What is Rule 42 and Rule 43 ITC reversal?

Why credit has to be reversed

Input tax credit is allowed only to the extent goods and services are used for taxable supplies in the course of business. When a purchase serves both taxable and exempt supplies, or both business and personal use, and you cannot trace it to one or the other, it is common credit. Section 17(2) and 17(1) of the CGST Act limit the credit to the taxable and business share, and rules 42 and 43 set the arithmetic.

Rule 42: inputs and input services

1. Start with the total credit for the month (T).
2. Take out credit used only for non-business purposes (T1), only for exempt supplies (T2) and blocked credit under section 17(5) (T3). None of these can be claimed at all.
3. Take out credit used only for taxable supplies, including exports (T4). This is claimed in full.
4. What is left is common credit (C2).
5. Reverse the exempt share: D1 = (exempt turnover ÷ total turnover) × C2, using the month's turnover.
6. Where common inputs also serve personal or other non-business use, reverse a further fixed share of C2 that the rule sets (D2).

The month-by-month figures are provisional. After the financial year, the calculation is redone on the whole year's turnover, by the due date the rule sets. A shortfall is paid with interest under section 50; an excess reversal is claimed back.

Rule 43: capital goods

Credit on capital goods used only for taxable supplies is claimed in full, and credit on capital goods used only for exempt or non-business purposes is not claimed. For capital goods used for both, the common credit is spread evenly over the useful life the rule assumes, and each month the exempt share of that month's portion is reversed, using the same turnover ratio. There is no annual true-up for capital goods.

What counts as exempt here

Exempt supplies for this purpose include nil-rated and exempt goods and services, and supplies outside GST such as alcoholic liquor for human consumption. Section 17(3) adds some others, including supplies on which the buyer pays GST under reverse charge. Interest earned on deposits, loans and advances is left out of exempt turnover for a business that is not a bank or other lender, so a D2C brand's interest on fixed deposits does not trigger a reversal.

Credit received through an ISD

Where a company's head office distributes common credit to its branches as an Input Service Distributor, the CBIC has clarified (Circular No. 260/06/2026-GST) that the ISD distributes the full credit and each receiving branch makes the rule 42 and 43 reversals on its own supplies.

What goes wrong

• No reversal at all because exempt sales are small. Even a small exempt line triggers it.
• Skipping the annual true-up. Monthly turnover swings, so the annual figure is usually different.
• Treating blocked credit as common. Blocked credit is taken out first, not shared.