Input Service Distributor (ISD) Under GST: A Comprehensive Overview

In today’s business landscape, many companies operate through a centralized head office while maintaining several registered branches across various locations. The head office often procures services essential for all units, leading to expenses that multiple branches may utilize collectively. Traditional billing practices mean that invoices for these services are typically directed to the head office. However, if the head office does not engage in providing output supplies, it may find itself accumulating input tax credits (ITC) that cannot be utilized effectively.

To address this challenge, the Input Service Distributor (ISD) mechanism was introduced under the Goods and Services Tax (GST) regime, allowing for the equitable distribution of ITC related to common input services across various registered units. This approach ensures that the credits from these common procurements are fairly apportioned among the consuming branches, facilitating a more organized and efficient tax credit utilization process.

The ISD concept under GST is a continuation of the legacy provisions from the Service Tax regime. The updated definition of ISD, as per section2 (65) reads as under:

“An 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, and liable to distribute the input tax credit in respect of such invoices in the manner provided in section 20.”

With this framework in place, let’s delve deeper into the significant aspects of the ISD mechanism, including recent changes, operational requirements, and implications for businesses.

ISD Mechanism: Key Features and Changes

ISD mechanism is meant only for distributing the credit on common invoices pertaining to input services only and not goods (inputs or capital goods). 

The ISD itself cannot discharge any tax liability and remit tax to government account.

ISD Optional Until March 31, 2025

According to Circular No. 199/11/2023-GST, issued on July 17, 2023, head offices have the flexibility to choose how they distribute ITC for common input services until March 31, 2025. They can:

• Distribute ITC via the ISD mechanism, as outlined in Section 20 of the CGST Act and Rule 39 of the CGST Rules.
• Issue tax invoices under Section 31 of the CGST Act to the respective branch offices (BOs) for the services utilized by them, thereby allowing BOs to claim ITC subject to the prevailing provisions of Sections 16 and 17 of the CGST Act.

This option provides head offices with the ability to determine the most efficient method of credit distribution.

Major Changes Effective April 1, 2025

Starting April 1, 2025, businesses will be mandated to register as an ISD, as required by the amended Section 20(1) of the CGST Act. The key aspects include:

• Every head office must be registered as an ISD if it receives invoices for input services on behalf of distinct units.
• The ISD will be responsible for the distribution of ITC from services liable to reverse charge under Section 9(3) and Section 9(4) of the CGST Act.
• The definition of ISD now explicitly allows for the distribution of tax credits for interstate transactions where the tax is paid under reverse charge (RCM).

Registration and Compliance Requirements

To operate as an ISD, entities must adhere to the following:

• Separate Registration: An ISD must acquire its registration by submitting Form GST REG-1.
• No Threshold Limit: ISDs are not subject to any minimum turnover threshold for registration.
• Multiple Registrations: Businesses can obtain multiple ISD registrations in multiple states if warranted by their operational structure.

Returns and Credit Distribution Mechanism

ISDs are required to file monthly returns (GSTR-6) for all ISD invoices issued by13th of next month. Here’s how the credit distribution process works:

• The ISD must issue a specific ISD invoice, as per Rule 54(1) of the CGST Rules, indicating that it is exclusively for the purpose of credit distribution.
• Credit should be distributed in the same month it is available and reflected in the ISD’s returns.
• Separate distribution of eligible and ineligible ITC is essential.

Credit Distribution Breakdown

The approach to distributing ITC will differ based on the location of units:

Ratio of Distribution

The fundamental principle for credit distribution states that it should only be allocated to the specific unit to which the inputs relate. If the input service has implications for multiple branches, the distribution will occur based on the pro-rata turnover of each unit, fostering fairness in credit utilization.

Illustrative Example

To understand the mechanics of ISD, let’s consider a case study:

Company: Webtel Ltd.
Head Office Location: Delhi
Branch (turnover) : Delhi(2 cr), Mumbai (2 cr), Kolkata(1 cr), Chennai (Nil)
Common Service: Audit services (billed to the Corporate Office)

Corporate Office at Delhi receives an invoice from Auditor of Rs. 10 lacs and a CGST & SGST of Rs. 90,000 each, total GST of Rs. 1, 80,000. It must act distribute it to branches. The distribution will be guided by the turnover ratio of each unit, ensuring an equitable and justified allocation of ITC.

Technology to play Key Role

Handling ISD manually is cumbersome and prone to human errors. Webtel has solutions for SAP and other ERPS whereby ISD mechanism is handled seamlessly. Following are a few benefits:

• In-built ISD compliances.
• Built in checks to correct clerical errors/mistakes.
• Auto check to ensure that ITC distributed is not more than available.
• Option to flag common expenses.
• Option to flag eligible & ineligible ITC.
• Automated bifurcation of ITC as per last year/quarter turnover.
• Automatic transfer of GST as per State of unit of distribution.
• Automated Accounting entries.

Conclusion

The ISD mechanism is designed to streamline the credit allocation process for businesses dealing with common expenditures, particularly those invoiced to a central location. By facilitating appropriate distribution of ITC, ISD strengthens the overall efficiency of the GST framework and enhances the seamless flow of credit to the numerous branches within a business. As compliance and registration requirements evolve, particularly with the mandatory provisions, businesses should remain proactive in understanding and implementing ISD requirements to optimize their tax positions effectively.