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December 26, 2025

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Basics of GST

Complete Guide to Rule 42 of CGST & SGST Rules

Rule 42 of the CGST and SGST Rules describes how a taxpayer needs to reverse the input tax credit in relation to goods and/or services used for both taxable as well as exempt supplies. This will be important for those taxpayers who are not in a purely taxable environment. A taxpayer usually operates in a mixed supply environment where it provides both taxable as well as exempt supplies.

What is Rule 42 of CGST & SGST Rules?

Rule 42 defines how to apportion (divide) and reverse ITC on inputs and input services when they are used for both:

Taxable supplies

Exempt supplies

Business and non-business purposes

It ensures that taxpayers only claim the portion of ITC that relates to taxable supplies.

Why Rule 42 Exists

The government allows ITC only on taxable supplies. If a business uses goods/services for exempt supplies as well, then claiming full ITC would cause revenue loss to the government.
Rule 42 provides a structured formula so every taxpayer follows the same method.

When Does Rule 42 Apply?

Rule 42 applies in the following cases:

You make mixed supplies (taxable + exempt).

You use inputs and input services for both types of supplies.

You need to reverse the proportionate ITC every month and finalize it annually.

Specific Conditions for ITC Reversal under CGST and SGST

Input Tax Credit (ITC) must be reversed in certain situations as prescribed under the CGST and SGST Acts and Rules. These provisions apply equally to both GCST and SGST, and reversal is required in the same proportion for both.

Relevant Rule (CGST & SGST)	Situation / Circumstances	ITC Reversal Required
Rule 37	Recipient fails to pay full or part consideration to suppliers	If payment is not made within 180 days from invoice date
Rule 37A	Supplier fails to pay GST through GSTR-3B	On or before 30th November of the following financial year
Rule 38	Banking and financial institutions opting special ITC method	At the time of filing regular returns (50% ITC reversal)
Rule 42	Inputs or input services used partly for taxable supplies and partly for exempt non-business or personal use	On a monthly or annual basis using prescribed formula
Rule 43	Capital goods used for taxable as well as exempt/non-business purpose	Periodic reversal using prescribed formula
Rule 44	Cancellation of GST registration or Switching to composition scheme	At the time of filing REG-16 or ITC-03
Rule 44A	Gold dore bars in stock as on 1 July 2017	Reversal of 5/6th of ITC at time of supply of gold jewelry
Section 16 (3)	Depreciation claimed on GST portion of capital goods under Income Tax Act	At the time of finalization of books for that financial year
Section 17(5)	Inputs used in good lost, stolen, destroyed, or written off	In the return for the month in which loss occurred
Section 17(5)(h)	Inputs use for free samples or gifts	In the return for the month when samples were distributed
Section 17(5)(i)	Tax paid under section 74 (fraud, suppression)	In the return for the month in which tax was paid

Types of Input Tax Credit Under Rule 42

ITC is divided into three categories:

1. Exclusive Credit for Taxable Supplies (T)

ITC is used only for taxable outward supplies.
This credit can be fully claimed.

2. Exclusive Credit for Exempt Supplies (E)

ITC is used only for exempt supplies.
This credit cannot be claimed. It must be reversed.

3. Common Credit (C)

ITC is used for both taxable and exempt supplies.
This part must be divided using the Rule 42 formula.

Step-by-Step Calculation of ITC Under Rule 42

Let:

T = ITC used only for taxable suppli

E = ITC used only for exempt supplies

C1 = Total eligible ITC on inputs + input services

C2 = Blocked credits (ineligible under section 17 (5))

C3 = Common credit after removing T & E

D1 = ITC reversal for exempt supplies

D2 = ITC reversal for non - business use

C4 = Net eligible credit

Step 1: Remove blocked credits

C1 – C2 = C

Step 2: Remove ITC exclusively used for non-business purposes

This part is D2 = 5 percent of total credit.

Step 3: Identify common credit

C3 = C – (T + E + D2)

Step 4: Calculate proportionate reversal exempt supplies

D1 = (Exempt turnover / Total turnover) × C3

Step 5: Final eligible ITC

C4 = T + (C3 – D1 – D2)

Practical Example of ITC Reversal under Rule 42

Example Data

Particulars	Symbol	Amount
Total ITC for the tax period	C1	₹1,20,00
Blocked Credit	C2	₹30,000
ITC Exclusively for exempt supplies	E	₹20,000
Exempt turnover	-	₹10,00,000
Total Turnover	-	₹50,00,000
ITC exclusively for taxable supplies	T	₹35,500

Step-wise Calculation

Steps	Particulars	Formula	Amount
Step 1	Common Credit	C = C1 - C2	₹1,20,000 - ₹30,000 = ₹90,000
Step 2	ITC attributable to exempt supplies (D1)	(Exempt turnover / total turnover) * C	(₹10,00,000 / ₹50,00,000) * ₹90,000 = ₹18,000
Step 3	ITC attribute to non-business use (D2)	5% of C	5% * ₹90,000 = ₹4,500
Step 4	Eligible Common ITC (C3)	C - D1 - D2	₹90,000 - ₹18,000 - ₹4,500 = ₹67,500

Final Eligible ITC

Final eligible ITC includes:

ITC exclusively for taxable supplies (T)

Eligible portion of common credit (C3)

If ITC exclusively for taxable supplies (T) = ₹35,500

Final Eligible ITC = T + C3

ITC = ₹35,500 + ₹67,500

ITC = ₹1,03,000

Common Mistakes Businesses Make

Claiming full ITC without checking except turnover

This causes heavy penalties and interest later.

Not maintaining proper records

Incorrect classification leads to wrong ITC calculation.

Missing annual adjustment deadlines

This results in interest liability.

Confusing Rule 42 with Rule 43

Rule 42 is for inputs input services.
Rule 43 is for capital goods.

Compliance Requirements Under Rule 42

Businesses must:

Maintain separate record for taxable & exempt supplies

Identify exclusive and common ITC

Calculate monthly reversal in GSTR-3B

Perform annual adjustment

Adjust differences with interest if required

Keep supporting documents for at least 6 years

Who Should Pay Special Attention to Rule 42

The rule is important for:

Manufacturers supplying both taxable and exempt goods

Service providers offer exempt services

Real estate projects

Hospitals

Educational institutions

Trading businesses with mixed supplies

NGOs with exempt activities

Final Eligible ITC After Rule

The taxpayers can finally claim is:

Full ITC on taxable supplies

No ITC on exempt supplies

Adjusted common ITC after reversals

This ensues fair credit distribution

Conclusion

Rule 42 of the CGST and SGST Rules has a significant role in proper use of Input Tax Credit. A person with taxable as well as exempt supplies has to ascertain how much of their ITC needs to be reversed in relation to their exempt supplies. A person understanding the calculations, turnover thresholds, and compliance requirements related to Rule 42 will be able to avoid penalties and interest. Monthly reconciliations well as correct annual reconciliations are key to maintaining good GST compliance and avoiding potential issues in the future.