GST Rule 86B: Effective GST Compliance Strategy

As the dynamics of GST compliance have evolved, Rule 86B has proved to be a vital regulation that plays an important role in the manner in which Input Tax Credits (ITC) are applied. The rule has been notified through the notification issued in Notification No. 94/2020 dated 22/12/2020 and guarantees that all taxpayers pay some part of their tax dues in cash instead of availing of full ITC.

We help make sense of GST rules at Tax Esquire. Read the following blog for a new and effective GST compliance strategy.

Reason for introducing Rule 86B

Prior to the introduction of Rule 86B, companies were availing ITC as an entire deduction to reduce tax liability, resulting in instances of artificial invoicing and false claims on ITC. In order to counteract these activities, the government implemented this rule so that there would be a genuine inflow of money into the system.

In simpler words:

Despite having enough ITC, you are still required to pay a minimum of 1% tax in cash (under certain circumstances).

Core Concept of Rule 86B

The application of Rule 86B is limited to using ITC towards paying tax liability:

ITC cannot be claimed beyond 99% of tax liability

At least 1% must be settled in cash

Taxable turnover exceeds ₹50 lakh per month

This is applicable only during the use of ITC, not during its claim.

Points to Consider:

Reverse Charge Mechanism (RCM): Transactions that occur via the RCM process cannot be included as a component of the output tax liability in the computation of the 1% cash payment.

Turnover: The figure of ₹50 lakh will be computed monthly and not on a cumulative basis from past month turnovers.

Zero-Rated Supplies: Although zero-rated supplies are not included when computing the 50 lakh limit, the 1% cash payment is calculated based on the entire output tax liability inclusive of supplies with tax payment.

Understanding the Real Impact

Stop theorizing now.

Corporate Truth

Consider a firm which is having

ITC Balance: High

Cash Balance: Low

Prior Situation: Nothing much was done; 100% utilization of ITC was possible

Current Situation: Needs cash arrangement for even 1% of total taxes due

It definitely will have an effect on working capital management

●       Case Study to Explain It More Clearly

●       Turnover every month = ₹1 crore

●       GST rate: 18%

●       Total GST amount: ₹18 lakh

●       ITC Balance: ₹20 lakh

●       Under Section 86B of CGST Act

●       Utilization of total ITC possible = ₹17.82 lakh

●       Balance of ₹18,000 required to pay in cash

Provision/Restriction on new rule [Rule 86B]

In discharging the output tax liability of the month, ITC will be allowed only up to 99% of the total output tax liability provided there is any ITC available. It implies that at least 1% of output tax liability should always be paid in cash via e-cash ledger.

For example :-

♦ Total turnover during April, 2021 =Rs. 1,00,00,000

♦ The applicable tax rate = 18%

♦ Hence, tax liability would be =Rs. 1,00,00,000*18% = Rs. 18,00,000

♦ ITC after applying rule 36(4)= Rs. 20,00,000

the availing of input tax credit shall not exceed 5% of the reported supplies in case where such supplies have not been auto-populated in the form GST-1

Pre-Amendment :- In this case, the supplier was able to clear his total liability of Rs. 18 lakh out of Rs. 20 lakh in his e-credit ledger. Therefore, the remaining balance in the e-credit ledger will be Rs. 2 lakh [20L - 18L]. There will be no discharge of liability from the e-cash ledger.

Post Amended :- The availing of the credit in the e-credit ledger can only be done up to 99% of the output tax liability. Therefore, the total amount to be utilized from the e-credit ledger will be Rs. 17.82 lakh [18L * 99%]. The remaining balance in the e-credit ledger will be Rs. 2.18 lakh [20L - 17.82L].

Applicability of restriction :-

The applicability of restriction is there in case value of taxable supply exceeds Rs. 50 Lakhs during a particular month

♦ For instance, if in the month of April, 2021, the value of taxable supplies exceeds Rs. 50 Lakhs then only the rule shall apply. In case next month, that is May, 2021, the value of taxable supply doesn’t exceed Rs. 50 Lakhs, the rule won’t apply at all.

Meaning of value of taxable supplies : - As per section 2(108), value of taxable supplies means a supply of goods and/or services that is subject to taxation.

♦ Therefore, in other words, it includes any supply for which charge is made as per sections 9 of CGST or 5 of IGST.

Rule 86B Violations

Despite all the strict conditions, however, the Rule provides some exemptions to mitigate its effect on specific companies:

Income tax payments: Where taxpayers or key management personnel of the company such as the proprietor, karta, managing director, or partners have paid income tax exceeding Rs. 1 lakh each year for the past two years, the above-mentioned obligation will not apply to them.

Exports or inverted tax structure refund: These exemptions apply to the company which has been refunded Rs. 1 lakh or more during the previous year, due to the letter of undertaking for export or inverted tax structure.

Payment made during other months in the same year: If the company has already made more than 1% payment of total output tax liability through cash settlement in the first few months of the year, they would also be exempted from the obligation imposed by rule 86B.

Government Companies/Institutions: These rules do not apply to any organization run by the government.

Impact of Rule 86B on Businesses

Rule 86B’s Impact in particular, appears to be targeted at large taxpayers with relatively higher taxable turnover, and therefore, its effect on micro and small businesses is not as likely. The primary objective of the rule is to reduce the practice of issuing fake invoices and using the same for ITC purposes to avoid tax payments.

In this regard, among other things, it requires a minimum cash payment of 1% so as to show genuine transactions rather than merely claiming ITCs to meet their tax obligations.

In the case of bigger businesses, however, this will lead to the management of working capital and cash flows. For those that are heavily reliant on ITCs, their tax obligation will be substantially reduced.

Rule 86 B is an important rule within the GST regime intended to avoid the abuse of ITC and maintain the minimum requirement of cash payment. Even as it places limitations, it offers several exceptions and relief options.