GST Rule Change from April 1, 2025: ISD Mandatory for Claiming Input Tax Credit

The Central Board of Indirect Taxes and Customs (CBIC) has introduced a significant amendment under the Finance Act, 2024, making the Input Service Distributor (ISD) mechanism mandatory for businesses availing Input Tax Credit (ITC) on common input services. This rule effective from April 1, 2025, will eliminate the use of cross-charge mechanisms for ITC distribution and require businesses to register under ISD for proper ITC allocation.

Notification No. 16/2024–Central Tax, issued on August 6, 2024, formally enforces these provisions, ensuring better compliance, reduced ITC fraud, and uniform credit distribution across multiple locations. Businesses that fail to comply with the ISD requirement will face denial of ITC and a minimum penalty of Rs. 10,000.

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This change is expected to impact companies with multiple GST registrations and those procuring input services centrally but utilizing them across various locations. The transition to an ISD-based system will require significant adjustments in GST registrations, invoicing, and accounting practices for businesses.

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Understanding the ISD Mechanism Under the GST

The Input Service Distributor (ISD) mechanism is a formal GST process where one entity (such as a corporate office) receives input service invoices and distributes ITC to other branches through ISD invoices. ISD was underutilized by businesses because they preferred cross-charging, which was easier to execute and did not require additional compliance. However, with the April 1, 2025 amendment, businesses must now use ISD for ITC distribution instead of cross-charges.

Current Practices and the Need for ISD

Cross-Charge Mechanism (Existing Practice)

Until now, most businesses were not using the ISD mechanism and instead distributed ITC through cross-charges. Cross-charging refers to one branch billing another branch for shared services under GST. It has been widely used by service-based companies, corporate offices, and multi-location businesses to distribute ITC for expenses like HR, IT support, accounting, and management services.

Why the Change?

The government has observed that businesses were avoiding ISD registration and instead using cross-charge mechanisms to distribute ITC. This led to tax leakages, errors in ITC allocation, and difficulties in audits. By mandating ISD, the government ensures uniformity, better compliance, and a structured ITC distribution process.

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How ISD Works Under the New Rule?

Businesses must register their corporate or head office as an ISD under GST. The ITC on shared input services must be distributed via ISD invoices to different GST-registered locations. ITC claimed through cross-charges will no longer be permitted

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Key Highlights of the GST Rule Change

1. Effective Date: The mandatory ISD rule will come into force from April 1, 2025.

2. Applicability: All businesses with multiple GST registrations across different states. Companies procuring input services centrally but utilizing them across branches. Service-based organizations, including IT firms, consulting businesses, and companies with centralized expenses.

3. Mandatory ISD Registration & ITC Distribution: Businesses must register their head office or central entity as an ISD. ITC on input services must be distributed only through ISD invoices. Cross-charging for ITC distribution will no longer be allowed.

4. Consequences of Non-Compliance: Businesses failing to register as ISD will face ITC denial for their branches. A minimum penalty of Rs. 10,000 will be imposed, which may increase based on the quantum of non-compliance.

Practical Example: How the ISD Mechanism Works

Consider a retail company operating in five states with a head office in Delhi.

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Old System (Before April 1, 2025 - Cross-Charge)

• The company purchases POS machines from a third-party vendor.
• The invoice is issued to the Delhi head office.
• The head office cross-charges the expenses to branches in Mumbai, Chennai, Kolkata, and Gujarat.
• ITC is claimed at each branch based on cross-charges.

New System (From April 1, 2025 - ISD)

• The Delhi head office must register as an ISD.
• The vendor issues an invoice to the Delhi head office.
• The ITC must be distributed through ISD invoices, not cross-charges.
• The ISD returns (GSTR-6) must be filed monthly.

Example of how Input Tax Credit (ITC) will be distributed through the Input Service Distributor (ISD):

Type of Services	ISD Location & Services Consumption Location	Nature of ITC in the Hands of ISD	Distribution of ITC by ISD
Services attracting GST under forward charge	Same State	CGST and SGST	CGST and SGST
	Different State	CGST and SGST	IGST
	Different State	IGST	IGST
Services attracting GST under reverse charge	Same State	CGST and SGST	CGST and SGST
	Different State	CGST and SGST (always)	IGST

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Conditions for Distributing ITC by the ISD

• Timely Distribution: The Input Tax Credit (ITC), whether eligible or ineligible, accumulated in a given month must be distributed within the same month.
• Distribution to All Consuming Offices: ITC must be allocated even to unregistered offices or branches engaged in exempt supplies, provided that these offices have consumed common input services.
• Location-Based Allocation: If input services are utilized at a single location, the entire ITC must be allocated to that specific location. If input services are used across multiple locations, the ITC shall be distributed proportionally based on the turnover ratio of each location.

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How Businesses Should Prepare for the Transition

• Register as an ISD Before April 1, 2025
• Upgrade Accounting & ERP Systems
• Train Finance & Compliance Teams
• Review & Modify ITC Allocation Strategies
• Monitor GST Updates & Compliance Regulations

Conclusion

The April 1, 2025, GST amendment making ISD mandatory for ITC distribution is a game-changing reform that removes the ambiguity around cross-charging and ensures fair tax credit allocation. Businesses must immediately start their transition to ISD compliance by registering as ISD, updating accounting systems, and preparing for the new GST requirements.

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