This page is for accountants whose client sells both taxable and exempt goods or services. If every supply is taxable, none of this applies. The general eligibility tests are in the input tax credit guide.
Why credit has to be split
Section 17(1) restricts credit to the input tax attributable to business purposes. Section 17(2) says that where goods or services are used partly for taxable supplies, including zero-rated supplies, and partly for exempt supplies, credit is restricted to the input tax attributable to the taxable and zero-rated supplies. Section 17(3) says the value of exempt supply is as prescribed and includes supplies on which the recipient pays tax on reverse charge, transactions in securities, sale of land and, subject to Schedule II paragraph 5(b), sale of building. That is why a company that only trades in shares or sells a plot of land can still have an exempt-supply ratio. The Act leaves the method to Rules 42 and 43.
The Rule 42 symbols, in plain words
Rule 42(1) works month by month, for inputs and input services (capital goods are in Rule 43).
| Symbol | What it is |
|---|---|
| T | Total input tax on inputs and input services in the tax period |
| T1 | Out of T, tax on items used exclusively for non-business purposes |
| T2 | Out of T, tax on items used exclusively for exempt supplies |
| T3 | Out of T, tax on items where credit is blocked under Section 17(5) |
| C1 | T − (T1 + T2 + T3): the credit credited to the electronic credit ledger |
| T4 | Credit used exclusively for supplies other than exempt, including zero-rated |
| C2 | C1 − T4: the common credit |
| E, F | E is the aggregate value of exempt supplies and F the total turnover in the State of the registered person, both during the tax period |
| D1 | Credit attributable to exempt supplies: (E / F) × C2 |
| D2 | Credit attributable to non-business use of common inputs: 5% of C2 |
| C3 | C2 − (D1 + D2): the common credit you keep |
Three details from the rule text. T1 to T4 are determined and declared at summary level in GSTR-3B. C3, D1 and D2 are computed separately for central tax, State or Union territory tax and integrated tax. D1 plus D2 is reversed in GSTR-3B or through Form GST DRC-03. Also, if you have segregated credit at invoice level, the non-business part goes into T1, the exempt part into T2, and the remaining credit on those items into T4. If there is no turnover in the period or the information is not available, E and F of the last period with turnover details are used.
D2 applies only where common inputs are used partly for business and partly for non-business purposes. In the example below none are, so D2 is nil.
Worked example: an Indore wholesaler, October 2026
The firm sells taxable goods and also has an exempt line. In October it had ₹6,00,000 of exempt supplies and a total turnover in Madhya Pradesh of ₹30,00,000, so E/F = 6,00,000 ÷ 30,00,000 = 20%. All figures are GST by tax head.
| Step | CGST | SGST | IGST | Total |
|---|---|---|---|---|
| T: input tax in the month | ₹1,20,000 | ₹1,20,000 | ₹80,000 | ₹3,20,000 |
| T1: exclusively non-business | ₹4,000 | ₹4,000 | : | ₹8,000 |
| T2: exclusively exempt supplies | ₹10,000 | ₹10,000 | ₹6,000 | ₹26,000 |
| T3: blocked under Section 17(5) | ₹3,000 | ₹3,000 | ₹2,000 | ₹8,000 |
| C1 = T − (T1 + T2 + T3) | ₹1,03,000 | ₹1,03,000 | ₹72,000 | ₹2,78,000 |
| T4: exclusively taxable | ₹53,000 | ₹53,000 | ₹32,000 | ₹1,38,000 |
| C2 = C1 − T4: common credit | ₹50,000 | ₹50,000 | ₹40,000 | ₹1,40,000 |
| D1 = 20% of C2: reverse | ₹10,000 | ₹10,000 | ₹8,000 | ₹28,000 |
| C3 = C2 − D1: common credit kept | ₹40,000 | ₹40,000 | ₹32,000 | ₹1,12,000 |
| Credit the month can use (T4 + C3) | ₹93,000 | ₹93,000 | ₹64,000 | ₹2,50,000 |
The arithmetic: T1 + T2 + T3 = ₹8,000 + ₹26,000 + ₹8,000 = ₹42,000, so C1 = ₹3,20,000 − ₹42,000 = ₹2,78,000. C2 = ₹2,78,000 − ₹1,38,000 = ₹1,40,000. D1 = 20% × ₹1,40,000 = ₹28,000. Final usable credit is ₹2,78,000 − ₹28,000 = ₹2,50,000, which equals T4 plus C3 (₹1,38,000 + ₹1,12,000). If D2 applied, it would be 5% of C2: ₹2,500 each on CGST and SGST and ₹2,000 on IGST, reversed with D1. Section 17(5) credit is taken out in T3 before C2, and the blocked credit guide lists those items.
Where it shows in GSTR-3B
GSTN’s manual says reversals that are absolute and not reclaimable, including those under rules 42 and 43 and Section 17(5), go in Table 4(B)(1), and reclaimable ones such as the Rule 37 180-day reversal go in 4(B)(2). The 4(B)(1) line is not in GSTN’s list of lines auto-drafted from GSTR-2B, so the rule 42 figure is yours to compute and enter. The GSTR-3B format guide maps the tables.
The annual adjustment
Rule 42(2) says the credit is calculated finally for the financial year before the due date of the return for the month of September following the end of that year. Compare the final D1 + D2 with what you reversed month by month:
| Case (FY 2026-27, illustrative) | D1 + D2 reversed in the year | D1 + D2 calculated finally | What the rule requires |
|---|---|---|---|
| Reversed too little | ₹3,00,000 | ₹3,40,000 | Reverse ₹40,000 in a month not later than September 2027, with interest from 1 April 2027 till payment |
| Reversed too much | ₹3,00,000 | ₹2,70,000 | Claim back ₹30,000 in a return not later than September 2027 |
The interest is at the rate in Section 50(1), which allows up to 18% a year; the exact notified rate is not quoted here. The excess is reversed in GSTR-3B or through DRC-03. The final calculation uses the same formula on the year’s figures. Rule 42(2) opens with an exception for certain real estate services, which this page does not cover.
Rule 43: common credit on capital goods
Rule 43 sorts capital goods three ways. Credit on goods used exclusively for non-business purposes or exclusively for exempt supplies is indicated in GSTR-3B and not credited to the ledger. Credit on goods used exclusively for supplies other than exempt supplies, including zero-rated, is credited. For the rest, the common-use goods, the tax on the invoice is credited directly and the useful life is five years from the invoice date. The common credit for each tax period is Tm = Tc ÷ 60, where Tc is the aggregate credit on common capital goods whose useful life remains. A machine with ₹1,20,000 of credit therefore carries ₹1,20,000 ÷ 60 = ₹2,000 of common credit per tax period. The part attributable to exempt supplies, Te, is worked from the E/F ratio, and Te with interest is added to the output tax liability in every tax period of the useful life. Te is declared separately by tax head in GSTR-3B. We do not show a worked Te because the rule text we checked defines one of its inputs in a clause that is omitted; take it from your CA. ITC on capital goods covers the rest, including Section 18(6) when you sell the asset.
Common credit is not ISD credit. An Input Service Distributor shares input service credit across distinct persons, and an office receiving input service invoices on behalf of distinct persons has to register as an ISD from 1 April 2025 (Section 20). Rule 42 apportions credit within one registration between taxable, exempt and non-business use.
Common mistakes
- Leaving blocked credit inside C2. Section 17(5) credit is T3 and comes out before the common credit is computed.
- Using all-India turnover for F. The rule says total turnover in the State.
- Leaving out reverse-charge supplies from E. Section 17(3) counts them as exempt supplies for this purpose.
- Reversing the whole of T2. T2 never enters the ledger in the first place; only D1 and D2 are reversed.
- Skipping the annual true-up. An under-reversal carries interest from 1 April.
Related guides
- How to calculate input tax credit and the order in which it is set off
- ITC kya hai? Input tax credit ka matlab, shartein aur GSTR-2B se rishta
- Financial credit note vs GST credit note Section 34
- IMS pending invoices: supplier credit rating and GST impact
Frequently asked questions
What is common credit under GST?
Under Rule 42 it is the input tax credit left after removing credit used exclusively for non-business purposes, exclusively for exempt supplies, blocked under Section 17(5), and credit used exclusively for taxable and zero-rated supplies. It is denoted C2 and is the credit used for more than one purpose, so part of it is reversed.
What is the formula for the exempt-supply share under Rule 42?
D1 = (E / F) x C2, where E is the aggregate value of exempt supplies during the tax period, F is the registered person's total turnover in the State during the tax period, and C2 is the common credit. D1 is reversed in GSTR-3B or through DRC-03.
What is the 5 per cent in Rule 42?
D2 is the credit attributable to non-business purposes where common inputs and input services are used partly for business and partly for non-business purposes. The rule fixes it at five per cent of C2. It is reversed together with D1.
When is the annual adjustment under Rule 42 made?
The credit is calculated finally for the financial year before the due date of the return for the month of September following the year end. Excess reversal is made in a month not later than September with interest at the Section 50(1) rate from 1 April of the next year. A shortfall in reversal can be claimed back in a return not later than September.
How is common credit on capital goods handled?
Rule 43 treats the useful life of capital goods as five years from the invoice date. Common credit attributable to each tax period is Tm = Tc / 60, and the part attributable to exempt supplies is added, with interest, to the output tax liability in every tax period of the useful life.
Start from a 2B-backed credit figure
Rule 42 starts with T, the total input tax in the month, so it only works if that figure is right. Drop the month’s GSTR-2B (Excel or JSON) and your purchase register into gstr2bmatch.in. The report puts each invoice in a bucket: matched, value mismatch, in books but missing from 2B, in 2B but not in books, with likely IMS Pending invoices flagged separately, and totals the ITC at risk in rupees. It does not compute Rule 42 or Rule 43. Your GSTR-2B and purchase register files are read in your browser and never uploaded to any server.
Related: eligible vs ineligible ITC, GST reconciliation for manufacturing companies, ITC claim rules.
Last checked: 1 Oct 2026. Sources: CGST Rules, Rule 42, Rule 43, CGST Act, Section 17, Section 20, Section 50, GSTN manual: creation, saving, payment and filing of GSTR-3B.