All about Input Service Distributor: Gearing up your business for FY 2025-26

 

CA. Shiv Kumar Bhasin

Introduction

The Input Service Distributor (ISD) concept has undergone significant modifications in the year 2024 and 2025, impacting the way businesses avail and allocate input tax credit (ITC). Not only has this concept been made now mandatory for taxpayers, but reverse charge transactions have also been integrated into this credit distribution mechanism.

 

For businesses operating in multiple states in India, it is the need of the hour to assess the necessity of obtaining new ISD registration and to understand the compliance requirements that follow registration.

 

This article explores the ISD concept in detail, including the procedure for distribution of ITC by ISD along with the special procedure notified for distribution of ITC on reverse charge transactions.

 

Additionally, this Article offers insights into how to prepare for the new mechanism by implementing necessary changes in accounting systems and return filing processes. It also outlines key actions that must be undertaken before the start of FY 2025-26, by the entities already registered in multiple states, for streamlining the availment and distribution of ITC.

 

 

1. Purpose and definition of ISD

The Input Service Distributor (ISD) mechanism is designed for businesses that operate across multiple states in India, where common input services are availed by various branches or units of a single legal entity. These common services are often procured centrally at the head office or a specific location but are utilized by multiple branches. The process of distribution begins with the ISD registering itself under GST as a separate registration. Firstly, the ITC is claimed by ISD and then it is distributed to the relevant branches or units across the country. This ensures that each branch utilizes its correct proportion of ITC on common services.

 

The definition of ISD contained in section 2(61) of the CGST Act, 2017 is stated as follows:

 

Input Service Distributor means an office of the supplier of goods or services or both which receives tax invoices towards the receipt of input services, including invoices in respect of services liable to tax under sub-section (3) or sub-section (4) of section 9 of this Act or under subsection (3) or sub-section (4) of section 5 of the Integrated Goods and Services Tax Act, 2017, for or on behalf of distinct persons referred to in section 25, and liable to distribute the input tax credit in respect of such invoices in the manner provided in section 20.

 

Below is an illustrative list of the common input services:

 

o     Accounting and auditing services

o     ERP services

o     IT softwares

o     Retainership based services

o     Advertisement

o     Online subscriptions

o     Banking and financial services

o     Facility management services

o     Travel and accommodation services

o     Training and development services

o     Insurance Services

o     Telecommunication services

 

2. ISD v. Cross Charge

The concept of cross charge is also used to distribute the common ITC on goods and services to the respective recipients across India. Cross charge involves issuance of tax invoice by the Head Office as an outward supply to the branches to which such ITC pertains. In this way, the ITC is cross charged to the respective recipient by the Head Office. Notably, cross charge can also be done for internally generated goods or services like a software developed by Head Office which is used across India by all the branches.

 

ISD is restricted for distribution of ITC on invoices received from third party (vendors). Hence, concept of ISD is not applicable for internally generated services provided by Head Office of an entity to its branches, which are to be specifically billed by Head Office to the branches through the mechanism of cross charge.

CBIC Clarification on ISD v. Cross Charge

It was clarified vide Circular No. 199/11/2023-GST dated 17th July, 2023 that in respect of common input services procured by the Head Office from a third party but attributable to both Head Office and Branch Offices or exclusively to one or more Branch Offices, HO has an option to distribute ITC in respect of such common input services by following ISD mechanism. However, till 31st March 2025, it is not mandatory for the Head Office to distribute such input tax credit by ISD mechanism. Hence, Head Office can also cross charge the input tax credit by issuing tax invoices to the concerned Branch Offices in respect of common input services procured from a third party by Head Office but attributable to the said Branch Offices and the Branch Offices can then avail ITC on the same subject to the provisions of section 16 and 17 of CGST Act.

Law w.e.f. 1st April 2025

Since the concept of ISD is made mandatory from 1st April 2025, cross charge would be applicable only in case of internally generated goods/services. Further, since ISD is restricted for input services only therefore cross charge would still be used to distribute the common ITC on inputs and capital goods.

 

3. Amendments made vide Finance Act, 2024 and Finance Bill, 2025

The GST Council in its 50th Meeting held on 11th July 2023 recommended that amendment may be made in GST law to make ISD mechanism mandatory prospectively for distribution of input tax credit of such common input services procured from third parties.

 

Accordingly, the GST Council in its 52nd Meeting held on 7th October 2023, recommended a law amendment with respect to ISD in Section 2(61) and Section 20 of the CGST Act as well an amendment in Rule 39 of CGST Rules, 2017 in respect of the same.

 

Consequently, vide Finance Act 2024, the definition of ISD and the distribution mechanism was amended to mandate the ITC distribution through ISD in case of common input services including the services notified under reverse charge notifications of the CGST Act.

 

Recently, vide Finance Bill 2025, another change was brought to include within the scope of ISD, the services notified under reverse charge notifications of the IGST Act also.

 

To sum up, the ISD is made liable to distribute ITC on common input services procured from third parties including the services on which liability is to be firstly discharged on reverse charge basis.

Note: The above amendments will come into force from 1st April 2025.

 

4. Registration and Return filing

As per clause (viii) of Section 24 of the CGST Act, a separate registration is compulsorily required to be obtained as 'Input Service Distributor'. For this a separate registration application is to be filed on the GST Portal.

 

Post registration, monthly return in Form GSTR-6 is to be filed by the ISD on the GST Portal. As per Section 39(4) of the CGST Act, the return is to be filed within 13 days after the end of that month.

 

The return mainly contains the details of invoices on which credit has been received on invoices issued by the vendors and those issued by the ISD to the recipient branches for credit distribution.

 

The return is to be filed on the basis of details contained in FORM GSTR-6A which is auto-populated on the basis of invoices uploaded by the respective vendor in its GSTR-1.

Auto-population in GSTR-2A/2B

As per Rule 60 of the CGST Rules 2017, the details of invoices furnished by an ISD for ITC distribution to the recipient in GSTR-6 will be made available to the recipient(branches) in Part B of their respective Form GSTR-2A. Further, Form GSTR-2B will also consist details of these invoices furnished by the ISD.

 

5. Procedure for distribution of ITC (applicable w.e.f. 1st April 2025)

The ISD, first of all, avails the input tax credit like any other GSTIN and then distributes the credit to other relevant branches. These branches, if registered, can avail the eligible ITC on the basis of invoice issued by the ISD to these branches.

 

The procedure for distribution of ITC is contained in section 20 of the CGST Act, 2017 read with Rule 39 of the CGST Rules, 2017.

 

The manner of distribution of ITC by ISD is summarized as below:

 

o   ITC available for distribution in a month shall be distributed in the same month.

o   Amount of ITC distributed shall not exceed the amount of ITC available for distribution.

o   ITC of tax paid on input services attributable to a recipient (branch) shall be distributed only to that recipient.

o   Eligible and Ineligible ITC needs to be distributed separately.

o   CGST, SGST, UTGST and IGST input tax credit shall be distributed separately.

o   IGST is to be distributed as IGST to every recipient.

o   CGST/SGST is to be distributed as CGST/SGST to a recipient located in the same State or Union territory in which the ISD is located.

o   CGST/SGST is to be distributed as IGST to a recipient located in a State or Union territory different from the location of ISD.

o   ISD shall issue an ISD invoice, as per Rule 54(1), clearly indicating in such invoice that it is issued only for the distribution of input tax credit.

o   In case the ITC already distributed gets reduced for any reason, ISD shall issue an ISD credit note.

o   ITC is to be distributed to even those recipients which are engaged in making exempt supply, or are otherwise not registered under GST Law.

o   ITC required to be reduced on account of credit note issued by the supplier to ISD shall be apportioned to each recipient in the same ratio in which the ITC contained in the original invoice was distributed.

Procedure for ITC distribution in case ITC is attributable to more than one branch

Such distribution shall be pro rata on the basis of the turnover in a State or turnover in a Union territory of such recipient, during the relevant period, to the aggregate of the turnover of all such recipients to whom such input service is attributable and which are operational in the current year, during the said relevant period.

 

Notably, in case of a registered person engaged in the supply of taxable goods as well as goods not taxable under this Act, the turnover shall be reduced by the amount of any duty or tax levied under entries 84 and 92A of List I of the Seventh Schedule to the Constitution and entries 51 and 54 of List II of the said Schedule.

 

Here, the term 'relevant period' is defined as follows:

 

(a) In case the recipients of credit have turnover in their States or Union territories in the preceding financial year then it will be considered as the relevant period.

(b) In case some or all recipients of the credit do not have any turnover in their States or Union territories in the preceding financial year, then relevant period will be the last quarter for which details of such turnover of all the recipients are available, previous to the month during which credit is to be distributed.

 

As per section 2(112) of the CGST Act 2017, "turnover in State" or "turnover in Union territory" means the aggregate value of all taxable supplies (excluding the value of inward supplies on which tax is payable by a person on reverse charge basis) and exempt supplies made within a State or Union territory by a taxable person, exports of goods or services or both and inter-State supplies of goods or services or both made from the State or Union territory by the said taxable person but excludes central tax, State tax, Union territory tax, integrated tax and cess.

 

Let us understand the procedure with the help of following illustration:

 

ABC Ltd. has head office in Delhi and 3 branches operational across India viz. Mumbai, Bangalore and Gurugram. The Head Office receives common input services in April 2025, pertaining to company as a whole, amounting to Rs. 1,00,000 on which GST has been charged as Rs. 18,000 (CGST+SGST). This amount of ITC is to be allocated by ISD to all the 4 GSTINs. The preceding year's turnover of the of Delhi, Mumbai, Bangalore and Gurugram branches was Rs. 5 Lakhs, 7 Lakhs, 8 Lakhs and 4 Lakhs respectively.

 

In this case, the company will take a registration separate from normal registration. Suppose the ISD registration is taken at Delhi. So, for April 2025, the ISD will avail the credit of Rs. 18,000 (CGST+SGST) and distribute it as follows:

 

Delhi: 18,000*5/24 i.e. Rs. 3,750 (Rs. 1,875 CGST + 1,875 SGST)

Mumbai: 18,000*7/24 i.e. Rs. 5,250 (IGST)

Bangalore: 18,000*8/24 i.e. Rs. 6,000 (IGST)

Gurugram: 18,000*4/24 i.e. Rs. 3,000 (IGST)

 

6. Special procedure for distribution of ITC on reverse charge transactions

There may be cases where common ITC arises on inward supplies covered under reverse charge mechanism. In this case, Section 20 read with Rule 39(1A) of the CGST Rules, 2017 provide that the normal registration, taken by the entity in the same state/UT as that of ISD, needs to pay the reverse charge liability and avail the ITC, if eligible. This ITC would then be transferred to ISD vide invoice issued in terms of Rule 54(1A). Now, the ISD would avail and distribute this ITC to the recipient(s) in the same manner of distribution as applicable in case of forward charge invoices as discussed in Para 5 above.

 

Notably, this procedure is applicable from 1st April 2025.

 

7. Format of ISD Invoice

Rule 54(1) of the CGST Rules, 2017 prescribes following contents to be included in an ISD invoice/ ISD credit note issued by an ISD to the recipient(s):

 

a)   name, address and GSTIN of ISD

b)   a consecutive serial number not exceeding 16 characters, in one or multiple series, containing alphabets or numerals or special characters- hyphen or dash and slash symbolised as -"-'', "/" respectively, and any combination thereof, unique for a financial year

Notably, ISD of a banking company or a financial institution, including a NBFC, the invoice may or may not be serially numbered

c)   date of its issue

d)   name, address and GSTIN of the recipient to whom the credit is distributed

e)   amount of the credit distributed

f)    signature or digital signature of the ISD or his authorised representative

 

Further, Rule 54(1A) of the CGST Rules, 2017 prescribes following contents to be included in the invoice issued by a normal GSTIN to ISD for transferring the RCM credit to ISD:

 

a)   name, address and GSTIN of the normal GSTIN having the same state code as the ISD

b)   a consecutive serial number not exceeding 16 characters, in one or multiple series, containing alphabets or numerals or special characters -hyphen or dash and slash symbolised as "-'' and "/" respectively, and any combination thereof, unique for a financial year

c)   date of its issue

d)   GSTIN of supplier of common service and original invoice number whose credit is sought to be transferred to the ISD

e)   name, address and GSTIN of the ISD

f)    Taxable value, rate and amount of the credit to be transferred

g)   Signature or digital signature of the registered person or his authorised representative

 

Notably, the taxable value in the invoice issued under Rule 54(1A) shall be the same as the value of the common services.

 

8. Penalties for non-compliance of ISD provisions

Apart from hefty penalties, the non-compliance of ISD provisions may result into issuance of Show Cause Notices as well.

 

In this regard, Section 21 of the CGST Act, 2017 provides for manner of recovery of credit distributed in excess. In case ISD distributes the credit in contravention of the provisions of GST Law resulting in excess distribution of credit to one or more recipients of credit, the excess credit so distributed shall be recovered from such recipients along with interest. For determination of recovery amount, Section 73/74/74A would be applied.

 

Further, Section 122(1) of the CGST Act, 2017 provides a penalty of Rs. 10,000 or an amount equivalent to the input tax credit availed of or passed on or distributed irregularly, whichever is higher, in the following cases:

 

a)   The entity was liable to be registered as ISD but fails to obtain the registration

b)   Takes or distributes input tax credit in contravention of the provisions of GST Law

 

9. Key action points for FY 2025-26

With the mandatory implementation of ISD mechanism effective from April 1, 2025, businesses must take a proactive approach to ensure compliance and operational readiness well in advance.

 

Businesses must review their current tax structures, assess their eligibility for ISD registration, and implement necessary system updates to accommodate the new framework.

 

Here are some essential action points for businesses to ensure a smooth transition into the ISD framework:

 

o   Obtain early registration - Businesses with multiple locations must apply for ISD registration immediately to avoid last-minute compliance challenges.

o   Update vendors with ISD GSTIN - Ensure all vendors are informed and update their records before March 31, 2025, so that invoices for FY 2025-26 are issued in the ISD's name.

o   Implement Rule 39(1A) for reverse charge - Integrate the reverse charge mechanism into accounting and ERP systems to ensure proper ITC distribution as per GST rules.

o   Train finance & Tax teams - Equip internal teams with the necessary knowledge to handle ISD invoicing, ITC allocation, and reverse charge compliance efficiently.

o   Ensure seamless transition & compliance - Proactive planning will prevent disruptions, ensure smooth ITC flow, and mitigate the risk of non-compliance penalties.

 

[Date: 20/02/2025]

 

(The views expressed in this article are strictly personal.)