ITC on free replacement warranty goods: Circular 195 explained

Tax authorities routinely questioned businesses that issued free replacement components to retail buyers. Audit officers issued show cause notices demanding credit reversals under Section 17(5)(h) of the CGST Act, arguing that free spare parts represent goods disposed of by way of gift or free samples. For manufacturers of industrial equipment, consumer electronics, and automobiles, these notices threatened lakhs of rupees in legitimate tax deductions. In practice, a common mistake during department audits is conceding that warranty replacements lack consideration. To understand broader restrictions on inward credits, refer to our analysis of blocked credit under GST Section 17(5) and how commercial promotions compare with ITC on promotional items and buy-one-get-one offers.

The statutory framework and Circular 195 clarifications

Section 17(5)(h) restricts input tax credit on goods lost, stolen, destroyed, written off, or disposed of by way of gift or free samples. A warranty replacement differs fundamentally from a voluntary gift or promotional handout. When a customer purchases a product accompanied by an express warranty, the obligation to repair or replace defective components forms an integral part of the initial contract of sale.

In response to widespread litigation across field formations, the CBIC issued Circular No. 195/07/2023-GST on 17 July 2023 under Section 168(1) of the CGST Act. The Board established three core principles governing original equipment manufacturers:

• Price absorption: The value of the original supply of goods includes the likely cost of replacement parts and repair services to be incurred during the warranty period. Tax was already assessed and paid on this composite value at the time of the original sale.
• No additional GST on free replacement: Because consideration was received upfront in the purchase price, no separate GST is payable on parts or repair services provided free of charge during the warranty period. If the manufacturer charges any extra consideration for upgrades or handling, GST applies solely to that additional amount.
• No input tax credit reversal: Supplies provided under warranty cannot be classified as exempt supplies or gifts. The manufacturer is not required to reverse input tax credit availed on raw materials, components, or repair services used to fulfill the warranty.

Distributor replacement models and credit treatment

In modern distribution networks, customers take defective products to authorized local dealers or service centers rather than shipping them back to the factory. Circular 195 outlines four distinct operating workflows between the original equipment manufacturer and the distributor:

1. Tax invoice from distributor to manufacturer: The distributor replaces the part from existing stock or purchases it from an external vendor. The distributor then issues a regular tax invoice to the OEM charging GST. The distributor does not reverse input tax credit, and the OEM claims the tax charged as valid input credit.
2. Advance requisition and replenishment: The distributor files a warranty requisition with the OEM. The manufacturer dispatches replacement components under a delivery challan without charging consideration. No GST is payable on this movement, and the OEM does not reverse input tax credit.
3. Credit note under Section 34: The distributor replaces components out of stock previously purchased from the OEM. The manufacturer issues a GST credit note under Section 34(2) of the CGST Act to reduce the distributor liability. Here, the OEM can reduce outward tax liability only if the distributor reverses the input tax credit originally availed on those parts.
4. Replenishment via delivery challan after replacement: The distributor replaces the component immediately from stock to avoid customer delays, then requisitions a replacement. The manufacturer replenishes the identical component through a delivery challan without invoice or consideration. No GST is chargeable, and neither party reverses input tax credit.

Extended warranty: composite supply versus separate service

Many retailers offer extended warranty protection beyond the standard manufacturer warranty. The GST classification depends entirely on when the contract is executed and who acts as the promisor under Section 8 of the CGST Act:

• Purchased at the time of original supply: When a buyer purchases an extended warranty from the product seller at the point of sale, the transaction qualifies as a naturally bundled composite supply. The principal supply remains the physical goods. GST applies to the combined value at the product rate, even if the base product attracts 12% or 28%.
• Purchased after the original supply: If a customer purchases an extended warranty months later, the warranty constitutes a distinct agreement. The transaction is classified as a standalone supply of repair and maintenance services, taxable at 18% under SAC 9987.
• Third party warranty contracts: If the warranty agreement is underwritten by an independent insurance company or third party administrator rather than the equipment supplier, it represents an independent service contract taxable at 18%, regardless of whether it is purchased alongside the goods.

Worked scenario: machinery manufacturer and authorized dealer

For example, consider Alpha Machinery Limited, a Pune manufacturer of CNC industrial equipment, and its authorized dealer Delta Tools in Ahmedabad. Alpha sells a CNC unit to an engineering enterprise for ₹12,00,000 plus 18% GST (₹2,16,000). The machine includes an 18 month comprehensive warranty. Alpha cost accountants project ₹60,000 in warranty maintenance costs per unit, which was factored into the ₹12,00,000 base price.

Nine months after installation, a specialized spindle assembly fails. Delta Tools replaces the assembly for the customer free of charge under warranty. The spare part has an inventory cost of ₹45,000 and carries input tax credit of ₹8,100 (18% GST). Let us examine the three possible settlement routes between Alpha and Delta Tools:

In Option A, Delta Tools charges Alpha ₹45,000 plus ₹8,100 GST. Delta reports this supply in Table 3.1(a) of Form GSTR-1, discharges the liability in Form GSTR-3B, and keeps its original inward input credit. Alpha receives the invoice in Form GSTR-2B and claims ₹8,100 in Table 4(A)(5) without reversal.

Reporting warranty credits in Form GSTR-3B

To avoid scrutiny notices under Rule 88D or Form DRC-01C, accounting teams must follow consistent reporting entries in Form GSTR-3B as outlined in the GSTN GSTR-3B user manual:

• Direct manufacturer repairs: Inward purchases of warranty spare parts appear in Table 4(A)(5) as eligible input credit. Because Circular 195 establishes that warranty fulfillment is not an exempt supply or gift, the manufacturer enters ₹0 under Table 4(B)(1) and Table 4(B)(2).
• Dealer credit note adjustments: When the manufacturer issues a credit note with tax adjustment under Section 34(2), the dealer records the reduction in Table 4(B)(2) under Reversals - Others. The dealer must not reduce gross purchases in Table 4(A)(5) directly, as that triggers discrepancy warnings during audit reconciliations.
• Service charges billed to OEM: When an authorized workshop provides warranty labour on behalf of the manufacturer and bills a servicing fee, the workshop reports outward taxable turnover in Table 3.1(a). The manufacturer treats this as an input service and claims the full credit in Table 4(A)(5).

Audit checklist for warranty management

1. Contract terms: Ensure standard sales invoices and product manuals explicitly specify the warranty duration and covered components.
2. Work orders: Maintain verified job cards showing customer complaints, serial numbers, and replaced component serials to establish authentic warranty claims.
3. Delivery challans: When moving parts to service centers without consideration, issue serially numbered delivery challans referencing Rule 55 with the notation "Replacement under warranty, not for sale".
4. Credit note tracking: When settling dealer accounts with Section 34 tax credit notes, obtain written confirmation that the dealer reversed input tax credit before adjusting outward tax liabilities.

Related guides

• ITC reversal on goods sent for exhibition abroad not sold: GST rules and Circular 108
• Pharma expired medicine ITC reversal: circular rules and procedure
• ITC on free goods and samples under GST: Section 17(5)(h)
• ITC on demolition and reconstruction of building: plant vs civil structure rules

Frequently asked questions

Last checked: 18 October 2026. Sources: CBIC Circular No. 195/07/2023-GST, Section 17(5)(h), CGST Act, Section 8, CGST Act, GSTN GSTR-3B user manual.