GST Alert: ISD Mechanism Becomes Compulsory for ITC Distribution from April 1

Starting April 1, a major change in the GST system will come into effect with the mandatory Input Service Distributor (ISD) mechanism. This rule ensures that state governments receive the correct share of taxes on shared services purchased at one location. Experts feel this will equitably distribute tax revenue to states.

The mandatory ISD mechanism was introduced through an amendment to the CGST Act under the Finance Act (No. 1) of 2024. It allows businesses with operations in multiple states to centralize invoicing for common input services, whether domestic or imported, at one branch or headquarters. This helps in the fair distribution of input tax credits among branches using these shared services.

What is the ISD Mechanism?

The Input Service Distributor (ISD) mechanism permits businesses that have branches in different states to centralize invoicing for shared input services, whether sourced domestically or imported. The input tax credit of such services is subsequently allocated between the branches using them so as to allocate the tax correctly.

Input Tax Credit (ITC) and ISD Mechanism Update

Input Tax Credit (ITC) is the GST paid on business purchases that can be deducted from the tax payable on sales. It assists in lowering the overall GST liability for registered businesses.

Earlier, businesses could choose between the ISD mechanism and the cross-charge method to allocate common ITC across their GST registrations. However, in July 2023, the Central Board of Indirect Taxes and Customs (CBIC) clarified that using ISD was optional for distributing ITC from third-party services.

From April 1, 2025, the ISD mechanism will be made compulsory for all enterprises to ensure a uniform process of distribution of common ITC between branches.

The mandatory Input Service Distributor (ISD) mechanism ensures that Input Tax Credit (ITC) is accurately distributed to the locations where services are actually consumed, preventing its accumulation at a single location.

Earlier, companies had two options: either the ISD mechanism or the cross-charge system to distribute common ITC. ISD registration was voluntary and companies could disburse credits when required However, after the amendment to the CGST Act, the ISD mechanism is now mandatory for offices receiving tax invoices for input services (including those under Reverse Charge Mechanism (RCM)) on behalf of multiple branches or entities.

Consequences of Non-Compliance with the ISD Mechanism

Non-compliance with the obligatory Input Service Distributor (ISD) mechanism may result in various problems, including:

• Regular ITC availed via the cross-charge method could be disallowed for recipient premises.
• Incorrect ITC distribution may lead to tax authorities recovering the amount from recipient locations, along with interest.
• A penalty may be imposed for improper ITC distribution, which will be either the irregular ITC amount or ₹10,000, whichever is higher.