India: Navigating the impact of credit notes on GST compliance

published on 18 February 2025 | reading time approx. 3 minutes

In Budget 2025, a significant change is introduced regarding the treatment of credit notes under GST, shifting the responsibility of input tax credit (ITC) reversal to suppliers. This amendment raises significant compliance concerns for businesses and necessitates a reassessment of ITC reconciliation strategies to avoid penalties and disputes.

Why Are Credit Notes Issued?

In a dynamic business environment, invoicing errors are inevitable. Credit notes serve as a crucial tool for rectifying discrepancies such as:

Overstated invoice values
Incorrect GST rates applied
Returns of goods or cancellations of services

Further such credit notes may also be issued in cases of trade discounts and volume-based incentives agreed beforehand between the supplier and the recipient.

While credit notes help maintain financial accuracy, their treatment under GST regulations demands meticulous attention to ensure compliance and avoid unnecessary tax liabilities.

What Is the Budget Amendment Related to Credit Notes Under GST?

The proposed amendment to sub-section 2 of Section 34 of the CGST Act introduces a fundamental compliance shift — recipients are now required to reverse ITC when a supplier issues a credit note. Previously, suppliers could reduce their output tax liability upon issuing a credit note, irrespective of whether the recipient had reversed the corresponding ITC.

Under the new amendment, suppliers can only adjust their output tax liability if the recipient has appropriately reversed the corresponding ITC.

This change, aimed at preventing revenue leakage and eliminating double tax benefits, necessitates a reassessment of ITC reconciliation strategies for businesses to ensure compliance and mitigate financial exposure.

What is the Objective behind the proposed amendment?

From a regulatory standpoint, this amendment reinforces the integrity of GST collections. By closing the loophole that allowed suppliers to reduce their GST liability while recipients continued to claim ITC, the government aims to create a more transparent and efficient tax ecosystem.

However, this transition places an additional burden on businesses, requiring them to enhance their reconciliation processes and improve coordination with their suppliers.

What are the Challenges foreseen for the Taxpayers?

For businesses, the amendment introduces stricter compliance requirements and increases the complexity of GST reconciliation. Key challenges include:

Lack of a Verification Mechanism: Till date, there is no automated mechanism for suppliers to verify whether recipients have reversed ITC, making compliance more difficult
Increased risk of litigation: Any inadvertent failure to reverse ITC could lead to tax demand, interest, and penalties
Disputes Between Suppliers and Recipients: Differences in understanding or implementation of the credit note reversal requirement could lead to disputes and strained business relationships
Impact on Trade Discounts and Incentives: Businesses that offer trade discounts and volume-based incentives must now track supplier credit notes more rigorously and ensure accurate ITC reversals before reducing their output liability

What are the Steps that need to be taken by the Taxpayers?

To comply with the proposed amendment and avoid penalties, businesses should take the following steps:

Implement Robust Reconciliation Mechanisms to maintain real-time tracking of credit notes issued by suppliers and match them against ITC claims to prevent discrepancies
Establish clear communication channels with suppliers to verify credit notes and ensure timely ITC reversals
Utilize GST-compliant accounting software to automate ITC reversals on account of credit notes and minimize human errors
Conduct periodic audits/reviews to ensure that credit notes are appropriately accounted for in GST filings
Assess and update vendor agreements to align with the new compliance requirements and ensure clarity on ITC reversals
Engage tax experts to navigate the complexities of the amendment and minimize compliance risks

At Rödl & Partner, we specialize in guiding businesses through complex GST challenges. Our expertise in tax advisory and litigation can help you:

Review your existing vendor contracts to ensure compliance with updated regulations
Minimize compliance risks and avoid potential disputes
Assist in vendor communications
Streamline reconciliation processes for seamless GST reporting