network (GSTN), is working on developing an “Input Tax Credit (ITC) Ledger.” This ledger will track ITC claims made by businesses more accurately, especially in relation to RCM transactions. According to sources, this new ledger system is expected to become operational in October or November.

How the ITC Ledger Will Work

The ITC ledger will specifically monitor ITC availed under RCM transactions. It will allow the CBIC to cross-check if the businesses have paid the required tax under RCM before claiming ITC. The primary goal of the ledger is to ensure that businesses only claim the ITC to the extent of the payment they have made under the reverse charge mechanism. This will help minimise tax leakages and curb fraudulent claims.

Compliance and Monitoring

From a compliance perspective, this system will simplify audits and assessments related to RCM, ensuring that the ledger correctly reflects all RCM-related data. By centralising the ITC data in one place, tax authorities will be able to conduct more efficient assessments and reduce disputes related to erroneous ITC claims. It will also streamline the verification process, minimising delays for genuine businesses.

Rise in Fake Input Tax Credit (ITC) Claims

The introduction of the ITC ledger comes at a crucial time when fraudulent ITC claims have been on the rise. According to the Finance Ministry, fake ITC detection surged by 50% in FY24, reaching a staggering Rs 36,374 crore, up from Rs 24,000 crore in FY23. Despite this, less than 10% of the detected amount was voluntarily deposited by businesses, as noted by the Minister of State for Finance, Pankaj Chaudhary, in his statement to Parliament in July 2024.

The scale of these fraudulent activities highlights the need for stricter monitoring mechanisms like the ITC ledger. The new system will help authorities track high-risk taxpayers who may be making excessive or fake ITC claims, allowing for greater scrutiny and early intervention.

Impact on Businesses: ERP Systems and Real-time Data Capture

For businesses, the operationalisation of the ITC ledger will require significant changes in how they manage their tax data. Specifically, businesses will need to ensure that their Enterprise Resource Planning (ERP) systems are adequately configured to capture RCM transactions and reconcile them with the GSTN’s ITC ledger in real time.

Preparing for the New ITC Ledger System

Tax experts stress that businesses will need to work closely with the GSTN to ensure a smooth transition to the new ledger system. For many businesses, this will mean upgrading their IT infrastructure to integrate with the GSTN, allowing for seamless data sharing and reconciliation. Failure to adequately track RCM data may result in delays or penalties during audits and assessments.

Benefits of the ITC Ledger: Preventing Tax Evasion and Enhancing Compliance

The introduction of the ITC ledger offers several potential benefits for both the government and taxpayers.

1. Preventing Tax Leakages

By ensuring that ITC claims are limited to the extent of RCM payments, the new ledger will reduce instances of fraudulent claims, helping the government plug tax leakages. This will result in higher revenue collection for the government, contributing to a more robust and fair tax system.

2. Identifying High-Risk Taxpayers

The ledger will enable tax authorities to identify high-risk taxpayers who may be availing of excessive ITC without fulfilling the necessary conditions. Such taxpayers will be subjected to greater scrutiny, potentially leading to early detection of fraudulent activities and minimising losses for the exchequer.

3. Simplifying Audits and Reducing Disputes

From a compliance perspective, the ledger will simplify audits related to RCM. Since all RCM transactions will be centrally recorded and reconciled in the ledger, tax authorities can easily verify ITC claims, reducing the chances of disputes between businesses and the CBIC.

Conclusion: A Step Toward Greater Transparency and Efficiency

The CBIC’s introduction of the ITC ledger represents a significant step toward improving transparency and efficiency in the GST framework. By closely monitoring RCM transactions, the ledger will ensure that businesses comply with the law while minimising tax leakages. As the system becomes operational, businesses will need to adapt their ERP systems to ensure smooth compliance and avoid penalties.

In the long run, the ITC ledger will likely foster a more compliant business environment and support the government’s efforts to curb tax evasion under the GST regime.