Input Tax Credit — Concept and Mechanism

Input Tax Credit (ITC) is the credit a registered dealer gets for the GST already paid on purchases (inputs), which can be used to reduce the GST payable on sales (output). It is the single mechanism that actually delivers the "value-added" feature described earlier and is what removes the old cascading (tax-on-tax) problem.

Here is the basic idea in plain terms: when a dealer buys goods, GST paid on that purchase is called input tax, and it sits in the dealer's books as a credit (an asset-like balance) rather than as an expense, because the dealer is going to recover it by setting it off against the GST charged to customers. When the dealer sells goods, GST collected from the customer is called output tax, and it is a liability owed to the government. At the end of the tax period, the dealer does not pay the full output tax to the government — instead, the available input tax credit is first set off against the output tax liability, and only the shortfall, if any, is paid in cash.

For an introductory treatment, the set-off principle can be stated as follows: credit of a particular type of input tax (CGST, SGST or IGST) is used first against the output liability of the same type, and any remaining IGST credit, once its own IGST liability is cleared, may be used to make up a shortfall in CGST or SGST liability. (The exact legal order in which credit can be cross-utilised between heads is laid down under GST law and has been revised from time to time — a student should treat the mechanism, not a fixed numeric order, as the durable idea.) Any liability that still remains after every available credit has been applied is paid in cash into the government's GST account. …