GST input tax credit: one product, four invoices

Tax on value added, not on the price

GST is charged at every step of a supply chain, yet the final price carries the tax only once. Input tax credit (ITC) is what makes that work. Each registered business sets the GST it paid on its purchases against the GST it charges on its sales, and deposits only the difference.

Our guide on running a small business by the numbers calls GST "an input-credit chain rather than a cost". This post follows one product through that chain, invoice by invoice, and then looks at the ways the chain breaks.

Four businesses, four invoices

This is an illustration with assumed prices for a product taxed at 18%, one of the three main slabs, with 5% and 40%, since the rate rationalisation of 22 September 2025. The rate for a real product depends on its HSN classification. Within a state, 18% is charged as 9% CGST plus 9% SGST; across states, as 18% IGST. The GST calculator does the split.

1. A component supplier in Gujarat sells parts to a manufacturer in Gujarat for ₹1,000 plus ₹90 CGST and ₹90 SGST.
2. The manufacturer sells the finished product to a distributor in Maharashtra for ₹1,500 plus ₹270 IGST.
3. The distributor sells to a retailer in Maharashtra for ₹1,800 plus ₹162 CGST and ₹162 SGST.
4. The retailer sells to a consumer for ₹2,200 plus ₹198 CGST and ₹198 SGST.

The government receives ₹396, which is 18% of ₹2,200. Each business paid 18% of its own value added and nothing on what it bought. The consumer, who cannot claim credit, bears the whole ₹396.

The set-off order, step by step

How each credit is used is fixed by law, and the GST input tax credit calculator follows it.

• Manufacturer. It owes ₹270 IGST and holds ₹90 CGST and ₹90 SGST credit. With no IGST credit, it uses CGST credit and then SGST credit against the IGST, and pays ₹90 in cash.
• Distributor. It owes ₹162 CGST and ₹162 SGST and holds ₹270 of IGST credit. IGST credit must be used first, and the split between CGST and SGST is the taxpayer's choice: ₹135 against each head. It pays ₹27 CGST plus ₹27 SGST, ₹54 in cash.
• Retailer. CGST credit of ₹162 meets ₹162 of its ₹198 CGST; SGST credit does the same for SGST. It pays ₹36 plus ₹36.

The rule that catches people: no CGST-to-SGST crossing

CGST credit can never pay an SGST liability, and the reverse. Take a trader in one month with ₹50,000 of CGST credit and ₹10,000 of SGST credit, owing ₹30,000 of each:

It holds ₹60,000 of credit against ₹60,000 of tax, and still pays ₹20,000 in cash. The unused ₹20,000 CGST waits in the credit ledger. That is real money out of the business's working capital, which the working capital calculator will feel.

Why credit is denied

Section 16(2) of the CGST Act allows the credit only when all of these hold at once:

• You hold a valid tax invoice and have received the goods or services.
• The invoice appears in your GSTR-2B. That happens only if the supplier reported it in their GSTR-1. No GSTR-2B entry, no credit, however valid the invoice looks.
• The supplier has paid the tax to the government.
• You have filed your own return.

Two time limits sit on top. If you do not pay the supplier within 180 days of the invoice date, the credit must be reversed until you do. And credit for a financial year must be claimed by 30 November of the following year or the date you file the annual return, whichever is earlier. Filing GSTR-9 early closes the window early.

Section 17(5) also blocks some credits outright, whatever the business use: passenger cars seating up to thirteen and their insurance and servicing, food and beverages, club and gym memberships, health and life insurance unless the law requires it, construction of your own building other than plant and machinery, goods given away as free samples, and anything for personal use. Goods-transport vehicles are eligible.

What a missing GSTR-1 costs the retailer

Suppose the distributor in our chain does not file its GSTR-1. The retailer's ₹324 of credit never reaches its GSTR-2B, so it pays the full ₹396 on its sale in cash instead of ₹72. Its gross margin on the product was ₹400; losing the credit takes ₹324 of it, or 81%, until the distributor files. The profit margin calculator shows how thin that leaves things, and margins should always be computed on GST-exclusive figures.

The practical rules:

1. Reconcile purchases against GSTR-2B every month, before you file, not at year-end.
2. Buy from suppliers who file on time. A cheap quote from a supplier who files late can cost 18% more than a fair one.
3. Pay suppliers within 180 days, or plan for the reversal.
4. Price inclusive or exclusive deliberately. An 18% surprise at invoice time loses customers.
5. Keep GST and TDS apart. A client who deducts income-tax TDS from your invoice is not reducing your GST; the TDS calculator shows what lands in your account.

Credit stuck in a ledger is cash not in your account, and it shows up when the bank tests your DSCR or your break-even volume. Professionals who bill clients and are registered for GST face the same chain; their income tax is a separate question, covered in our guide to presumptive tax for freelancers (section 58 of the Income-tax Act 2025, still widely called 44ADA) and the presumptive tax calculator. Annual returns have their own traps, listed in tax filing mistakes to avoid. The official source for rules and forms is the GST portal and CBIC.

This post is for education only. GST rates, rules and deadlines change; the example uses assumed prices and an 18% rate for illustration. Check the current position with your tax adviser before filing.