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Mandatory ISD Regime Takes Shape - Insights on the Finance Bill, 2024

Feb 07, 2024

Sahana Rajkumar
Associate Partner, Lakshmikumaran & Sridharan

Derlene Joshna
Senior Associate, Lakshmikumaran and Sridharan Attorneys

The Finance Bill, 2024 proposes to substitute the provisions of Goods and Services Tax (GST) Law relating
to Input Service Distributor (“ISD”). At first glance, the proposed amendments appear to be aligned with
the recommendations of the GST Council in the 50th and 52nd meetings. In this article, the authors
would provide their insights on the amendments proposed to the ISD provisions under GST and highlight
some issues which can be resolved before the amendments are made effective.

Recommendations of the GST Council

50th GST Council Meeting

In the 50th GST Council Meeting, it was noted that the present formulation of Section 20 read with
Section 24 of Central Goods and Services Tax Act, 2017 (“CGST Act”) does not indicate that ISD
mechanism is mandatory and that taxpayers have an option to distribute ITC by issuing tax invoice
between distinct persons (colloquially referred as ‘cross-charge’).[1]

The Law Committee opined that ITC on account of input services attracting GST under reverse charge
mechanism (RCM), should also be distributed through ISD route and that the same will require
amendment in law.[2]

In the context of these issues, the GST Council approved the Law Committee’s recommendation to issue
a circular to clarify that ISD is not mandatory for the past period.[3] The GST Council also approved the
Law Committee’s recommendations of carrying out necessary amendments to make ISD mechanism
mandatory with prospective effect.[4]

52nd GST Council Meeting

Pursuant to the recommendations in the 50th GST Council Meeting, the Council has approved the actual
amendments to be made in Section 2(61) and Section 20 of the CGST Act and Rule 39 of the Central
Goods and Services Tax Rules, 2017 (“CGST Rules”) in respect of the same.[5]

Analysis of the proposed amendments to ISD related provisions

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The Finance Bill, 2024 proposes to substitute the definition of ISD and the provision governing the
manner of distribution of credit.

Substitution of the definition of ‘Input Service Distributor’

Clause 11 of the Finance Bill, 2024 proposes to substitute the definition of ISD under Section 2(61) of the
CGST Act. The proposed definition of ISD with the definition presently provided in the GST law are tabled
below.

Proposed definition Present definition

(61) “Input Service Distributor” means an office of(61) “Input Service Distributor” means an office of
the supplier of goods or services or both whichthe supplier of goods or services or both which
receives tax invoices towards the receipt of inputreceives tax invoices issued under section 31
services, including invoices in respect oftowards the receipt of input services and issues a
services liable to tax under sub-section (3) orprescribed document for the purposes of distributing
sub-section (4) of section 9, for or on behalf ofthe credit of central tax, State tax, integrated tax or
distinct persons referred to in section 25, andUnion territory tax paid on the said services to a
liable to distribute the input tax credit insupplier of taxable goods or services or both having
respect of such invoices in the mannerthe same Permanent Account Number as that of the
provided in section 20;[6] said office;

Substitution of Section 20 prescribing the manner of distribution of credit by ISD

Clause 12 of the Finance Bill also proposes to substitute Section 20 of the CGST Act. Sub-section (1) of
the proposed Section 20 provides as follows:

“(1) Any 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, for or on behalf of distinct persons referred to in section 25, shall be required to
be registered as Input Service Distributor under clause (viii) of section 24 and shall distribute the input
tax credit in respect of such invoices”

Sub-section (2) of the proposed Section 20 provides as follows:

“(2) The Input Service Distributor shall distribute the credit of central tax or integrated tax charged on
invoices received by him, including the credit of central or integrated tax in respect of services subject to
levy of tax under sub-section (3) or sub-section (4) of section 9 paid by a distinct person registered in the
same State as the said Input Service Distributor, in such manner, within such time and subject to such
restrictions and conditions as may be prescribed.”

Sub-section (3) of the proposed Section 20 provides as follows:

“(3) The credit of central tax shall be distributed as central tax or integrated tax and integrated tax as
integrated tax or central tax, by way of issue of a document containing the amount of input tax credit, in
such manner as may be prescribed.”

Analysis and Comments

The definition of ISD is proposed to be amended to make the ISD “liable” to distribute ITC in the manner
provided in Section 20. Similarly, the proposed Section 20(1) reiterates the text of the ISD definition and
mandates the requirement to be registered as ISD under Section 24(viii) viz., provision which mandates
compulsory registration of an ISD. These proposed changes in the text of Section 2(61) and Section 20(1)
emphasize the GST Council’s intention to make ISD mechanism mandatory with prospective effect.

The recognition of input services liable to GST under RCM in the proposed definition of ISD raises a doubt
on whether the ISD will henceforth be liable to pay GST under RCM on such input services. A reading of
the proposed Section 20(2) provides some clarity on this doubt. As per the proposed Section 20(2), the

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ISD shall distribute the following credits:

the credit of CGST or IGST charged on invoices received by him.

the credit of CGST or IGST in respect of services subject to GST under RCM paid by a distinct
person registered in the same State as the said Input Service Distributor.

As of date, the following two options are available in respect of distributing ITC pertaining to common
input services through the ISD mechanism.

Option 1: Common input services may be directly invoiced to the ISD registration for further
distribution of ITC to the BOs.
Option 2: A taxable person with same PAN and state code as the ISD may receive the
common input services and raise an invoice in terms of Rule 54(1A)(a) of the CGST Rules on the
ISD for further distribution of ITC to the BOs.

As the present definition of ISD merely refers to ‘tax invoices issued under Section 31’ and does not
explicitly recognize distributing ITC through Option 2 viz., invoice raised under Rule 54(1A) of the CGST
Rules, it is plausible that the proposed amendments in Section 2(61) and Section 20(2) seek to align the
provisions of the CGST Act with the practice already in place through the CGST Rules.

The wordings of the proposed Section 2(61) and Section 20(2) may at first glance raise a doubt on
whether the ISD will henceforth be liable to discharge GST on common input services attracting GST
under RCM and distribute the credit of the GST so paid to distinct persons. However, in the view of the
authors, reference to ‘invoices in respect of services liable to tax under sub-section (3) or sub-
section (4) of section 9’ in the definition of ISD is to be read along with Section 20(2) wherein it has
been stated that ISD shall distribute credit of tax paid under reverse charge ‘by a distinct person
registered in the same State as the said Input Service Distributor’. In essence, ISD would merely
distribute the credit of GST paid by the regular GST registration of a taxpayer (located in the same State
as that of the ISD). The said regular registration would remit the tax under reverse charge and
subsequently raise an invoice under Rule 54(1A) on the ISD for further credit distribution. In simple
terms, Option 2 is mandatory for common input services liable to GST under RCM. Such harmonious
reading is necessary to render all provisions workable.

While the present Section 20 provides for the manner of distribution of credit on the basis of recipient
GST registrations’ turnover in the CGST Act itself, the proposed Section 20 provides that the manner of
distribution of credit will be prescribed through the CGST Rules. The Law Committee has taken a view
that the manner of distribution of ISD credit as provided in Section 20 does not require amendment at
present and that alternate objective criteria may be explored in future, if deemed appropriate, after
consultation with trade.[7] The corresponding amendments to the CGST Rules are awaited to see if there
is any change in the manner of distribution of credit by an ISD.

The proposed sub-section (3) to Section 20 is similar to the present Section 20(1) and provides that the
credit of central tax “shall be” distributed as central tax or integrated tax and integrated tax as
integrated tax or central tax, by way of issue of a document containing the amount of input tax credit, in
such manner as may be prescribed. This proposed modification also re-emphasizes the mandatory nature
of the ISD mechanism.

Concluding remarks

The proposed amendments discussed in this article will come into force as law once the Finance Act,
2024 is enacted and the sections proposing these amendments are notified by way of notification.[8] It is
imperative for companies to review the impact of these proposed amendments on their business
operations before they come into force.

Apart from the issues highlighted in the GST Council meetings, further clarity is required on various
issues incidental to credit distribution through ISD route. For example, there is no explicit provision
stipulating a time limit within which an invoice referred to in Rule 54(1A) is required to be raised. It merits
to be seen whether the time limit for availing credit under Section 16(4) is also extended to credit
distributed through ISD mechanism. It is hoped that suitable clarifications settle these issues for

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taxpayers.

[1] Agenda Item 3(xix): Issues pertaining to ISD mechanism and taxability of services provided by one
distinct person to another distinct person, Agenda for 50th GST Council Meeting (Vol III), available at
https://gstcouncil.gov.in/sites/default/files/Agenda/Agenda_VolumeIII_50th.pdf.

[2] Id at para 7.1.2.1 of Agenda Item 3(xix).

[3] Circular No. 199/11/2023-GST dated 17th July 2023 was issued pursuant to the recommendations of
the 50th GST Council Meeting.

[4] Minutes of the 50th GST Council Meeting dated 11.07.2023

[5] Press Release on the 52nd GST Council Meeting dated 07.10.2023. A copy of the Agenda Notes and
Minutes of the 52nd GST Council Meeting are not available in the public domain as on 02.02.2024.

[7] Supra Note 1 at Para 7.1.2.2.

[8] Clause 1(2)(b) of the Finance Bill, 2024.

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