Input Service Distributor (ISD) and cross charge under GST

Input Service Distributor (ISD) and cross charge under GST,

Key themes and important information related to Input Service Distributor (ISD) and cross charge under GST,

Briefing Document: Input Service Distributor (ISD) vs. Cross Charge under GST

I. Executive Summary:

This Article provides a comprehensive overview of the Input Service Distributor (ISD) mechanism and its interplay with cross-charge within the Goods and Services Tax (GST) framework in India. The Finance Act 2024 (and subsequent discussions anticipating the likely effective date of April 1, 2025) introduces significant changes making ISD registration mandatory for entities with multiple GST registrations under the same PAN. This briefing explores the implications of this change, clarifies the distinction between ISD and cross-charge, outlines compliance requirements, and addresses common issues and interpretations based on various legal provisions, circulars, and expert opinions. The content reflects an analysis of the CGST Act, CGST Rules, relevant notifications, and webinar excerpts addressing the implications of mandatory ISD.

II. Key Themes and Concepts:

Mandatory ISD Registration (Likely Effective April 1, 2025):

The Finance Act 2024 (and analysis anticipating implementation on April 1, 2025, reflected in several sources), significantly alters the landscape by making ISD registration compulsory. This contrasts with the previous regime where it was considered optional. MGDS & CO states: “However, w.e.f. 01/04/2025, GST law has been amended and ISD registration which was optional, has been made mandatory. Hence cross charge option not available (except self-generated services).”

This mandate applies to assessees with multiple GST registrations under the same PAN, whether in the same state or different states.

Finance act 2024 has made ISD compulsory. There is also section 24 of CGST act 2017 Which says

“SECTION 24. Compulsory registration in certain cases …

(viii) Input Service Distributor, whether or not separately registered under this Act”

Distinction between ISD and Cross Charge:

Cross charge applies to internal transactions between the HO and distinct persons, while ISD applies when the HO receives invoices for input services pertaining to multiple distinct persons from external vendors/ Third parties.

Cross Charge:

This is a popular terminology for charges done by the head office to the branch office and vice versa, is not explicitly defined in the GST law but is rooted in the concept of “distinct persons” under GST

Cross charge is a mechanism used for transactions between distinct persons within the same legal entity, such as a head office (HO) and its branch offices. These distinct entities have separate GST registrations

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The transactions between these distinct entities are considered a supply, even if made without direct payment. This is because the HO provides support services like accounting, IT, HR, and marketing to its branches.

Entry two of the schedule one read with Section 71 and Levy section 9 so the cross chart triggers because it is a presumed that there are certain internally generated services which is being used or the ho supports the various distinct entities“.

Cross charge is appropriate for internally generated services . HR ,admin support ,payroll processing ,salary of CEOs etc

Valuation of cross-charged services is based on the open market value. If that’s not available, a cost-plus 10% markup is used. However, if the recipient of the service is eligible for full Input Tax Credit (ITC), the value declared on the invoice by the HO can be considered the open market value.

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A significant issue was the inclusion of employee costs in the value of cross-charged services. However, a CBIC (Central Board of Indirect Taxes and Customs) circular clarified that including the salary of HO employees involved in providing services to branch offices is not mandatory, even if the branch doesn’t get full ITC

Input Service Distributor (ISD)

The ISD mechanism is designed to facilitate the transfer of ITC from the head office, which receives invoices, to the distinct entities that actually consume the services.

Without the ISD mechanism, the HO couldn’t claim ITC because the services aren’t exclusively for its own use, and the branches couldn’t claim ITC because the invoices aren’t in their names.

This is a mechanism for distributing input tax credit (ITC) on input services to distinct persons (branches/units) having the same PAN.

“It facilitates the transfer of the ITC from centralized office receiving the tax invoices for services to the offices consuming or to the distinct entities consuming Services”

ISD is applicable for external vendor-provided services consumed by multiple GST registrations, but the vendor invoices are received centrally . ISD comes into play when the HO raise the invoice for input Services pertaining to one or more distinct persons”

“Please note, as evident from the name itself, Input SERVICE distributor provisions are not applicable on goods/ Inputs/ Capital Goods.”

- Key features of the ISD mechanism:
  - It’s relevant for businesses with multiple locations and separate GST registrations.
  - It cannot be used to transfer credit to entities with different PAN numbers, such as subsidiaries or holding companies.
  - ISD applies only to input services, not to goods or capital goods.
  - The ISD acts as a facilitator, not a supplier or recipient of services.
  - A separate GST registration is required for ISD.
- Distribution of credit under ISD must follow specific rules:
  - It must be done through a prescribed document (ISD invoice).
  - The amount distributed cannot exceed the available credit.
  - ITC related to a specific recipient must be distributed only to that recipient.
  - The remaining credit is distributed based on the ratio of each unit’s turnover to the total turnover.
  - The turnover includes both taxable and exempt supplies, but excludes taxes and supplies under reverse charge.
  - The relevant period for calculating turnover is the preceding financial year. If a unit doesn’t have turnover for the entire year, the last quarter for which data is available is used.
  - ISD returns (GSTR-6) must be filed monthly.

Controversies and Clarifications Regarding ISD
- A major point of discussion has been whether using the ISD mechanism is mandatory for services used by distinct entities, or if cross-charge is sufficient.
- Arguments exist for both sides. Some claim ISD is mandatory based on legal interpretations and advance rulings. Others argue it’s optional, citing a CBIC FAQ and a GST Council clarification.
- The Finance Act 2024 seeks to make ISD mandatory by changing “may” to “shall” in Section 20, it is effective from 1stAapril 2025
- Another debated issue was whether an ISD could claim credit for taxes paid under the reverse charge mechanism (RCM). It may be paying RCM through normal registration and then transferring it to the ISD. The Finance Act 2024 intends to address this.

ISD Compliance and Procedures:

Registration: A separate GST registration as an ISD is mandatory (effective April 1, 2025) and distinct from the regular supplier registration .

“separate application is should done for ISD registration so this is some mandatory provision your one normal registration cannot act as ISD registration.Registration has to be separate. h ISD Needs to apply for registration using the GST portal’s new registration application, specifying that “Input Service Distributor only” should be selected under “Reason to obtain registration”

“The provisions are mandatory w.e.f. 01/04/2025. Hence, from the said date, assessees have to comply with the ISD provisions i.e. invoices have to be routed through ISD registration.

Invoicing: Vendors providing common services used by multiple distinct persons should raise invoices on the ISD registration number .When any service is consumed by more than one GST registration, the vendor (service provider) for the said service has to be informed by the Assessee (service recipient) to raise its invoice to ISD registration number only.

ISD must issue an ISD invoice (or credit note) to the recipients of credit, containing specific details as prescribed in Rule 54 of the CGST Rules (CGST Rules, 2017).

A registered person with the same PAN and State code as the ISD can issue an invoice/credit/debit note to transfer credit of common input services to the ISD (CGST Rule 39 & 54).

“the Input Service Distributor shall issue an Input Service Distributor invoice, as provided in sub-rule (1) of rule 54, clearly indicating in such invoice that it is issued only for distribution of input tax credit“.

Distribution of Credit: The credit must be distributed in the same month it is available . Thus whatever you receive, you must distribute.

Allocation is typically pro-rata based on turnover (CGST Act, 2017).

Credit attributable to a specific recipient should be distributed only to that recipient (CGST Act, 2017). ” The credit of tax paid on input services attributable to a recipient of credit shall be distributed only to that recipient” (CGST Act, 2017).

The “relevant period” for turnover calculation is either the preceding financial year, or if some recipients have no turnover in that year, the last quarter for which details are available (CGST Act, 2017).

ISD must separately distribute eligible and ineligible ITC, as well as ITC related to CGST, SGST/UTGST, and IGST (CGST Rule 39). The ISD has to bifurcate the credits.

Returns: ISD is required to file a monthly return in Form GSTR-6 by the 13th of the following month, even if there is no ITC to distribute.

GSTR-6 Late Fee Waiver: Notification No. 7/2018. Late fees apply for delayed filing.

The return should ideally be filed after vendor reports in their GSTR-1 .

GSTR-6 can only be filed after the 10th of the month, and before the 13th.

Amendments & Finance Bill 2025:

Clause 120 of the Finance Bill 2025 seeks to amend section 20 of the CGST Act so as to explicitly provide for distribution of input tax credit by the Input Service Distributor in respect of inter-state supplies, on which tax has to be paid on reverse charge basis (CGST Act 2017 Amendment by Finance Bill 2025).

“Input Service Distributor in respect of inter-state supplies, on which tax has to be paid on reverse charge basis, by inserting reference to sub-section (3) and sub-section (4) of section 5” (CGST Act 2017 Amendment by Finance Bill 2025)

Penalties and Consequences of Non-Compliance:

Distributing credit in contravention of Section 20 can lead to recovery of excess credit, along with interest .

Section 122 outlines penalties for various offenses, including taking or distributing ITC in contravention of Section 20 (CGST Act Section 122: Offences and Penalties). Penalties can be significant.

“he shall be liable to pay a penalty of ten thousand rupees or an amount equivalent to … input tax credit availed of or passed on or distributed irregularly, or the refund claimed fraudulently, whichever is higher.“

Reverse Charge Mechanism (RCM):

Rule 39(1A) of the CGST Rules allows a registered person with the same PAN and State code as the ISD to issue an invoice/credit/debit note to transfer the credit of common input services subject to reverse charge to the ISD (CGST Rule 39).

The Finance Bill 2025 seeks to explicitly allow ISD to distribute credit related to services subject to RCM.

III. Issues and Interpretations:

Optional vs. Mandatory ISD (Pre-Finance Act 2024): There were differing views before the Finance Act amendment 2024, with some arguing ISD was optional based on the word “may” in Section 20(2).

Treatment of Common Services: A key debate revolves around whether ISD is mandatory even for common services used by distinct entities, or if cross-charge can be used instead . “whether this is required to be rooted through ISD or it can be cross charged this is the very very highly debated question from the Inception from July 2017 till date”

The FAQ issued by CBIC for banking, insurance, and stockbroker services suggests an option to either cross-charge or raise ISD invoices.

“he has an option to either cross charge the services or to raise an I invoices.

Now with the Finance Act 2024 making ISD mandatory (effective April 1, 2025), such debates will likely be moot, and all external vendor invoices relating to services consumed by multiple GSTINs under the same PAN will need to go through the ISD mechanism, unless an alternate invoice to the end consumer GSTIN arrangement with the Vendor is established.

Impact on Vendors: The vendor (service provider) must be informed to raise invoices to the ISD registration number when any service is consumed by more than one GST registration under the same PAN . “The vendor (service provider) for the said service has to be informed by the Assessee (service recipient) to raise its invoice to ISD registration number only. In case it is not done, then department may disallow the entire credit, by stating the same as a non compliance of GST provisions.”

Services subject to RCM The Finance Bill 2025 will allow ISD to distribute credit related to services subject to RCM. This resolves previous ambiguities.

Actionable Insights and Recommendations:

Assess Applicability: Businesses with multiple GST registrations under the same PAN must immediately assess whether ISD provisions apply to them.

Obtain ISD Registration: If applicable, apply for ISD registration immediately to ensure compliance from April 1, 2025, onwards.

Inform Vendors: Communicate the ISD registration number to vendors providing common services used by multiple GST registrations.

Review Contracts/Purchase Orders: Amend existing contracts and purchase orders to reflect the ISD registration number.

Revisit ERP Systems: Modify ERP systems to accommodate ISD invoicing and credit distribution requirements “Erp systems perhaps needs to be revisited and the documents and you need to modify suitably.”

Understand Credit Distribution Rules: Thoroughly understand the rules for distributing ITC, including the pro-rata turnover-based allocation and the “relevant period” definition (CGST Act, 2017 & CGST Rule 39).

Ensure Timely Filing: Adhere to the monthly filing deadline for GSTR-6 to avoid late fees (TaxmannWebinar excerpt).

Monitor Legislative Changes: Stay updated on further clarifications or amendments to the GST law and rules related to ISD.

Conclusion:

The mandatory ISD registration (likely effective April 1, 2025) introduces significant changes to GST compliance for businesses with multiple GST registrations. Understanding the distinction between ISD and cross-charge, complying with the prescribed procedures, and staying informed about legislative updates are crucial for avoiding penalties and ensuring smooth ITC flow. The need to act now is emphasized in many of the documents, so businesses with multiple GST registrations should be taking steps immediately.

Refer Input Service Distributor in GST : Updated Study Material 2025