The Central Board of Indirect Taxes and Customs (CBIC) has introduced a significant amendment under the Finance Act, 2024, making the Input Service Distributor (ISD) mechanism mandatory for businesses availing Input Tax Credit (ITC) on common input services. This rule, effective from April 1, 2025, will eliminate the use of cross-charge mechanisms for ITC distribution and require businesses to register under ISD for proper ITC allocation.
Notification No. 16/2024–Central Tax, issued on August 6, 2024, formally enforces these provisions, ensuring better compliance, reduced ITC fraud, and uniform credit distribution across multiple locations. Businesses that fail to comply with the ISD requirement will face denial of ITC and a minimum penalty of Rs. 10,000.
This change is expected to impact companies with multiple GST registrations and those procuring input services centrally but utilizing them across various locations. The transition to an ISD-based system will require significant adjustments in GST registrations, invoicing, and accounting practices for businesses.
The Input Service Distributor (ISD) mechanism is a formal GST process where one entity (such as a corporate office) receives input service invoices and distributes ITC to other branches through ISD invoices. ISD was underutilized by businesses because they preferred cross-charging, which was easier to execute and did not require additional compliance. However, with the April 1, 2025 amendment, businesses must now use ISD for ITC distribution instead of cross-charges.
Until now, most businesses were not using the ISD mechanism and instead distributed ITC through cross-charges, which refers to one branch billing another branch for shared services under GST. It has been widely used by service-based companies, corporate offices, and multi-location businesses to distribute ITC for expenses like HR, IT support, accounting, and management services.
The government has observed that businesses were avoiding ISD registration and instead using cross-charge mechanisms to distribute ITC. This led to tax leakages, errors in ITC allocation, and difficulties in audits. By mandating ISD, the government ensures uniformity, better compliance, and a structured ITC distribution process.
From April 1, 2025, all businesses with multiple GST registrations across different states and those procuring input services centrally will need to register their corporate or head office as an ISD under GST. ITC claimed through cross-charges will no longer be permitted.
For instance, consider a retail company operating in five states and headquartered in Delhi. The company will need to adjust its practices significantly to comply with the new ISD requirements.
The April 1, 2025, GST amendment making ISD mandatory for ITC distribution is a game-changing reform that removes the ambiguity around cross-charging and ensures fair tax credit allocation. As the deadline approaches, businesses need to immediately start their transition to ISD compliance by registering as ISDs, updating accounting systems, and preparing for the new GST regulations.
While the move to ISD is designed to enhance compliance, it does not come without challenges. Businesses must obtain separate ISD registrations and appropriately bifurcate their expenses to distinguish which expenses should be allocated via ISD and which are subject to other methods of credit distribution. This means revisiting how invoices are received, communicated to vendors, and processed in the company’s IT systems. Additionally, teams responsible for procurement, accounts, and taxation will need to be well-versed in the new ITC distribution rules, signifying an added compliance burden.
Moreover, the potential consequences of non-compliance are far-reaching. Businesses that fail to adhere to the ISD requirement may have their ITC claims denied, resulting in considerable financial repercussions. This could also mean that penalties, starting at Rs. 10,000 and possibly escalating based on the amount of irregular ITC, will apply.
Overall, the mandatory ISD requirement is a critical step in streamlining the ITC allocation process and ensuring that tax credits are appropriately claimed. As businesses prepare for this shift, they must approach compliance proactively to avoid penalties and ensure they can navigate this new regulatory landscape effectively.
