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Input Service Distributor: Understanding this impending mandatory requirement of GST law

Input Service Distributor: Understanding this impending mandatory requirement of GST law

The Input Service Distributor (ISD) is a mechanism that enables the distribution of input tax credits related to common services across various units or factories within an organisation. Initially introduced under the Service Tax regime, the ISD concept transitioned into the GST framework with minimal modifications when GST was implemented in July, 2017.

At the onset of GST, there was some uncertainty as to whether ISD provisions were mandatory or optional, leading some taxpayers to adopt a combination of cross-charging and ISD for expense allocation and credit distribution among their branches.

In the 50th GST Council meeting, held on July 11, 2023, a recommendation was made to clarify through a circular that ISD provisions had been optional up until that point. Additionally, it was proposed to amend the GST law to make ISD provisions mandatory in the future. Following this, Circular No. 199/11/2023-GST, dated July 17, 2023, was issued, formalising the GST Council’s recommendations.

Subsequently, the Interim Union Budget, announced on February 1, 2024, proposed amendments to Sections 2 and 20 of the CGST Act, 2017, making ISD provisions mandatory. Further, on July 10, 2024, Notification No. 12/2024-Central Tax was issued, amending Rule 39 of the CGST Rules, 2017, to prescribe the method for allocating ITC by an ISD.

On August 6, CBIC issued Notification No. 16/2024-Central Tax, which stated that ISD provisions would become mandatory from April 1, 2025.

With the impending mandatory implementation of ISD, taxpayers are advised to review their current practices for allocating expenses and distributing credits. To ensure a smooth transition to the mandatory ISD system, the following actions are recommended:

Assess Common Expenses: Begin by assessing each common expense to determine its eligibility for ISD. Establish clear guidelines for classifying expenses for ISD or cross-charging, ensuring consistency in future evaluations. A detailed review of all expenses is essential.

Develop a Standard Operating Procedure (SOP): After assessing the expenses, create an SOP and a transition plan to minimise disruptions during ISD implementation.

Update Business Systems: Inform the business of the necessary adjustments, including updates to IT systems. This includes incorporating ISD registration details into ERP systems, setting up ISD ledgers, and modifying procurement processes. Additionally, manage the distribution of ineligible credits through ISD and address reversals at the recipient’s GSTIN level, which may require changes to the ERP system.

Vendor Communication: Communicate with vendors to ensure they are aware of the new GST numbers for invoicing purposes. This step is critical to ensure that all expenses are attributed to the correct GSTIN following ISD implementation.

Team Training: Provide training for relevant teams, such as procurement and accounts payable, to ensure they understand the new processes and can perform their roles effectively.

Ensure Compliance: Address all mandatory GST compliance requirements related to ISD, such as obtaining ISD registration, issuing ISD invoices for credit distribution, conducting monthly reconciliations, and filing ISD returns.

The mandatory implementation of ISD also presents an opportunity to reevaluate and potentially optimise credit allocation across an organization’s GST registrations. Although the deadline for ISD implementation is approximately six months away, the extensive preparations required, alongside other obligations like monthly compliance, the newly introduced Invoice Management System, statutory audits, and year-end compliance, suggest that it is advantageous to begin the process early to avoid a last-minute rush.

Considering the above, it would be interesting to witness how taxpayers will adjust to this new requirement and whether the compulsory ISD provisions will enhance transparency or introduce additional complexity into the tax system.

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