ITC Reversal Under Rule 42 and 43: Worked Examples for FY 2026-27
Rule 42 and 43 ITC reversal formulas explained with real worked numbers, not just theory. See exactly how the calculation runs.
Words by
Nimisha Chanda
Every finance team that files GSTR-3B can recite the Rule 42 formula. Far fewer can produce the actual working papers when a reversal number gets questioned in an audit, by a new CFO, or by the GST department during scrutiny. The formula is not the most difficult part but running it correctly on your own turnover and ITC figures, month after month, is. This piece works through both calculations end to end, with real figures at every step, so you have something to check your own numbers against.
What Rule 42 and Rule 43 Actually Cover
Rule 42 and Rule 43 of the CGST Rules, 2017 both restrict input tax credit (ITC) to the portion actually used for taxable business activity. They apply when a registered person cannot cleanly separate inputs, input services, or capital goods between taxable and exempt use, or between business and non-business use.
The line between them is straightforward, and it’s the single most-asked question on this topic:
Rule 42 governs inputs and input services, basically raw materials, components, and services like accounting, repairs, or logistics that get consumed within a tax period.
Rule 43 governs capital goods, be it machinery, plant, equipment, computers, and similar assets that get used over several years. Because capital goods deliver value over time rather than in the month of purchase, Rule 43 spreads the ITC over a deemed useful life of five years (60 months) rather than reversing it all at once.
Both rules apply only when the credit is common: used partly for taxable supplies (including zero-rated) and partly for exempt supplies, or partly for business and partly for non-business purposes. Credit that is exclusively one or the other never enters this calculation; it’s either fully claimed or fully blocked at the outset.
Rule 42 vs Rule 43 at a Glance
Rule 42 | Rule 43 | |
|---|---|---|
What it governs | Inputs and input services | Capital goods |
Timing | Reversed monthly as consumed | Spread over 60-month useful life |
Mechanism | Lump-sum reversal of the exempt portion | Fractional monthly reversal of amortised credit |
The Rule 42 Formula, Stated Precisely
Rule 42(1) breaks total ITC on inputs and input services (T) into five buckets, then reverses two of them. Here is every variable, in the order the rule computes them:
T - Total input tax credit on inputs and input services for the tax period.
T1 - Credit used or intended to be used exclusively for non-business purposes.
T2 - Credit used or intended to be used exclusively for exempt supplies.
T3 - Credit that is blocked outright under Section 17(5) (motor vehicles for non-permitted use, employee travel benefits, and similar categories).
T4 - Credit used or intended to be used exclusively for taxable supplies, including zero-rated supplies (exports and SEZ supplies).
C1 - Credit that actually reaches the electronic credit ledger: C1 = T minus (T1 + T2 + T3).
C2 - Common credit left after removing the credit already assigned exclusively to taxable use: C2 = C1 minus T4. This is the pool the reversal is actually computed on.
D1 - Reversal attributable to exempt supplies: D1 = (E divided by F) times C2, where E is the aggregate value of exempt supplies in the tax period and F is total turnover in the state for that period.
D2 - Reversal attributable to non-business use, applied when non-business use isn’t separately identified: D2 = 5% of C2, flat.
C3 - What’s left of the common credit after both reversals: C3 = C2 minus (D1 + D2). This is the eligible ITC that stays in your credit ledger.
The amount actually reversed each month is D1 + D2, reported in Table 4B of GSTR-3B.
Rule 42 Worked Example
Take a mid-market manufacturing company registered in Karnataka, making both taxable goods and a smaller line of exempt supplies, for a single tax period.
Turnover for the month:
Exempt supplies (E): ₹3,60,00,000
Total turnover in the state (F): ₹18,00,00,000
E divided by F = 0.20 (20%)
ITC for the month:
Out of the original ₹42,00,000 in ITC on inputs and input services, ₹5,60,000 (T1+T2+T3) never reaches the credit ledger at all, ₹19,40,000 (T4) is claimed in full because it’s exclusively taxable, and of the ₹17,00,000 in genuinely common credit, ₹4,25,000 gets reversed. Net ITC available for this bucket: ₹19,40,000 + ₹12,75,000 = ₹32,15,000.
Run this on your own numbers. Pull your actual T1 through T4 splits from your ITC register, your exempt and total turnover from your outward supply data for the period, and the same six-row table produces your own reversal figure. The structure doesn’t change; only the inputs do.
Rule 43 - Capital Goods ITC Reversal
Rule 43 uses a different mechanism because capital goods aren’t consumed in a single tax period. The rule assumes every capital good has a useful life of five years (60 months) from the date of invoice, and spreads the common credit evenly across that period rather than reversing it all in the month of purchase.
The variables, per Rule 43(1):
Tc - Common credit on a capital good: the ITC on a capital good used, or intended to be used, partly for taxable and partly for exempt supplies (or partly for business and non-business purposes). Capital goods used exclusively for exempt supplies or non-business purposes never enter the credit ledger at all; capital goods used exclusively for taxable supplies (including zero-rated) go in at full value.
Tm - Monthly common credit: Tm = Tc divided by 60. If more than one capital good is common in a given period, the Tm values are summed to arrive at Tr, the aggregate monthly common credit for that period.
Te - The amount actually added to output tax liability that month: Te = Tr times (E divided by F), using the same exempt-turnover-to-total-turnover ratio as Rule 42, for the same tax period.
Unlike Rule 42, Rule 43 doesn’t reverse a lump sum for the credit that’s ineligible. It reverses a fraction of the monthly-amortised credit, every month, for as long as the useful life runs - or until the capital good is disposed of, whichever comes first. After 60 months from the invoice date, no further reversal is required even if the asset is still in mixed use.
Rule 43 Worked Example
Continue with the same company. In the same tax period, it commissions a piece of manufacturing equipment used for both taxable and exempt output from day one.
Capital good details:
Equipment value: ₹2,00,00,000
GST paid at 18%: ₹36,00,000 (this is Tc, since the equipment is common-use from the start)
Useful life: 60 months from date of invoice
Turnover for the month (same as the Rule 42 example): E = ₹3,60,00,000, F = ₹18,00,00,000, E divided by F = 0.20
₹12,000 gets added to output tax liability for this one asset, this one month. The same ₹60,000 monthly base gets tested against that month’s exempt ratio every month for the next 60 months (or until disposal). If the exempt ratio shifts from 20% to 30% in a later month, the reversal for that month rises to ₹18,000, with no change to Tc or Tm. This is why a capital-goods register tracking purchase date, Tc, Tm, and months elapsed matters more than any single month’s calculation - the reversal obligation runs for five years.
The Annual Recalculation Most Teams Miss
Both rules require an annual recalculation.
Under Rule 42(2), the monthly D1 and D2 figures are provisional. At year-end, the same formula is recomputed using actual annual turnover figures instead of the monthly estimates used during the year. If the annual reversal required exceeds what was actually reversed month by month, the shortfall must be added to output tax liability, with interest under Section 50 from 1 April of the following financial year. If the annual figure comes in lower than what was already reversed, the excess can be reclaimed as additional ITC. This true-up is due in the GSTR-3B for September following the financial year end, or the date of filing the annual return (GSTR-9), whichever is earlier.
Under Rule 43(2), the same principle applies across the useful life of the capital good, not just one financial year - the annual figure is compared against the sum of monthly Te reversals made during the year.
The teams that get caught out are usually the ones whose exempt-turnover ratio moves meaningfully during the year: a new exempt product line launched in Q3, a large one-off exempt transaction, a client mix shift. A flat 20% assumption held all year, then trued up in March against an actual ratio that moved to 26% for six months, produces a real interest bill. Interest under Section 50(1) currently runs at 18% per annum on the shortfall, calculated from the due date of the September GSTR-3B to the date of actual payment.
Building This Into Your Monthly Close
The manual version of this calculation works fine for one product line and one exempt supply category. But it breaks down fast once a company runs multiple GST registrations, a capital goods register with assets at different points in their 60-month cycle, and an exempt-turnover mix that shifts quarter to quarter.
The failure isn’t usually the formula. It’s the tracking underneath it: which invoices sit in T1 versus T2 versus T3, which capital goods are still inside their useful life window and which have crossed 60 months, and whether last month’s E/F ratio is still the right one to use or whether this month’s actual turnover has moved enough to matter before the annual true-up forces the issue.
Reconciling GST data automatically, rather than rebuilding the T1 through T4 split by hand every month across every registration, is what turns it into something that’s already correct going into the annual return.
Get your Rule 42 and Rule 43 numbers reconciled correctly, every month, without rebuilding the working papers by hand, with Nova.
