Distribution of ITC through ISD is not mandatory before April 2025 Amendment

Micro Labs, a Bengaluru-based pharmaceutical company, managed its taxes centrally. While it distributed tax credits (ITC) for regular services through the Input Service Distributor (ISD) route, it handled Reverse Charge Mechanism (RCM) credits by issuing tax invoices directly to its branches a process known as “cross-charging.” The GST authorities took issue with this, claiming the company had to use the ISD mechanism for everything. They slapped the firm with a massive demand for tax, interest, and penalties covering five years.

Main Issue: Was it legal for companies to distribute common tax credits via cross-charging instead of the ISD route before the law was officially tightened in 2025?

HC Held: The Karnataka High Court allowed the writ petition and quashed the impugned order, holding that the distribution of ITC through cross-charging was valid and permissible. The Court observed that prior to the amendment effective from 01.04.2025, the definition of ISD did not cover services liable under the Reverse Charge Mechanism, thereby creating a practical limitation for taxpayers. Relying on CBIC Circular dated 17.07.2023, the Court held that distribution of ITC through ISD was not mandatory and taxpayers had the option to distribute credit by issuing tax invoices under Section 31.

The authorities failed to consider this binding clarification and proceeded on an incorrect assumption that ISD was the only permissible method. The Court further noted that the petitioner had availed only eligible ITC and that the distribution of such credit to branch offices was in accordance with law. Since the impugned order disregarded the statutory framework and binding circular, it was held to be arbitrary and without jurisdiction. Accordingly, the demand of tax, interest, and penalties was set aside.

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